It is always better to research several stocks in the same industry so that you have a comparative analysis. However, the biggest constraint in doing your own research is time. Retail investors who have many other things to do may not be able to devote as much time as professional analysts. There are numerous ratios and parameters that need to be evaluated for value investing. Most of us can’t do the same. It’s not easy to read the balance sheet of a stock. Neither everyone has got so much of time and interest. So, I decided to pick up important parameters from balance sheet and explain in the simple language which can be easily understood by all. BUT, I am not a qualified and certified financial advisor. My understanding may not be 100% accurate. So, it is advisable to do your research also. The investor must look into the following few important fundamentals of a stock in a balance sheet before buying:-
Sales/Earnings
This is also known as Top Line since it is on top of balance sheet. If the company’s sales figure is consistently growing that shows it is able to sell its product in the market. Check last five years sales figure and a good company should give atleast 10% earnings growth per annum.
Profit After Tax (PAT)
This is also known as Bottom Line since it is somewhere in the bottom of balance sheet. PAT is what is left over after everything is subtracted- direct expenses, indirect expenses, interest and taxes. So, if a company’s PAT is growing consistently, it reflects the efficiency and good management. If the PAT is growing, company will have a healthy reserve & surplus that can be used to pay dividends or in capital expenditure of the company without raising considerable debt. Check last five years PAT figure and a good company should give atleast 10% PAT growth per annum.
Price to Earnings (PE)
Low PE is not always good. It can be a value trap like most PSU banks, leveraged enterprises and real estate companies. Companies that have consistently generated at least 10% revenue and profit growth in the last five years can be considered for value picking provided other important parameters also support. Also, different industries have different PEs, so it has be comparable with industry PE.
Debt
Most important and critical parameter in present day scenario. Debt to equity ratio must not be more than 1. Debt free companies are gem in the market. Even in difficult periods like demonetization and implementation of GST or any other market disruptions, the company with low/no debt can weather the storm and turn around quickly.
Return on Capital Employed (ROCE) or Return on Equity (ROE) or Return on Net Worth (RONW)
Must be more than 12-15% but again depending upon the industry. Ultimately, stock prices follow earnings. So in order to know whether stock prices would be moving up or down in the future, you need to know where future earnings are heading. It's basically connecting what has happened in the past to what's expected to happen in the future.
Cash Flow
Company must be generating consistent cash flow from operations to pay all liabilities, pay healthy dividends and have surplus for capital expenditure without raising substantial debt.
Dividend
Most investors don’t buy a stock for its dividends. Even so, the periodic payment of dividends to shareholders is a good indicator of the company’s financial soundness. A good and consistent dividend paying company is always preferable.
Earnings Per Share (EPS)
A company with a high earnings per share ratio is capable of generating a significant dividend for investors, or it may plow the funds back into its business for more growth; in either case, a high ratio indicates a potentially worthwhile investment, depending on the market price of the stock.
Margin of Safety
One abiding principal of value investing is to buy a stock with margin of safety or even after identifying the stock at higher price buy regularly with systematic plan. Even a good stock at higher valuations is a risky bet. During bull runs investors can get swayed by irrational exuberance.
The Bottom Line
The ultimate goal of every investor is to make a profit. However, as the saying goes, not all roads lead to Rome. Never blindly accept what stock analysts have to say and always do your own research. Not everybody can be an investing expert, but you can always improve your analytical skills when it comes to stocks.
DISCLAIMER : The above information is available on public domain and has been taken mostly from websites and YouTube videos freely available on internet. The opinion expressed above is in no way recommendation of buying or selling. You must consult your financial advisor before making any fresh investment in equity market.
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