How to Choose Stocks to Buy in India?
There is a well-saying quote by Peter Lynch- “An important key to investing is to remember that stocks are not lottery tickets”.
The vast investment opportunities may overwhelm you when you first enter the investment world. As beginners, we are so enthralled by the profits of others that we blindly follow them. But do you know, over 90% of people who invest blindly in stocks lose money in the stock market? The reason is that they do not conduct preliminary research. They just pick shares based on their friends or family’s suggestion. This may cripple your earnings in the long run.
Ways to Choose Best Stocks to Buy in India?
There are different ways to pick a stock, but let’s learn the most important ones:
1. Set your investment objectives:
The first step in selecting investments is determining the goal of your portfolio. Everyone wants to make money when they invest, but investors may be more concerned with generating an income supplement during retirement, preserving their wealth, or capital appreciation. Traders also seek quick gains and a variety of price patterns. The companies you seek to acquire will be determined by your goals.
Without setting any specific goals, you won’t be able to buy or sell your investments. Before proceeding to the stock selection stage, you must first determine what short-term and long-term objectives you hope to achieve with your stock market investments.
2. Understand the company and their business model:
By purchasing a share, you become a part-owner of that company. It is your responsibility as a partial owner to understand how the company operates. Long-term stock performance is determined by the performance of the business. Study the company’s business model, its products and services, and how it generates revenue.
Also, check what sector they are in. How many businesses do they own? Take into account various aspects of the company’s governance. You can also use stock screeners for this. Stock screeners can assist you in filtering through companies based on specific criteria, ensuring that any investments added to your portfolio are consistent with your strategy.
3. Perform the Ratio analysis:
It is very essential to check the fundamentals of a company. If the company’s fundamentals are not very strong, then there is no need to do further investigation or research. So, to check whether the company is healthy, you need to perform ratio analysis. Comparing these ratios over time and between peers in the same stock market sector or industry can assist investors in making better investment decisions. Here are the top ratios which you should look for:
· Price-to-Earnings Ratio (P/E Ratio):
The most well-known financial ratio among investors is the Price to Earnings ratio. Everyone likes to look at a stock’s P/E ratio. It indicates how much the market is willing to pay for the company’s earnings. The P/E ratio is derived by dividing the market price per share by earnings per share (EPS). An investor should always compare a company’s PE with the industry’s PE. An investor may purchase a share if a company’s PE is less than the industry’s PE. This is because we are receiving the shares at lower valuations than the industry.
· Earnings per share (EPS):
EPS measures a company’s profitability on a per-share basis. For example, if the company have 1,000 outstanding shares & it earns a profit of Rs.1, 00,000, then EPS would be 1,00,000/1,000 which is Rs.100 per share. The higher the EPS, the better it is for its shareholders.
· Current ratio:
This ratio shows the liquidity position of the company. Divide current assets by current liabilities to get the figure of the current ratio. You can find current assets and current liabilities in a Balance Sheet statement.
For example, a company with total current assets of Rs.300 lakh and total current liabilities of Rs.120 lakh. So, the current ratio would be 300/120, which is 2.5: 1.
An ideal current ratio is 2:1. A ratio below 1:1, where current assets are lower than current liabilities is risky for the company.
· Price to book value ratio (P/B ratio):
This ratio compares a company’s market value and book value to obtain a fair price. With this ratio, an investor can easily compare if the stock is undervalued or overvalued and accordingly make a bull/sell decision.
The price to Book value ratio is calculated as Market Price per Share / Book Value per Share. A ratio greater than one frequently indicates overvalued stocks.
· Return on equity:
The (ROE) of a company measures how well a company generates profits for its shareholders. The return on equity formula is the Net income / Equity of the shareholders. ROE assists investors in making investment decisions and can be used to compare one company to another to determine which is a better investment.
4. Examining the Stocks’ Competitive Advantage:
Once you have narrowed down your stock’s name, it’s time to look for its USP i.e., Unique Selling Point. Warren Buffett also called this concept ‘MOAT’. The most important characteristic which you must look for while picking a stock is a long-term competitive advantage. Check whether the company’s competitive advantage will last for years. Products and services that are sustainable are more likely to reward investors. In addition, to conduct a thorough competitor analysis, factors such as scale, unique brands, switching costs, network, etc. can be considered.
5. Understand Stock Charts and Recognize Trends:
Reading charts can help you understand the history of a stock and identify emerging trends. Stock charts and trends can help you determine which stocks are performing well and which may be due for a breakout soon. With this, you can still get a sense of how a stock will perform in the short and long term.
Making investing decisions only on the base of charts or indicators is called technical analysis. And technical analysis is mostly used for short-term trading. To invest for the long term in good fundamental stocks and in-depth research, you need to perform both fundamental and technical analysis. It is critical to consider both types of analysis to ensure that you do not overlook any important information.
6. Determine the debt position of the company:
Debt is a liability incurred by a company while doing business. Companies may borrow money to run their day-to-day operations or to expand their operations. A small amount of debt is necessary for a company’s growth. However, even a high-profit company’s stock can be dragged down by high debt. This is due to the fact that interest on debt can eat into a company’s profits. So, look for a company that is debt-free or whose debts are steadily decreasing. The debt position can be found in the liability section of the balance sheet statement.
While analyzing the company’s debt profile, look for the debt-to-equity ratio. This ratio depicts the proportion of debt versus shareholder equity that is required to fund a company’s assets. A higher debt-to-equity ratio means that the company is aggressively financing its expansion with external funds, i.e., through debt. So, avoid investing in companies with high debt. In general, a good debt-to-equity ratio is 2:1.
7. Research about the company’s management:
A good management team can take the company to new heights. It is critical to conduct thorough research on the management of the company you intend to invest in. First, you should conduct some research to determine who is in charge of the company. You should be aware of the company’s CEO, CFO, MD, etc. Also, check what is their qualifications and experience.
Also, look for a management team who is in the company for a very long. Because long tenure indicates steady growth and is a sign of a healthy company.
If the company provides good perks to its employees and staff, this is also a sign of good management. The performance of a company’s staff and employees has a large impact on its results. Employees who are satisfied will give their best effort.
The last factor is transparency. Management’s responsibility is to be fair and transparent and honestly announce annual results to shareholders without any manipulation.
8. Other important tips:
- A steadily increasing Reserve and Surplus is regarded as a positive sign. At least 5 years of data must be checked to conduct a thorough analysis.
- Avoid penny stocks because they are usually new and need time to prove their worth.
- To outperform, a stock must be in an exciting industry. You must concentrate on industries and sectors that have the potential to grow over the next five years.
- If your goal is to generate income from your investments, then you should investigate the company’s dividend history before purchasing its stock.
- Before purchasing a stock, you should consider the company’s profitability. Return on Capital is the most effective metric for determining profitability.
- Rather than attempting to select stocks for short-term growth, it makes sense in some cases to purchase stocks for the long term. Consider value when learning how to find good stocks.
- Invest in companies that you understand. This will improve your ability to read stocks.
Stocks can provide high returns on investment, but they always carry the risk of extreme highs and lows. Before entering this field of investment, it is critical to understand the fundamentals of the stock market. So, as a beginner, it is suggested to start with less volatile stocks and diversify your portfolio to average out your risk. Investigate a company thoroughly.
Also, check your risk tolerance, and the time and capital you have available when choosing the best stock broker in India. Keep investing and witness the power of compounding. Happy Investing!