How to determine which stocks to buy?

How to determine which stocks to buy?

It is common knowledge that stock investing is the way to beat inflation and earn higher than average returns over the long term. Once you have decided to test the waters and invest your hard-earned money in stocks, the question is, which stocks to buy? The good news is, you don’t have to be an online trading or stock trading expert to start investing. Let us look at a simple framework to start stock picking.

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Know Thyself:

Like every other area in life, even stock investing requires you to know your goals, risk appetite and time horizon clearly. If you can stomach high volatility, new age businesses or mid-caps are your picks. If you are looking for regular dividend income, then you can invest in stable stocks with high dividend yield. Large-cap blue chips are less volatile and are suitable for long-term growth in your portfolio.

Promoters and Management:

Quality of management and promoters hold value for the future of the business and company’s management. Promoters’ stake in the business is another indicator of their belief in the company and skin in the game. You can find out more about a company’s management through annual reports and websites.

Business Model:

A company’s business model, market potential, segment growth opportunities and unique business proposition indicate the robustness of future earnings. The brand value of the company’s products and market share provide a glimpse into its standing against competitors.

You can learn more about a company’s unique competitive advantage from market reports, media and customers. 

Sound Financials:

As a stock investor you must recognise metrics like revenue, debt, earnings, cash flow, profit growth, earnings per share of a company to analyse its financial strength and stability.

Let us look at some of the ratios and metrics used to understand a stock’s health:

P/E Ratio: It shows the price an investor is paying for each rupee of earning. You must compare the current P/E with the stock’s historic P/E, industry average & competition’s P/E, to check if the stock is overpriced.

Price to Book Value: The P/BV ratio compares market price of a stock to its book value. If it is less than one, it shows undervalued stock. Again, you must compare the ratio with that of industry players.

Debt to Equity Ratio: This ratio shows how much debt the company has taken compared to owner’s equity. Higher leverage compared to peers indicates default or business risk. Some industries are capital intensive; therefore, you should not look at this ratio in isolation, but among sector-specific stocks.

Current Ratio: It shows how the current assets of the company cover the current liabilities. You must be cautious if this ratio is less than one.

Earnings Per Share: EPS trend indicates company’s profitability over a period of time. The higher the EPS, the better the performance.

Interest Coverage Ratio: This ratio tells you about the solvency of the company and its ability to repay the interest on debt.

All Weather Stocks:

There are certain industries which bear the impact of an uncertain economic environment, industry trends, or cyclical events more than other industries. For example, travel, airlines, automobiles are impacted by government policies, recession, fuel prices etc. It is safer to invest in stocks that fulfil an inherent market need e.g. food, infrastructure, healthcare and not impacted by cyclical or external factors.

Knowledge and stock research will help you make informed decisions and will make you confident with online trading and stock market investments.

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