Secret Sauce for Stock Picking

images (4) 1. Business – The first and the foremost thing a person should know before investing is to understand the business of the company. What the company is all about! You should know about all the products of the company , how it makes them and the risk associated with the products in terms of fluctuation in the prices of raw materials. You should check whether the company has any subsidiary, its performance and the business of the same. Check whether the company has any export business and how much it contributes to the overall turnover of the company.

2. Industry – Now you should see the industry to which the company belongs. How has the industry fared in the past, its present scenario and future growth prospects. Do a Porter 5 forces analysis which will give you a sense of the overall competitiveness of the industry, threat of new entrants etc. You should compare the growth of the company with the growth of the industry to assess how has the company performed. Check for the headwinds, the company has been facing like government intervention in the pricing of products, sluggish growth in demand etc. Find out where the company stands in the industry in terms of market share.

3. Moat/Competitive Advantage – A company can continue to give you handsome returns in the long run if there is something unique in it. You should check for that. What is the company’s USP or how can it get a competitive edge over its peer, be it in terms of the margins of the company , a unique product profile or some new innovations to cater to the requirements of the customers. By being a market leader in its industry, the company will get a command over others in terms of pricing power, getting a strong clientele base etc.

4. Corporate Governance – A company although a seperate entity cannot run itself and thus is dependent on the management. Before investing you must, I repeat, must check the management of the company which includes it’s directors, promoters and the key managerial persons (CFO, CEO etc.). A company must have adequate independent directors which, having a strong corporate background. These directors keep a strong eye on the management thereby preventing any misuse of the shareholders money. A company has a good management if it honours its previous promises.
For example – Management has committed in 2015 that they will expand their capacity by 50% in three years and in 2018 company has actually achieved it.

5. Top Line and Bottom Line – Top line refers to the revenue of the company. Invest only in those companies which have witnessed a continuous growth in their revenue. Also watch out for the pace of the growth.if the company’s sales are increasing at an increasing rate then you have found a gem. Coming to bottom line, it represents the net profit of the company. The company’s profit should accompany it’s revenue growth. Always look out for companies whose profit growth is higher than its revenue growth. It is a signal of increasing profitablity. This duo is present in every successful organisation.

6. Cash Flow – One of the most important financial statement of a business. It is divine into three parts Cash Flow from Operations,from Investing and from Financing. Your company must have positive cash flow from operations. To be specific the company’s cash flow from operations should be in line with the company’s net profit or above it. Cash flow from operations reveals how much cash tha company is actually earning from its business. You must never choose a company that has a history of negative cash flow from operations, even though it may have an outstanding net profit.

7.Valuation – In simple terms it means whether the company is cheap or expensive to buy. A company may be qualifying every parameter but is available at an expense price. To check valuation, you should check the company’s price/earnings ratio or P/E ratio. It reflects how much you are paying for the company to earn one ruppee of profit. There is no such universal parameter of P/E as it varies from industry to industry, so one should compare the company’s with the industry’s P/E. Look for companies that have their P/E lower than that of the industry. This is a signal that company is currently undervalued and it is a good price to include it in your portfolio.

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