Analyse a stock thoroughly before before investing. As consumers how much time do we take to make a buying decision, say for a mobile phone ?
It’s approximately 15-30 days after we receive a ‘tip’ about the said product. The tip could be an ad, or a friend’s recommendation or any such information that gets you clued into the product. Now imagine you receive a ‘stock tip’ on social media, either twitter or an influencer YouTube video or for that matter a friend recommending you the stock. What do you do next ? OR what should you do next ?
To answer this question, let’s go back to our mobile buying decision timeframe. 15-30 days. Why ? Because you would want to see if the features are good, price range is suitable for you, brand value is also a consideration, maybe you want to compare with the peers in the same category and so on. Basically its a well researched & informed decision making process. Now going back to the ‘ stock tip’ you received. What do you do next ? OR what should you do next ?
The smart thing to do after you receive or come across an interesting ‘stock tip’ is to analyse a stock as a value investor. And, these 7 parameters should help you get going :
- Industry Sector
- Business
- Balance Sheet
- Cash Flow
- Future Potential
- Management
- Peers
Industry sector – Get an understanding of the economic and financial prospects of a sector of the economy. The assumption is that not all sectors have a linear growth trend. In fact no sector has a linear growth trend for long periods. There are always phases in which different sectors show growth potential. It can be due to government policies, or some geo-political occurrences or an innovation pertaining to that sector. Sector analysis will help in understanding macro parameters determining the potential of that sector as well as potentially identifying undervalued stocks.
Business – Understanding what a business does ( make or sell or both ) helps you understand the economics behind the business. Does it own the entire supply chain ? Is the product or service dependent on 3rd parties ? If yes, how much is the dependency ? What is today’s raw material cost & how will it change in the future ? How many manufacturing plants ? How many people are on rolls ? What is the attrition rate ? If you are able to find answers to some of these it would help in understanding the general direction in which the business is moving.
Balance sheet – There are 2 key points to look at while you analyse a stock balance sheet a) assets – cash, amount receivable, inventories, real estate, IP, brand value & many such parameters. b) liabilities – supplier payments, wages, taxes, debt & interest on debt & more. However the key to understanding a balance sheet is to do a historical analysis ( typically 5 years – 10 years). It shows how well a company is able to utilise its assets and manage the liabilities for operations, measured primarily by operating profits over the years. A healthy uptrend over the years shows a potentially well managed company.
Cash flows – Typically there are 3 ways a company can generate cash a) through operations b) through investments c) through financing. One thing to note is the fact that it’s important to understand not just inflow of cash but also outflow. While routine business operations might generate a lot of cash flow to the business, it might also happen at the same time that the company has a significant interest payment on long term borrowing. If a company doesn’t have a lot of free cash available then it might not be able to pay dividends or make business investments or buy back stock etc which are healthy indicators or value creation in the business.
Future potential – This is a very critical aspect while you analyse a stock. Scour through the company reports about management commentary on the sector / industry, do keyword research via google about the industry, products in the industry, follow analysts who speak about the industry & keep an eye on regulations that the government brings out.
Management – Another critical aspect is to understand the ‘who’ & ‘how much’ behind a particular business. The ‘who’ pertains to key management professionals of the company, their tenure & pedigree in the business, their decision making thought process ( listen to concalls), their business when the sector / demand is muted ( analyse balance sheet 2 years before and after ). The ‘how much’ pertains to the promoter holding in the company, key management professionals’ ownership, dilution / buying history, as well as any indicators in related party transactions.
Peers – A key consideration while you analyse a stock is to do relative analysis of your favoured stock with respect to its peers. This will help you understand if a stock is overvalued or has the potential to be part of your portfolio. Either way, making an apple to apple comparison using key fundamental & technical indicators will give you a direction ( buy or avoid) but is not really a fool proof way to make a definitive decision. Peer analysis can help you begin your journey into technical analysis of stocks.
This top-down approach will help contextualise the data around your stocks picks. You will be able to make better & informed decisions with respect to your investments and more importantly to take a more judicious buy / sell / avoid decision.