Shortlisting Companies for Detailed Analysis

Modified: 04-Jul-20

The current article in this series, aims to highlight the necessity of shortlisting a few companies for detailed analysis, out of the thousands of companies available to an investor. We would also learn about various tools, which an investor can use for shortlisting these companies.

 

Why Shortlisting of Companies is Necessary?

At April 18, 2020, there are 8,484 stocks listed on Bombay Stock Exchange. Each of these stocks represents a company running a unique business. Business of each of these companies is different from all the other companies whether they are from the same or different industries.

For example, a pharmaceutical company will have a business entirely different from a telecom company. Moreover, within the pharmaceutical companies, a company selling its products in Indian market will have a very different business from another company, which sells its products in overseas markets. Among pharmaceutical companies, which focus on overseas markets, a company, which sells its products in US & other developed countries will have a different business than the company, which sells its products in Africa & other developing countries.Therefore, investing in any company will expose an investor to a business that would be very different from investing in any other company.

Therefore, investing in stocks of one company will produce very different results than investing in stocks of any other company. Therefore, it is suggested that an investor must be very particular about choosing the companies in which she invests her hard-earned money.

An investor should analyze a company in detail before adding it to her portfolio. However, it is very difficult for any investor to analyze all the companies available for investment. Their number stands at 8,484 today and is expected to increase in future. Therefore, every investor should use a process for filtering out all the companies that do not meet her requirements. She should then focus on the remaining companies to find out the companies, which she feels are the best. Such companies will prove to be great investment opportunities for her.

The process of shortlisting companies is necessary so that an investor can focus her limited time and effort on a few targeted companies. Shortlisting companies before analysis helps an investor get maximum benefit out of her effort.

 

Different methods for shortlisting companies for detailed analysis:

There are many different methods used by investors to shortlist companies for analysis. Some of the common methods are described below:

  • Magazines: There are many magazines that are focused on stock markets e.g. Dalal Street, Capital Markets etc. These magazines regularly publish many articles with basic analysis of companies. If an investor reads these magazines regularly, she can select the companies mentioned in these magazines, which she likes, for detailed analysis. However, an investor should not invest in any company just because it is recommended by these magazines. These magazines should serve merely as a source to select stocks for detailed analysis. Final decision should always be based on investor’s own analysis.
  • Newspapers:  Similar to magazines, many newspapers have business sections and publish stories about different companies. If an investor likes any company based on a news article, she should analyze it further in detail, before making investment decision.
  • Television: Many TV channels have special programs, which give coverage to growing companies. Such programs present good analysis of company’s history, its brands, its customers etc. They also feature interviews with the company’s management. These programs can be a good source of information for selecting companies for detailed analysis.

However, all these methods, which use mainstream media to shortlist companies have a limitation. Mainstream media usually covers those companies, which are famous and the market has already recognized the value of their stocks. Therefore, stocks of such companies usually sell at a premium and potential for future price increase is generally limited.

Therefore, many investors try to use sources where they can find companies, which have potential for high growth in their business and whose stocks are not yet recognized by the markets. Some of such methods are mentioned below:

  • Local Marketplace: Many investors try to find companies suitable for investment by focusing on bestselling products in the local markets. They visit malls, shops etc. to find out about the most selling products and the shops that sell them. One of the successful investors, Peter Lynch, has written that he had taken many investment ideas by observing the products bought by his wife and children. If an investor decides to follow this approach, she should find out whether the companies, which make the highly demanded products, are available for investment on any stock exchange. If yes, then she should analyze these companies in detail. This approach is best for identifying companies in consumer goods industries.
  • Online Stock Screeners: Stock screeners are tools provided by different websites, which allow investors to search for companies that meet their investment criteria. Once an investor mentions her stock picking criteria, these websites show her a list of companies meeting her search criteria. Then, the investor can analyze these companies further. An investor should select her stock picking criteria based on the investment approach that she finds suitable to her as detailed in the part 2 of this series.

 

My Method of shortlisting companies for detailed analysis

I follow a bottom-up fundamental analysis approach in which I look for high growing companies available at attractive stock prices. After reading books of successful investors and based on personal experience in stock investing, I have prepared a list of stock picking criteria. These criteria can be used with the stock screening tools of different websites. These criteria help me in shortlisting companies for detailed analysis, which are growing fast but are yet to become famous.

I am confident that at the end of this series of articles “Selecting Top Stocks to Buy”, all the readers would be able to make their own stock picking criteria, which would help them select stocks based on their stock picking approach. Such criteria would reflect the personal approach of every reader and will help her proceed on her stock investing journey.

Online Stock Screeners available to Investors:

Once an investor has formed her stock picking criteria, all she needs is a tool for searching companies based on these criteria. Now a day, there are many websites, which offer online tools to investors for shortlisting companies based on their criteria. These websites are paid as well as free ones:

Paid websites offer more features than the free websites. However, an investor should consider paid websites only if she has a very large portfolio. Free websites are good enough to meet analysis requirements of an individual investor. I believe that if an investor’s portfolio is smaller than INR 10 cr, then she should not use paid websites, as annual charges of paid websites would be a significant cost to her portfolio.

My favorite online stock screening tool is www.screener.in. It is a very simple to use website. It has very elaborate instructions for helping the first time uses.

I have given below a few screenshots demonstrating the step-by-step approach for using its stock screener. I have used a sample set of stock picking criteria for this demonstration.

 

Demonstration:

Stock Screening Criteria

In the above screen, I have searched for companies where:

  1. Sales have grown by a compounded annual growth rate (CAGR) of at least 10% for last 10 years.
  2. Net profit have grown by a compounded annual growth rate (CAGR) of at least 10% for last 10 years.
  3. Debt to Equity ratio is less than 1 and
  4. Cash generated from operation is positive

Once an investor clicks on “Run this screen”, the website will provide her with a list of companies whose stocks meet the criteria specified above.

Stock Screening Output

One can see that there are 152 companies out of the total more than 8,484 companies, which meet the sample shortlisting criteria. An investor would notice that 152 companies is still a large number and it would be very time consuming to analyse these companies in detail. Therefore, an investor can further tighten her screening parameters to reduce the size of the filtered list. For example, increase the sales growth parameter to 15% and net profit growth parameter to 30%:

  1. Sales have grown by a compounded annual growth rate (CAGR) of at least 15% for last 10 years.
  2. Net profit have grown by a compounded annual growth rate (CAGR) of at least 30% for last 10 years.
  3. Debt to Equity ratio is less than 1 and
  4. Cash generated from operation is positive

Stock Screening Criteria Tightened

An investor would now notice that on tightening the criteria, the number of filtered stocks has come down to 34, which is a manageable number of stocks to start the analysis.

Stock Screening Output Tightened Criteria

Now an investor can focus her time & effort on analysis of these 34 companies and ignore the balance 8,450 companies.

Whenever an investor believes that her search criteria are not giving her a reasonable number of filtered stocks, then she should tweak her criteria. If the number of stocks on initial search is very high, like in the above example, then she may tighten the parameters. On the contrary, if the list of filtered stocks on initial search is very low, then she may relax the parameters.

The aim of screening process as a starting point of investor’s analysis process is to provide a short and manageable list of companies where the investor will do the detailed analysis.

*Please note that the screening process is to shortlist stocks for futher detailed analysis. The screening process is not to simply pick up stocks from the list and invest money straightaway.

An investor can now click on each company’s name to find out more details about each company in the search results.

Company Snapshot:

Graphite India Ltd Key Ratios Dashboard Screener

Profit & Loss details for last 10 years:

Graphite India Profit And Loss Statement

Balance Sheet details for last 10 years:

Graphite India Ltd Balance Sheet

Cash flows details for last 10 years:

Graphite India Cash Flow Statement

Thus, we can see that now a day, some very useful tools for information on stocks & companies are available to every investor. Stock selection is no longer a field reserved for only a few big investors. Any common investor, including you and me, can search for great companies and analyze them in detail.

In current era, to become a successful investor, all we need is the right approach towards stock investing, some amount of hard work and an internet connection!

 

Answers to Investors’ Queries

CAGR or “year on year” growth rates

Hello doc sir one question comes in my mind after reading ur article about analysis of stocks, while looking sales growth or NPM, you are saying that one should look at CAGR of last 7 to 10 years, so I want ask whether I have to look year by year like if I look sales growth year by year then it’s not above 15 % in all the years, which is your criteria but the CAGR of sales growth is 25%.

So what should we see, Sir? Each year or only CAGR?

Similarly, if we see NPM, then the CAGR might be there above 8%, however, year on year, it might be sometimes 3 % and sometimes 4%. Please clarify. Thanks a lot.

I am a small investor and a new learner. Now days, I am reading your blog sir and some queries have come to my mind so please don’t mind to help me to learning process. thanks.

Author’s Response:

Hi,

Thanks for writing to me!

Year on year performance is expected to vary significantly as the business environment keeps on changing year on year. Therefore, an investor should primarily focus on CAGR, however, she should also take care that the entire CAGR should not be because of abnormal growth in any one or two years.

Read: Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Using Sales Growth as a Screening / Shortlisting Criteria

Hello sir,

I have attended your workshop in Mumbai and I must say it was one of best class I have ever attended.

I have many doubt sir, which I encountered after returning home. I will send you my query one by one.

Right now, my doubt is related to sales growth. Sir, is it necessary to keep sales growth > 15% for past 10 years or range of 12-15% is also enough.

Author’s Response:

Hi,

Thanks for writing to me! I am happy that you found the workshop valuable.

Choosing the criteria for selection of stocks is purely an investor’s prerogative. I would prefer the growth rate to be as high as possible unless it crosses >30% at the level the growth rates become a bit unsustainable in the long run. However, if an investor believes that a company that she has found has all other good parameters in place and is growing within 12-15% range, then she may go ahead with that company.

Read: How to do Business Analysis of Companies

You may ask any of your queries here.

All the best for your investing journey!

Regards

Vijay

 

Which parameters should be focused while screening stocks?

Dear sir,

Your post & blog is very useful to all learners of fundamental stock investing. I want to know, as a learner when I scan stocks in Screener, which critical parameters should be focused like p/e ,debt to profit, debt to equity, PB x PE etc.

Author’s Response:

Thanks for your feedback! I am happy that you liked the article and the website.

Before using the stock filtering feature of screener, you need to decide what parameters of the stocks that you consider, are the best indicators for a fundamentally good stock. Once you have identified those parameters, then you can set the objective values in the filtering tool of screener to find out the stocks that meet your parameters. Such objective parameters can be PE, D/E etc. as mentioned by you.

I have written dedicated articles on the website about financial analysis, valuation analysis, business analysis and management analysis. In each of these articles, I have explained the vital parameters to judge the fundamental position of any company. Many of these parameters are objective in nature where an investor can assign a threshold value like P/E <10, D/e <0.5, sales growth rate >15% etc.

You can find a compiled list containing all these parameters at a single page here:

Final Checklist for Buying Stocks

Ideally, I would prefer to invest a stock which meets all the parameters. So I would set filter levels at the threshold value of each of these parameters and then analyse the resultant stocks presented by screener.

You should go through the articles on “Selecting Top Stocks To Buy” and you would find detailed step by step process about the way an investor should approach stock investing.

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

I believe that the links I have shared above would give you a good insight about stock selection. Take your time to understand each concept discussed in these articles. I am sure by the time you would finish reading them, you would have decided your own checklist of parameters.

Regards,

P.S.

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