Equity investing: Five factors that determine a winning stock
January 26, 2021 3:15 AM
Earnings potential, competition dynamics, uniqueness, management and innovation patterns help in identifying whether a company is suitable for investment in the long term
Let us discuss some of the important parameters that should be considered by every investor while selecting a stock.
By P Saravanan & Manas Mayur
As the Indian stock market indices touch new highs, many investors have one major question in their mind—whether they should buy more shares or wait. One of the keys to becoming a successful investor in the market is selection of right stocks. Let us discuss some of the important parameters that should be considered by every investor while selecting a stock.
Earnings potential It is essential that investors check whether the products / services of the companies whose stocks they propose to buy, have the potential to increase its revenue in the future. Revenue can increase only when the demand for the products / services is there for a very long time. Therefore, it is important to evaluate and ensure that the products/services of the company that you plan to invest are not going to be redundant very soon. Accordingly, pick stocks that have great earning potential in the future.
Competition dynamics Investors should also pay attention to competition dynamics in the sectors that they propose to invest. One should prefer sectors wherein the scope of any new competitor is relatively difficult. Companies in sectors where huge upfront investments are required and there are higher switching costs for their products or services can be a safe bet for the future. For instance, the auto segment requires significant initial investment upfront and continuous research and development cost, which generally does not enthuse any new competition.
Uniqueness Investors should check what is the uniqueness of the company where they want to invest. The company can enjoy sustainable earnings if its products or services are not challenged. The uniqueness could be of a perceived quality which cannot be matched by its competitors. It could be trust and or post sales experience or reputation built through positive experiences, etc. Sometimes products in the market are identified by their brands, either because the company was the first to introduce such a product or because of a long period of advertising, and therefore in the consumer’s mind there is no replacement for them.
Management It is very important to assess parameters such as who are the promoters of the company, their shareholding and active involvement in managing the affairs of the company. Generally, when the promoters hold significant shares and keep on increasing their stake, it is a good signal for the investors. Any notable decrease in promoter’s stake can be seen as a red signal. Further, how actively they are involved in key managerial policies of the company should be observed through the financial reports and communications from the company.
Innovation Consumer preferences and expectations are evolving and difficult to predict. Therefore, it is important for the companies to continuously improve and innovate their products. Investors must evaluate whether the company is spending enough resources on research and development, launching new products as per the requirements of the customers, brand building through advertisements or not. Though these expenses may not guarantee the success of the products in the future, investors can look at the past records of the successes of every new product launched.
While the above parameters are not exhaustive, they can certainly help in identifying good companies suitable for investment in the long term.
Check if the products/ services of the firm have the potential to increase revenue
Go for sectors where the entry of a rival is difficult
Check the uniqueness of the company or its products
Know if promoters are increasing their shareholding and are actively involved in managing the company
Check if the firm is spending on R&D, launching new products as per needs of consumers
P Saravanan is professor of finance & accounting, IIM Tiruchirappalli. Manas Mayur is associate professor, Goa Institute of Management