Most new investors make the mistake of buying stocks based on recommendations or following a famous investor’s portfolio.
While this approach might work for a few people, this is generally not encouraged. Why? Because each investor has a unique profile and risk tolerance. This makes it essential to analyze and invest in companies you know.
Read on to learn how to evaluate a stock before buying.
The evaluation of a stock involves finding answers to some vital questions. Consider your evaluation successful if you have concrete solutions to the questions below by the end of your analysis.
A deep dive into these questions will be required to evaluate a stock before buying.
There are two levels of analysis that you are required to do – company-level analysis and industry-level analysis.
A company is as good as the people running it. Checking management quality means conducting a background check on those running the company.
What should you look for?
Such factors enable you to run a quality check on the management. This is not difficult at all. A simple internet search will help you check all the related news.
Corporate governance means all the rules and practices put in place to run the company. Corporate Governance is one of the top tools for understanding a company's management quality. For many experienced shareholders, it is not enough that a company is churning profits.
Corporate governance involves checking-
If you want to evaluate a stock in India or anywhere else, an ethics check is required at all costs before you get to the financials.
Once your base is set, look at the financials of the company. Let’s see the main things to look for when I say financials-
Where is the company headed? Is it expected to grow on a consistent note? For future growth prospects, you will have to assess all the parameters above historically and make a projection into the future.
Even if there is a deviation, if the management is strong and financials have been good over a long period, the company will probably perform well in the future (no guarantee, though).
You should also look at what the future of the larger industry looks like. Say you want to invest in ICICI Bank. Your analysis should not stop with analyzing just ICICI Bank Ltd but the banking sector as a whole.
Industry-level information is also easily available. You can see if your chosen company is over-performing or underperforming its industry consistently. Here is how:
It’s important to compare a company's performance with peers from the same industry. You cannot reach the debt level of a bank to an IT company and then arrive at a decision.
All industries perform differently. Therefore, remember that parameters and financials should compare with industry peers only.
It would be best to look at how the management tackled the highs and lows of the economy. And how did the company perform during the lows, was it able to weather macroeconomic storms.
You need to also look at how the company performed during its highs; did it splurge or spend judiciously on growth parameters.
Analyzing historical performance during extremes is important to understand how efficiently the company tackles economic and industrial booms and busts.
Most of these ratios can be calculated with the help of information available on company balance sheets. The Securities Exchange Board of India (SEBI), the markets regulator, the stock exchanges, the Bombay Stock Exchange (BSE), National Stock Exchange (NSE) mostly have all the resources on the financials.
Insolvency and Bankruptcy Board of India will have all the details on bankruptcy proceedings, if any. A general news check will also give what has been happening around the company. Financials are also available on the company’s website.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.