Making big money in stock markets is not an easy task. Apart from lots of patience and discipline, it requires a sound understanding of the market as well as constant education. Successful investing also requires resisting offers from the so-called investment gurus who promise to make you a crorepati in the short term.
Here are some of the most important factors while picking up wealth-creating stocks:
1. Debt-to-equity ratio:
The debt-to-equity ratio is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Finding companies which have lower ‘debt-to-equity’ ratio will just increase your probability of making money. Therefore, try to find companies having the ‘debt-to-equity’ ratio below 2, which means total liabilities of a company are not more than two times of its share capital and reserves.
“If the ‘debt-to-equity’ ratio is more than 2, then chances are that the company is spending a large chunk of money on interest payment alone. It’s a reliable tool while checking a company’s health, but one just can’t rely on the debt-to-equity ratio alone. It should be looked in tandem with interest coverage ratio. As such debt is not bad, but too much dependence on debt for a long time is a very serious issue and the shares of such a company must not find place in one’s long-term portfolio,” says Umesh Mehta, Head of Research, SAMCO Securities.
2.PEG ratio:
The price/earnings to growth ratio (PEG ratio) is a stock’s price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. While investing money in stock markets, it’s important to find companies at cheap valuations, but more important is to check how fast those companies are growing. Price to earnings/ profit growth is an important valuation indicator while choosing a company for investing money. If the PEG ratio is lesser than 1, it shows the company is reasonably valued and there exists margin of safety while buying such stocks. ‘Safety first’ should be the motto of every investor. Only the P/E ratio does not give a clear picture. But when seen in conjunction with PEG, it gives a clear picture of whether such PE valuation is warranted based on the PEG ratio. “High growth companies enjoy high PE ratio in general. If there is a mismatch in such equation, then it is an opportunity to either buy or sell. For example, if a company with PE of 12 is growing at 25% year on year, this indicates a value buy stock. On the other hand, if for a PE of 30, the growth of the company is 15%, that means other things being equal, this is an overpriced stock and must be sold or fresh purchase should be avoided,” informs Mehta.
You may also watch:
3. Look for established businesses:
Warren Buffett says, “Turnaround seldom turns.” Investors should, therefore, try to find out well-established businesses rather than looking for turnaround companies. Established and well-managed businesses often throw a lot more opportunities of making money in the long term than companies which have a damaged balance sheet (for whatever reason) and are now trying to find their feet. Rarely do such companies turn profitable. While investing in turnaround companies, one must check whether the company is at a turf because of cyclical problems or there are company-specific issues. Later cases should be avoided because there is a likelihood of structural problems.
4. Risk-adjusted returns:
While investing, the most critical and important factor is to find out favorable ‘risk-adjusted returns’. Diversifying your portfolio in 10 companies across 10 sectors is advisable as it will significantly minimise the risk of losing big. For, by having a diversified portfolio, one can spread one’s portfolio risk. “It is possible that one or two stocks bought by you may underperform, but at the aggregate level, a sectorally well-diversified stock portfolio containing industry leaders is bound to give superior risk-adjusted returns in the long term,” says Mehta.
5. Check ROCE/ROE ratios:
Finding established businesses and investing into such diversified portfolio isn’t enough to make big money. It’s also a vital thing to check whether a business is running efficiently or not. One can capture the efficiency of a company by checking its return on capital employed (ROCE) and return on equity (ROE) ratios. Ratios higher than 18% indicate superior-quality businesses and more often create wealth over the long term. It’s also important to check whether incremental ROCE and ROE is higher than its longer-term averages. Higher ratios indicate the company is enjoying economies of scale and is growing efficiently.
You may also watch:
6. Go for sectoral leaders:
Finding sectoral leaders as a policy for investment is advisable viz-a- viz buying a sectoral laggard and then hoping for it to catch up. Many times this does not happen and investors end up owning poor-quality businesses, which underperform over a long period of time. Investors, therefore, must remember that for quality stocks, ‘no price is too high to buy’. Long-term investments are like marriages. One has to go for the best.
7. Invest in consumer-facing businesses: Looking for consumer-facing businesses or searching a B to C business can also turn out to be more profitable. “Past observation suggests that these businesses need smaller working capital cycles, have cleaner balance sheets and more potential for incremental growth and sustainability. These businesses have strong bargaining power and can raise prices to counter inflationary tendencies. Building strong brands creates consumer stickiness, which is essential for sustained growth,” says Mehta.
Looking for consumer-facing businesses or searching a B to C business can also turn out to be more profitable. “Past observation suggests that these businesses need smaller working capital cycles, have cleaner balance sheets and more potential for incremental growth and sustainability. These businesses have strong bargaining power and can raise prices to counter inflationary tendencies. Building strong brands creates consumer stickiness, which is essential for sustained growth,” says Mehta.
8. Don’t let emotions cloud your judgement
The lure of big money is difficult to resist, particularly in a bull market. Investors become greedy when they hear the stories of fabulous returns being made in the equity market in a short period of time. This leads them to buy shares of unknown companies without really understanding the risks involved. Thus, “instead of creating wealth, such investors burn their fingers very badly the moment the sentiment in the market reverses. On the other hand, in a bear market many investors sell their shares at rock-bottom prices, again losing money. Therefore, don’t let fear and greed cloud your judgement,” says Ashish Kapur, CEO, Invest Shoppe.
You may also watch:
9. Put your money in business you understand
If you thought that investing in a equity market means investing in any stock, then you are wrong. Instead of a stock, you should try to invest in a business and that too which you understand. In other words, before investing in a company, you should know what business the company is in. “Try to understand, for instance, what the company buys and sells, and how does it make money. Thus, the more you understand the business of a company, the better you will be able to monitor your investment, and the less will be the chances of losing your hard-earned money,” says Kapur.
10. Follow the fundamentals of investing
Market experts say that merely having good knowledge may not be sufficient to earn good rewards from the stock market if the basics of investing are forgotten. These basics can help you hold your ground even in a difficult market situation and can create big money going ahead. Even world-renowned investors would not have been able to make big money had they not followed the fundamentals of investing. Therefore, the sooner you learn doing it, the better it will be for your future.