Many beginners join share market to make their fortune. But after sometimes they leave the market suffering a huge loss. It is also seen that many investors can never make a profit. They also give up investment in share market. It is seen that due to some blunders investors make the loss. Here we will guide how to pick best stocks for consistent returns.
In order to pick the best stocks for consistent returns, you should check out the following parameters of a company before investing there.
Debt: Net Worth ratio
If the company has marginal or low debt or it is a debt-free company, the company is worth investing. Let us illustrate what is the difference between a high debt company and a debt-free company. When a company has huge debt from the market or bank or any other commercialinstitutions, then the company concentrates on the debt and its effort goes to pay the debt. It cannot be sincere about the service, quality of the product or any other important aspects needed in the business. On the other hand, if the company is debt free, the company can concentrate on product quality, service and customer satisfaction only. That is why a debt-free company is better than a high debt company.
Compounded sales Growth
Select a company that has been generating sales Growth annually during the last 5 financial years of at least 10%. When a company’s sales increases, then naturally the company will make more profit. So this will affect its share price.
Profit after Tax (PAT) growth
Choose a company whose profit growth increases at least 15% on a year-on-year basis. Titan Company’s profit growth in 2018 has increased 72% on year-on-year basis.
Return on Equity
If a company fails to give you a yearly return of at least 20%, you may stop investing in that company and move to another one.
Healthy Dividend Payout
It is a fact that investors invest in a company to get a healthy dividend payout. So, if a company is capable to offer its investors a dividend on the investment it is worth investing. A healthy or profit earning company uses half of its profit to generate dividends for the investors. The other half is used to expand the business or to simply run the business.
Good dividend paying stocks must have following features
- Consistent dividend payout over the past 5 years.
- High dividend yield for last 5 years.
- Growth in dividend per share from time to time.
The price-earnings ratio (P/E ratio)
When a company’s sales & profit margin increases, naturally its share price also increases. This is commonly known as the Price-Earnings Ratio or P/E Ratio. Companies with a high P/E ratio are growth stocks that achieve a higher share price on a year-on-year basis. However, their relatively high multiples do not necessarily mean their stocks are overpriced and cannot give better returns for the long term. The lower P/E ratio of a sector does not mean that this sector is undervalued and is going to boom and deliver a multi-bagger return in the near future with compared to those sectors which have higher P/E ratio. These sectors have higher valuation just because the market is bullish on these sectors and their future potential like Automobile, FMCG, Petroleum, etc. They are core sectors of the Indian economy and have the potential to deliver a robust performance in the upcoming years.
You can invest in such companies or stocks which have low P/E ratio compared to stocks with high P/E ratio, after analyzing the factors like Debt ratio, Compounded Sales Growth, Compounded Profit Growth, Market Cap, and Return on Equity, management etc. Suppose you want to invest in paints and pigments sector. After fundamental analysis, you notice that Asian paints satisfy all the conditions, but has a high P/E. So you decide to invest in paints sectors which have a strong entry barrier and will be able to deliver steady returns in the near future. You should search for such company or stock which has strong fundamentals i.e., Debt ratio, Compounded Sales Growth, Compounded Profit Growth, Market Cap, and Return on Equity etc.
- Read also: Guide to Stock Picking Strategies
- Read also: How to choose a stock
- Read also: Learn how to pick value stocks
Business Model
According to ace investor Warren Buffet, an individual investor should invest in such companies or stocks whose business model or modus operandi is clear as a day to the investors. It is very important to understand what the business of the company is like. In other words, what the company sells or what services it offers and how the company makes a profit from its operations is also to be considered.
Investors should also see whether the demand of the product the company sells will remain constant or move upward in future. For example, food products, steel, electronic tools are inevitable in everyday life. So, the demand for these things will remain constant or increase in the future. The companies operating in these sectors will make a profit.
Again, how a company operates its business influences its profit margin. It is also a part of the business model of a company to distribute the profit among its shareholders. How a company produces its products, how it sells them, how the packaging of the products are attractive, the company’s marketing policies all these things form a business model.
The source of capital or fund to run or expand the business is also very crucial. An under debt company cannot afford to distribute the dividends among its shares holders, because a lion share of the profit goes to repay the debt. On the other hand, a company which is a zero debt company can yield better dividend and better return in the future. So, the above-mentioned points are treated as the business model of a company. By reviewing the business model you can get a clear idea whether the business model is unrealistic or there is any chance that the business will succeed.
Management of the company: Management is the backbone of the company. A qualitymanagement may raise a company to the pick. It is a proven fact that a good management in competitive industry yields better returns than the worst management in the monopoly market. In order to access the strength of a management, you need to consider the following aspects.
- The persons who manage the company’s business and the persons in key positions i.e., CEO, CFO, COO & CIO.
- You need to examine the educational and employment backgrounds and previous employment records of the personnel. Suppose, the CEO previously worked in the coal sector and then he has shifted to technology. There are minimum chances that he will succeed. Ask yourself whether he is able to deliver success to the company.
- You should analyze the management’s style of how the team manages the business. You can check whether the management promotes the business as an open, transparent and flexible way.
- You need to analyze when the management has taken charge of the company. Suppose, the management has been unchanged during the past 10 years. Then this long tenure of the management is a good indication. It means the management is quite successful and has delivered the desired financial results such as compounded sales growth, compounded profit growth, a good return on equity. If you see a company is changing a management team frequently then you need to invest your money to somewhere else.
Competitive advantage
A competitive advantage allows a company to produce quality service and better products for its customers. Then this competitive advantage accelerates the company’s sales margin which increases profit margin than its competitors i.e., peer companies. While you invest your money in any company you should choose such a company that has a sustainable competitive advantage in respect of cost structure, brand reorganization, corporate reorganization, product quality distribution network and superior customary support. The brand value or name of any company is in the billions of money. A portfolio of brand influences the sales and growth of the company in many ways. It is a competitive advantage than its peer companies.
Let’s understand this with an example. Whenever we talk or think about adhesive the first name comes to our mind is Fevicol, Fevistick, Fevikwik, m-seal, Dr. Fixit etc. All these are brands of Pidilite industries. The products of Pidilite Industries possess a superior quality. The company maintains a vast distribution network and superior customer service to establish itself as a market leader in the adhesive Sector or Industry.
Whenever we talk or think about Trolly or casual Bags the first name comes to our mind is Aristocrat, Skybags etc. All these are brands of VIP industries. So, you need to consider these factors before making an investment in a company.
After selecting the company, you need to analyze the industry or sectors in which the specific company is in operation i.e., the growth potential of the industry. A mediocre company in a growth industry can generate a better return on equity than a good company in a dying industry. You have to watch out which industry is growing and likely to deliver a better return on equity.
Ownership Structure
You need to check out the promoters’ stake, mutual fund holdings, Foreign Institutional investors i.e., FIIs stake etc. As you are investing in their business, you need to know the goodwill, management intelligence etc.
Future plans
The most crucial part is to check out the future plans i.e., the expansion of business, marketing policy etc. Suppose, Titan Company is quite famous for making ornaments, jewelry, wrist watches etc. So, you need to keep a close eye whether Titan Company enters in a new segment or makes an expansion of business which will increase its market share.
Let’s make it clear with an example.
There are many reasons for which investors particularly the beginners make blunders. The biggest blunder they make is that they get tempted to the cheap price of shares. They prefer the companies that have cheap share prices like Amtek Auto, JP Associates, and Reliance communication instead of Minda Industries, Titan Company, Whirlpool of India.
There is a misconception among investors that the price of a share that costs Rs. 50/- may easily rally to Rs. 100/- within 3-4 months, whereas the share that costs Rs. 500/- will not rally to Rs. 1000/- within 3-4 months even within one year. So, an investor with Rs. 10000/- holds that by choosing Rs. 50/- per share, he will get 200 shares whereas by opting share that costs Rs.500/- will provide him with only 20 shares. So in the first case, he gets more shares. Now in future, if the share price goes up and becomes Rs. 100/- from Rs. 50/- rupees, he will definitely make a huge profit. They think that Rs. 500/- is itself is a big amount. So there is less possibility that this specific share may become Rs. 1000/- after 6 months or more. This is the biggest blunder made by these investors.
They do not check the fundamentals of the company in which they invest. They should check the fundamental points like Debt: Equity Ratio, Market Cap, and profit growth Margin, and Sales Growth margin, Return on Equity etc. Here are some comparison lists of best and worst companies.
So from the above discussions, it is concluded that an investor should buy shares of Bajaj Finserv, Minda Industries, Titan Company instead of Amtek Auto, JP Associates, and Reliance Communication.
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