Before you invest in any stock, it’s important to understand the company’s business and its offerings. You should consider businesses that are futuristic in nature, expected to grow in the future, and are not unstable (like electric vehicles, green energy, technology). For example, if you invest in a company producing goods that are losing importance in recent times (like plastic bags) then you may not be able to achieve long-term growth in your stock portfolio.
Moreover, it’s also important to have the right concentration of various industries in your portfolio (i.e. growth and value-related stocks).
The second most important thing is what the sales graph looks like. Sales growth provides a clear idea about the acceptance of a product offering in the market. Also, it increases the overall net profit for the company if the costs are tightly managed.
It is also important to analyze the % of repeat sales (i.e. old consumers buying products again and again) vs new consumer sales. A decent % of repeat sales indicates consumer loyalty and in turn, makes the company desirable to invest in.
After looking at the business profile, you should also determine how big the company is in terms of its market capitalization. Depending on the market cap, the company can belong to one of the below categories:
The companies with a market cap of less than INR 5,000 crore fall under this category. The growth opportunities associated with the company are high, but the level of risk is in no way less either. When there are chances of these companies to grow, there are equal chances of these companies to fall quickly with bigger losses as well.
Companies with a market cap between INR 5,000 crore and INR 20,000 crore are classified as mid-cap companies. Investing in these companies is less risky than in small-cap firms and more profitable than large-cap ventures.
The companies with a market cap of more than INR 20,000 crore are categorized as large-cap companies. Investing in these companies is less risky as they have already proven their growth potential in the market. Thus, if you invest in a large-cap firm and suffer a loss, it has the potential to cover up the losses.
P/E Ratio (Relative Analysis)
Now as we have seen the business profile, revenue growth, and company size. We should not start looking at some imp valuation multiples for retail investors. The Price / Earnings Ratio is one of the most important multiples to consider in such a case.
It is generally said that the lower the P/E, the lesser you pay to buy that company’s stock (which is a win-win situation). However, the value obtained must not be negative or too low as a too low P/E may never pick up in the future and can get worse (due to lower trade levels and market demand).
It is important to see this number in a relative manner (i.e., checking between competitors) and shortlist a not too high P/E. For example, doing a quick check between TCS, Infosys, Wipro, HCL, Tech Mahindra comes up with some P/E ranking
Rule of Thumb: For a Growth stock, P/E can be a little higher and for a Value stock, a lower P/E within competitors is better.
Return on Equity
Calculating the Return on Equity (ROE) helps figure out a company’s profitability with respect to its equity. It is expressed as:
From the Indian perspective, If the RoE is 15% or above, it signifies the company is performing well and clears the checkpoint for investment.
Promoters are people who actively participate in forming and establishing a company. They are generally the major shareholders in the company or people holding the management position. A company having more than 40% of promoters holding gives confidence to investors and clears the checkpoint of investment. If a company has lower promoters’ % then one can lookout for further shareholders’ analysis and see if the company has some reputed names on the list.
Free Cash Flow
Free cash flow gives an idea of how much cash the company is freely available in the business (after deducting working capital and CAPEX). This provides confidence to investors that the company is not going to face any liquidity crunch in near future.
Debt / Equity Ratio
The Debt / Equity ratio provides information on how levered the company is. To compute the debt to equity (D/E) ratio, the following formula could be used:
A lower debt/equity is considered good in the eyes of investors. However, if the business has high growth potential and the company can manage a much higher RoE than the cost of debt then a higher debt/equity is also considered a wise alternative.
It is also important to check this ratio in a relative manner (looking for all possible competitors) to gauge the real positioning.
At times, the companies might be doing exceptionally well, however, it is important to check the recent developments and see if you have any negative news or rumor. In such a scenario, one should put that stock on a watchlist and wait a bit before taking any action.
News also helps us understand any major structural changes company is going through (like major offering changes, management conflicts, government regulations), and the stock might become unattractive to investors.
Investing in stocks is crucial, but if you consider the following parameters and act accordingly, purchasing multi-bagger stocks would be much easier.