Every correction creates a long term opportunity to choose businesses. However, there are a number of criteria to be applied before finally investing in a stock. Above that, there are more than 5000 stocks listed on the stock exchange making it even more difficult for retail investors with limited resources to screen the best out of the lot. There would be many stocks ticking a few matrices but only a few businesses ticking most of the filters.
Should you go for market leaders or companies with a turnaround plan or small businesses with huge potential or businesses with a promising leader?
As a long term investor, one should look for promising and futuristic businesses i.e. management should be forward-looking, consistent in a year on year growth and dynamic in their decision-making process.
Buying any stock is very similar to buying any consumer product, let’s say, a mobile phone. Just as you would research, understand and compare the features, benefits and specifications of a mobile phone with its peers in the same price range before actually buying it, every investor should always research the company, understand it’s business and its competitor’s scalability before actually investing in it.
One must always remember stock is a share of the ownership of a company. So when you invest in a certain company you own a part of it.
Basic homework before investing in a company.
- Analyse the Industry: Understanding the industry the company operates in, gives the broader picture of where the company is headed. An industry growth rate will enable the growth for each of the companies in the industry depending on their respective market share. A company can be a market leader yet underperform if the overall industry has a slumbered growth. This would be the first step of the analysis where top focused industries with high forecasted growth rate are identified. One can study the government investment plans and its focus to develop a particular industry. This would enable the investor to understand whether the industry would remain lucrative in the near future or not.
- Selecting the stock : Once the lucrative industry has been identified, the next step would be identifying the most promising company within that industry. Going with market leaders help to minimize the risk exposure to a particular sector. Market leaders tend to leave the industry late in a recessionary period and capture the market share earlier once the economy revives. This is possible because of the availability of resources and skills to monetize and capitalise on the available opportunity.
- Understand the business of the company: Since investing shares in the company would mean proportionate ownership, it is imperative to understand the business in and out. It would include the business model, scalability of the products, company’s USP, how they generate profits, its competitors etc. A very simple SWOT analysis should be enough to make a preliminary inference about the company.
- Competitors: The company’s market share in the industry will empower to capture opportunities earlier and faster than its competition. One needs to understand the key points where the company is better or worse than its competition and accordingly, value the company. The exclusivity and scalability of the product / service of the company will support the company to be market leader for a longer period of time.
- Company’s Management: Investing in a company without knowing its management is like giving money to a stranger and expecting something in return. A good management can be identified by reading a firm’s management statement and management commentary where the top management shares their view on the company‘s past performances and future prospects. A good management driven company will always have better prospects to grow and sustain for a longer period of time. Another reason why knowing the management of the company is important is because they would be running the day to day operations as well as take strategic decisions for the company. Owners usually don’t have a say in here since ownership and management are different in case of a corporate structure.
- Analyse Financial Statements: Financial Statements of a company consists of a Balance sheet (reflecting the position of the company), Income statement (reflecting the performance of the company) and Cash flow statement (reflecting the cash position and liquidity of the company). These statements need to be studied, understood and compared period on period to make a right investing decision.
- Analyse Financial Ratios: This helps an investor to compare a company’s performance with its peers in different aspects. The key aspects could be profitability, liquidity, solvency, valuations and operating ratios.
The most commonly used indicators are valuation ratios and profitability ratios. The former contains ratios such as price/earnings while the latter has return on capital employed (ROCE) and return on equity (ROE). One should always keep in mind that a selected stock should have high profitability and low valuations as compared to its peers.
These basic steps should be followed by every investor along with in-depth analysis specific to the industry and type of business. This practice of evaluating stocks is known as Fundamental analysis – Top down approach.
We have screened, analysed and cherry-picked the following stocks which are present in our StockBasket as well.
- Hindustan Unilever
- Tata Consultancy Services
- Bajaj Finance
- HDFC Bank
- Godrej Consumer Products
- Jubilant Foodworks Limited
- National Institute of Information Technology
These are the top ten growing Companies as well as the market leaders in their respective sectors backed with good management, strong financials and amazing track record.