5 Factors to Consider Before Picking Stocks

"Although it must be clear that what happens to prices of stocks over short periods of time is largely a reflection of changes in investor psychology, there is more than enough information readily available to assist in the process of identifying issues that have a better-than-average chance of outperforming the market. 

Understanding the importance of this information is the difference between the astute investor and one who is awash in incomprehensible data."

Read more at:
https://www.investopedia.com/advisor-network/articles/5-factors-consider-picking-stocks/

Stock Picking: Keys to Successful Investments

"What takes place in the short run for individual stocks and the market generally is unknowable. This is driven primarily by psychology. 

It is over longer periods that improving fundamentals that push stock prices higher become meaningful. In most cases, stock prices are a reflection of underlying profits. A company that consistently improves its earnings will see its shares rise over time."

Read more at:

http://www.investopedia.com/advisor-network/articles/101716/stock-picking-keys-successful-investments/

3 Secrets of Successful Companies

When small investors enter the stock market for the first time, they often make the mistake of buying individual stocks based on a friend's tip or a relative's recommendation. 

Such initial steps usually end up with a loss of the invested capital - either because the entry is at an inopportune time, or the stocks selected are of the cheaper/riskier variety, or both.

For the novice investor, the better way to start investing in the stock market is to select a couple of good equity and balanced funds and invest regularly - leaving stock selection to experienced fund managers.

At some point of time however - may be two or three years down the road - it may be a good idea to start selecting your own stocks. 

Why? Because fund managers tend to have a herd-like mentality - selecting from the same group of well-researched stocks for different funds. That leads to steady but average returns.

For above-average returns, one needs to select a few mid-cap and small-cap stocks for a 'satellite portfolio' - along with a 'core portfolio' of large-cap stocks.

Selecting under-researched mid-cap and small-cap stocks is not a trivial task. It requires knowledge and experience to choose from thousands of listed companies.

So, where should one start? Look for three essential characteristics that make a company successful. These are:

1) Barriers to entry
2) Management quality
3) Market leadership

What about other important metrics like Profit Margin, P/E, P/BV, RoE, Debt/Equity ratio, Interest Coverage ratio, Cash Flow, Growth rate and so forth? Those need to be looked at also for a more detailed study and analysis.

Learn more about the '3 Secrets of Successful Companies'. 

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Why you need the resilience and discipline of a door-to-door salesman to succeed in the stock market

If you are thinking: "What on earth is a door-to-door salesman?" then you probably belong to a generation that has never seen 3D picture discs in a View-Master or listened to a 78 rpm vinyl record on a gramophone. In which case, you have obviously never met a door-to-door salesman. 

There was a time in the not-so-distant past, when many retail products - particularly encyclopedias - were sold by salesmen who knocked on the doors of homes to demonstrate and sell their wares.

Just like the buggy whip and the hurricane lantern have almost disappeared with the onslaught of industrial and technological progress, so has the profession of door-to-door selling.

A few years ago, Forbes magazine had listed '10 Top Dead or Dying Career Paths'. Telemarketing and door-to-door selling was 7th on the list - just ahead of photo film processing.

Before the advent of the Internet and social media, the only way smaller manufacturers or dealers could mass-market their products was through door-to-door selling. 

Salesmen were paid a token salary - or none at all - and made money through sales commissions only if they met their monthly or quarterly targets. Each salesman was allocated a specified locality or territory - where they had to compete with other salesmen selling similar or different products.

Home owners were bothered and irritated by their door bells being rung by salesmen at all odd hours trying to sell them anything from incense sticks and toothpaste to books and vacuum cleaners.

Most slammed the door shut on the faces of the salesmen. A few who were kind enough to listen to a salesman's pitch probably didn't buy, giving some excuse like "I just bought a similar product" or "I don't have enough cash with me."

In other words, making a sale itself was a difficult task. Meeting stiff monthly sales quotas was nearly impossible. Still, the salesmen would go on their rounds come rain or shine - knocking on doors and getting them slammed in their faces.

You can just imagine the kind of resilience and discipline that was required to carry on - despite knowing that the chances of success were negligible. But when they did make a sale, good salesmen ensured that they sold their higher-valued products so that they could earn more commission.

Being able to handle repeated disappointments and having the mental wherewithal to bounce back and keep trying is just the kind of discipline one requires for success in the stock market.

A successful salesman eventually developed a winning strategy after repeated failures. So should a stock investor. 

If you have tasted some success by buying a stock without doing much research and then selling it at a profit, you are unlikely to be able to repeat your success.

Even after doing proper study of a company's annual report and its stock price chart, the stock you pick may not give you the returns you expect. 

Eventually, the resilient and disciplined investors will learn from their mistakes (or follow the advice of an experienced investor) and learn to follow a plan and a strategy that enable them to select winning stocks.

And once they have picked a winner, they buy a lot of it and hold on for the long-term to reap the benefits of dividends, rights, bonuses and buybacks.

How to Select a Company for Investment - a guest post

The long correction since Mar '15 in the Indian stock market may have finally come to an end. The time for a pre-budget rally has arrived. If you were waiting to enter the market, don't wait any more.

But which stocks should you buy from the hundreds that trade every day? Buying a stock is not buying a piece of paper (or an entry in a demat account). You are buying a 'share' of a business.

In this month's guest post, Nishit explains how you should go about selecting different companies for investment. Promoter integrity is at the top of his selection criteria.

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The Indian economy is showing signs of green shoots and we are in the take off state right now.  People who I meet often ask me how to select a company for investment. There are many things which go into the selection of a company but the most important parameters for me are Corporate Governance, Ethics and Transparency.

I usually look at where the broad economy is going and from that I identify which sectors will do well. Once the sectors are identified, next is identifying companies within the sectors. Investing in a company with a crooked promoter in a good sector will still lose you money. An honest promoter is the most important yardstick while selecting a company.

Promoters can make mistakes which are acceptable; skimming off money from the shareholders is not. Satyam is a prime example of a blue chip company in a very exciting sector of IT going bad. Satyam not only jeopardized the jobs of its employees, eroded shareholder value, it also shook the confidence within the IT industry.

If I was a foreigner waiting to invest in India, I would constantly think which other Satyam was lurking in the wings in the Indian IT industry. Now if we were to compare this with a TCS or Infosys or even a Wipro, the promoter ethics are above board. Wipro might be slow to change but at least we know that the promoter is not skimming off money.

This is the very reason the Tata group of companies is my favorite while investing. With their long history and illustrious background, there is very little chance of fraud happening with the Tata companies. They may be slow to change, there could be some mishaps in decision making but that is acceptable.

If I am assured of promoter honesty then 50% of my worries are taken care of. Stock picking is an art. I normally make up my mind in 30 minutes whether or not to buy or not to buy a stock. If I cannot decide in 30 minutes it means there is something wrong somewhere.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

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Market Cycles and Sectors

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12 Things You Need To Know About Financial Statements

When stock markets are in turmoil, like now – Sensex up 300 points one day and down 500 points the next – the tendency of many small investors is to get paralysed by fear. They tend to sell their stock holdings just when the market nears a bottom.

Fear is a strong emotion that is difficult to control – specially when your hard-earned money is going down the drain. It is also the single most important reason why small investors don’t make as much returns from their stock holdings as they should.

There is of course another important reason why returns from stock investments are often meagre: poor selection of stocks. In a bid to generate outsize returns, small investors chase ‘cheap’ or momentum stocks with non-existent fundamentals.

So, how does one select good stocks? By learning the basics of fundamental analysis. And how does one go about doing that? By studying annual reports of companies. Annual reports analysis can be tedious and boring – but it is an essential skill if you want to invest in stocks.

It requires nothing more than common sense, knowledge of junior school arithmetic and basic accounting concepts. It isn’t rocket science. Thanks to the Internet, annual reports are readily available on company web sites.

To help you get started, here is an article from investopedia.com. Bookmark the article if you are a new stock investor. There are lots of useful links in it that you may wish to go through.

The article can help seasoned investors as well. It is always good to brush up on your fundamental analysis skills. And, who knows? You may even pick up a few new insights.

Related Post

How to read an Annual Report

How to select good mid-cap and small-cap stocks for your portfolio without trying too hard

We are living in an age of instant gratification. No one has the time or patience to brew a nice cup of filter coffee. Too much hassle. Just go to the nearest coffee bar and pay through your nose; or, boil a cup of water and stir some instant coffee in it.

Want to buy a car? No need to save money for 10-15 years. Just go to a car dealer, show your income statement or tax return, pay a token lump sum amount and drive out in a shining new 4-wheeler, and then pay nearly double the cost of the car through monthly EMIs.

Want to enter the stock market? Just open a demat account and a trading account with a large broker or bank, and start buying the next Infosys and the next L&T being discussed in stock forums or business TV channels. Instant gratification doesn’t quite work in this case, does it? Where are the huge returns that every one seems to talk about?

Instant gratification usually ends up costing you much more – in terms of money, health, stress. If you are really interested in fabulous returns from the stock market, there is only one way out. Learning to do things the proper way – which means spending time and being disciplined and patient. Easier said than done for most people, who work hard, live fast and prefer to go for vacations at Langkawi or Nice.

If you neither have the time, nor the inclination to learn how to select good stocks – a process that requires learning how to read an Annual Report, calculating financial ratios, studying economic conditions in the country and overseas, supply and demand in various industrial and service sectors, and observing different patterns on price charts – here is a simpler process.

Select the top-ranked (by 5 yr returns) mid-cap and small-cap funds listed at valueresearchonline.com and check their top 10 equity holdings. The hard work has already been done for you. Just go through the table below.

Religare Invesco Mid N Small Cap	BNP Paribas Midcap	Franklin India Smaller Companies	ICICI Prudential Value Discovery
Brittania	VA Tech Wabag	Finolex Cables	ICICI Bank
DB Corp	Idea Cellular	Yes Bank	Reliance Ind
Gateway Distripark	Axis Bank	Repco Home Fin	Sadbhav Engg
ING Vysya Bank	HPCL	JK Lakshmi Cement	PI Industries
Federal Bank	Yes Bank	Mindtree	Exide
Redington	IndusInd Bank	Cyient	Mindtree
Guj Pipavav Port	Oil India	Amara Raja	Amara Raja
City Union Bank	Alembic Pharma	SKF India	Guj Pipavav Port
AIA Engineering	Orient Cement	Axis Bank	Balkrishna Ind
Greaves Cotton	Motherson Sumi	Aegis Logistics	Max India

Leaving aside a few large-caps like ICICI Bank and Reliance Ind, the rest are a representative sample of good mid-cap and small-cap stocks. So, here are two things you can do:

1) Select a few stocks from the four funds and add them to your portfolio. Choose the ones whose businesses you understand to a certain extent. Alternatively, choose stocks that are appearing in more than one fund – like Amara Raja, Mindtree, Axis Bank and Yes Bank.

2) If you are really pressed for time (or lazy), start a SIP in any one of the four funds. Each of these funds has returned about 25% for the past 5 years. That indicates a consistency of performance over the long-term.

Related Posts

Can investments in only 3 funds provide adequate portfolio diversification?

How to pick Stocks for Investment - Part I

How to pick Stocks for Investment - Part II

How to pick Stocks for Investment - Part III

5 enduring stock market myths debunked

The quote: “A lie repeated often enough becomes the truth” has been variously attributed to Vladimir Lenin and Joseph Goebbels. Adolf Hitler wrote in Mein Kampf: “The greater the lie, the greater the chances that it will be believed.”

Is a myth the same as a lie? Not quite. A lie is a deliberate attempt to suppress or conceal truth. Oxford Dictionary has this definition of myth: ‘A widely held but false belief or idea.’  So, a myth probably evolves from a lie.

Why do stock market myths exist, and why is it necessary to debunk them? One of the ploys used by analysts and fund managers is to propagate myths so that less-educated investors (in terms of stock market knowledge) remain confused.

Some times, analysts and fund managers hide behind these myths because they are confused about the price movements in the market and don’t want to look like fools if they predict something and the opposite happens.

It is the small investor who starts believing these myths and gets taken for a ride in the process. So, it is important to understand the difference between what is a myth and what is truth.

Here are some enduring and oft-repeated stock market myths, and the truth behind those myths:

1. The stock market is a ‘zero sum’ game because for every buyer there is a seller

Wikipedia defines a ‘zero sum’ game thus: ‘In game theory and economic theory, a zero-sum game is a mathematical representation of a situation in which a participant's gain of utility is exactly balanced by the losses of the utility of the other participant(s).’

The myth is not the ‘zero sum’ part, but the ‘for every buyer there is a seller’ part. Any one who has bought or sold a large lot knows that. If you try to sell 1000 M&M or L&T shares in the market, it is unlikely that some buyer is just waiting to buy those 1000 shares from you. Chances are, there are several buyers each wanting to buy 50 or 100 shares each.

If the stock price falls after you complete your selling, then you ‘win’ and the several buyers ‘lose’. If after a few days, the stock price starts to rise and goes above your selling price, then you ‘lose’ and the several buyers who bought from you ‘win’.

2. There is plenty of cash waiting in the sidelines

The myth is to justify why Nifty should move higher. The truth is: cash waiting on the sidelines will always remain on the sidelines in the secondary market. Why? Imagine you have just received a fat bonus due to excellent performance at work, or have made a big profit after selling some real estate. You now wish to enter the stock market to buy some shares, but are hesitant because of high prices.

So, you have cash waiting on the sidelines, right? Now, a correction sets in and you find some attractive buys to deploy your cash. What happens to the cash that you had on the sidelines? It just changes hands and goes to sellers of the stocks. Now you know why a stock market is actually called a stock exchange.

You exchange your cash for stocks. The seller(s) exchange their stocks for cash. The cash goes back to the sidelines – minus some STT and brokerage. (In the primary market, cash does go from the sidelines into a company conducting an IPO. That cash will be used for purchasing productive assets and hopefully won’t get stolen.)

3. Time in the market is better than timing the market

Say that to a Japanese investor (the Nikkei has gone nowhere for many years) and he will probably call you a ‘bakayaro’ or even a ‘chikuso’! This myth works great for fund managers, because the longer investors stay invested in a fund the better it is for the fund manager. He has more funds to invest and can make some long-term bets.

But if you want to generate market beating returns, you have to resort to ‘timing’ your entries and exits. That doesn’t mean frequent churning of individual portfolios. But exiting if the Nifty P/E moves above 22 or buying when Nifty P/E falls below 14 can significantly improve your returns.

4. This is a ‘hope’ rally, or a ‘liquidity-driven’ rally

This is what analysts say when they have advised investors to book profits at every rise, and Nifty keeps moving higher and higher. I mean, talk about stating the obvious! Has there ever been a rally without hope or liquidity? Investors buy because they have the money to invest and hope that the index will move up.

When liquidity gets sucked out of the market – whether due to profit-booking or bunching together of IPOs (though that hasn’t happened for some time) - what happens to the rally? It stalls. You don’t need a degree in Nuclear Physics to understand that.

5. This is a stock picker’s market

Except for the period between Oct and Dec 2007, when even cats and dogs turned into lions and tigers overnight, I can’t recall a time when it wasn’t a stock picker’s market. If you wish to build wealth for the long-term (as opposed to enjoying the adrenaline rush in day trading), you have to learn how to pick stocks that can and will stand the test of time.

How will you know that beforehand? The best way is to choose stocks that have already withstood the test of time – like HUL, Colgate, ITC, M&M, Tata Motors. Does that mean you should stay away from mid-cap and small-cap stocks? Yes, and no.

Yes, if you are not confident about the process of stock picking. No, if you follow these simple and well-documented steps. However, following those steps will require discipline and diligence. The eventual rewards will be much more than adequate.

Announcing re-opening of paid subscriptions to my Monthly Investment Newsletter

I am pleased to announce the re-opening of paid subscriptions to my Monthly Investment Newsletter for a 3 weeks period from July 1-21, 2013. Only a limited number of subscriptions will be on offer – strictly on a first-come first-served basis – to enable me to provide personalised attention and guidance to each subscriber.

If you are interested in subscribing, please send an email to: mobugobu@yahoo.com at the earliest for details.

The past 6 months have been a challenging and humbling experience for me. Challenging because even fundamentally strong mid-cap and small-cap stocks have faced the wrath of bears. The Nifty touched two successive 52 week highs in Jan ‘13 and May ‘13, but the subsequent sharp bear phases decimated most mid-cap and small-cap stocks.

Humbling because a few stocks have not performed up to expectations yet, still subscribers have kept faith in my stock picking abilities. Those who have been following my blog posts already know what kind of stocks I like, and what type of stocks I avoid. The guiding principle is to choose well-managed, financially sound companies that give steady (rather than spectacular) returns and have growth prospects.

Subscribers receive monthly technical updates to identify entry/exit points and stop-loss levels. That helps to ensure that profits are maximised and losses are minimised. In a 2-3 years time frame for which stocks are recommended in the newsletter, most stocks have provided significant returns to subscribers through capital appreciation and dividends.

What is important to understand is that none of the recommended stocks were ‘cheap’ – fundamentally strong stocks rarely are - and some had already run up quite a lot when they were recommended.

Why wait if you need help in selecting fundamentally strong stocks with growth potential? Just subscribe to my Monthly Investment newsletter. Send me an email (at mobugobu@yahoo.com) soon – subscriptions will close on Jul 21, 2013.

Announcing re-opening of paid subscriptions to Monthly Investment Newsletter

I am pleased to announce the re-opening of paid subscriptions to my monthly investment newsletter for a 3 weeks period from July 1-21, 2012. A limited number of subscriptions will be offered – strictly on a first-come first-served basis to enable personalised attention and guidance to each subscriber. Special offers await the first 12 subscribers.

If you are interested in subscribing, please send an email to: mobugobu@yahoo.com at the earliest for details. Your email address will be kept confidential.

The newsletter has completed 30 issues. Stock picking in the past 12 months was a challenge because stock indices turned volatile and sentiments were negative. Small-cap and mid-cap stocks bore the brunt of bear selling, with some trading at or near their 2008 lows.

All the stocks recommended in the newsletter in the previous 12 months belonged to the small-cap and mid-cap categories (except one large-cap pick). A couple of stocks have already given substantial returns. Some haven’t performed well, with a few currently trading at or slightly below their recommended prices. However, each and every stock moved higher after my newsletter recommendation.

In a 2-3 years time frame for which the stocks were recommended, I expect most stocks to provide significant returns to subscribers through capital appreciation and dividends. I can claim that with reasonable confidence because stocks are chosen on the basis of strong fundamentals; plus, subscribers receive monthly technical updates to identify entry and exit points.

If you require help in selecting good stocks in uncertain times, all you need to do is subscribe to my Monthly Investment Newsletter. Send me an email (at mobugobu@yahoo.com) soon – subscriptions will close on July 21, 2012.

Stock Picking Strategies

Some times, I like to watch business TV channels for the sheer entertainment they provide. None more than a financial adviser who hosts a half-hour show twice a week where viewers call in with their queries and the host of the show lambasts them about their stock picks.

I was watching the show last evening. A viewer called in with a query on India Glycol. On learning that the viewer was a marketing professional at a brokerage house, the host asked whether good advice was being provided to the brokerage clients or not.

The viewer responded with a resounding ‘Yes’ only to face a tougher question from the TV show host: “Can you please tell me what India Glycol produces?” After the briefest of hesitations, the viewer said: “I don’t know.”

The next question was even tougher: “What is Mono-Ethylene Glycol?” This time, the viewer responded promptly: “I think some pharmaceutical product.” The TV show host slammed down the phone receiver and went apoplectic! It was too funny for words.

He looked straight at the camera and started shouting at the top of his voice: “Don’t you feel ashamed of yourself? This is the kind of good advice you provide to your clients? What is happening to this country? When will you people learn how to pick good stocks?” On and on he went for a couple of minutes before sitting down in sheer exhaustion.

Part of the anger was an act – but only a part. Most small investors enter the stock market without a clue about how to select a stock for trading or investment. No wonder they end up losing money. Then they compound the problem by ‘averaging’ the stock as it continues to fall – turning a smaller loss into a much bigger one.

If you want to learn stock picking strategies, you can read a 11 part tutorial at investopedia.com. The first part can be found at the following link:

http://www.investopedia.com/university/stockpicking/#axzz1ydDfLEzu

Links to the next 10 parts are available in the above link.

Related Posts

http://investmentsfordummieslikeme.blogspot.in/2009/03/how-to-pick-stocks-for-investment-part.html - Part I

http://investmentsfordummieslikeme.blogspot.in/2009/04/how-to-pick-stocks-for-investment-part.html - Part II

http://investmentsfordummieslikeme.blogspot.in/2009/06/how-to-pick-stocks-for-investment-part.html - Part III

How to identify winning stocks – a guest post

The Sensex and Nifty have been quite volatile lately, jumping up and down like a kid on a trampoline. Small investors are not sure whether to buy or sell. At times like these, it may be better to sit back and do nothing.

Niteen has a better idea. Learn how to identify winning stocks using his 12 parameters. If you like his post, please write a comment or query. Your feedback may motivate him to contribute regularly.

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After 18 years in the stock market, I have observed that most small investors are only interested in tips for making quick money. But without exception, they end up losing money. Remember that the reverse of ‘TIP’ is ‘PIT’. ‘TIP’s can take you to the ‘PIT’s. There are no short cuts to making money. The stock market is a place that requires a highly disciplined approach. To make money, investing should be viewed as a long term process.

How to identify a winning stock without depending on tips? What are the parameters that help in choosing a winner?

The most important parameter is the ‘Margin of Safety’. The concept of margin of safety was first introduced by Benjamin Graham, author of investment classics like ‘The Intelligent Investor’ and ‘Security Analysis’.

Graham said: "Margin of Safety is always dependent on the price paid". One should buy a stock when it is worth more than its market price. This is the central thesis of the value investing philosophy, which emphasises preservation of capital. Graham looked at unpopular or neglected companies with low P/E and P/BV ratios.

If you feel that a stock is worth Rs 100, buying it at Rs 75 will give you a margin of safety. In case your analysis is incorrect and the stock is worth only Rs 90, the Margin of Safety provides a cushion against a possible loss. In India, markets tend to be volatile, so it becomes more important to look at each stock through the magnifying glass of Margin of Safety.

Very few stocks make it through the stringent screening process given below, and many potentially investment-worthy stocks can get excluded. If you come across any tips and get tempted to invest, at least you should screen those stocks through these parameters to ensure that you are not overpaying.

There are 12 parameters grouped under four heads.

(I)  Valuation & returns

• P/E ratio < 40% of highest average P/E ratio over previous 5 years: take the highest P/E ratio of each year for last 5 years and then take an average
• Earnings yield (E/P) > 2 x (RBI bond yield): RBI Bonds give a return of around 8%
• Dividend yield > 2/3 x (RBI bond yield): Dividend yield is calculated by dividing the last dividend paid by a company, by the current stock price. Some companies retain earnings and do not pay dividends to maintain growth. But most blue-chip companies that have grown from the time they were not blue-chip, have consistently paid dividends for many years

(II)  Balance Sheet related

• Current ratio > 2.0. This will give you a positive Net Current Asset Value (NCAV) number per share
• Stock price < 1.2 x (Book Value)
• Inventory trend: Inventory trend should reflect revenue numbers. Goods are produced to be sold, and not stored in a warehouse. If inventories increase faster than sales, a problem is brewing
• Minimum 12% Return on Invested Capital (ROIC)
• Debt/Profit =<5 and Debt/Equity ratio =<1.5: A company should pay its debt out of its profits, and not out of the equity base of the company. A ratio of 5 means that the debt can be paid out of 5 years profits

(III) Profit & Loss related

• Revenue and profit should preferably increase consistently during last 5 years. A drop in any one of the 5 years can be considered also
• Consistently paying dividends, bonuses: This is in line with (I) above

(IV) Governance

• Published Statements of previous 6 months/Management Discussion and Analysis (from Annual Report): If the management is over optimistic about future earnings, an investor should stay away. Infosys, which is well-known for its transparency, has always been cautious in projecting future earnings
• Shareholding pattern – Buying, selling or pledging: If management is selling/pledging their holdings, the stock should be avoided

The above parameters are available (or, can be calculated) free of cost from sites like: www.icicidirect.com, www.anagram.co.in or from economictimes.indiatimes.com.

There can be cases where you need to consider some additional parameters. The measurement of one parameter can be relaxed due to the strength of another parameter. This comes through experience and a new investor/analyst should avoid relaxing the parameters.

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(Niteen S Dharmawat is an MBA who has been working with Indian IT companies. A firm believer in long-term financial planning, and an 18 years veteran of the stock market, he likes to analyse the economy, and individual stocks. He also conducts investor education sessions.

Niteen blogs at http://dharmawat.blogspot.com.)

Related Post

What exactly is the Margin of Safety?

Announcing the re-opening of subscriptions to my Monthly Investment Newsletter – and a Sensex update

There have been several reader queries about when subscriptions to my Monthly Investment Newsletter will re-open. Some of you who had missed the deadline in Jan ‘10 have also written to me recently.

I am pleased to announce the re-opening of newsletter subscriptions for a 3 weeks period from July 1-21, 2010. Like in Jan ‘10, only a limited number of subscriptions will be on offer – strictly on a first-come first-served basis.

If you are interested in subscribing, send an email to: mobugobu@yahoo.com at the earliest for details.

These past six months have been an interesting experience for me – and a profitable one for those subscribers who bought stocks at the recommended prices. It is easy for me to pick stocks for my blog posts when there is no pressure to perform.

It is even easier when the stock market is in a bull phase – as anything you touch soars up. The real challenge in stock selection occurs when the market is in a prolonged sideways consolidation.

Those who have followed my stock chart pattern discussions know by now what kind of stocks I like, and what type of stocks I avoid. The guiding principle has been to choose well-managed, financially sound companies that give steady returns and protect the downside.

Non-subscribers may be interested to know how the recommended stocks have fared. Without revealing the names of the stocks (it won’t be fair to my subscribers to do so), here is a brief results table with price on recommended date, subsequent high and low prices, and gains (absolute and annualised) as on Jun 30, ‘10:

Stock	Date	Price	High	Low	Close	Gain	Ann.
A	Jan 31	206	274	195	250	21%	51%
B	Jan 31	131	222	120	219	67%	161%
C	Feb 28	78	87	70	76	- 2.5%	- 7.7%
D	Mar 31	178	254	171	220	23.5%	94%
E	Apr 30	82	116	75	91	11%	66%
F	May 31	171	202	148	194	13%	161%

This is not merely an effort to blow my own horn. All six stocks are small caps picked for long-term of 2 to 3 years. The fact that they are showing decent short-term gains (except one) – even after falling from their recent highs - is a testimony to their underlying strength.

What is more important is that these stocks were not ‘cheap’ and had already run up quite a lot when they were recommended. The lesson is that even near 52 week highs of the Sensex, there are stocks available that can provide good investment gains.

To cut a long ‘commercial break’ short, if you need help in selecting good stocks in uncertain times, all you need to do is subscribe to my Monthly Investment newsletter. Send me an email (at mobugobu@yahoo.com) soon – subscriptions will close on July 21, 2010.

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A Sensex Update

The bull case: All three EMAs are moving up with the Sensex getting support from the 20 day EMA. Sensex hasn’t dropped much while Asian, European and US indices are tanking.

The bear case: Volumes are getting lower at peaks since the Jan ‘10 high. Of late, down day volumes are exceeding up day volumes in spite of FII buying.

RSI is still above the 50% level but falling fast. The slow stochastic is below the 50% level and the %K has given a bearish cross below the %D.

FII action holds the key now. Any further weakening of indices in Europe and USA may lead to a pull out by FIIs.

How to select a stock - an analysis of the exercise for readers

Before I get into a detailed analysis of last week's stock picking exercise, I would like to extend hearty congratulations to all of you who participated.

Regardless of your answer, the willingness to participate in an open forum indicates a desire to learn and share - which are great qualities for success in life (and in investments). As far as I am concerned, you are all winners.

The information given about the companies was brief. But it was adequate to decide which of the three should be added to a list for more detailed analysis. Thousands of stocks trade every day, and it is not possible for small investors to check the fundamentals of even a fraction of the traded stocks.

One uses short-cuts to create a short list. I start with the cash flows from operating activities. Why? Because a listed company is in existence for one reason only - to generate cash. Cash in a manufacturing business is like gasoline to an automobile. Without a regular supply of it from its operations, a business can run for a while but will eventually come to a halt.

All three companies have positive cash flows from operations and negligible debt. But sales are low and so are the NPMs - an indication that the sector is a profitable one but has low volume and low margin. That is why, it is a bit surprising that all three have outperformed the Sensex by moving above their Jan '08 prices.

The fact that all three have been around for at least 30 years means that the business models are sustainable. The low P/E is an indication that the market is not enthused by the low growth of the sector.

As small investors, we don't have huge capital at our disposal. To make sure our limited resources are not frittered away in chasing multibaggers, the prudent option is to look for companies where internal accruals are sufficient to pay for expansion and investments.

Debt is not bad per se - if it can generate more cash than the debt repayments. But when debt is incurred merely for rapid growth - disaster happens. The sorry state of the high fliers in retail and real estate is a clear example.

So we have three companies - all with good fundamentals in a sector with low risk and low growth. How do we choose one over the other?

Most of you chose Stock 'N' and there were several reasons for doing so. Highest sales, highest EPS, best RoE, strongest technicals. The clinching reason - not mentioned by any one - is that its sales are more than the combined sales of the other two! Even in a low growth sector, one company is growing faster than its two closest and older competitors.

Though it is trading at a much higher price, Stock 'N' is available at a Market Cap to Sales ratio of less than 1. Some of you have mentioned about this ratio (without explaining why it may be relevant). Others haven't. Next Tuesday's post will explain the importance of the Market Cap/Sales ratio.

The exercise was an effort to demonstrate what kinds of stocks can be added to a 'watch list' for more detailed analysis. A 'buy' decision can only be taken after a more thorough look at past performance and business outlook.

Now for the awards announcements.

VJ gets the nod (and applause) for the most logical explanation covering all the important points. Just follow your investment plan, and you will retire a rich man!

sreyO gets an "A" for effort. Though his explanation wasn't brief, he pointed out that a comparison is possible only if all three stocks have the same face value. Pretty impressive for some one who hasn't started investing yet.

A big 'THANK YOU' to the rest of you for taking part in the exercise.

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.

Why investors board the wrong train and then refuse to get off

Why is it that many investors seem to specialise in boarding the wrong trains (read: stocks) and then simply refuse to get off, even though logic and common sense dictates otherwise?

After watching part of the presentation of the Railway budget, where the honourable minister thoroughly entertained the treasury benches as she took on the opposition by throwing taunts at them, I was reminded of a movie I had watched several years ago.

In the British film 'Clockwise', a very uptight and ridiculously punctual headmaster, played by John Cleese, is invited to speak at the headmaster's conference at a distant town.

He diligently prepares for the visit, goes to the railway station well on time, boards the train and starts memorising his typed speech - only to realise too late that he had boarded the wrong train.

He quickly gets off, but misses his own train and then faces one hilarious misfortune after another as he desperately tries to ensure that he is not late for the headmaster's conference. To cut a long story short, he eventually reaches the conference on time - in a dishevelled and chastened condition.

The moral of the story? Trying to be too punctual can create unnecessary situations, including boarding the wrong train. But getting off quickly may ensure that you reach your destination on time.

Many investors would rather follow the stock ideas of others than learn to do the hard work of stock selection themselves. That can create serious financial problems.

Either one buys into a momentum stock with questionable fundamentals. Or, even worse, one buys a fundamentally strong stock after it has already run up a lot and the smart money is getting out.

End result is the same. One is stuck with a stock bought at higher prices. Then begins a prolonged period of 'loss aversion' - asking questions at different investment groups about the future of the company and when one can get back one's 'buy price'.

Not selling a losing position in the hope of breaking even may be the biggest cause of losses faced by small investors. There is only one solution. Get off the train! If you learn how to set stop-losses, you will incur smaller losses.

(Haven't learned how to set stop-losses yet? Read Chapter 2 of my FREE eBook.)

eBook: A big 'THANK YOU' to all readers

When I finally launched the FREE eBook on the last day of 2009 as a New Year gift, little did I expect such a wonderful response. I have been totally overwhelmed by the love, affection and respect that has flooded into my mail box.

I had decided to respond to each request for the eBook personally and promptly - instead of through an impersonal automated system. Due to the huge number of requests, I may not have been able to respond to all readers fast enough. Thanks for bearing with me.

Many of you have already completed reading the eBook and sent me suggestions for improvement and inclusion of various topics. This level of reader involvement and commitment has really impressed me.

For reasons of brevity, I had limited the eBook to a few of my earlier blog articles that gave an overview of how the stock market psychology works, what kind of portfolio to build, what mistakes to avoid and economic indicators to watch out for.

The excellent response and reader involvement has motivated me to plan two more eBooks - one on Fundamental analysis, and one on Technical analysis. These would require more effort and careful planning. I expect to announce the launch of one of them in the second half of 2010.

Some readers have requested me to hold training programmes on Technical analysis. I have been pondering over this for a while, and need to work out the logistics of delivering such a programme over the Internet.

To start with, the training programme will be restricted only to readers residing in and around Calcutta. The details will be announced later - I'm targetting an April 2010 launch.

Regarding the paid monthly newsletter - 'commercials' were liberally sprinkled in the eBook ('There is no such thing as a free lunch' - Milton Friedman), the brief outline is given below:-

1. There will be an annual subscription and a half-yearly subscription. (You can send me an email at mobugobu@yahoo.com for the rates.)

2. A detailed analysis of a carefully selected, under-the-radar stock will be featured each month. It need not be a 'hidden gem', and can be a large-cap, mid-cap or small-cap stock that is fundamentally strong and holds growth promise.

3. Links to some interesting articles on global markets will be provided.

4. A brief monthly review of the Sensex will be presented.

5. Each subscriber will be able to chat on-line with me exclusively once a month for 15 minutes.

6. To enable individualised attention, only 12 subscriptions are being offered initially, on a first-come first-served basis. Subscriptions will remain open till Jan 28, 2010 - but may close earlier if 12 subscribers sign up before then. So book your spot early.

7. Individualised portfolio creation, analysis, and discussion will be provided on request at additional charge. The charges will be discussed and mutually agreed upon. (I will offer portfolio help to non-subscribers as well - as I've been receiving several requests from readers over the past few months. But subscribers will get priority, and a discounted rate.)

8. The first newsletter should be ready for distribution by Jan 31, 2010.

If you haven't sent a request for the FREE eBook yet, do so now. Check the link below for details. The FREE eBook offer will remain open till Jan 31, 2010.

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eBook: How to become a better investor

What is the Return on Assets (RoA) ratio?

The Return on Assets (RoA) ratio is a measure of profitability of a company relative to its total assets (which includes share capital plus all its short-term and long-term loans). It tells us how effectively and efficiently a company's management is utilising its assets to generate a profit.

There are a few different ways to calculate the RoA ratio (also called the Return on Investment ratio). The simplest is to divide the net profit during a 12 month period by the total assets. In other words,

Return on Assets (RoA) ratio = (Net profit / Total assets) x 100

If the Net profit of a company is Rs 5 Crores and total assets is Rs 100 Crores, then the RoA will be 5%. Another company may earn Rs 10 Crores on total assets of Rs 100 Crores. Its RoA will be 10%. Needless to say, the higher the RoA the better. Which means the company is able to generate more profits with less or equal amount of investment.

An RoA of 15% is considered the benchmark for profitability. But the figure is different for different industries. Therefore, the RoA should be used to separate the men from the boys within an industry or sector - and not used for comparing across sectors.

Why? Let us take a Bharti or RCom. They need to constantly invest in new equipment and towers for growth. Or, a Maruti or Tata Motors that need to innovate and invest in new models and infrastructure. Likewise, for power generating businesses like NTPC or Suzlon; airline companies like Jet and Kingfisher; metal producers. Such companies are asset-heavy. Therefore the RoA ratio tends to be 5% or lower.

Contrast these sectors with some asset-light ones like software services or travel services or brokerages. All you need are some furniture and computers and you are in business. Naturally, the RoA ratio is 20% or higher, because the real assets in these sectors are people.

The financial sector, particularly banks, need to constantly borrow money to loan it out again. So the RoA ratio can be as low as 1%. What is a small investor to do? Avoid banks and manufacturing, and only invest in services companies?

Obviously not. That would be putting all your eggs in one basket. Therefore, use the RoA ratio to find out which banks, or auto makers, or steel and power companies are more profitable than their peers in the same sector.

Some prefer to add the interest expenses to the net profit to calculate the RoA ratio. Others add the working capital requirements to the total assets. Which particular formula to use depends on the type of sector being analysed.

There is another formula to calculate RoA:

Return on Assets (RoA) ratio = (Net profit margin x Asset turnover ratio) x 100

where, Net profit margin = Net profit / Sales

and, Asset turnover ratio = Sales / Total assets

Mathematically, the second formula is the same as the first, but gives us a different view of a business. It shows that profitability can be attained in two different ways. The first is by increasing the net profit margin (by reducing costs, or better still, by charging premium prices - like the Tanishq retail stores of Titan). The second is by turning over your assets many times during the year (a practice followed by discount retail stores, like Pantaloon).

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How to distinguish between a good company and a great company

(Wishing all my blog readers from near and far a very merry Christmas and a happy 2010.)

How to distinguish between a good company and a great company

If you are going to become a better investor you will not only need to distinguish between a good company from the not so good, but more importantly, learn to distinguish the merely good from the truly great company.

After all, it is your hard earned money. Why squander it on the not so good or a merely good company when you can let your money work for a truly great company?

So, how do you go about finding the truly great companies? In a mini-series on how to find out the financial health of a company, I had explained why I prefer to check the financial health prior to checking the profitability.

One of the major reasons is that profit figures are 'doctored' in a large number of companies. Cutting costs instead of increasing sales, calculating depreciation by different methods, valuing inventory differently, making inadequate provisions for taxes or debt or R&D expenses, using 'other income' or a one-off adjustment are some of the ways by which companies show 'profits'. And these are 'legal' methods!

Checking out the cash flow from operations and the other financial health ratios separates the good company from the not so good. But the cash flow from operations or the net profit margin does not provide any information about how much money is being used in the operations of the company.

We have to find out how much real profit a company is able to generate from the money it invests in the business. Almost all companies - whether listed or otherwise - borrow money from others (banks, financiers, relatives, friends, shareholders) and use that money to run its operations and generate a profit.

So the true differentiator between the great company and the merely good is how efficiently it can generate a higher profit relative to the amount invested in the business (also referred to as the 'capital employed').

In another mini series of forthcoming posts, I will discuss about financial efficiency and profitability ratios.

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What does the Interest Coverage Ratio signify?

When should you 'hold' and When should you 'fold' a stock?

There are four things you can do with a company's stock:-

1. Avoid it 2. Buy it 3. Hold it 4. Fold (or, sell) it.

In several blog posts, I have indicated the types of companies that an investor should avoid, and why. A quick recap may not be out of place here. Companies with

* questionable management
* negative cash flows from operations
* high debt and frequent share issues
* 'me-too' products with no competitive advantage
* low trading volumes
* high 'beta' (i.e. stock rises and falls more than the index)
* low growth in sectors that have seen better days, are the ones to pass on.

A series of articles have also been written about market cycles, sector selection, top-down and bottom-up methods for picking individual stocks, 'margin of safety' and 'circle of competence'. 'What to buy' should be supplemented with technical analysis to decide 'when to buy'.

Hopefully, readers have started absorbing some of the guidelines and are now sitting on (or in the process of building) a portfolio of well-chosen, fundamentally strong stocks, from sectors or industries that they can understand. That is only half the job done.

Buying a stock doesn't make any one any money. Holding it for a reasonable length of time, and then selling it at a profit completes the cycle.

How long should one hold a stock? Warren Buffett is ready to hold it forever. You may not have that long a time frame. But long term isn't one year. To get proper returns from a stock, you should hold it for at least 3 to 5 years. Like good wine, a stock should be given time to mature.

That doesn't mean you put it in a locker and forget about it. Industry and company developments should be regularly followed. (If you are unable, or unwilling, to track your portfolio - refrain from buying stocks. Invest in index funds/ETFs or balanced funds.) Irrational price movements - either up or down - should be used as opportunities to book partial profits or add to your portfolio.

When should you sell? That's the million dollar question. If you can learn the art of selling, you will be on the path to riches. Before we get to that, one must learn when NOT to sell. Do not sell a stock if

* the price has gone up from 41 to 48 in 15 days
* the quarterly results have been below expectations
* a temporary calamity has stalled production
* a big order has fallen through

There are only three reasons why a stock should be sold. By 'sold', I mean sold off completely from the portfolio.

1. You realise you've made a mistake in selecting the stock. Could be due to making incorrect assumptions, or, not researching the stock adequately.
2. The fundamentals of the company takes a turn for the worse. A failure of imported technology, fraud by top management, new and more nimble competitors changing the rules of the game, a big acquisition turning sour, could be some of the causes.
3. There is a sudden emergency or unforeseen requirement of money, for a medical condition or a job loss or a daughter getting admission in a foreign university or investment in an apartment.

I also use the 'sleeplessness indicator' - though it may not be universally reliable! If I'm unable to go to sleep at night because a stock investment isn't turning out the way it was supposed to, I sell it the next day.

(Readers may please share why they have sold stocks, if any mistakes were made and what lessons were learned.)