|
If you are looking to invest directly in the equity market there are
some basic areas to take into consideration.
Investors who do not prefer to invest in the
equity markets through the mutual fund route need to be very careful in their
analysis of the companies in which they are investing into.
The need for this kind of analysis becomes even more important in today's
context where each and every stock is moving up with or without any
reason. The information availability with investors has increased rapidly and
significantly over the last few years with the publication of quarterly
results being now compulsory. Besides results today most of the results and
details about the company are available on company web sites and also on the
websites of the National and Bombay Stock Exchanges.
Although the analysis of company financials and business analysis,
ideally is a job left to professionals, investors who would like to invest of
their own should look at various factors. The prominent among them
would be as follows (not essentially in the sequence of importance)
Price of a stock is not very important it is the valuation that is
important
Typically in bull markets investors get attracted to low priced stocks. However, such stocks might be the
most dangerous to invest into. First of all, if a stock is low priced despite
the markets having moved up substantially then there has to be a reason
behind it. That reason might be that the company is not doing well
financially. Also it is important for investors to see the paid up value of
the share of a company, where these days the face value of the shares of a
company typically vary from Rs 1 to Rs 10. Most of the people think that all
stocks are with a Rs 10 face value and as such a stock priced at Rs 10 with a
Rs 1 face value would in the traditional sense be actually trading at a price
of Rs 100. Moreover shares should be analyzed in terms of its price earning
ratio (the most simple valuation tool for non-professionals) rather than the
price of the stock. As a simple example if one share is trading at Rs 1000
and another is trading at Rs 10, but the per share earning of the first
company is Rs 200 then its P/E is 5 (i.e. the stock is trading at 5 times its
current earnings). However if the per share earning of the second company is
Rs 1, then its P/E is 10, which essentially means that it is more expensive
than the company whose stock price is Rs 1000.
Prefer tax-paying companies
When bull markets start a large number of companies, which were not doing
well earlier and had hardly any profits to talk about start showing good
profits growth. Investors should be vary of such companies and should try to
see the earnings of the company before tax and after tax. If a company is
paying high taxes on its earnings then its profits are likely to be more genuine
than companies that pay very low taxes.
Try to see the free cash flow
This is also something that is very important but may be difficult for most
people to understand. I will try to be as simple as possible. This is an
analysis where an investor can come to know that whether the profits that are
getting reported are actually flowing as cash into the company or is just
getting to the profit and loss account through an increase in the debtors of
the company. This also helps to analyze whether the business of the company
is improving or deteriorating in terms of efficiency. These days' cash flow
statements are a part of the annual reports of companies, which investors can
go through.
Look at the direction of the movement of Return on Networth
Return on net worth is the profit after tax of the company divided by its net
worth. Companies that show an improving trend in this ratio will typically
provide positive returns to shareholders, whereas companies which might have
a high level of this ratio, but which is declining are more likely to give
negative returns to shareholders.
Use common sense
Common sense is the most important and most difficult to use thing while
investing. For example if a particular company is making some claims about
its future growth prospects which do not seem likely given the performance of
the domestic or global economy, investors should a such stocks even though
the prospects might look very encouraging. If one believes that eh domestic
economy will grow very rapidly and have huge investments in infrastructure
then common sense would imply buying companies that benefit out of this. A
buying stocks of companies where business models seem too complex or very
difficult to analyze.
Try to optimize not maximize
Typically investors try to maximize their returns by taking excessive risks.
As markets move up investors will end up putting most of their money in
high-risk small cap stocks. However this is a strategy, which would
ultimately fail and most investors will end up making losses? The ideal
strategy is to have a good mix of high quality large cap and mid cap stocks
and invest only a small part in speculative small/mid caps (maybe not more
than 5% of your money)
Understand that stock prices move on future prospects rather
than the past
Although the past history of a company is very important for a proper
analysis of the prospect of the company, investors should realize (which most
people don't) that the stock prices move up and down based on future
prospects of earnings growth rather than what has happened in the past. As
such most of the results, which relate to a past date are already factored
into the stock prices. As such a proper view formation on the future
prospects is essential for successful investing.
Do not buy every thing in one lot
As we advise investors in our equity schemes to go for systematic investing,
while investing directly into equities a systematic investment route should
be the preferred route. Here the investor spreads out investments over
different times and market levels so as to get good returns over the long
run.
I have tried to cover a few points that can help investors invest better. I
will try to add more such points in future articles. However the most
important thing while investing in equities is that equity investing is for
the long term. After doing proper due diligence and investing, investors
should try to give at least 3-5 years for their investments to bear fruit.
©
Deepak Softworks
|