A combined 7000+ companies were listed in the two core stock exchanges in India, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), at the end of FY 2021. With so many companies operating across many sectors and segments, how do you identify which company is best for investment in the share market? In our discussion, we will focus on investing in the share market.
Financial experts tell you, ‘invest in the company/business, and not just in its stock’. Sound cryptic? The simplified version is, do not jump on the trading bandwagon simply guided by the price movements of various stocks. In the volatile and unpredictable share market, what goes up can suddenly come down and vice versa.
The wiser way to invest is by carefully researching the company and its business. A sound business is bound to bounce back from any slumps, while an inherently unsteady business may show short spurts of price rise but is unlikely to sustain it. Here are points to keep in mind when you jump on your investing journey.
To succeed as a trader, dropping the idea of making a quick buck in the stock market is vital. Have a future horizon in mind and look at companies with growth potential. Historical performance acts as a decent beacon - yes, but do not let it become the sole deciding factor.
A company’s potential can depend on several factors, such as the sector it operates in, its competitors, and more. A simple example is the hospitality industry. For over a dozen years, the hospitality industry has been the star performer in the country, yet it has been witnessing a noticeable recession in the post-pandemic era. Hence proved that it is the future potential you need to consider and not rely entirely on historical performance.
Several factors influence stock prices. They can be localised, geopolitical, socio-economic, or entirely global. The ongoing military conflict, for example, has affected stock prices worldwide. Or the rising inflation in the US has had a global domino effect. While these events cannot be predicted, you need to stay informed about such developments. Information regarding the directly affected sectors can have a strong bearing on picking the right companies to invest in. For example, if a leading steel exporter has received sanctions, it is more probable that domestic steel companies will get more demand, thereby leading to a surge in their stock price.
You do not need to be a financial expert, but familiarizing yourself with the correct terms and their implications is essential to better grasp a company’s performance. This, in turn, helps you identify the right companies to invest in. One of the foremost aspects of identifying the best company for investment in the share market is carefully researching and understanding its financial status. For example, companies with a high debt against their name should be flagged red in your list. Cash-rich companies are known to withstand market volatility better; hence, they deserve your consideration more.
Another important guiding tool is the P/E or the price-to-earnings ratio. The (P/E) ratio relates a company’s share price to its earnings per share. A high P/E ratio usually implies that the company’s stock is overvalued, which is why a lower PE ratio is what you- should be tracking. There are several other technical beacons that you can use depending on your ability to absorb the information and inclination to delve into it deeper. Fortunately, almost all of this information is available in the public domain.
Once you’ve filtered out the company’s financials, get into its business model. Investigate if the model is easy to understand. Why you might ask? Assume you have to choose someone you have to pay for, say 24 months and in return, they will offer you a certain percentage of the earnings.
While choosing, you’re bound to first understand what they will do to repay you, right? And you’ll also understand how they are going to do it. Stocks are the same. If you can understand the business of that stock, then you can make better decisions about buying, selling or holding that stock.
MOAT is a huge ditch that surrounds a castle or fort that is filled with water and used as a form of self-defence. Similarly, some stocks have a MOAT around them. It’s very tough for competitors to get ahead of them in that sector. Maggi(Nestle) is a really good example. Even Pidilite for that matter and there are so many more. This will weed out many companies and aid in finding the best company for investment in the share market.
What is the company you’re eyeing doing differently than its competitors? The USP of the company that makes them stand out is also crucial before deciding to invest. Reliance Jio, for example. They’re dominating the market because of free calls and internet availability at a low cost. Similarly, find out what the company you’re interested in is doing differently than others.
Arguably the most important question you need to find the answer to before you put your money on them. The management is the heart and soul of the company. Do some research on the company's leadership team, study the history of how they have grown the company, and read up on what they plan to do to grow the business. Good management will always have the best intentions for the company and will be evident in how the company has performed.
The suggestions mentioned above are in no way exhaustive. They are a means to get you started in the right direction. Based on your level of expertise and comfort, you can choose to dive as deep as you wish to. You can also subscribe to expert journals, stock publications and other informative material to expand your spectrum.
The downside of this can be too much information overload or getting caught up in the wave of opinions. Try to stay away from both. Irrespective of where you choose to take your information, there is no substitute for thorough research. All the information you gather needs to be put through a sifter which should include filters like your personal financial goal with the investment in consideration, investment horizon in terms of time, and risk appetite.
New investors may stick to companies with proven performance and strong financials. These are usually large-cap companies, a.k.a blue-chip companies. There is, typically, less risk associated with them which is why they are a good place to start your trading journey.
It is not prudent or possible to name one specific company here. The right company depends on your individual trading choice. However, if we were to generalise, it is often suggested that large-cap companies are safer and hence more stable, while mid-cap companies tend to have higher potential for growth. It is not uncommon for small-cap companies to provide double returns. Eventually, it all boils down to your risk profile and the amount of research you have put in to identify the growth potential of the specific company.
New investors are encouraged to start with safe large-cap companies like HDFC Bank, Reliance, TCS, Infosys, Asian Paints, etc. This is because the companies have a solid presence in their respective sectors and their stock prices are less volatile.
Companies with a market capitalisation (market-cap) of ₹ 20K Cr and above are known as large-cap companies. In terms of their current market cap, the top 5 companies in India are Reliance Industries, TATA Consultancy Services, HDFC Bank, Infosys, and ICICI Bank.
These are recommended for new investors and those with low-risk appetite, who prefer lesser but steady gains.
Companies with a market valuation in the range of ₹ 5K Cr to ₹ 20K Cr are grouped under the mid-cap category. Some prominent examples include Canara Bank, Bharat Heavy Electricals Ltd., Hindustan Petroleum Corporation Ltd., TVS Motor Company Ltd., and Zee Entertainment Enterprises Ltd.
These are recommended for the more adventurous investors since mid-cap companies are generally yet to realise their full potential.
Small-cap companies have a market valuation of under ₹ 5K Cr. Some notable examples here are Future Retail, PVR, Blue Dart, JK Lakshmi Cement, and Indian Bank.
These stocks have the highest element of risk and need to be invested in carefully. The volatility is extremely high, and while there can be instances of a rapid surge in stock price, there can also be a prolonged period of underperformance. Proceed with extra caution.
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