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Tips to help you select best stocks

June 04, 2014 10:23 IST

Tips to help you select best stocks

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Arnav Pandya

With television channels blaring away numbers like 23,000… 24,000… 25,000 into your ears on a daily basis, it is difficult to ignore the stock market. But in these times, retail investors need to be more cautious than ever.  

When buying stocks in the secondary market, the whole idea for a lay investor is to gain from holding stocks of companies that are fundamentally sound and will do better in the future.

This helps create wealth by constructing a strong portfolio.  

But with so many factors at play such as government, policies, Budget and others, it often becomes difficult for an individual to know what they should be looking in companies or their stocks so that their investment decisions make them wealthier.

While some of the factors are obvious like financial performance and low debt, it is also important to consider some smaller details that might have escaped your attention before choosing a stock.

A look at some such factors that can be useful in selecting the right stocks:

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Image: One shuold study fundamentals of the company stocks in which he wants to invest.
Photographs: Abhijit Mhamunkar/Rediff
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Sector position

Apart from the individual company performance, it is also important to look at the sector's performance.

An outlier, without an exceptionally different business model, cannot remain one for too long.

Sooner or later, it will be sucked into the sector's woes. Depending on that there can be several positives or negatives to growth of a company.  

Also, it is important to ensure that the company you choose works in a sector that is growing and presents ample growth opportunities.

But this is not always present at the ground level. There are also other external factors that impact the sector and in turn, the company.

Like the rupee and other foreign exchange movement, this can prove to be a driver for earnings for an export-oriented company in the areas of information technology or pharmaceuticals or textiles.

 There could also be a factors like environment concerns affecting a sector.

This can work in both directions and hence, a look at what the sector position is along with the potential for growth and challenges ahead.

There can also be a long-term view taken on a company based on the sector that it is in.

For example, if there is an expectation that a particular sector like infrastructure or shipping or real estate could revive, then companies in the sector would do well in the future. Consider them for investment.

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Image: A man looks at a screen across the road displaying the Sensex on the facade of the Bombay Stock Exchange.
Photographs: Danish Siddiqui/Reuters
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Financial performance

The financial performance of a listed company is one of the first things that every investor should consider.

This is one of the primary drivers of the share price of a company over a longer time period.

The sales and net profit of the company should be rising which would enable it to accumulate financial strength.

Even the operating profit margin (OPM) should be stable or rising, which will enable investors to consider paying a better price-to-earnings (PE) multiple for the company, especially where the number are improving consistently.  

In addition, a strong balance sheet is also essential where there is just enough debt that can be serviced by the company and it is able to recover the dues from its customers in an effective manner.

This would ensure that there is an element of sound financial strength that inspires confidence among the investor.

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Image: People look at a screen across the road displaying the election results on the facade of the Bombay Stock Exchange.
Photographs: Danish Siddiqui/Reuters
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Liquidity

There are times when the investor ends up buying a stock or company where liquidity is a big question.

This can lead to a big hit as far as the overall investment is concerned because if the company does not have enough money when its investors want it back, this could force the investor to stick around.

Liquidity, thus, becomes a crucial factor that cannot be ignored and if this is low, then the risk in the investment would go up.  

Business model

There are companies with unique business model.

This could come from the fact that they operate in an area where there are fewer similar companies.

Or, they could be doing something that is completely different. So, they have made a mark for themselves.

This becomes a key point as it would raise the valuation of the company in the market, but it is not enough for a company to just have a unique business.  

It is equally important for it to ensure that they are able to build on it and ensure that it is able to make profits on a sustainable basis.

This can be a key point from the investment angle for individuals.

The ability to innovate and keep ahead of competition would be enabled by the business model and this can become a key factor distinguishing a company while the investment decision is being made.

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Image: An investors should consider the business model of the company in which he wants to invest.
Photographs: Reuters
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Promoters

There are always a lot of questions around a company's promoters. For investors, looking for long-term investment, this is important.

They should have an idea about the background of the promoters and their track record.

They are the ones who control the company and their decisions will pave the way for future growth or disaster.  

This is important, to that extent, to have clarity on the promoters as their personal financial situation could also spill over to the company especially if there is a negative development.

The manner in which promoters have acted in the past and treated their shareholders and other stakeholders also holds importance in terms of developing a comfort factor while investing in a particular company.

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Image: An image of Goddess Lakshmi is placed between monitors displaying share price index at a share trading market.
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Corporate governance

Look at the corporate governance track record. If a company has been managing its affairs well, investors need not worry.

But there could be decisions made by the company that are not in favour of the investors.

In India, still we do not have strong investor protection bodies that could make things difficult for promoters who do not work in the favour of investors.

Globally, however, the scenario is completely different where strong investor lobbies ensure that companies do not take investor-unfriendly decisions.  

If there is a company that has a high potential but its corporate governance is questionable, then the investor needs to understand that they need to weigh the returns expectations from the company against the risk the investment will entail to see if it works for them.

In other words, in India, the onus is on the retail investor to consistently monitor the company and if required, exit at the first hint of investor unfriendliness.


Image: In India, still we do not have strong investor protection bodies that could make things difficult for promoters who do not work in the favour of investors.
Photographs: Rediff
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