How to Determine What Stocks to Buy?

Given the diverse range of stocks available in the market, it is challenging to select shares to buy that suit one’s investment needs.

Moreover, it is often challenging to skim through financial statements to identify which companies have solid revenue and profit growth and a favourable debt position. If you’re wondering about How to Pick Stocks or How to Choose Stocks, this blog is just for you!

That said, there are a few factors that prospective investors can consider while selecting stocks for investment.

How to Pick Stocks - 8 Key Metrics You Need to Know

While the investment amount, time horizon, and risk appetite vary with each investor, there are a few common pointers that can help all investors.

For you to find good stocks to buy or invest in, you need to check these below-mentioned points. These are some things to know before investing in stocks:

1. Determine Your Investment Goals

Investment goals vary among different investors. For instance, older investors tend to be interested in capital preservation as their retirement years approach.

On the other hand, when young investors select shares to buy, they usually aim to increase their returns and grow their portfolios over the years.

Therefore, it can be said that one’s goals dictate which stocks to buy:

• Individuals seeking regular income will turn to those stocks offering high dividend yields that have steady earnings and cash flows.
• Those who desire growth are drawn to younger companies that exhibit promising growth in the future based on the investment (through borrowings) made today.
• Investors seeking capital preservation will opt for businesses that have been in operation for decades and reached saturation. Such businesses offer predictable and stable profits.

2. Checking The Competitive Advantage of The Stocks That You’re Interested In

Once you have determined what kind of investment goals you have in mind, you can narrow down the stocks-to-invest. In this respect, one of the key factors to look into is whether a business has a sustainable and unique edge over competitors, popularly known as a moat.

Additionally, when individuals select shares to buy, it is important to ascertain the durability of this competitive advantage. That is, whether the company will continue to have its edge over its competitors for years to come.

Products and services with a sustainable and wide moat tend to be the ones delivering rewards to investors. Furthermore, one can weigh in factors such as scale, unique brands, switching costs, network, and intellectual property to conduct a thorough competitor analysis.

3. High Return on Capital

Businesses with a High Return on Capital make a lot out of little, while those with a Low Return on Capital make a little out of a lot. As a result, if a stock has a High Return on Capital, it probably has a strong moat and will provide you with a good return on your investment.

As a general rule, you should seek out stocks that have a High Return on Capital.

4. Profitability

Prior to picking a stock, you should take the company's profitability into account. A metric called Return on Capital is the most effective way to gauge profitability.

Return on Capital, which is calculated as a percentage, is equal to Net Income minus Invested Capital. You can either research the financial statements and make your own calculations or simply obtain them directly from online data sources that offer them.

5. Quantitative Analysis

In this process, an investor examines a company's financial data to ascertain its "true value." Whenever you're considering investing in a business, be sure to check out its financials.

You shouldn't look into a company's finances if they don't meet your personal investing criteria and don't look promising. You can do this by looking at the balance sheet, income statement, and cash flow statement for the business.

6. Qualitative Analysis

This puts less emphasis on the numbers and more on the characteristics of a great company that would entice an investor to invest in it. We'll use an illustration to help you understand this:

Most people think of the company rather than the fruit when I mention the name ‘Apple’. This is a fantastic illustration of incredible brand recognition that is here to stay. There is a lot of consumer trust that comes with having a household brand name.

People are, therefore, much more likely to try out new products when they are introduced, especially if they are innovative or unique.

7. Before An Investor Considers a Stock, It Must Satisfy the Investor's Individual Fundamental Requirements

There are several ways to assess a stock’s current price and its financial and fundamental performance. Here are a few of them:

• Price to Earnings Ratio or P/E: Having a very P/E ratio, higher than the industry average, at times indicates that the stock is extremely overpriced
• Price to Book Ratio or PBV: The same goes with the PB ratio as well. Ratios deviating a lot from the industry average, higher or lower, call for attention.
• Earnings Per Share or EPS: EPS should indicate steady growth, at least in the last five years.
• Debt to Equity Ratio: There cannot be a standard debt-to-equity ratio across sectors. Some industries do take on a lot of debt to expand their business, such as manufacturing. Compare companies within the same industry to analyze the stock.
• Current Ratio: The current ratio defines the liquidity position of the company. It tells us if the current assets of the company are enough to fund the current liabilities.

Do note that the above-mentioned ratios are a few of the metrics with which one can assess a company; however, these are not the only metrics to consider for an investment decision.

An investment decision ideally should be backed by thorough research.

8. Determining the Managerial Efficiency

When individuals select shares to buy, it helps if they conduct thorough research about a company’s management and gauge its efficiency. The potential investor can understand better if she/he attends managerial meetings (conducted every quarter to discuss the quarterly performance of the company).

Alternatively, investors can also attend the annual general meeting (AGM) conducted every year to answer questions from shareholders.

Here are a few pointers to note on the management’s efficiency-

• Tenure Of the Management

One can determine a company’s stability based on the length of tenure of its management. The long tenure of top management usually indicates steady growth and consistency.

• Shareholding Pattern

All the listed companies release this information every quarter as per SEBI, the market regulator's mandate. Now, you, as an investor, can check the holdings of different shareholders, including promoters, institutions, Government, and even retail investors.

Generally, a company with a higher promoter holding means that the promoter is invested in the company, which could indicate the stability of the company. Similar is the case with institutional investors.

However, promoters are not required to have a higher stake in their company all the time. There are companies that do well with less promoter involvement as well. That said, you can still note the changes in shareholding to take a call on your investment.