Got excited by the bull run? 10 questions you must ask before buying a stock

By: |
Published: June 14, 2017 10:41:06 AM

Making money in the equity markets is not a child's play and requires a great deal of research, patience and discipline. You, therefore, need to be careful while buying a stock.

Market, BSE Sensex, Nifty, Kerala, North East, Sun Pharma, Tech Mahindra, RelianceThe lure of big money has often thrown investors into the lap of stock markets.

Stock markets are currently hovering around their all-time high and whenever the bull run continues, investors’ equity appetite increases. Otherwise also, the lure of big money has often thrown investors into the lap of stock markets. However, making money in the equity markets is not a child’s play and requires a great deal of research, patience and discipline. You also need to ask lots of questions to be sure enough that you are investing in the right stock.

Here’re 10 queries which you should ask for your satisfaction before buying a stock:

1) Size of Opportunity: What is the size of opportunity that the company is operating into? If the potential is huge and the pie is increasing at a reasonable pace, then that sector has to be selected for further identifying the best company to own. The first test, therefore, is identifying the size of opportunity.

2) Competition Risk: What is the competition risk in the industry in which the company operates. “Companies should be selected keeping in mind the overall industry competition and entry barriers. Companies operating in an industry with a weak competitive environment with high entry barriers should be preferred to companies operating in a highly competitive environment with low entry barriers. (So as to remain certain that the company is in a position to retain/grow its market share),” says Umesh Mehta, Head of Research, SAMCO Securities.

3) Regulatory Risks: What is the nature and extent of regulatory risks faced by the industry in which the company operates. Companies should be selected from an industry which enjoys low interference from regulatory authorities than from an industry which is highly regulated.

4) Growth Rate: By what rate have the sales and profits of the company increased in the past and by what rate is it expected to increase in the foreseeable future. “Companies showing a high growth rate and high growth potential should be identified and selected while companies with negative earnings growth should be avoided. Ideally 20% is the standard benchmark,” says Mehta.

5) Dividend Payout Ratio: What is the quality of earnings of the company? This aspect is embedded in the quantum and consistency of the amount of dividends paid by the company to its shareholders. Companies with a consistent dividend payout ratio of over 50% should be identified and preferred while companies with a poor payout ratio of less than 10% can be avoided.

6) Debt Position: What is the debt position of the company? Companies operating without the burden of debt or with minimal debt burden should be preferred over highly-leveraged companies. “Ideally 1:2 is the upper limit for a prudent business to model to survive and grow. Debt equity ratio higher than 1:2 becomes a risky business to invest,” says Mehta.

7) Employment of Capital: How efficiently has the capital been employed by the company? Companies which have efficiently employed their capital will have a high return on capital employed in contrast to companies which have been ineffective in employing its capital which will have a low RoCE. Ideally ratio higher than 18% should be preferred for investment.

8) Promoters’ Holding: What is the position of the promoters’ holding in the company? “Companies with minimal pledging of promoters’ holding shall be identified and preferred over companies in which a majority of the promoters’ holding is pledged. (High pledging of promoters’ holding shows doubts regarding the management of the company with the lenders and anytime the shares may be sold off in the market, causing a downward spiral in the stock prices),” informs Mehta.

9) Funding Growth of Company: Whether the company requires constant growth capital to grow or internal cash generations are sufficient to fund the growth for the company? If constant dilution is required, then the existing minority shareholders will be a long-term disadvantage as the earnings will be regularly diluted.

10) Price Above 200-Day Moving Average: Whether prices are above the 200-day moving average, then it can be presumed that the company is doing good and the fundamentals are being discounted in the price and there is no hidden factor or event or insider selling which is or will damage the future prospects of the company. Price above 200 average gives a safety net to the investor.

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Next Stories
1Are non-income tax payers required to link Aadhaar with PAN? Find out here
2Mutual funds: Why debt funds are better than bank fixed deposits
33 Stock market lessons from current bull run: Stick to goals, time horizon, liquidity needs