A view of the Bombay Stock Exchange (BSE) building in Mumbai, Thursday, February 24, 2022.
A fall in the stock market provides the perfect opportunity for retail investors to buy quality stocks. The Indian market has shown a beautiful correction after a one-sided rally in the last almost three months, with Sensex touching 62,245 and Nifty touching 18,604.
With so many stocks, it can be a daunting task for investors to cherry pick and add the best ones to their portfolio. “While it can still be easy to find the right stocks, it can be difficult to achieve the right amount of diversification. Always remember to choose quality over quantity,” said Anand Mehta, VP of Wealth Management at Kopper.
Mehta suggests choosing the right stocks to invest in to help investors optimize returns.
1. Fundamentals – Start with the Basics
A company with a strong balance sheet is like a company with a strong backbone! Look for companies with good earnings and margin growth. Low debt is a good set of assets, however, each industry has different parameters to determine, it is always easier to do a comparative analysis and choose the right one.
Skim through the product/service line and competitive landscape, if the company deals with a set of products/services with fewer options and peers that are irreversible. These companies have a unique competitive advantage.
Pro Tip: While there is no ideal time frame to look at, at least 5 years of past data will give you an idea of how the company is doing.
2. Invest in what you know
This is one of the fundamental principles that support veterans like Peter Lynch, Warren Buffet, advising people to invest in what they already know. If you don’t understand the business, it’s simply not worth investing your money in. By understanding business, we mean knowing the key business drivers, risks or hazards.
Pro Tip: However, this does not mean that you invest in all the businesses you understand, which will lead to an extremely fragmented portfolio.
3. Management Discussion and Analysis (MDNA)
MDNA is a very important section in the balance sheet, however, before you refer to this section, have a look at the management of the company, their experience, expertise and track record. Whether management is able to take the company’s business to the next level is an important question that you should be able to answer.
Pro Tip: Look at the MDNA section in the Balance Sheet of the last 3 years and find out the vision, key milestones they have chalked out and assess whether they have tried to achieve these key milestones in the recent past.
4. Avoid Momentum Stocks
If some stocks keep popping up on your feed or your friends are talking about it, it is quite normal to be attracted to such stocks. They may be on the upside, however, buying a stock based on its recent ability to provide supernormal returns can be quite risky. Also, finding the business model interesting isn’t reason enough to put your money there.
Pro Tip: Always look at the company’s prospects, do your research, understand the key revenue drivers, risks and competitive landscape before investing.
5. Leverage Burden
Another important aspect to look for in a company is how it has handled debt over the years. Naturally there are some sectors which have high debt. Real estate, power/infrastructure builders etc.
Pro Tip: All these capex heavy companies have high leverage, for such companies, it is important to look at the EBITDA margin and their asset quality to determine their ability to repay their debt easily.
For other sectors like retail, footwear etc, where the credit requirement may be relatively less, we need to look for companies with low debt and strong revenue growth.
6. Topline Driven or Bottomline Driven
While it’s important to identify companies that are key revenue drivers, as stated earlier, there’s also a need to understand expense patterns and how margins play out for the sector. If the company is volume-based (eg retail, footwear etc.), revenue growth should be strong.
Companies operating in a specific location (eg branded cosmetics, branded clothing) have to demonstrate consistent growth in margins.
Pro Tip: Therefore, understanding the types of cash flows in a business, the dynamics of the business and what aspects to look for can be the key to finding the right set of stocks.
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