After opening a demat account to start investing in the stock market the first thing that comes to our mind is ‘which share I should buy now’. So the most important part for beginners in stock market is
- Selecting good stocks and
- Having a good trading or investing psychology.
There are various factors we have to look at in order to be profitable in the stock market. Let’s know about the first thing in this article that is how to select good stocks. To select good stocks we should follow the following few steps.
- Finding the trending sector or business
- Choose the leaders of that sector
- Check their business performance
- Check financial ratios
- A good management
- A good share holding pattern
- Long term chart
- Current valuation
- Check the technicals for short term goals
- Diversification
Finding the trending sector or business
Look at your surroundings and try to understand which business is trending and going to be in trend for at least 5 years. For example the medicine business was in demand during 2020 due to covid19, so pharma stocks were in good demand and gave a multi bagger return during this period but that trend couldn’t last long after decline in covid cases. But IT stocks are in demand because due to lock down, work from home and various other restrictions most of the companies & institutions develop online platforms to provide better service to customers and public. After being familiar with online services, now people are preferring this due to ease of doing various tasks online like online shopping, online payment, online study etc. So companies and institutions have to continue these online services and this will grow more in the future and for which they need help from IT consultants and companies. So the revenue of the IT companies may increase in the future also and this sector will be in trend for some more years. There are various other examples of trending sectors like Electric Vehicle, Renewable Energy etc. If we regularly follow business news or articles we could know which business is in trend in current market.
Choose the leaders of that sector
Look at which companies are doing well or have popularity in that sector. Mostly leaders of any sector often have more popularity and investing in those companies are less risky because most of the sector leaders are large cap stocks hence low volatile. To find the sector leader you can check in various financial websites to find stocks in different sectors and check whose market cap is largest. For example below is a list of Automobile companies from Screener.com website. We can check here their market cap, share price, financial ratios and many more details about the company and stock. From here we can choose some stocks and add them to our watch list.
Check their business performance
Then we have to check their business performance because all good companies may not generate good profits. So we have to check their financial performance. We may not understand all the financial terms in a company balance sheet but with some general knowledge we can understand if the company is profitable or not.
- First thing is to check its revenue should be growing.
- Then the operating profit must be growing.
- Net profit sometimes varies due to certain changes in taxation, interest payment etc. We have to check if the net profit is consistent and growing.
- Profit making companies should have good reserves and cash flow.
- Companies having huge debts have to pay a good amount of interest and loan repayment which affect their profitability. So debt free companies or with low debt are good for long term investment.
You can check company financials in Google search or you may check any financial websites like Moneycontrol, Tickertape, Screener etc. Read more here in this article about best mobile app & websites for stock market news and analysis in India.
Check important financial ratios
Most of the time we may be confused with these huge numbers. So to make analysis simpler we can check the financial ratios. But one thing we should remember that we have to compare the ratios with the sector or with other companies in that sector (that is peer comparison) for a better analysis.
Earnings per Share (EPS) is the net profit of the company per share. More EPS means the company is generating more profit.
Price to Earnings ratio (PE Ratio) this is the per share earnings of the company compared to its per share market price. Less PE shows the company is earning more compared to its share price.
Price to Book ratio (PB Ratio) shows the per share book value of the company compared to its per share price. Low PB shows the company is available at a good value.
Return on Capital Employed (ROCE) is how much return the company is generating compared to the capital it uses in business. Higher ROCE shows good profitability.
Return on Equity (ROE) is how much return the stock is generating compared to its total equity shares.
Compound Annual Growth Rate (CAGR) is the per year growth rate of the company. More CAGR shows higher growth.
Debt to Equity ratio is the total debt on the company compared to its total shareholders’ equity. Debt free company is good for investment but in case have some debts then Debt to equity less than 0.5 is good.
A good management
After financials we have to check the management and shareholders. Companies of reputed groups (Like TATA group or Reliance or Adani groups in India) are considered good because they are trustable and will not default so easily. But we could not find all companies with reputed management and as a retail investor we could not deeply analyze the management but we can check that there shouldn’t be any negative sentiment against the company management like fraud or court cases etc.
We can also analyze about the management from the past history of the company and how they have managed the company during difficult times like recessions etc. And is the company paying regular dividends, promoters are increasing their stake in the company or trying to exit, these are some thing which shows management’s trust on the business. We can also watch their interviews and management commentaries at the time of publishing quarterly results & annual general meetings, from where we could know about their future planning and growth prospects.
A good share holding pattern
Companies in which promoters have more than 50% shareholding is considered good because they have good control over the company and always try to make good profit because they will be benefited more. In which companies there are more holdings of Institutional Investors like Mutual funds, DIIs and FIIs are considered good because they have more analysis skills and powers than retailers. So if they trust any company then it is considered good. And most important is the promoter holding should not be pledged. Because pledging is also a debt and might be risky in case it defaults.
Long term chart
Then we have to check the past performance of the company in the stock market. Because market factor in everything. There may be some points we couldn’t know about the company but the market knows it and it will be reflected in its price movement. So first we have to look at its all time chart or at least 5 years chart. Just Google the Company name & write Share Price, it will show a lot of information including the chart. Select the Max or at least the 5yr chart. If it is in a growing manner or in a upward direction then we can say it a good company to invest in.
Sometimes charts are like highly up and down structures. These companies are considered as volatile in nature and might be risky. Some companies which are currently at 80% 90% lower than their highs are generally not good for investment because there must be some issues due to which they are running at such low price and most of them may be already bankrupt. Some newly listed companies where there is no chart of more than 5 years, we have to deeply analyze their fundamentals before investing.
Current valuation
At last we have to look at the price valuation of the company. Because buying a good company at a fair value is also important. To select a good price we need some technical analysis tools like Moving Averages, RSI, MACD etc. But if we don’t want to study all this then we can simply draw a trend line and buy when the stock is close to its trendline. For which we have to check the short term chart that may be 1 year or 6 months chart. Then draw a straight line which must be touching the maximum points of the lower parts of the chart.
That straight line could be considered as the trend line. We should buy when the trendline is in the upward direction and if the trend is in the downward direction then we may wait for a trend reversal and buy when the price starts to move upward.
Check the technicals for short term goals
If we want to invest for a short term goal, then we have to check the technicals thoroughly along with all these fundamentals. The shorter period we take to consider the more difficult is to calculate the price movement. Because there are a lot of factors which affect the price of a company in the short run but good companies with good fundamentals will definitely grow more in the long run. We have to learn the basic technical analysis tools and techniques, charts and chart patterns, indicators etc. for better analysis.
Diversification
Some other factors we have to keep in mind at the time of stock selection is diversification. There is a tale ‘never put all your eggs in one basket’.
Sometimes due to any internal causes like allegations, court cases or Govt fines against management etc. or external causes like any changes in Govt. policies or global situations, asset loss due to natural calamities etc. some stocks or sectors may not perform well for some times and we also could not perfectly predict how much time it will require to go out of it and make upward moves. So if we invest in a very limited number of stocks or in any specific sector stocks then our portfolio may show negative returns for a long time.
For example the Auto sector stocks saw a downfall from 2018 onwards due to tightening of Govt rules related to driving & licensing of vehicles. Now this sector is showing some upward move after 2020. So we should diversify our portfolio with various types of stocks from different sectors also in order to manage stock specific and sector specific risks.
Most important for beginners in the stock market
Most important thing to remember for beginners in the stock market is, short term trading is more risky and requires more skills & expertise, so you should focus on long term investment rather than losing money in Intraday and Futures & Options trading. After a few years when you gain a good knowledge and experience in the share market then you can decide to jump into trading if you want to do so at that time.
To know more about how to be profitable in stock markets you can check this post. If you like this post please share with your friends. Thanks for visiting our page.
Disclaimer : This article is based on our personal research, views and experiences. Anyone can differ from these views. This is for information and educational purposes only. Please do your own research and analysis before making any decision.
