A view of Bombay Stock Exchange (BSE) building, in Mumbai, Thursday, Feb. 24, 2022.
A stock market downfall offers the perfect opportunity for retail investors to buy quality stocks. The Indian market has shown a handsome correction in the last nearly three months after one-sided rally that saw Sensex touching 62,245 and Nifty 18,604.
With so many stocks galore, it can be quite a daunting task for investors to cherry-pick and add the best ones to their portfolios. “While finding the right stocks may still be easy, the right amount of diversification can be tough to achieve. Always remember to choose quality over quantity," Aanand Mehta, VP of Wealth Management at Koppr, said.
Mehta suggests tips on choosing the right stocks to invest in which can help investors optimize returns.
1. Fundamentals – Start with the basics
A company with a strong balance sheet is like one with a strong backbone! Look for companies that have good earnings and margin growth. Lower debt, is a good set of assets, although, there are different parameters to determine each of the industries, it is always easier to do a comparative analysis and choose the one that gives the right signals.
Skim through the product/service line and the competitive landscape, if the company deals with the set of products/services which are irreplaceable, with lower substitutes and peers. These companies have an unparalleled competitive advantage.
Pro Tip: While there is no ideal timeframe to look at, at least 5-year past data should give you a fair idea of how the company has been doing all along.
2. Invest in what you know
This is one of the basic tenets that stalwarts like Peter Lynch, Warran Buffet endorse, they recommend people to invest in what they already know. If you do not understand the business, then it is simply not worth putting your money in. By understanding the business, we mean knowing the key business drivers, risks or threats.
Pro Tip: This, however, does not mean that you invest in all the businesses that you understand, which will lead to an extremely fragmented portfolio.
3. Management Discussion and Analysis (MDNA)
The MDNA is a very important section in the balance sheet, however, before you look into this section, take a look at the management of the company, their experience, expertise and track record. Is the management capable of growing the company’s business to the next level, this is a key question that you should be able to answer.
Pro Tip: Look at the MDNA section in the past 3 years balance sheet and ascertain the vision, key milestones that they have chalked out and assess whether they have tried to achieve these key milestones in the recent past.
4. Avoid momentum stocks
If certain stocks keep popping up on your feeds or your friends have been talking about it, it is quite normal to feel drawn towards such stocks. They may be on an upward trend, however, buying a stock based on its recent ability to provide super normal returns could be quite dangerous. Also, finding the business model interesting is not reason enough to put your money there.
Pro Tip: Always look through the company prospects, do your research, understand the key revenue drivers, risks and competitive landscape before you invest.
5. Leverage burden
Another key aspect to look for in the company is how it has handled debt over the years. There are inherently some sectors that tend to have higher debt. Real estate, electricity/infrastructure manufacturers etc.
Pro Tip: All these Capex heavy companies tend to have high leverage, for such companies, it is important to look at the EBITDA margin and their asset quality to determine their ability to conveniently pay off their debt.
For other sectors like retail, footwear etc., where the debt requirement may be relatively low, we need to look for companies with low debt and strong revenue growth.
6. Topline driven or bottom line driven
As stated earlier, identifying the companies with key revenue drivers is important, there is also the need to understand the expense pattern and how the margins playout for the sector. If the company is volume-based (for example retail, footwear etc.,) the revenue growth has to be strong.
For companies that operate in the niche space (for example branded cosmetics, branded clothing) the margins have to exhibit sustained growth.
Pro Tip: Hence, understanding the type of cash flow the business has, the business dynamics and which aspects to look for can be the key to finding the right set of stocks.
