Stock Picking: How to choose good quality stocks for long term investment

Identifying a good stock from the universe of listed stocks can be a difficult task for any investor. A wrong pick could bring your investment portfolio to ground levels.

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Wall Street had taken its cue from oil and recouped early losses on Wednesday, in a wild session that saw the Dow swing in a 420-point range. (Reuters)

Identifying a good stock from the universe of listed stocks can be a difficult task for any investor. A wrong pick could bring your investment portfolio to ground levels. To give an example, MMTC share price declined 96.55 per cent in the past five years. MMTC share price declined from Rs 1,290 on October 29, 2010 to Rs 44.45 on October 29, 2015. Similarly, share price of IVRCL, Opto Circuits, Lanco Infratech, Unitech and Bhushan Steel declined over 90 per cent duirng the same period.

Share price of Ajanta Pharma jumped 4876.49 per cent to Rs 1587.50 on October 29, 2015 from Rs 31.90 the same day five years ago. Likewise, La Opala RG and Marksans Pharma surged 3,814.95 per cent and 2,493.29 per cent during the same period.

Therfore, a thorough study of balance sheet, financial ratios, income statement and promoters background could guide you to pick quality stocks.

According to SMC Investments and Advisor there are certain methodologies, which an investor should consider in choosing the potential stocks. Below are six points listed by the brokerage house to find a quality stock.

1) Company Business model and promoters credential: At the first point it is very important to understand the business in which the company is working and at the same time look out for the factors that distinguish it from others in the same peer group. It is also important to give closer look to the management in terms of their ability and acumen to ascertain whether they have the ability and knowledge to take business to new heights.

2) Revenue: After getting a good understanding of the business one now needs to look into the revenues. That means whether the company is in the service business or in manufacturing it becomes imperative on the part of the investor to try and gauge how the company is clocking in revenues and it ability to growth them.

3) EBITDA: EBITDA reflects clear picture of the company’s operating profit. If the company has high operating profit, it means it has the potential to give good returns to the investors.

4) Debt/ Equity ratio: Debt/Equity Ratio measures a company’s financial leverage. If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing.

5) Earnings per share (EPS) and price multiples: Investors should always calculate the Trailing Twelve Months (TTM) basic EPS and revenue to calculate current Price to EPS (P/E) and Price to Sales (P/S) respectively of a stock. If the EPS of the company is performing significantly well, then one should consider investing in the stock.

6) To consider capital expenditure & structural changes: Investors should consider read the company website. The investors should go through the company so that he/she could get the recent announcements related to capital expenditure, structural changes in the company, other major management decisions, etc. He should also read the Chairman’s speech which gives the vision and expansion plans of the company.

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First published on: 31-10-2015 at 12:56 IST