Tips to choose the right stocks
Look at the management of the company. A strong and able management is one of the very important decision factors. This is a basic study but 50 per cent of the confidence is derived through a good leadership of the company that you are investing in.
Perform some valuation analysis. Company X is priced at Rs40 and Company Y is priced at Rs60 in the same sector. Which stock you would buy? Is it X because it is priced lower than Y or Y because has higher price in Market? The price does not really tell anything. P/E (Price to Earning) ratio is one of the most popular numbers the market looks at while finding the value. This is the ratio of market price of the stock to the EPS (Earning per share. Net Income / outstanding shares). This tells how much the market is willing to pay for the earnings it is generating. But there is no right P/E. Higher P/E appears more expensive but also can be an indication that market is keeping a lot promise on this company and willing to pay higher price. Lower P/E is an indication of not so confidant outlook or what this is the stock what market calls 'hidden gems'.
But P/E ratio is not all that tells the story completely. There are various other factors that together give a better picture. Like Market Capitalization (MCAP) is a good indication of size of the company and also a basis to compare two companies of same size, earnings and earnings growth, return on equity (net income / book value) are some of the other numbers one uses to understand value of the company.
Other factors like order bookings, expansion plan, acquisitions, fixed assets like land, investments in other companies indicate the health of the company.
Understanding margin of safety Benjamin Franklin, known as 'Father of Value Investment' presented a concept called 'Margin of Safety' in 1934, which is still a base for value investment. In a very simple terms margin of safety says that we should buy the stock at a lower price (present market price) than the intrinsic value of the stock. Identifying real or intrinsic value of the company is a very subjective analysis. There is always a margin for error in identifying the real value. Hence, the margin of safety helps to cover those errors. Again there is no right margin of safety; it depends on your risk appetite and conviction.
Don't confuse the price with value. Don't misinterpret a stock trading at Rs100 falling to Rs70 is the right value to buy. Finding the intrinsic value of a stock needs some technical analysis.
Some Do's and Don'ts:
1. Never get attracted by the hot tips by broker friends or the support and resistance limits or buy/sell recommendations on a daily basis. Most of those tips are for traders and does not matter to the long-term investors. Always note that the brokerage houses have vested interest in recommending certain stocks that may not match with your interest.
2. Get ideas from these recommendations but do your own homework to make buy and sell decisions.
3. Don't attempt to time the market and make speculations to decide to sell and buy. If you feel the stock still is not over priced buy it and is fully valued, sell it.
4.Don't panic on market corrections. Technical corrections are indication of healthy markets. An investor finds value when there is a big correction or market fall due to some panic, political instability or any other reasons. Take opportunity to average your investment.
5. Give enough time for your investment to grow.
6. Spread the risk wisely on different sectors. As companies de-risk their regional, business dependencies, it is important to de-risk your investments across sectors. Not only within stocks but also spread the investment across different asset classes like postal schemes, savings, Mutual funds based on your risk appetite.
7. Last but not the least if you feel not confidant of doing a good job at this, don't gamble with your hard earned money, pay for a professional to do it