Imagine Alladin (From Arabian Nights) being alive today with his magic lamp. Imagine him being a equity investor. What would have happened with him having the magic lamp willing to fulfill all his wishes? He would have never made a loss , always bought winning stocks and made ton and tons of money, dwarfing the likes Warren Buffett etc. But, alas that happens only in fairytale and not in reality. In reality, there is no magic lamp. But, there are still ways and means of finding winning stocks . There is a definite science to finding a great stock with great earning and capital appreciation potential. Following are the qualities that you must look at before zeroing on any stock:
1. Bargain price on Offer? - The first thing any value investor looks at in a stock is its price. This is because to be able to make money on stock exchanges, one has to buy at low levels and sell at high levels. Hence, one must always look for stocks which are being sold at bargain prices on the exchange. How do we know if the price being quoted for a stock is low enough? There are many factors which will help you decide that like PE multiple,cash on balance sheet,traditional stock price,PEs of rival companies etc. Great companies having good business fundamental trading at multi month lows during bear market phase offer such opportunities. For example , In India , in Oct 2008 the entire banking stocks were beaten down to a level where the stocks of
front line stocks like ICICI, HDFC , SBI were available at very attractive price.
2.PE Less than the PE of the broad market - Price to Earning ratio (PE) indicates the price premium market is willing to pay for the earnings that the stock will deliver. Companies with good performance track record command high PE multiples as compared to the others.In order to find winning stocks , one needs to look at companies which are fundamentally sound and are trading at PE multiple which is less than the broad market PE multiple. For example, If BSE is
trading at PE multiple of lets say 10 and Infosys is trading at PE multiple of 8 , then this makes infosys a great buy , assuming other things being normal. This is because companies which are trading at less than market PE will eventually reach the market PE multiple, driving the stock price up. Here the thing to note is that just PE multiple alone is not to be used a criteria for stock selection as there are other factors too which influence the stocks performance. Also this strategy works well with large cap companies only.
3.Return from stock earnings to be greater than return from FD - Another aspect to look for in a winning stock is its earning per share (EPS). EPS is the return on your investment in the company. For example if the stock price of a SBI is Rs 1000/share and the EPS is Rs150, then the actual return that you will get from your investment in SBI (not accounting for capital appreciation of stock price) will be 15%. Now compared to any FD available in the market, this is
better rate of return and hence makes sense to invest in it.As a thumb rule,Warren Buffett advocates choosing stocks which offer a return of at least 15% compounded annually over along period of time. Anything less than that is not worth it.
4.Current Assets to be 1.5 times the Current Liabilities - Another feature of a good stock is that the current assets exceed the current liabilities of the company by 1.5 times. How does this help the company? Higher current assets mean that the company is financially sound and is in no danger of defaulting on any of its financial obligations. Also it will ensure that the company's functioning will never be affected due to paucity of funds.
5. Good corporate governance record - Post Satyam episode in India, this has become a thing of paramount importance. Corporate governance now is ranked as number one requisite by lot of global investors before they decide to invest their money in any stock. Hence , please look for companies with clean record on this account to ensure you don't land up with another Satyam in your portfolio.
6. Past Growth and return on equity record - Companies which have delivered consistent growth in earnings are much better than companies which have high but erratic earnings record. One must always prefer companies which are growing consistently at a stable rate. It ensures that you make money consistently over a long period of time and this performance will also result in capital appreciation in the stock price in future, resulting in even higher gains.Warren Buffett explains this concept with his holdings in Coca Cola which has deliver consistent growth over last 30 years.
7. Company should be in top 3 in its segment- As a thumb rule, please invest only in companies which are in top 3 in their segment. This is because rarely will you find companies ranked 4,5 etc in any segment making any decent money over a long period of time. Sticking with the leaders means you are with a company which knows a thing or two about this segment and has done well.
8. Management Profile- The importance of this can not be overstated. A company is as good as its management, because, the company is run by them and they take all the major decisions. Hence , you should look to invest in company which has got good managerial talent taking all its critical decisions.Find out about its CEO, Board members etc and their performance track record in the same company and also with other companies that they have been associated in the past.A good company with spectacular management is better than a spectacular company with average management.
So , next time you are about to buy a stock, ask yourself if that stock has all these attributes? If yes, then you have a winner at hand.
Stay wise n stay wealthy..