Pre-Requisites For Investing In Stocks
Before you start your investment journey, you’ll need a savings bank account, a Demat and trading account, and a device with an internet connection. There are host of trading platforms like IIFL, Upstox, Zerrodha but before choosing any platform do compare their charges and services like regular reports, analysis etc. Many people start investing in the stock market with expectations of becoming ‘Richie-rich’. Investing in the stock market has the potential to give huge rewards, but it comes with a risk.
But making decisions based on knowledge and research can reduce the risk significantly. But we advice don’t borrow for investing and try to pay off your high-interest debts before entering the market. Also make sure that you hive off the amount you are willing to invest after securing the funds you need for your basic necessities. And finally, they should keep some cash in hand to tackle emergencies.
How to Start Investing in 2023?
Step 1: Start with Known Companies
If you are a new investor then better start making note of the companies behind the products and services that you use. For example, the sim card that you use may be from Bharti Airtel, a debit card from HDFC Bank, Fevicol from Pidilite, paint from Asian Paints, the software in your office from TCS, coffee from Nestle, petrol from Bharat Petroleum Corporation, car from Tata Motors and so on.
Once you’ve made a list, find out if the company has been in existence for a long time. Check if you are satisfied with its products and services. Now search for the company’s name and quickly go through its website. This will help you to get a better understanding of its business. Then search for its share price and the latest news about it on Google and other portals like ET money, Moneycontrol etc.. This will give you insights into the latest developments in the company and the industry it operates.
Once you have skimmed through the information of say 10-15 companies on your list, it’s time to take a look at their fundamentals or key metrics before deciding whether to invest or not.
Step 2: Shortlist Companies Based On Good Fundamentals
Out of the 10-15 companies that you read about, let’s say that you liked the businesses of most of them. But, you are willing to invest in only the best. At this point, you have to shortlist companies with something called a 2-minute analysis. If the company is not fundamentally strong, then there is no point in spending more time diving deeper.
For starters, you can take help of websites like ETmoney, IIFL, Moneycontrol and other such publications to get knowledge about the company’s performance. Search for the name of the company and it will show you important ratios, revenue, profit, and other key metrics. Here’s what you should check:
- Revenue and Profit: Check if the revenue and profit of the company are increasing. The revenue is the income generated through business operations and the profit is the income left after deducting expenses. Screen these metrics on a year as well as a quarterly basis. If the revenue and profit show an increasing trend, it is a good sign.
- Earnings per share (EPS): EPS is the company’s net profit divided by the number of outstanding shares that it has. The higher a company’s EPS is, the better it is. If the EPS is also showing an increasing trend, it is a good sign.
- Debt-to-equity ratio: The debt-to-equity ratio is calculated by dividing a company’s total debt by its shareholder’s equity. It indicates the degree to which a company finances its operations by debt. In general, this ratio should be less than 1.0. However, it depends from industry to industry. For example, capital-intensive industries tend to have a debt-to-equity ratio higher than 1 as against a service oriented company like TCS where Debt to Equity should be less than 1.
- Price-to-earnings ratio (P/E) and Industry P/E: This ratio indicates if a company’s share price is expensive or not. It is read with the industry P/E. It compares a company’s share price to its earnings per share. For example, Tata Steel’s price-to-earnings ratio on February 02, 2023, was 5.20, while the price-to-earnings ratio of the industry that it belongs to was 11.39. This could mean that Tata Steel was undervalued as compared to its peers.
- Price-to-book Value: This ratio compares a company’s market valuation and book value. Book value is the total value of assets a company’s shareholders would get if the company was liquidated. Generally, companies with a price-to-book value under 1.0, are preferable, which indicates that Market Price of shares is equal to the book value. In addition, compare it with competitors and the industry average. The lower this ratio is, the better it is.
- Return on Equity (ROE): Return on equity measures a company’s profitability and how efficient it is at generating profits. Ideally, it should be greater than 20%. The higher the ROE, the better a company is at converting its equity into profits.
- Current Ratio: This ratio gauges a company’s ability to pay short-term obligations that are due within one year. It indicates the relationship between a company’s assets and liabilities. For example a company with a current ratio equal to five means that it has assets five times more than its liabilities. Ideal ratio is 2.
- Price to Sales ratio: This ratio compares a company’s stock price to its revenue. Generally, companies with a price-to-sales ratio under 1.0, are preferable. In addition, compare it with competitors and the industry average. The lower this ratio is, the better it is.
- Promoter’s stake: Unless it is a professionally managed company, the promoters’ stake is an important factor to check. An increase in the promoter’s stake is a good sign and vice versa. Promoters have the best knowledge about what is happening in the company. If they believe that the company will do well, they increase their stake. However, if they continuously sell large portions of their stake, it could be a red flag. Sometimes they sell small portions of their stake to start a new venture or for personal reasons, which may not be a major concern.
Step 3: Will People Still Be Using These Products And Services 10 Years From Now?
As compared to 20th Century, this 21st century things like buyers habits, new and new products or services comping up are changing rapidly and therefore it is very vital to check whether the company you are analyzing is dealing in such products or services which will be there after 10 years also.
Once you have identified companies that are fundamentally strong currently, it’s time to think if they will remain strong. Think if their products and services continue to be in demand years from now. For example, if a company is merely making locks and keys, their business might not exist a few years from now. Since People are already switching to card keys and biometric locks.
It will have to adapt to these trends without which its products and services might become obsolete. Companies making pen drives might not exist as people are switching to cloud storage.
On the other hand, don’t you think that people will continue to buy things like edibles and fast-moving consumer goods? They are necessities, have been around for years, and will continue to sell, going forward. People might buy these things online, instead of buying them from stores. Companies might update the ingredients and formula, but they will continue to exist. They will make money and reward their investors.
While there is a concept of making money in the short term, ace investors have mostly made money by holding on to stocks for the long term. The stock market tends to compound returns in the long term. So, invest in those companies that will exist even after 10 years or more.
Step 4: Find Out If The Company Has A MOAT
The concept of a ‘MOAT’ was popularized by Warren Buffet. In simple terms, refers to a business’s ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders. Some companies have a moat and they tend to become great investment opportunities.
For example, IRCTC has a monopoly when it comes to the rail network, in terms of booking tickets and catering services. No matter which app you use to book tickets, they are all redirected to IRCTC for booking e-tickets. Radhakishan Damani’s Dmart (Avenue Supermarts) has a low-pricing strategy making customers flock to Dmart instead of its competitors.
Another example is Maruti Suzuki which dominates the passenger vehicle market in India because of its cost advantage. The company sells cars at a low price, such that most of its competitors cannot match it. This works well in the Indian market where a majority of customers are price sensitive.
Step 5: Debt Situation
Debt is one of those ways by which companies borrow funds at a lower cost as compared to equity. It gives them financial leverage. However, too much debt can prove to be bad. It is like a hole in a boat, that causes it to sink. Mighty companies have had to shut down because of unmanageable debt.
In general, many investors do not invest in companies that have very high debt. Check if their debt-to-equity ratio is ideal. Further, the company’s balance sheet will have information about its debt. In the case of banks, where borrowing and lending is the normal course of business, check for non-performing assets (NPAs) and avoid investing in banks that have high NPAs.
Step 6: Quality of Management
The management of a company can make or break it. Look at the qualification and experience of key people in a company like the CEO, CFO, MD, and so on. Find records of their performance. Important details about a company’s management are often found in its annual reports, website, and news. Then, go through the company’s vision, mission, and value statement. These statements communicate the company’s purpose and help investors understand the management’s plans for the company.
Another important factor to notice is the tenure of the management. If the top management of the company has served a long term and has led to steady growth in the company, it is a good sign. Transparency is another major factor. Good management explains reasons for poor performance with honesty and without manipulations.
Do not forget to check if the company provides good working conditions and perquisites to its employees. When employees are treated well, they propel the company to achieve success. However, frequent strikes, lockdowns, and union demands indicate that the management is not fulfilling the employees’ needs.
In Closing
We hope that to start with your investing journey, above mentioned points will help you in choosing a good share for your portfolio. But at the end we would request you to focus on staying invested for longer period as in short term markets are always volatile and may give you losses but if you have fundamentally strong shares in your basket then eventually you will gain.
