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Tuesday, June 1, 2010

How to select a stock - an exercise for readers

From time to time, I receive requests from readers to write about how to select stocks. I wrote a post back in Feb '09 titled:

How to Select Stocks within Infrastructure Sector

In that post, I had highlighted the importance of studying the cash flows from operating activities (a statement usually well hidden in the depths of an Annual Report) which separates the champions from the pretenders.

This time around, I would like to put the onus on the readers to do the selecting. Readers need to use the 'Comments' link below the post (or, if you are feeling shy, send me an email) to briefly explain which one of the three stocks is the best choice and why.

To remove any bias, the sector name and the names of the stocks are not being revealed. All three are manufacturing companies that sell their products in India and overseas. Let us call them S, I, and N.

They are fundamentally strong small-cap companies that have been around for more many years, and outperformed the Sensex by going past their Jan '08 bull market highs during the recent rally.

Given below are the brief details of the three stocks, based on which readers would need to make a choice. Why only these criteria and not others? Because these are the ones I take a quick look at to decide whether a more detailed study is warranted.

Stock 'S' : Almost 50 years old, part of an NRI group.

  • Equity: Rs 4 Cr (Promoters hold 75%); EPS: 20; P/E: 4; NPM: 8%; RoE: 14
  • Sales: Rs 68 Cr; M-Cap: 32 Cr; Debt: negligible
  • Dividends: steady for the past 5 years
  • Technicals: fell to the level of the Jan '08 top during the recent correction; after a brief consolidation has slipped down

Stock 'I' : 35 years old, Indian company with foreign collaboration.

  • Equity: Rs 9.5 Cr (Promoters hold 60%); EPS: 6.5; P/E: 6; NPM: 10%; RoE: 9
  • Sales: Rs 80 Cr; M-Cap: 37 Cr; Debt: negligible
  • Dividends: intermittent in 3 of the past 5 years
  • Technicals: fell to the level of the Jan '08 top during the recent correction; seeking support there

Stock 'N' : 30 years old, Indian company with foreign collaboration.

  • Equity: Rs 8.5 Cr (Promoters hold 80%); EPS: 30; P/E: 6; NPM: 8%; RoE: 17
  • Sales: Rs 190 Cr; M-Cap: 150 Cr; Debt/Equity: less than 10%
  • Dividends: rising during past 4 years
  • Technicals: fell during the recent correction but remains 60%above the Jan '08 top

Note: Assume all three companies have positive cash flows from operations. NPM = Net Profit Margin; RoE = Return on Equity. The indicated figures are rounded-off.

The reader with the best logical explanation for the choice will be duly acknowledged on my blog. I may or may not agree with the choice.

So put on your thinking caps, and give it your best shot.


feltra (Raman R) said...

Dear Subhankar ji,

THANKS! for setting out such an exercise.. I am very very interested to read the discussions that follow from your readers (hope you will publish all of them, not just the winners one)..

For the past 5 years or so, I have searched in vain for some such exercise done by experienced folks - maybe it is there somewhere, but it sure has eluded me...

Just one request: If you can, please conduct such exercises regularly - for learning purposes.

Thanks very much & Warm Regards,
PS: Of course, I will post my own "analysis" however ludicrous it may be...

raj said...

As u have said ur self,all the three company are fundamentally strong nil debt,high promoter holding,positive cash flow ,low pe.honestly i am not able to see the differentiator.

Titu said...

Hello Sir,

My first choice is Stock 'N' because,
1) Dividends are rising.
2) Stock didn't fell below Jan 08 top which shows stronger bull trend
3) Promoters holding is maximum

but still I like to invest 25-30 % in stock 's' too, it's my second choice, I will select both companies.


Doctor Universe said...

The first one "S" is Narmada Gelatin.

Pramod said...
This comment has been removed by the author.
Subhankar said...

@feltra: Appreciate your kind words. Will await your answer to the question.

@raj: I will try and explain how to differentiate between fundamentally good stocks.

@Titu: Good attempt at explaining. But the exercise didn't allow you to choose two stocks!

@DocU: The question was: Which stock among the three is the best choice and why? Why don't you attempt an answer to that question? The exercise isn't a 'whodunit'!

@Pramod: The three choices are 'Stock S', 'Stock I' and 'Stock N'. Would you like to rephrase your answer?

Thanks to all of you for responding. I'll await a few more responses. An analysis explaining my choice will be posted on Thursday, June 10, '10.

sreyO... said...

Dear Sir,
I'm very new to the market and I've not made my investment yet...I'm just to be a better investor...

I'm posting my analysis here, may be it is not proper, but I hope with your guidance, soon I'll be a better investor.

I assume face value of all the stocks are equal.

Stock I is most liquid as promoters hold 60% and its equity is highest among the three. NPM is highest with negligible debt and the P/E is 6 which suggest the stock is rightly priced. Sales volume is more than double of it's market cap which suggest a right turnover ratio.Dividends are intermittent for the past years...may be beacuse of the fact that it's using some of the profits for the growth of the company. Technically it is at good position as it is seeking support at Jan'08 high. Sensex has not reached at the level but the stock it is beating sensex by return. Although the RoE is lowest, it is my most preferred stock among the three.

Stock N has M-cap highest among the three but sales volume suggest its low turnover ratio. It is the most illiquid stocks among the three as promoter holds 80% of the total equity. Equity is moderate at 8.5 cr. NPM is 8% but company has debt highest among the all. NPM is higher may be the tax adjustment for the debt. Dividends are rising signalling its maturity stage is reaching. technically, the stock is trading at quite higher level posting 60% appreciation compared to Jan'08 high. RoE is highest among them. It is my second choice.

Stock S has lowest equity and promoter holding is high enough at 75%. It is also an illiquid stock. EPS is higher at 20, RoE is 14 and P/E is as low as 4. Sales figure suggest quite high turnover ratio which is also not healthy. All the facts put it at doubt list to do sustainable better performance in the future although dividend payment is consistent. This stock is my least preferred.

Analysis ta boro hoye gechhe....apnar mulyaban somoyer jonyo dhanyobad.

Titu said...

Hello Sir,

In that case my answer is stock 'N'


SG Money Mind said...

I would go for the Stock 'N' given the limited choice. Reasons, 1) Of the three it has the highest sales and market cap and a reasonable D/E ratio, which lowers the risk among the three 2) Has the highest RoE, 3) NPM is the second best among the peers, 4) Dividends have risen which is a strong positive compared to the other two stocks, 5) PE of 6 looks reasonable from the investment perspective and 6) the company is in the market and also has foreign collaboration which would add value as it grows.

Now, will I invest in Stock 'N'? My answer is a definite 'No'. The sales/market cap figures of 190/150 Cr are a big dampener, unless I have followed the company for few years. Instead I would choose a (midcap) stock from my existing portfolio. What I know about existing managements, in which I am a stakeholder, is better than what I know only today.

jay said...

I will go for Stock N as the market cap is good and the sales turnover is also high. Also, the company is paying steady dividend. the stock didnt fall during the crisis also.

Joe said...

Dear Shubhankar ji,

I will go for stock 'N' due to following:-
1. High Promoter holding.
2. Rising Dividends.
3. High RoI.
4. High Sales wrt Equitity.
5. Inverstors have shown confidence in the script.

I am a novice in the stock market.



Doctor Universe said...

Dear Subhankarji

Yes I did oversee the question asked. Sometimes childish emotions do override sanity of thought.Regret inconvenience.

Coming to the main question I would go for the third one "N" because NPM is almost same for all but "N" has higher EPS ROE and dividends is also increasing. Moreover it is still higher than 2008 shows its inherent strength or strong fundamentals.

scorpio said...

Stock N - as dividends are increasing, so growth is there. I would also check the P/E with its peers, does the PE always be at 6, if yes then why is the market not seeing its growth.

Safety of Margin is 16%, which is lower than than the 4 PE stock, but I still would go for stock N.

Did this stock move in the year 2008 what if it was flat then and now it has moved

Will want to know where is the growth going to come or want to know how sustainable is the profits in the future. Again I am still learning to figure out businesses.

Thanks again for such a post, it will surely bring out nice ideas.

chakola said...

I would prefer Company "N" due to following
1. Adequate size (market cap>100cr)
2. Moderate PE <15
3. Market cap/Sales is more than other 2 company
4. Debt/equito ratio good
5.Divident record - consisent for 4yrs which is also good
6. Promoter holding more than other 2 company
7.Price remain 60% above jan'08 top

Sanjib said...

Dear Subhankar da,

I would pick stock S because of following:

1. Low equity base
2. High promoter holding
3. Good RoE (though not the best amongst the three)
4. Low P/E indicating higher margin of safety
5. Debt: negligible
6. Steady dividends (not rising as in N) - which imply constant growth of the company and/ or good management even in bad times.

As for technicals, I would wait for an opportune time to get in. I don't think you asked us to buy NOW!!

Ruy Guy (Sanjib Chakraborty)

chakola said...

Dear sir,
kindly add following to my earlier comment for 'N' company
ROE is more than 15 which much more than other two company


satvinder said...

I would like to invest in Stock N as It has highest ROE, Promoters holding, a respectable mkt. cap, rising dividend, manageable debt, and good sales figure. and is not badly trashed by the investors. and is in it's bull phase.

Pramod said...

I will buy company N as first choice

1. Increasing Dividend indicates growth and profitability potential of the business

2. inspite of the very high promotor's holding, promotors seems to be investor friendly.

( Higher promoter holding may be detrimental to investors sometimes)

VJ said...

My Choice is N with following rationale:

1. Highest ROE: ROE captures almost everything in a stock and is the most important factor according to me

2. Rising dividends: This is a sure sign of improving business outlook.

3. Reasonable P/E of 6

4. Sales: The only company with nearly 200 cr in sales.

5. Promoter Holding: 80% means promoter considers his company valuable, enthuses confidence.

6. Debt/Equity ration of 0.1 which is negligible.

7. Technicals: indicates that company is in a Long Term Uptrand