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How to Select Stocks for Investing in India: Fundamental Analysis?
June 15, 2022
Everyone knows that investing your money is the best way to grow your money. But
When
we talk about investing, the key question that comes to mind of every investor is where to
invest.
There are plenty of ways to invest in India. If you want a good return on your investment (ROI) and if your risk appetite is a bit high, the Stock Market is the best investment option for you.
In reality, if you expect a good return, there is always a risk factor. You can always reduce your investment risk by doing proper and smart analysis by yourself.
There are plenty of ways to invest in India. If you want a good return on your investment (ROI) and if your risk appetite is a bit high, the Stock Market is the best investment option for you.
In reality, if you expect a good return, there is always a risk factor. You can always reduce your investment risk by doing proper and smart analysis by yourself.
❝Risk comes from not knowing what you are doing.❞
—— Warren Buffett
Did you know that more than 90% of people in India lose money in the stock market because they do not analyze the company?
Did you know that more than 90% of people in India lose money in the stock market because they do not analyze the company?
If you want to learn how to do fundamental analysis and smartly pick stocks for
consistent returns then you are at the right place. In today's blog, we will discuss how to choose
fundamentally good stocks for investing in India and what to keep in mind while doing a fundamental
analysis of a company.
Here are the key points to follow when you choose the right stocks to invest in the Indian stock market.
Online stock screeners help filter stocks based on certain criteria and parameters like market capitalization, dividend yield, P/E ratio, revenue growth, debt-to-equity ratio, ROE, and ROCE, etc.
You can't finalize a stock based on only one or two criteria and parameters as there are many other factors to think about before selecting a stock for investing.
When you're picking stocks for further analysis, a useful factor to start with is "Market Capitalization," but there are many other factors to think about.
Understanding the company's business is crucial because it is unwise to invest without knowing where your money is going, why it is being invested and who will benefit from it.
✯ When you are investing in the stock market, you should always think that you are investing in a business, not in a particular stock because if the business does well then the price of that stock will also go up and vice versa.
After checking all the points discussed above it is time to check the financial numbers to know the financial health of the company. This is one of the most important things to check before investing in a company.
These are important parameters to check to know the financial health of a company.
These are the key points to know about company management —
The shareholding of the promoters should be higher than that of other investors and the shareholding of the promoters should be more than 50% of the total shares of the company. The shares of promoters must be unpledged.
If the promoters increase their stake in the company it is usually a sign of a good company.
If your selected stock passes all of the above filters now the question is what will be the exact price of that share? To know the exact value of any share, we need to calculate the intrinsic value of that company. Proper valuation of the stock, as well as the company, is very important to minimize your losses and maximize your profits. After the proper valuation of the company, there is another principle of investing called "margin of safety".
✯ "Margin of safety" is the difference between an investment's intrinsic value and its market value, which acts as a protective buffer for investors to purchase any investment product at a significant discount to mitigate potential risk and uncertainty.
These are some important valuation metrics that can give you an insight into whether the company is overvalued or undervalued -
◉ The ideal PEG Ratio is 1 or less than 1.
◉ Lower values for Price to Earnings Ratio (P/E), Price to Book Ratio (P/B), Price to Sales Ratio (P/S), Price to Cash Flow (P/CF), P/FCFF, P/FCFE, EV/EBITDA, and M.CAP to SALES are generally preferred, as they imply potentially more appealing valuations concerning earnings, market capitalization, and free cash flow when comparing a company to peers, especially when these metrics are lower than competitor and industry averages.
Here are the key points to follow when you choose the right stocks to invest in the Indian stock market.
1. Choose Your favorite Sector:
Before selecting a particular stock, you must first choose two or three business sectors [such as
FMCG, Metal, Banking, etc.]. You need to have a basic idea about the business of the sectors you are
choosing. If you have a basic idea about a sector then it will be very easy for you to understand
the
business of a particular company in that sector.
2. Choose The Company From The Sector Of Your
Choice:
After selecting the sector of your choice, you need to select companies from each selected sector.
Initially, you need to pick a maximum of 3 or 4 companies from each sector. Online stock screeners help filter stocks based on certain criteria and parameters like market capitalization, dividend yield, P/E ratio, revenue growth, debt-to-equity ratio, ROE, and ROCE, etc.
You can't finalize a stock based on only one or two criteria and parameters as there are many other factors to think about before selecting a stock for investing.
When you're picking stocks for further analysis, a useful factor to start with is "Market Capitalization," but there are many other factors to think about.
3. Understand The Basics Of Business:
After filtering companies based on their market capitalization or any other parameters, you should
try to
understand the basics of their business and their products and services. Understanding the company's business is crucial because it is unwise to invest without knowing where your money is going, why it is being invested and who will benefit from it.
✯ When you are investing in the stock market, you should always think that you are investing in a business, not in a particular stock because if the business does well then the price of that stock will also go up and vice versa.
❝Never invest in a business you cannot understand.❞
—— Warren Buffett
Here are some key points to keep in mind when analyzing the business of a particular company.
◉ If the company is product-based then what
kind of product
does the company produce?
If the company is a service-based company then what kind of services does the company provide?
Do you understand the company's products and services?
To understand the company's business, you must first understand the company's products and services. The more you understand the company's products and services, the easier it will be to understand the company's entire business.
◉ Do people like the company's products and services? Does the company have great growth prospects in the future?
If the answer is yes, do you think people will use these products and services in at least the next 10-15 years?
If the company has a lot of potential for future growth and people like products and services, then this type of company can give you excellent returns in the long run.
◉ Does the company have any Economic Moat or any other special advantages?
✯ An Economic Moat is a sustainable competitive advantage that allows a company to maintain its profitability and protect its market position. This can be achieved through factors such as brand recognition, cost advantages, network effects, or regulatory barriers that make it difficult for competitors to undermine the company's success.
When choosing a company to invest in, you should first consider the company that has "Economic Moat" because it is really difficult for its competitors to beat them in their sector.
◉ Competition Analysis:
The main thing when analyzing a company's competition is to find out what the company is doing uniquely (USP) in their business that other competitors are not doing to capture more customers and to withstand competition.
✯ For short USP (Unique Selling Proposition) means the unique strategy that a company adopts to expand its customer base in the long run.
USP for a company can be anything like their quality products at relatively low cost, advertising strategy, distribution strategy, any special offer for the customers, after-sales service, etc.
If the company is a service-based company then what kind of services does the company provide?
Do you understand the company's products and services?
To understand the company's business, you must first understand the company's products and services. The more you understand the company's products and services, the easier it will be to understand the company's entire business.
◉ Do people like the company's products and services? Does the company have great growth prospects in the future?
If the answer is yes, do you think people will use these products and services in at least the next 10-15 years?
If the company has a lot of potential for future growth and people like products and services, then this type of company can give you excellent returns in the long run.
◉ Does the company have any Economic Moat or any other special advantages?
✯ An Economic Moat is a sustainable competitive advantage that allows a company to maintain its profitability and protect its market position. This can be achieved through factors such as brand recognition, cost advantages, network effects, or regulatory barriers that make it difficult for competitors to undermine the company's success.
When choosing a company to invest in, you should first consider the company that has "Economic Moat" because it is really difficult for its competitors to beat them in their sector.
◉ Competition Analysis:
The main thing when analyzing a company's competition is to find out what the company is doing uniquely (USP) in their business that other competitors are not doing to capture more customers and to withstand competition.
✯ For short USP (Unique Selling Proposition) means the unique strategy that a company adopts to expand its customer base in the long run.
USP for a company can be anything like their quality products at relatively low cost, advertising strategy, distribution strategy, any special offer for the customers, after-sales service, etc.
4. Understand The Financial Numbers:
✯Financial
Numbers: It is a
combination of numbers and ratios that describes the financial condition of a company as strong or
weak.
After checking all the points discussed above it is time to check the financial numbers to know the financial health of the company. This is one of the most important things to check before investing in a company.
These are important parameters to check to know the financial health of a company.
◉ First, The market capitalization of
the
company should be more
than
1000 crores. *If your risk appetite is a bit high and you want to get higher returns, you
can
invest in a company with a market capitalization of over Rs 500 crore if the fundamentals of the
company are good.
◉ Debt to Equity Ratio (D/E) should be less than 0.2. *Zero is the best.
◉ Debt-to-Assets Ratio should be above 1.0.
◉ Interest Coverage Ratio should be above 1.5.
◉ Return on Equity (ROE) and Return on Capital Employed (ROCE) should be above 15% for the last 3 years.
◉ Sales growth and Profit growth should increase by at least 15% for the last 3 years.
◉ The company must be profitable for at least the last 3 years. *A longer track record of sustained profitability is preferable.
◉ Gross Profit Margin (GPM), Operating Profit Margin (OPM), and Net Profit Margin (NPM) should be higher than peers.
◉ Current Ratio (CR) should be greater than 1. *The ideal Current Ratio is 1.33 to 3.
◉ Quick Ratio should be greater than 1.
◉ Asset Turnover Ratio, Inventory Turnover Ratio, Payables Turnover Ratio, and Payable Days should be higher than the industry benchmark or competitors.
◉ Lower values for Working Capital Days, Cash Conversion Cycle, Debtors Turnover, Days of Sales Outstanding, and Working Capital to Sales are generally considered more favorable when comparing a company to peers.
◉ As an investor, do not invest in stocks with red flags (GSM and ASM).
✯ You can find all these numbers and ratios in any stock screener available on the internet.
◉ Debt to Equity Ratio (D/E) should be less than 0.2. *Zero is the best.
◉ Debt-to-Assets Ratio should be above 1.0.
◉ Interest Coverage Ratio should be above 1.5.
◉ Return on Equity (ROE) and Return on Capital Employed (ROCE) should be above 15% for the last 3 years.
◉ Sales growth and Profit growth should increase by at least 15% for the last 3 years.
◉ The company must be profitable for at least the last 3 years. *A longer track record of sustained profitability is preferable.
◉ Gross Profit Margin (GPM), Operating Profit Margin (OPM), and Net Profit Margin (NPM) should be higher than peers.
◉ Current Ratio (CR) should be greater than 1. *The ideal Current Ratio is 1.33 to 3.
◉ Quick Ratio should be greater than 1.
◉ Asset Turnover Ratio, Inventory Turnover Ratio, Payables Turnover Ratio, and Payable Days should be higher than the industry benchmark or competitors.
◉ Lower values for Working Capital Days, Cash Conversion Cycle, Debtors Turnover, Days of Sales Outstanding, and Working Capital to Sales are generally considered more favorable when comparing a company to peers.
◉ As an investor, do not invest in stocks with red flags (GSM and ASM).
✯ You can find all these numbers and ratios in any stock screener available on the internet.
5. Do research on company management:
Just as our brain controls all the functions of our daily life, so too for a company, the management
team controls all the functions of the company. So the management team is a very important part of
the
company. A stable, loyal and efficient management team can greatly improve a company's performance
in
the long run. These are the key points to know about company management —
◉ The first step is to see if the management team is stable. Are
there any frequent changes in the management team?
Frequent changes in company management are not a good sign for the company and it can affect the performance of the company.
◉ Is the management team efficient enough to run the company?
Research their work history and check how many years they have been in the current company?
Long lasting and efficient management is a good sign for the growth of the company.
◉ The management should be loyal enough to explain their strengths as well as their shortcomings to their investors. It is the responsibility of management to clearly explain to the investors the business details of the company such as performance, profit-loss, future goals, etc.
If an adverse situation arises, the management must come forward and explain the problem and what steps they are taking to address it.
The management should announce their quarterly and annual results in a timely manner without any manipulation.
Frequent changes in company management are not a good sign for the company and it can affect the performance of the company.
◉ Is the management team efficient enough to run the company?
Research their work history and check how many years they have been in the current company?
Long lasting and efficient management is a good sign for the growth of the company.
◉ The management should be loyal enough to explain their strengths as well as their shortcomings to their investors. It is the responsibility of management to clearly explain to the investors the business details of the company such as performance, profit-loss, future goals, etc.
If an adverse situation arises, the management must come forward and explain the problem and what steps they are taking to address it.
The management should announce their quarterly and annual results in a timely manner without any manipulation.
6. Check the share holding pattern:
When you research the shareholding pattern of a company you will find 4 main types of investors such
as
Promoter, FII, DII, and public. The shareholding of the promoters should be higher than that of other investors and the shareholding of the promoters should be more than 50% of the total shares of the company. The shares of promoters must be unpledged.
If the promoters increase their stake in the company it is usually a sign of a good company.
7. Valuation:
✯ Valuation means
calculating
the intrinsic value of a company or calculating the actual value of the company, not the market
value.
If your selected stock passes all of the above filters now the question is what will be the exact price of that share? To know the exact value of any share, we need to calculate the intrinsic value of that company. Proper valuation of the stock, as well as the company, is very important to minimize your losses and maximize your profits. After the proper valuation of the company, there is another principle of investing called "margin of safety".
✯ "Margin of safety" is the difference between an investment's intrinsic value and its market value, which acts as a protective buffer for investors to purchase any investment product at a significant discount to mitigate potential risk and uncertainty.
❝The three most important words in investing are Margin of Safety.❞
—— Warren Buffett
To reduce your risk as an investor
you should buy a stock below its intrinsic value and this is called
margin of safety.
Your margin of safety should be calculated according to your risk preference. These are some important valuation metrics that can give you an insight into whether the company is overvalued or undervalued -
◉ The ideal PEG Ratio is 1 or less than 1.
◉ Lower values for Price to Earnings Ratio (P/E), Price to Book Ratio (P/B), Price to Sales Ratio (P/S), Price to Cash Flow (P/CF), P/FCFF, P/FCFE, EV/EBITDA, and M.CAP to SALES are generally preferred, as they imply potentially more appealing valuations concerning earnings, market capitalization, and free cash flow when comparing a company to peers, especially when these metrics are lower than competitor and industry averages.
The Bottom Line:
These are some important points to follow before investing in any stock in India. But there are many
more important points and factors to check before investing in any stock. There are many books you
can read and learn about investing. Do your own thorough research and due
diligence before investing in any stock or any other investment product.
