How to pick a Stock for Investment

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Picking stock for investment is not a difficult task, people tend to get confused while picking up the stocks and somehow lose their money by investing in not so good quality of stocks, from this, we clearly understand that picking up stocks for investment is merely an art and not a science. There is no "foolproof" system, but we do have some unique techniques based upon which one can easily pick up the stocks with a higher rate of returns as compared to the market average. Here we will be mainly discussing about the quantitative aspects of the company.

Analysing the company's fundamentals are considered as a milestone of investing. One can be a fundamental analyst as well but for that, some basic skills to understand the financial impact of the company according to the industry is required along with some basic mathematics. As an investor one should be able to notice the financial power and health of a company with the help of financial statements of the company.It includes the company's profit and loss statement, balance sheet, income statement, and cash flow statement. Investments based upon the fundamental analysis of the company requires the investors to stay committed with it for a long period of time.

How to check the financials of a company?

Here is the easy to understand checklist of the financial performance of the company:

Revenue Growth: First thing that a person should check in the revenue of the company is the profit and loss statement. If the profit margin of the company is growing in every quarter or it is growing annually, then it can be classified as a good stock. The rate of revenue growth should also be intact and in line with profit growth. "Compounded annual growth rate" (CAGR) gives one a sense about the functioning of the company i.e "how the company works" and how is it evolving and growing across the business cycle. Companies that are growing over 15% of CAGR basis are good companies to invest in.

Profit: The profit of a company is calculated before and after giving tax. Profit that is generated by the company before giving the tax "PBT" refers to the net operating income after deducting operating expenses. On the other hand the profit that is generated after giving the tax "PAT" is the company's profit after deducting its tax liabilities. If the profit of the company grows every quarter as well as annually then it's a good stock to invest your money. Before investing in a company's stock do check its "Gross Profit Margins" evolved over the years. Investing in a company with a GPM of 20% or above can be profitable.

Earnings Per Share (EPS): EPS is the amount of profit that the company is making on a per share basis. People tend to invest upon the stocks that have growth in terms of EPS while they react negatively for the stocks with reduction of EPS.

Debt Level and Reserve Capital : We now look through the Balance Sheet items. Look into the company's "Debt level and Reserve Capital". High debt means the company is operating on high leverage. Plus the finance cost eats away the earnings. The company should not be highly leveraged. Suppose the Debt of a company was 100 crores in 2014, 90 crores in 2015, 70 crores in 2016, 50 crores in 2017 and its Reserve Capital in 2013 was 210 crores in 2014, 218 crores in 2015, 226 crores in 2016, 240 crores in 2017, here you are seeing the Debts of this company is decreasing every financial year and the Reserve Capital is increasing every financial year. So, it's a safe company to invest in. If a Company has zero debt but has good Reserve capital then it's a Golden stock to invest. Suppose, the company had huge debts but every quarter it's decreasing its debt, then it can be a turnaround stock to buy.

Return on Equity (ROE): It is a measure of financial calculated by dividing net income by shareholder's equity.ROE is considered a measure of how effectively management is using a company's asset to create profits. ROE is expressed as a percentage and can be calculated for any company if net income and equity are both positive numbers. Sustainable growth rates and dividend growth rates can be estimated using ROE assuming that the ratio is roughly in line or just above its peer group average. Although there may be some challenges, ROE can be a good starting place for developing future estimates of a stock's growth rate and the growth rate of its dividends.
Shareholding Pattern:
Now let's see the Shareholding Pattern of that stock. The percentage of the stock promoter's holdings and public. Suppose in 2014 Promoter Holding was 66% and Public or Institutions holding were 34%, in 2015 Promoter Holding were 70% and Public and institution were 30%. In 2016, Promoters holding were 72% and public and institutions were 28% and in 2017 the Promoters holdings are 75% and public and institutions are 25%. So it is a very less risky stock because promoters holding has increased every year so they have faith in their company and If FIIs holding also increases every quarter or annually then it is an additionally good point for the stock.

P/E Ratio: The P/E ratio measures a company's current share price relative to its per-share earnings. It's calculated by dividing the market value per share by earnings per share. A good rule of thumb for value investors is to look for stocks with a P/E less than 40% of the stock's highest P/E over the previous five years. Now see the company's P/E ratio and also check its Industry P/E ratio. Suppose there is a Pharma stock trading at 200 rupees and its P/E ratio is 9 and Its Industry P/E ratio is 27. It means that the stock has the potential to triple from here because its Industry P/E ratio is thrice its own P/E ratio.

Pledging of Shares by Promoters: Simply put, it is taking a loan against the shares one holds. It can be done by both investors and promoters. Pledging of shares is common in companies where promoter holding is high. While pledging shares, ownership is retained by promoters. In a rising interest rate scenario, promoters often use shares owned by them as collateral for loans. If the majority owner in your company has pledged a sizeable chunk of his or her equity, it could trigger a volatile price movement in a falling market.

Book Value: Book Value is the Total Assets of a company is Divided by the total no of shares. Suppose its Book value is 85 and the share is already trading at 450. For me, it is already an overvalued stock because it is trading way above its book value. Even though it is a good company, the risk element is high for investment. Now, Suppose the Book value of a stock is 300 and it's currently trading at 75. It is a good pick for investment because its Book value is still 4 times its current price. But you have to check other above-mentioned factors also to invest. if it's Book value is higher than its current price that doesn't mean the stock is good.

Conclusion

It is to conclude here that to pick a stock that helps you gain profit in the stock market, the above mentioned points should always be considered. If you are able to develop a comfortable opinion based on facts, then the business surely appears to have investable grade attributes and therefore worth investing in. However, before you go out and buy the stock, you should also ensure the price is right. Not just these there are many other factors to take care about but these points play a key role to help you gain profit while investing.

Last updated on 11th Jun 2019

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User Comments

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1. Priyanka Desai  Oct 11, 2019 11:53:06 AM IST Reply
A very informative post to come with. For investing in stocks I would prefer Motilal Oswal .It gives you latest updates related to stock market.






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