How to Select Stocks for Investment? | Fundamental Analysis
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Whether you are a trader or an investor, the primary skill required in the stock market is selecting a Stock. Selecting the right stock for investment can bring fortunes and can also lead to losses.
There are a lot of other factors in investing however in this article we will learn about how to select a stock for investment?
The most important question that rings in every Investor's mind – How should one pick a stock for Investment? Or what criteria should be considered? What are the good stock-picking strategies?
This article outlines the approach on how to select stocks using fundamental analysis.
There are thousands of stocks listed, hundreds of ways of selecting stocks and tens of evaluating parameters to select therefrom. From such galaxy of permutations how to select that one stock? The best way to start with is through understanding how successful investors have done it consistently year after year and amassed huge wealth investing in stocks.
5 step approach for great stock picking
Crisp summary of the Warren Buffet way would act as an important guide to start with.
- Approach stock purchases as buying a business rather than just a stock purchase in the portfolio.
- Evaluate the true worth of the business considering the future earning potential
- The margin of safety is the real risk containment measure and not stop loss
- Turnaround seldom turns and therefore Invest in great businesses that are generating free cash flows
- Invest for the long term to generate inflation-adjusted superior returns.
So when one tries to answer the question of how to choose stocks to invest in, the moot question, therefore, is how to identify a great business and what all parameters should be used.
A practical example would throw open important insights. The company mentioned below has over a decade, growing its revenues and earnings consistently for the last 10 years, by far a huge task. Its Return on Equity (ROE) is staggering at around 30%, consistently, year after year. Such superior quality earnings are a great opportunity to invest. The debts are minimal and dividends are paid regularly. Stocks like this whether now or 5 or 10 years ago had the same kind of business strength and potential in the past and even today. These are the kind of wonderful businesses which Warren Buffet meant that has the wealth-creating potential. Whether it is bought 5 years ago or 10 years ago or are bought even now, these businesses have a high probability of delivering great returns even in the future too, based on the present and past track records. The example below makes a clear case of wonderful business in the present times, they will most likely be a wonderful business even in the future also.
“More profitable companies today tend to be more profitable companies tomorrow although it gets reflected in their future stock prices, the market systematically underestimates this today, making their shares a relative bargain.”– Warren Buffet
In the above example, ITC a consumer-oriented business model having strong brands which sustain bargaining power and helps to stay ahead of the competition. These are the kind of businesses one should invest. The compounded annual growth rate - CAGR in price appreciation is 20% including dividends, which is the rate of growth even Warren Buffet compounded his wealth for becoming the richest man. Thus selecting a great stock is no great a science, but following the above footsteps is.
Samco helps clients in a profound way by analysing every stock based on above footsteps and has assigned Samco Stock Ratings to every stock to make the life easy for the investors.
Samco Stock Ratings can act as the first point of fundamental analysis and help individuals on the process of how to choose stocks to invest in.
It is designed to help investors who have no information on how to do fundamental analysis in the Stock Market.
Samco Stock ratings, is a meticulously done study on almost every listed stock of NSE by studying annual reports and consolidated financial statements and scanning them objectively through the principles laid down by legendary investors, resulting into every stock being rated from AAA – AA – A – BBB – BB – B – CCC – CC – PENNY. Just like credit rating agencies rate the creditworthiness of the company, we have rated the business worthiness or the quality of the company. It’s like if every student gets a grade in the school for performance, why shouldn’t a stock be rated similarly if an objective set of rating parameters are available.
The rating can act as a guide or the second opinion on the stock, which the users can rely upon before deciding whether to buy or not to buy and it also, highlights the ideal conditions when the stock will outperform and underperform.
How Samco Stock Rating identifies and rates wealth-creating stocks?
Identifying wonderful companies with an established track record is the key philosophy on which the rating system is devised. Rather than evaluating the company based on just stock price movements, which by definition will fluctuate at all the times, instead one should analyze the character of the business. We at SAMCO have scanned the stocks objectively through the guiding torch of history’s greatest legendary investors by rating the stocks on 20 all encompassing vital business parameters, which effectively measures the underlying efficiency of business model, earnings growth and its quality, ability to generate free cash flow, constructive or destructive power of leverage, transparency and governance amongst several other parameters, each being rated on a scale of 1 to 10 culminating into a stock being rated on a weighted average basis and getting a ranking from AAA to PENNY stock. AAA or blue-chip stocks being the best in terms of wealth creation possibilities and Penny stock being the worst in terms of wealth-destroying.
[caption id="attachment_577" align="aligncenter" width="589"] SAMCO Stock Ratings - 6 Key Areas for Analysis[/caption]
Some important questions that every investor should ask before investing in a stock
- Does the business have the potential to grow?
- Is there a large market available for the goods/services of the business?
- Can the business withstand competition?
- Can the business generate 15% RoE consistently?
- Can the business grow its EPS at 15% consistently?
- Does the business have too much debt? Can it service its debt?
- Does the business generate free cash flows and are its earnings genuine?
- Does the promoter philosophy believe in wealth creation?
- Are too many of the promoters stocks pledged?
- Does the management allocate capital efficiently in business?
This is an indicative checklist for investors before picking stocks, however the same not exhaustive.
Time is a friend of wonderful business…….” Warren Buffett. We are sure that people associating with us shall always go for wonderful companies in their portfolio and overtime achieve an enormous amount of wealth in their lifetime. Welcome to the world of intelligent stock picking.
To begin investing with SAMCO, India's leading discount broker, open a free account today.