January 8, 2015

Selecting Top Stocks to Buy - A Step by Step Process of Finding Multibagger Stocks

“Selecting Top Stocks to Buy” is a series of articles written by us in which we have touched upon various steps required to be taken before an investor decides about investing in stock of any company.

The series contains a few articles, each dealing with different aspect of stock selection ranging from attributes of a good stock investor to detailed analysis of companies. These articles, if read in sequence and implemented with diligence, would help any reader whether he is well verse with finance or not, develop a sound process of stock selection. However, each article is complete in itself. If a reader feels like going through a particular article out of turn, it would be perfectly fine, as it would help her get insights about the particular theme/step covered in that article. However, if you are new to stock markets and wish to learn stock investing holistically, I would recommend that you cover each article one by one in the sequence they are written.

Most of these articles have been compiled in the form of an e-book (pdf format). You may read more about the e-book and its feedback from the readers in the following article: “Peaceful Investing – A Simple Guide to Hassle-free Stock Investing

A step by step process to learn fundamental analysis to select multibagger stocks for long term investment, Learn Value Investing, Stock Investing, Equity Investing, book, investing books

List of Articles

Getting The Right Perspective Towards Investing

Given below is a brief summary of the topics covered in each of these articles.

I wish you all the best in your investing journey!

This article talks about the attributes that are required in a good stock investor:

  • Reading
  • Patience and emotional control

The article also throws light on certain prevalent myths about expectation from a good stock. Myths state that a stock investors need to have below mentioned qualities, which are in fact not needed:

  • A degree in finance
  • Knowledge of advanced mathematics.

Are Your Stocks Losing Money While The Market Is Going Up?

This article highlights the most common mistakes made by individual investors while investing in stock markets:

  • Misinterpreting Financial News Channels as a Reliable Source of Investment Information
  • Seeking Advice From the Wrong Advisor (TV Experts)
  • Letting Emotions Influence the Investment Decisions
  • Not Comprehending the Opportunity Cost of the Money

The article also explains the simple steps to avoid these most common mistakes:

  • Conducting Own Analysis before Buying any Stock
  • Regular Monitoring of Stocks in the Portfolio
  • Avoiding Emotions to Influence Investment Decision
  • Selecting a Good Advisor (if any)

This article explains features of different stock picking approaches being followed by stock market participants worldwide:

  • Fundamental Analysis
  • Technical Analysis

The article compares features of fundamental and technical analysis to help the reader make her choice between the two approaches.

The article explains different approaches under fundamental analysis:

  • Top-down approach & Bottom-up approach and
  • Growth investing & Value investing

Comparative analysis of top-down & bottom-up approaches and growth investing & value investing approaches is done to explain clarify pros & cons of each approach to readers. The article helps readers to pick up an approach suitable to her interests, time availability and effort requirements.

The article ends with the details of stock picking approach being followed by me: “bottom-up fundamental analysis approach in which I look for high growing companies available at attractive stock prices”. The article also provides reasons and thought process behind selection of the particular stock picking approach by me.

Why I Left Technical Analysis And Never Returned To It!

The article highlights the comparative features of fundamental investing vs technical investing and elaborates my reasons for leaving technical analysis and choosing fundamental analysis as my preferred approach of stock investing.

This part of the series elaborates the importance of filtering the universe of stocks before an investor decides to spend time analyzing any one of them in detail. The article highlights that on an average, any filter containing good selection parameters will screen out almost 99% of the companies available on stock exchanges. Therefore, the investor would have a manageable list of 1% of stocks, which she needs to study in further detail for selecting stocks for investment.

The article provides list of different sources available to investors for shortlisting stocks like print or electronic media, local market places and online stock screening tools.

The article provides a step-by-step demonstration of stock screener tool available at www.screener.in

This article explains the essentials of the framework to be followed while conducting detailed analysis of companies under different stock picking approaches available to an investor like technical analysis, fundamental analysis and within fundamental analysis, growth and value investing approaches.

The article briefly describes the steps I follow while doing detailed analysis of a company: financial, business & industry, management and valuation analysis.

The article is dedicated to help the reader understand the ultimate source of information about any company: its annual report.

It covers the various sources from where an investor can get the annual report of a company like company websites, stock exchange websites, financial websites or other paid sources.

The article explains different section of the annual report and the way an investor should interpret the information provided in respective section. Brief details about sections containing vital non-financial information about the company and its guidance like communication from promoters and senior management, director’s report, management & discussion analysis, qualifications of persons in charge of the company and report on corporate governance etc. has been covered.

The article explains to the reader about the important parts of the annual report, which contain vital financial information about the company like auditor’s report, balance sheet, profit & loss statement, cash flow statement, notes to financial statements and related party disclosures.

The article helps the reader gain an insight into the annual report and enables her to learn about different sections of the annual report to be referred to find out desired information.

The article covers in the step to be followed while doing in-depth financial analysis of a company. It explains in detail about different parameters, which an investor should use to access the financial health of the company and its business.

The parameters are segregated based on the analysis of financial statement concerned:

  • Analysis of profit & loss statement: sales growth, profitability, tax payouts and interest coverage
  • Analysis of balance sheet: debt to equity ratio and current ratio
  • Analysis of cash flow statement
  • Parameters using mix of P&L, B/S and cash flow statement: cumulative PAT vs cumulative CFO

The article demonstrates the financial analysis by using data of different companies being traded on Indian stock exchanges.

The article provides the threshold values of the eight parameters that an investor must analyse before concluding about financial status of any company.

The article is focused on the detailed valuation analysis of a company. It explains various parameters that should be analysed by an investor. The article elaborates:
  • P/E ratio
  • PEG ratio
  • Earnings yield
  • P/B ratio
  • Price to sales ratio
  • Dividend yield

The article provides the reader with threshold values of all the parameters that should be used by the investor while doing detailed valuation analysis of the company. The article also introduces an important concept of Margin of Safety to the reader.

3 Principles to Decide the Investable P/E Ratio of a Stock for Value Investors

This article is an attempt to help the reader tread on a guiding path to determine the right price i.e. P/E ratio to be paid for a stock. The article attempts to determine a few of the factors that influence the P/E ratio of the stock and tries to bring a some objectivity to the approach of determining the right P/E ratio that the investor might be willing to pay for the stock.

The article focuses on the key criteria that an investor should look at while deciding about the P/E ratio (premium or discount) that she may pay for any company. These criteria would help her in deciding about the maximum P/E that she may pay for a company, which she has initially bought at very attractive levels but the stock has now increased in price and P/E ratio. This would also help her in deciding her strategy for accumulating stocks which are already existing in her portfolio.

Hidden Risk of Investing in High P/E Stocks

The current article is an attempt to put in perspective the odds of success and the hidden risks that investors face while investing in high P/E stocks.

The article highlights that an investor should focus on finding fundamentally sound companies available at low P/E ratio and avoid buying companies with high P/E ratio. If an investor is able to follow this approach and find a handful of stocks over her lifetime, then she could expect to have the odds of the market turned in her favour. In this way, she can expect to generate significant wealth from stock markets without losing her peaceful sleep.

How to earn High Returns at Low Risk - Invest in Low P/E Stocks

This article highlights that stocks with high P/E ratio offer limited return with high risk. Stocks of companies with low P/E ratio offer potential of high returns at low risk.

The article also stresses that low P/E ratio should not be the only criteria for selecting a stock for buying. Investors should focus on finding a conservatively financed, fast growing company available at low P/E ratio. The company should be a fundamentally strong company, which is yet to be recognized by the market. It has to meet all the criteria of the checklist for buying a stock.

This article covers the tools that an investor can use for assessing the business & industry analysis of the company, in which she plans to invest.

Business & industry analysis is one of the most contentious areas where two persons rarely agree upon a common conclusion regarding the prospects of any company or sector. Therefore, the article helps the investor to prepare a framework within which she can analyse the company and arrive at a decision about the company.

The article tries to help the investor find out companies with sustainable business advantage (Moat) by using information available from secondary sources. I recognize that an individual investor does not have the time to access primary sources of information like visiting company stores, manufacturing plants, meeting its customers, suppliers, vendors etc. Hence, the article relies on secondary sources of information and uses various parameters & tools to find out superior companies depicting healthy year on year sales growth:
  • Comparison of sales growth with industry peers 
  • Increase in production capacity and sales volume
  • Conversion of sales growth into profits
  • Conversion of profits into cash
  • Creation of value for shareholders from the profits retained by the company

The current article is an attempt to elaborate on relevance of Industry P/E ratio in the stock analysis. The article also guides the readers on the importance and usage of Industry P/E ratio in selection of stocks for investing.

Management Assessment of a Company:

Detailed Version

This article focuses on the reasons why I believe that analysis management is the most important aspect of stock analysis. This article gives examples of various companies like Gujarat Automotive Gears Limited where the management has been taking the past, present and future profits of the company away from the minority shareholders.

In the second part, we discussed the following tools for management assessment:
  • Promoters’ background check
  • Promoters’ salary
  • Related party transaction

In the third part, we discussed the following tools for management assessment:
  • Warrants and their misuses
  • Management focused on the share price
  • Dividends funded by debt

In the fourth & the final part, we discussed the following tools for management assessment:

  • Accounting juggleries 
  • Competence 
  • Promoters’ faith in the business

Abridged Version

This article covers the most important, but often overlooked aspect of stock analysis: management analysis. The article segregates different parameters to be used for management analysis under subjective parameters and objective parameters.

Subjective parameters include:
  • Background check of promoters and directors
  • Management succession plans and salary being paid to potential successors
Objective parameters include:
  • Analysis of salary of promoters vs. net profits of the company
  • Project execution skills
  • Consistent increase in dividend payments
  • Promoter shareholding
  • Promoter buying the shares of company
  • Foreign institutional investors (FII) holding

Finding out whether a Company is Cooking its Books/Manipulating its Numbers

This articles aims to help readers in finding out various methods deployed by companies to manipulate their earnings, cash flows and balance sheet metrics. It helps the reader through the key parts of their disclosures, which could have directed a discerning reader to the gimmicks played by the management.

Analysing Credit Rating Report of A Company

This article highlights the benefits of reading a credit rating report of a company. The article discusses seven key benefits of reading credit rating reports:

  • Important Business Details and its Key Strengths & Weaknesses
  • A Glimpse into the Critical Confidential Information
  • Key Factors affecting Company's Performance including Key Risks that it might face going ahead
  • Another Independent Opinion apart from the Statutory Auditor, on the Company’s Financial Position
  • A Third Party Verification of Investor’s Analysis
  • Year on Year Credit Rating Movement: Good Proxy for the Performance
  • Rather than a Rating, it's the Movement of Credit Rating, which is More Important

Assessing "Margin of Safety" of a Stock

This article highlights the importance of one of the key parameters of stock investing: Margin of Safety. The article provides easy to use assessment tools to find out the margin of safety provided by any stock investment. The article discusses key sources of margin of safety for a stock:

  • Margin of Safety in the purchase price:
    • Earnings Yield being higher than 10 years bond (Government Securities) yield
  • Margin of Safety in the business of the company:
    • Self Sustainable Growth Rate (SSGR) being higher that current sales growth
    • Positive Free Cash Flow (FCF) post meeting entire capital expenditure

This article is a compilation of all the checklists, which have been described under detailed analysis of financial, valuation, business & industry and management aspects. This is a checklist which is would come very handy for any investor while doing stock analysis. 

You may share this article as a summation of all the learning of the entire series “Selecting Top Stocks to Buy”.

How To Analyze Operating Performance of Companies

This article contains a guide to 5 simple steps, which help an investor gauze the level of operating efficiency that a company has displayed in the past. Operating efficiency forms an important parameter to evaluate the performance of any new investment opportunity as well as for monitoring the ongoing performance of existing portfolio companies.

Analysis of operating performance helps an investor to differentiate a good performing stock which sound underlying business practices. If followed diligently, the steps shared in this article can help an investor in finding out the red flags of accounting  manipulations by unscrupulous companies.

I believe that analysis of a company on the parameters shared in this article is essential before an investor commits her hard-earned money to any stock.

Finding Self Sustainable Growth Rate (SSGR): a measure of Inherent Growth Potential of a Company

SSGR is the measure of the potential of a company to which it can grow in a debt-free manner. We notice that there are certain companies, which keep on growing with deploying funds from internal accruals whereas there are other companies, which regularly need to resort to alternate sources of funds like debt & additional equity to finance their cash-flow requirements. SSGR parameter helps us identify, whether any company has the ability to sustain its growth by using cash generated from its profits.

The article elaborates the method of SSGR calculation and its successful application on multiple companies belonging to diverse industries.

SSGR can serve as a useful guide and an additional parameter for stock selection for a fundamental investor.

How Many Stocks You Should Own in Your Portfolio

This article aims to highlight the need for having an appropriate number of stocks in an investors portfolio. The article guides an investor to decide the suitable number of stock for herself by explaining the lower and upper limits to the number of stock in a portfolio. The investor would be able to understand the benefits as well as pitfalls of increasing the number of constituent stocks in her portfolio.

How to Monitor Stocks in Your Portfolio

Monitoring of stocks in the portfolio is as important an exercise as the selection process. The current article guides an investor to the activities required to effectively monitor her portfolio by helping her delineate such activities under:
  • Ongoing monitoring
  • Quarterly monitoring
  • Annual monitoring
 Effective monitoring helps an investor to be on top of the stocks in her portfolio and avoid surprise development, which might lead to erosion of the wealth created by her carefully screened portfolio.

Understanding the Quarterly Results Filings of Companies

This article focuses on understanding the key information contained in the quarterly results published by companies and their interpretations. The articles is aimed at helping the reader to develop a framework in getting the critical information from quarterly filings within a short amount of time.

An investor should focus on the following key aspects while studying the quarterly results:

  1. Timing of results disclosure: delay in results disclosure should not be taken lightly
  2. Independent auditor’s review report: should be read for all the key comments
  3. Profit & loss account: focus more on the year till date (YTD) performance, next on the year on year (YoY) performance and least on the quarter on quarter (QoQ) performance
  4. Balance sheet: mandatorily do the funds flow analysis
  5. Shareholding pattern: analyse the change in promoters’ shareholding and pledge levels
  6. Notes to the results: read all the points in the notes carefully to understand developments related to key aspects of company’s developments.

Trading Diary of a Value Investor

The article highlights that an investor should develop a stock picking approach suitable to her with her own stock picking criteria and do valuation analysis before buying a stock. Once she develops the habit of analyzing each stock in detail before she invests her hard-earned money, she would be confident about her decision of buying any stock.

The hard work and time invested in analysis would help her maintain a stable view towards her stocks. She would not fall prey to emotions of fear & greed and would be able to think like a business owner and focus on long-term wealth creation. This would enable the investor to hold on to her stocks though out the times of distress and exuberance.

When to Sell a Stock 

In the end, it is important for an investor to differentiate between buying & holding a good investment and keeping a poorly performing stock with wishful thinking of seeing its revival. The investor should have a methodical approach to screen her portfolio and get rid of poor stocks so that her time & effort as well the hard-earned money is spent on fundamentally sound stock, which have the potential to create long-term wealth for her.

This article helps an investor with the guidelines to find out potential 'sell' candidates in her portfolio.

3 Guidelines for Selecting Stocks Ideal for Retail Equity Investors

This article talks about the key challenges faced by retail investors who have a daytime job and also explains the key advantages, which retail investors enjoy viz-a-viz institutional investors.

The article elaborates the ways in which retail investors can overcome their limitations and build upon the advantages available to them.

The article explains the key features that retail investors should look for in the stocks, which would be suitable for them considering the constraints faced by retail investors.

In future, I would be writing more articles about stock investing, monitoring and other aspects. Therefore, you may like the blog’s Facebook page, subscribe by email (in the field on top right edge of the blog) or follow the RSS feed so that you would immediately get to know when new articles are published on the blog. 

Please provide your feedback on the blog and this series as comments or you may contact me here.