Stock Market investments are risk prone. There is no sure shot formula to
succeed in the stock market. Hence, investors at times
invest in the market based on broker recommendations, research report, tips
from friends or family, rumours, trend or by gut feel. Identifying and
investing in good stocks, although not easy, is a must to create long term
wealth.
Since the stock markets have come into existence,
investors have always faced a dilemma in selecting good stocks. Many a times, a
stock that is cheap could be undervalued, or it could be nearly worthless and
overvalued because of some traders betting on a miracle and some hoping to sell
to those people before the company collapses. Similarly, when a stock is highly
priced, it may be due to over expectation or hyping on factors not
fundamentally right.
In case of stocks which saw a hype, investors have lost
heavily believing in their growth story and trying to ride on the price
momentum. For instance, a couple of years back, realty stocks were touted to be
the next big story based on their land banks. Many of the overhyped sectors
have actually delivered superlative returns over a period of time. But now many
of these stocks have fallen from their peaks and investors have suffered
losses.
Investors must study and analyse before choosing stocks.
For those who are not financially savvy, here are some tips on how to do it.
The first and most important thing for any investor to do
is, to look at the company's financial statements. It is also advisable to pick
stocks from sectors and markets that you know and have experience in. This can
give you an added advantage.
Some of the factors investors must look at before picking
a stock are:
Earnings Per Share: When you research a stock, the first thing you should
look at is the Earnings per Share (EPS). This is the amount of profit the
company is making on a per share basis. Market appreciates stocks which have a
growth in EPS while it reacts negatively for stocks with stagnant or
reduction in EPS.
Dividend yield: A dividend is
a cash payout to shareholders, usually an annual payout by profit making
entities. A stable or increasing dividend means the company has good cash flow
and a positive outlook for the future. A decreasing dividend usually means the
company is trying to keep some cash on hand for other expenses, possibly a sign
of tough times ahead. One indicator of a good stock to buy is a high dividend
yield. The yield is the yearly dividend as a percentage of the stock price. A
high yield means you are getting a larger dividend for your investment. Stocks
which have a higher dividend yield have better valuation in the market as
compared to those with a lower yield. infrastructure stocks like power or
telecommunication which normally have a lower dividend yield have a lower
valuation as compared to multinational companies' stocks.
Debt: Stay away from companies with high amounts of debt when looking for good stocks to buy. As most investors
have found out recently, it can be very difficult for companies with large
amounts of debt to survive, especially in recessionary times. In recent times,
we have seen the fall in Kingfisher Airlines due to high debt. Pharmaceutical
company, Wockhardt, too had similar issues on debt repayment, but it saw a
turnaround after restructuring its debt. The profitability of companies with
overleveraged balance sheet more often than not are affected by the high
interest outgo. These can have cash flow issues too. Any downgrading in credit
rating resulting due to cash flow issues can have an adverse impact on stock
price.
Future prospects: Understanding future
prospects is important as part of financials. You can identify the factors that
may influence the future performance of a stock. For instance, good monsoons
should help stocks in the fertilizer sector. Future prospects of the company
can be enhanced or marred by policy decision. For instance, opening up for FDI can have a positive influence in anticipation of
increased capital inflows. However, factors like technology changes can have
either a positive or adverse impact. Some of the stocks have been badly
affected due to changes in technology and non adaptation to market realities.
Peers: Compare
your identified list of stocks against its peers in the same industry or
sector. Looking at competing companies and their fundamentals can be a great
way to size up a potential investment. It is advisable to invest in a market
leader than the second or third rung stocks. Peer comparison is required as the
same will help in relative valuation of the stock. Say a stock like Hindustan
Unilever may look expensive on a standalone basis but if compare it with the
valuation of other stock in the same industry it may look to be attractively
priced. Price earnings ratio is usually used for comparing the valuation of a
company vis a vis its peers.
Strong brand: Companies
with strong brands are likely to perform better in the long run even if they
may be less profit making in the short run. Market puts a value to the brands
too while valuing a company with strong brands. A classic example of this is a
company like Bata India where inspite of muted growth, the share price is high
on account of brand value.
Conclusion: Doing proper
analysis and due diligence is an important part of investment process. It is an activity that needs to be done before
investing. Once you get the methodology, identifying good stocks will not be
difficult.
