Generally people want to invest in the stock market, but don’t know how to do it. Here are 10 things you must know before buying a stock.
By Abhinav Angirish
Generally people want to invest in the stock market, but don’t have the knowledge to make it work. People simply see the numbers that a bullish stock market is showing out and want to throw in their money expecting it will go with the flow. This lack of knowledge results at inappropriate structure of portfolios, leading to unexpected returns and undue risk. One, however, just needs to do a little bit of groundwork before investing in any asset. Doing this will go a long way in reducing one’s overall risk. The groundwork needed for investing is something that anyone can achieve with some time and effort. It just takes a little time, a bit of learning, and self-motivation to do research about a company in which you are planning to invest:
1. Business: Before one decides to invest in a particular stock, the first thing one should check is the sector the company is in and the business itself. How can one invest in a company without knowing what it does?
2. Competitors: Once a person is aware of the nature of a business, then comes the stage of knowing others in the same business, i.e. the competitors of the business. Being aware of the competitors and their tactics is a good way to check the prospect ability of a business. The lower is the number of competitors, the better is the chance of glowing in the future.
3. Profit margin: Profit margin is a useful ratio and can help provide an insight into a variety of aspects of a company’s financial performance. There are hardly times when a company’s individual numbers (like revenue or expenditures) indicate much about the company’s profitability, and the earnings of a company often don’t show the true story. Increased earnings are great, but an increase does not mean that the profit margin of a company is increasing. At a basic level, a low profit margin can be interpreted as indicating that a company’s profitability is not very convincing. Profit margin may also indicate certain things about a company’s ability to manage its expenses. High expenditures relative to revenue, i.e. a low profit margin may indicate that a company is struggling to keep its costs low, perhaps because of management problems. This is a clear indication that costs need to be under better control.
4. Inventory to Cash (time): Inventory to cash is a ratio which indicates about how much time (days) a company takes to convert its inventory to cash. An inventory ratio must be compared with the industry median. A higher than the industry median ratio would indicate that the company is carrying too much inventory and is currently overstocked. And a lower than the industry median ratio would mean that the company is under investing in inventories and would end up losing opportunities in the market to benefit and gain.
5. Ownership structure: Knowing the owners of the company is very important before planning to invest in their companies as at the end of the day, you are indirectly investing in them. As you are investing in their faith, goodwill & intelligence, presence of negativity in any one of these areas would mean a riskier investment.
6. Volatility: If you are planning to make an investment, it is necessary for you to check the volatility of the investment, i.e. the frequency of up and down movements of the investment. It’s usually measured by the standard deviation from the expectation. A very high volatile stock would be a very risky investment and at the same time a stable stock would be considered comparatively less risky.
7. Beta: The Beta factor describes the movement in a stock’s return in relation to the market return. Beta is a measure of the systematic risk of a security in comparison to the market as a whole. It represents the tendency of a security’s returns to respond to swings in the market. A beta of 1 indicates that the security’s price moves with the market. A beta of less than 1 indicates that the security will move with less force than the market. A beta of greater than 1 indicates that the security will move with more force than the market. Knowing this fact of a security will help you set and achieve your goals.
8. PE Ratio: The price/earnings ratio (P/E ratio) is the ratio of a company’s stock price to the company’s earnings per share. The ratio is used to compare valuation of a company with peers in the industry. It helps us to know whether a company is fairly or under-priced/over-priced. A company with same operations and goodwill of another company in an industry should be priced the same. Hence, if the PE ratio of one of them is higher than the other, it is over-priced and if it is lower than the other, it is underpriced.
9. Earnings sustainability and growth: A company might be earning a lot and might have made a huge sum of money in a short period of time, but before you jump out to be a part of them, ask yourself: Are the earnings reported sustainable for the long term? And will it be able to grow in future like other good companies? Onetime gains can boost a profit/loss statement easily, but that doesn’t mean that it will occur again in the future.
10. Future plans: It is very important for investors to know the company’s future goals and approaches to new projects. As you are planning to invest in a company, their future plans are indirectly your future plans now. So, it is necessary for you to know what are the company’s plans to grow the business sales, how will they expand market share, etc. Finding out all this will tell you about the future growth prospects of a company.
(The author is Managing Director, Abchlor Investment Advisor Pvt Ltd)