Investing in the stock market can be a transformative journey for growing your money. If done correctly, it has the potential to multiply your wealth significantly. However, selecting the right stocks to invest in, particularly those that can increase your money in the long term, requires a strategic approach. In this blog, we will delve into the methods through which your money can increase over time and the process of selecting such stocks.

As we embark on this journey, I am joined by my brother, Vibhu Rajshakur, who is just starting to learn about the stock market. To get him started, I have opened his account and gifted him Rs. 2,82,000. This amount has already generated a 12% return in the past five to six months, which is quite impressive. This gift represents his Demat account, which contains various good investments, including Indian and international stocks from America and China, as well as holdings in companies like Oppo and Vivo. Additionally, his account includes stocks from banks like HDFC Bank, ICICI Bank, and Axis Bank, and even gold, which has also seen a 12% return in the last six months.

The focus today is on learning how to select stocks. Interestingly, despite the good returns, Vibhu’s account currently holds no individual stocks; instead, it is composed entirely of ETFs (Exchange Traded Funds). I am a big fan of ETFs because they provide exposure to a variety of stocks without the need for picking individual ones. This diversified approach helps in mitigating risks.

Now, let’s dive into the process of selecting individual stocks. When considering a stock like HDFC Bank or Hindustan Unilever, you can’t just buy it based on its name or reputation. It requires studying the fundamentals and technical aspects of the stock. People generally invest in the market in two ways: by looking at the charts (technical analysis) and by analyzing the fundamentals (fundamental analysis). Value investing, which focuses on long-term investments, often ignores the charts. However, understanding both aspects can be crucial.

A common saying in investing is “price discounts everything.” This means that if something good is about to happen to a company, it will start reflecting in its stock price. Conversely, if something bad is on the horizon, the price will also show that. Fundamental analysis often lags behind because it relies on historical data. For instance, Hindustan Zinc has been a good stock over the years, but just looking at its fundamentals won’t tell you when to buy.

Technical analysis involves looking at charts to understand the price movement and identify patterns. For example, a stock might be in a consolidation phase, where its price moves within a certain range. A technical analyst will wait for the price to break out of this range before investing. This approach helps in timing the market better.

When investing, it’s important to have a horizon. If you are investing for the long term, such as five to six years, your money should ideally double in that time frame. If it doesn’t, you might need to reconsider your strategy. In my opinion, if you cannot double your money in six years, you are not investing wisely. For instance, putting your money in a fixed deposit (FD) will double it in about 12 years, which is a much slower growth rate.

I personally prefer ETFs because they are diversified and less risky compared to individual stocks. ETFs track an index, which is a collection of stocks with different weightages. Investing in an index helps in outperforming most mutual fund managers. Additionally, I use averaging, a technique where you buy more when prices drop, to maximize returns. This method works well with indices but can be risky with individual stocks.

For example, if you are 19 years old like Vibhu, you have the advantage of time. You can afford to take more risks since you don’t have major responsibilities like a mortgage or children. At this age, it’s about creating wealth for the future. Taking calculated risks is crucial. Swing trading, where you buy and sell stocks within a short period, involves setting a stop loss to manage risks.

Let’s look at a practical example. Hindustan Unilever is a strong company, and its stock might have doubled in price in a short period if you had bought it at the right time. For instance, if you had bought it at Rs. 360, you would need the price to reach Rs. 720 to double your investment. By analyzing the chart, you can identify when the stock is likely to rise and make your move.

Understanding the concept of what makes a stock cheap or expensive is crucial for any investor. It’s not just about the current market price but involves delving into the company’s fundamentals and intrinsic value. Let’s take a practical approach to this, as this will help you grasp the essential concepts without needing to dive into complex formulas.

When we talk about a company’s stock being cheap or expensive, we’re referring to its valuation in relation to its intrinsic value. Intrinsic value is an estimate of a company’s true worth based on its fundamentals, such as earnings, dividends, and growth potential. This contrasts with the market price, which is what investors are currently willing to pay for the stock. For example, if a company’s stock is trading at ₹760, determining whether it’s cheap or expensive requires analyzing its intrinsic value.

One way to assess intrinsic value is by looking at fundamental metrics. The Price-to-Earnings (P/E) ratio is a common tool used here. The P/E ratio is calculated by dividing the current market price of the stock by its Earnings Per Share (EPS). EPS is derived from the company’s total earnings divided by the number of outstanding shares. For instance, if Hindustan Zinc’s current price is ₹757 and its EPS is ₹19, the P/E ratio would be approximately 40. A P/E ratio of 40 can be considered high, implying the stock might be expensive unless justified by high growth prospects.

Another important metric is the Price-to-Book (P/B) ratio, which compares the market value of the stock to its book value. The book value represents the net asset value of the company per share. For instance, if a company’s book value per share is ₹500 and its stock price is ₹750, the P/B ratio is 1.5. A lower P/B ratio could indicate the stock is undervalued, but it’s essential to understand the underlying reasons, as sometimes a low P/B ratio can result from inherent problems in the company’s fundamentals.

The Price-to-Cash-Flow (P/CF) ratio is also significant. It measures the market price of the stock relative to the cash flow generated by the company. Cash flow is crucial as it shows the actual amount of cash the company has to reinvest, pay dividends, or reduce debt. For example, a company like Apple is renowned for its substantial cash reserves, which provides a cushion against downturns and opportunities for strategic investments.

Beyond these ratios, looking at a company’s revenue growth is essential. Consistent year-on-year revenue growth is a positive indicator. For instance, if Hindustan Zinc’s revenue has grown from ₹24,000 crores in 2021 to ₹30,000 crores in 2022 and further to ₹35,000 crores in 2023, it shows a healthy upward trend.

Profitability metrics, such as Return on Equity (ROE), also play a critical role. ROE is calculated by dividing net income by shareholders’ equity, indicating how effectively management is using equity financing to generate profits. A higher ROE typically signals a more efficient company

When evaluating stocks, it’s also vital to consider market conditions and sentiment. For instance, during economic downturns, stocks often trade below their intrinsic value, providing buying opportunities for savvy investors. Conversely, during booms, stocks can become overvalued.

Liquidity is another key difference between investing in stocks and real estate. Stocks offer higher liquidity, meaning you can quickly sell them and convert them to cash. Real estate investments, however, tend to be less liquid, often requiring more time and effort to sell properties.

Using online screeners like Ticker Tape or Screener can simplify this process, as they aggregate and analyze these metrics for you, providing scores and insights into whether a stock is overvalued or undervalued. For example, if Hindustan Zinc shows a low valuation score on these platforms, it might indicate it’s currently expensive relative to its fundamentals.

Understanding financial terms like EBITDA and net profit is essential for anyone studying business, especially those pursuing BBA or planning to do an MBA. These terms play a critical role in evaluating a company’s financial health. Let’s break down these concepts in simple language.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Essentially, it represents a company’s earnings before accounting for these specific expenses. This measure provides a clear picture of a company’s operational profitability by excluding the costs of debt, taxes, and the reduction in the value of assets over time. For instance, if a company has a net profit of ₹100 crores, but it paid ₹10 crores in interest and accounted for ₹20 crores in depreciation and amortization, the EBITDA would be ₹130 crores. This figure shows the company’s earnings from its core operations without the effects of financial and accounting decisions.

Depreciation and amortization are often confused, but they are quite different. Depreciation refers to the reduction in value of tangible assets like machinery or buildings over time due to wear and tear. For example, a machine that cost ₹10 lakhs may depreciate by ₹1 lakh every year. Amortization, on the other hand, applies to intangible assets such as patents or goodwill. It’s similar to depreciation but for non-physical assets.

Interest expense is another crucial component deducted from earnings. Most companies borrow money to fund their operations, and the cost of this borrowing is the interest expense. For example, if a company borrows ₹100 crores at an interest rate of 10%, it will incur an interest expense of ₹10 crores annually. This expense reduces the net profit but does not affect EBITDA.

Taxes are the next major deduction from earnings. After paying interest, companies must pay taxes on their earnings. For example, if a company has a pre-tax profit of ₹90 crores and the tax rate is 30%, it will pay ₹27 crores in taxes, leaving a net profit of ₹63 crores.

Now, let’s discuss the profit metrics beyond EBITDA. Profit Before Interest and Taxes (PBIT) is the earnings before accounting for interest expenses. If our example company has an EBITDA of ₹130 crores and a depreciation and amortization expense of ₹20 crores, the PBIT would be ₹110 crores. Profit Before Taxes (PBT) is the profit before deducting taxes. Using the same example, if the company has a PBIT of ₹110 crores and pays ₹10 crores in interest, the PBT would be ₹100 crores.

The final metric is net income, which is the profit after all expenses, including interest and taxes, have been deducted. In our example, with a PBT of ₹100 crores and taxes of ₹27 crores, the net income would be ₹73 crores. This figure is crucial as it calculates Earnings Per Share (EPS), a vital measure for shareholders. If the company has 1 crore shares outstanding, the EPS would be ₹73.

EPS is also used to calculate the Price to Earnings (P/E) ratio, which is a key indicator of how much investors are willing to pay for each rupee of earnings. For example, if a company’s share price is ₹730 and the EPS is ₹18, the P/E ratio would be approximately 40. This ratio helps investors determine if a stock is overvalued or undervalued compared to its earnings.

Additionally, it’s essential to understand the concept of dividends, which are a portion of earnings distributed to shareholders. If a company earns ₹18 per share but distributes ₹13 as a dividend, it retains ₹5 for reinvestment. This dividend payout is a significant aspect of shareholder returns.

Understanding a company’s balance sheet is like evaluating a potential groom for a friend’s sister. You’d look at his income, debts, and what he has left after spending. Similarly, a balance sheet shows a company’s assets and liabilities. Current assets, like cash or inventory, are essential as they can be quickly converted to cash. Non-current assets, such as property or equipment, are valuable but less liquid.

When conducting a long-term analysis of a company, it’s essential to examine its financial performance over the past five years rather than focusing on short-term fluctuations. For example, if we look at a company’s total assets over the last five years, we can identify trends and patterns that are more indicative of its overall health. In this context, let’s consider a company with the following total assets over the past five years: ₹42,000 crores, ₹46,000 crores, ₹45,000 crores, ₹44,000 crores, and ₹35,000 crores. This shows a decreasing trend, which can be a cause for concern.

When analyzing a company’s financials, it is crucial to use the available data, even if it’s not the most recent. For instance, if data for 2024 is unavailable, decisions must be based on 2023 data. This principle applies to fundamental value investing, where investors rely on historical data to make informed decisions. A common individual may not have access to the latest data, but they can still make sound decisions based on the parameters provided.

One key metric in fundamental analysis is the price-to-earnings (PE) ratio, which helps investors assess whether a stock is overvalued or undervalued. Although the PE ratio data might be outdated, investors can use formulas to estimate the current ratio. It’s important to remember the advice of experienced investors like Pushkar, who emphasized the significance of understanding and calculating these ratios.

Another critical aspect of analyzing a company’s financial health is examining its liabilities. Liabilities are of two types: current liabilities, which need to be paid immediately, and non-current liabilities, which can be paid over a longer period. Ideally, a company’s current liabilities should be lower than its assets. For example, a company with ₹44,000 crores in assets and ₹10,000 crores in liabilities is in a strong position. However, if liabilities increase, it raises a red flag. A healthy ratio is when liabilities are less than half of the total assets.

In addition to liabilities, other important components of a balance sheet include total equity, total liabilities, and shareholders’ equity. The balance sheet gives a comprehensive view of a company’s financial standing, and understanding the interplay between assets and liabilities is crucial. Revenue and net income (or EBITDA) are vital metrics in the income statement, reflecting a company’s profitability.

Cash flow analysis is another essential part of fundamental analysis. Investors should examine the net change in cash, which indicates whether a company’s cash reserves are increasing or decreasing. A positive net change in cash is a good sign, while a negative change can be concerning. For instance, if a company had positive cash flow in 2022 but negative cash flow in 2023, it indicates a decline in financial health. Free cash flow, which represents the cash available in the company after capital expenditures, is particularly important. Consistently increasing free cash flow is a positive indicator.

To illustrate, let’s consider the financials of ITC, an Indian conglomerate. ITC’s cash flow has been increasing year over year, with positive net changes in cash and substantial free cash flow. The company’s assets are also increasing annually, and its liabilities remain under control. In terms of revenue and EBITDA, ITC shows steady growth, making it a stable and attractive investment.

While fundamental analysis focuses on company-specific factors, it also involves considering macroeconomic conditions. Global economic trends and sentiments can impact investment decisions. For example, changes in interest rates by the Federal Reserve or the Reserve Bank of India affect the stock market. Higher interest rates might encourage investors to move their money from stocks to safer investments like fixed deposits, leading to a potential decline in the stock market.

Understanding macroeconomics is crucial for fundamental analysis. Investors need to assess global economic projections, inflation rates, and unemployment data. These factors can significantly influence stock market performance. Even without extensive degrees, a thorough understanding of these elements can enhance investment strategies.

In addition to fundamental analysis, technical analysis plays a significant role in investment decisions. Technical analysis involves studying price charts and identifying trends. For example, if a stock’s price chart shows a consistent upward trend, it might indicate a good buying opportunity. Conversely, a downward trend could signal caution. Key concepts in technical analysis include support and resistance levels, which help predict future price movements.

Combining fundamental and technical analysis provides a comprehensive view of a company’s potential. For instance, a fundamentally strong company with a positive price trend is an attractive investment. However, investors should avoid catching a “falling sword,” or buying a stock that is rapidly declining in price.

Debt-to-equity ratio is a crucial financial metric used to assess a company’s financial leverage and stability. Essentially, it compares the total debt of a company to its shareholders’ equity. A higher ratio indicates that a company is financing more of its operations through debt, while a lower ratio suggests a more balanced or equity-heavy approach. Ideally, investors prefer a debt-to-equity ratio of less than 1, meaning the company has more equity than debt, which typically signifies financial health and lower risk.

Let’s delve into some real-world examples to better understand this concept. Take Vodafone Idea, for instance. The company has a staggering debt of ₹2,37,766 crores, and its equity is negative. This is a massive red flag for potential investors because a negative equity implies the company’s liabilities exceed its assets, indicating severe financial distress. Investing in such a company would be akin to gambling, as the risks far outweigh the potential rewards.

Similarly, many small-cap companies might show a high debt-to-equity ratio, but for this discussion, we will focus on larger, more established companies in the Nifty 50 index. For example, Adani Enterprises has a debt of ₹53,000 crores and equity of ₹37,000 crores. Here, the debt-to-equity ratio is greater than 1, which signals that the company is heavily leveraged. While this does not necessarily mean the company won’t perform well, it does suggest higher financial risk, making it less attractive to conservative investors who prioritize financial stability.

A prudent investment strategy involves filtering out companies with a debt-to-equity ratio of less than 1. This ensures that the company has a strong equity base and is less reliant on debt, which generally makes it a safer investment. To streamline this process, investors can use financial screeners to filter out companies based on various criteria.

For instance, by using a screener to explore the top 500 companies in the Nifty index, investors can filter based on the debt-to-equity ratio. After selecting the debt-to-equity filter, one can further refine the search by applying a price-to-earnings (P/E) ratio filter. A P/E ratio of less than 25 is typically preferred, as it suggests the company is reasonably valued relative to its earnings. A negative P/E ratio would indicate that the company is currently operating at a loss, which is generally a warning sign for investors.

Consider a few examples of companies filtered through these criteria. Rajesh Exports has a P/E ratio of 6, but its debt-to-equity ratio is a high 4.9, making it a less desirable choice. On the other hand, Gujarat Narmada Valley Fertilizer has a P/E ratio of 6.7 and a very low debt-to-equity ratio of 0.02, making it a potentially attractive investment. Similarly, Bajaj Holdings and Investment Limited shows a P/E ratio of 12 and a debt-to-equity ratio of 0.18, positioning it as a strong candidate for further analysis.

Ultimately, after filtering based on these financial ratios, investors should perform fundamental analysis on the shortlisted companies. This involves scrutinizing their financial health, growth prospects, management quality, and market position. By doing so, investors can build a watch list of promising stocks and monitor their performance before deciding to invest. This disciplined approach helps in identifying financially sound companies with good growth potential, thereby minimizing risk and maximizing potential returns.

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