It’s continuously vital to pay time in knowing an organization, its business, money health and prospects. however does one have the time, resources and energy to check concerning 1,400 firms listed on the National Stock Exchange (NSE) and concerning 4,900 on the Bombay Stock Exchange (BSE) before choosing the one to invest?
If these numbers cause you to uncomfortable, sample these: the market capitalisation of those firms ranges from some lakhs to over Rs a 2 lakh crore and therefore the costs of shares from less than a rupee to over Rs 12,000 per share.
So, how and where does one build a start? we tend to offer you seven basic screening criteria, which is able to assist you shortlist firms that are value researching within the 1st place.
1. Is the company’s market cap more than Rs 250 crore (Rs 2.50 billion)?
Setting a minimum market cap floor extremely helps — it eliminates terribly little firms, or penny stocks. Generally, little firms have a tiny low revenue base and that they don’t pay an excessive amount of on investor relations. This makes tracking them troublesome. At Outlook cash, we don’t look into firms that have a market cap of less than Rs 250 crore. regarding five hundred firms at NSE pass this criteria.
2. Are the company’s trading volumes high?
The company ought to have an reasonable trading volume — a minimum of some thousand shares per day. If you get into a stock that has low volume, it will become tough to induce out when the markets fall. Each rise and fall is sharp in stocks with low volume. Also, the impact price is high.
3. Does the company make quality disclosures?
The company should have good quality disclosures. This is an easy test. All you have to do is visit the company website and see press releases and results for the last few quarters. In the results part, you need not get into numbers in detail as of now, but do see how the developments of last quarter have been explained.
For example, see if cost has increased, or margins have declined, and whether there is an explanation for it.
Large companies, especially in the information technology sector, are generally good at this. Tata Consultancy Services [Get Quote], India’s largest IT company by revenue, has a transcript of analyst conference call on its website, which possibly answers all the questions that investors have.
Availability of information makes tracking easy and decision-making becomes quicker while you are invested in the company.
4. Does the company have operating profits?
Sometimes, firms raise cash from the equity markets in their initial stages and hope to cover the costs by generating profits from operations later. Actually, they are in a very stage once they pay cash for, say, fitting plants, or research and development facilities.
These businesses sound exciting, however will be risky. it’s advisable to avoid such firms. New projects involve plenty of regulatory approvals and may get delayed, which might escalate value. Also, stock costs of such firms are the primary to fall throughout any broader market correction, as there aren’t any earnings to support the costs.
This is specifically what happened with Reliance Power, that doesn’t have any of its plants in operation. Its public issue got heavily oversubscribed (73 times) owing to general euphoria within the market, however sentiments modified between issue and listing. the issue went on to become one in every of the most important disasters within the markets.
Therefore, it’s continually safer to be in firms that generate profits from their operations.
5. Does the company generate constant cash flows?
At times, fast-growing firms could show profits while not generating money. These firms are in their expansion stage. They need to get money eventually and create value for the shareholders.
Companies with a negative money flow could got to get further capital, either through debt or equity. Debt can increase the danger whereas equity can dilute the earnings, which is able to get mirrored within the share prices also.
6. Is its return to equity (RTE) constantly above 10 per cent?
RTE is that the profit a company generates with the shareholders’ cash and is calculated by dividing net profits with shareholders’ equity. It indicates how well a company has deployed investors’ cash.
The RTE is usually low in case of manufacturing companies and is higher for services corporations because the value of setting infrastructure is low in services companies. Use ten per cent because the minimum limit for companies to qualify. There are almost four hundred companies listed on NSE with a market cap on top of Rs 250 crore that generated return on equity on above ten per cent within the financial year 2007-08.
7. Is the earnings growth constant or cyclical?
Cyclical earnings implies that profits move up or down depending on the business cycle. Businesses generally move in cycles.
This is commonly seen in commodity companies, where a shortage or sudden rise in demand helps prices to move up, resulting in super normal profits for a while. Sugar is a classic example of cyclical earnings.
Bajaj Hindustan , the largest sugar company in India, saw its share prices soaring from Rs 200 in November 2005 to Rs 550 in April 2006 on the back of rising sugar prices; net sales for the company went up Rs 394 crore (Rs 3.94 billion) in the March 2006 quarter compared to Rs 282 crore (Rs 2.82 billion) in the September 2005 quarter.
But by the end of the December quarter, net sales went down to Rs 286.64 crore (Rs 2.86 billion) and the share price to Rs 140. The biggest risk in investing in cyclical or commodity stocks is that you could enter at the wrong time.
Once the cycle is reversed, it becomes difficult to get out. Commodity prices are interlinked globally, and any demand-supply mismatch in one corner of the world can disturb prices all over.
Companies in the pharma and FMCG space have stable growth in the long term as demand in these sectors depends on the business cycle and macroeconomic movements. The services sector also has stable earnings growth compared to commodity stocks.
If you carry out these seven checks, you will, by and large, be able to eliminate companies that are not worth investing. However, investors must note that these conditions are not fool-proof and there can always be exceptions.