How do you decide if this stock is worth buying ?

 

I am a firm believer in the “value investment” philosophy. The more I stay in the stock market the more I am amazed by the wisdom of Warren Buffet and Benjamin Graham. So if you are looking for a tutorial to to make quick money, you are in the wrong place.

This is for the people who want to stay “invested” in the market against people who want to “trade” in market.

I have a list of things that one should usually check to judge if a stock is worth investing in the long run.

A. Primary Markets ( Or IPO ) [ as a special case ]:

Things that one should check, for an IPO, in addition to the list of parameters listed for secondary market  are:

1. Draft Red hearing prospectus: 

A Draft Red Herring Prospectus, or offer document, is when a company that is planning to raise money from the public provides information about its business operations and financials. This includes details about its promoters, reason for raising money, how the money will be used, risks involved with investing in the company and so on.

2. IPO Grading:

This is optional for companies but if its done, it needs to be considered.

B. Secondary Market:

1. Background of ‘Promoters’:

  • Need to be experienced.
  • Check for fraud background.

2. Purpose of issue

  • How raising the fund helps the value of the company
  • How does it affect sales and/or profits.

3. Interest of promoters in the company

  • Need to have higher share for confidence
  • If they are selling their share company might be heading for loss.

4. Valuation

  • Real Estate Company : Land Bank ( Value of land they already own )
  • Banking : P/BV ( BV = net assets/ no of shares )
  • Manufacturing : Profits
    • Should have a lower P/E ( less than 20 at least )
  • Hospitality sector : replacement cost of assets
  • If issue price > fair value then skip the company

5. Financial Analysis

  • Turnover
    • Compare year on year and should show a consistent growth.
    • Compare with industry.
  • Operating Margins
    • Better the operating margin better the company.
    • Steady decrease in operating margin with increase in turnover signals sacrificing of margin for sales.
  • Net Profit Margin:
    • Increasing value means, company is becoming operationally stronger and paying less interest cost to support growth.

6. Earnings per share ratio:

Lower EPS signifies company is just creating more money by giving out more equity and not a good sign.

7. Cost of Debt:

  • Good companies often get cheaper funding than others.

8. RONW ( Return of net worth ):

  • The higher the ratio the better the company is utilising it shareholders fund

9. Debt-Equity Ratio

Signals how much of the total capacity of the company is funded by borrowed funds and how much by owned funds.

10. Good Fundamentals:

  • Healthy dividend pay track record
  • Check company products and services.
  • Does the company have a competitive advantage/edge.
  • Does the company hold patents and copyrights.
  • Does the company have international presence.

11. Management:

  • Background – Educational and technical.
  • Experience in current business.
  • Factors certifying capability/integrity and transparency.

12. Secrets tips of good investors: 

Be on the lookout for following things while investing.

  • Business/Financial restructuring could result in financial performance.
  • Commissioning of large capacity extension to scale
  • Acquisition of loss making/inefficiently run company at an inexpensive valuations and successful turnaround
  • New line of business
  • Commissioning of  new production unit/activity in companies with access to natural resources.
  • An opportunity created by change in regulation.
  • Look for companies with consistently high returns on equity and capitol employed at cheap valuations due to their low annual growth.

 

13. Metrics analysis:  

  • Return on equity greater than 15
  • Return on Capital Employed greater than 15
  • Compounded Sales growth of last 5 years greater than 10.
  • Debt equity ratio less than 1.
  • Increasing profit margins.
  • If the business has Operating profit margin greater than 25%, then some of its products have monopoly or are market leaders.
  • Efficient Working Capital Management
  • Good Management quality
  • PEG ratio less than 2.
  • Increasing EPS from last 5 years
  • Positive Cash flow from Operations from last 5 -7 years
  • CFO/EBITDA greater than 70% from last 5 years (CFO is Cash Flow from Operations before taxes)
  • NOW Finally do the Discounted Cash Flow Analysis to find out the intrinsic value of the business.

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