How to identify stocks to invest in?

We have a very simple approach to investing stocks. In our simple approach to investing in stocks we have one like and one dislike. We LIKE to make a lot of money. We DISLIKE losing money. We are quite patient and in no hurry to make lots of money. So we invest in the long term without worrying about the short term prices. So this is how we do it.

We take care of our like and dislike by an approach in which we identify stocks with underlying business meeting most of the following criteria

Stocks with a good business

We like high or growing market share businesses which are run by an honest and competent management in product categories which are growing. We like it even better if we have a strong brand supporting the market share.

Stocks where the businesses make good money

We like stocks of businesses which make good money for real. We look for good money via profit margins and earning growth. We look for real money when we see cash being generated by the businesses when we read their cash flow statements. We believe the money earned is for real if it can shared via dividends. So we like consistent and increasing dividends and get worried if dividend is not paid or reduced. We focus on the consistency of dividend payouts and not the dividend yield per se.

Stocks cheap with respect to asset value

We don’t miss checking out the Price to Book Ratio of the stocks we are interested in. While we are calculating the Book Value we don’t forget to read the annual report and try to understand the quality of the calculated book value. We love companies which have cash reserves as a part of the book.

Stocks cheap with respect to earnings

Price to earnings ratio or the PE ratio is something we really like to look at. We like a low price relative to current or future earnings. At times we may not get a stock cheap relative to current earning. In such cases we go back in the past to see the quality and consistency of past earnings. This helps us understand if we can get the stock cheap relative to future earnings based on the past earning pedigree. At times the past may not tell us about the future, in such cases we like to look at the potential opportunity on hand.

While look at the future opportunity, we are no fortune tellers and have no special skills in building forecasts.

Stocks where insiders are buying the stock

We keep scanning annual reports, quarterly stock holding data and bulk deal transactions to have an understanding of the behavior of insiders and large shareholders related to their stock holdings in the company. We love it if we find that insiders in the company and insider in the stock market are buying the stock. We hate businesses where promoter stocks are pledged.

Stocks where prices have fallen a lot

Market volatility always gives opportunities where the price may have fallen significantly without any real news about the business prospects. We love scenarios where bad global news which may not directly impact the business bring in price corrections.

 Stocks which are small caps with potential of becoming a large cap

India stock markets are not well researched when it comes to small caps. Small caps though very risky, gives us a niche to play in. We cannot hope to compete with large brokerages etc in the large cap universe which is quite well researched.  We prefer small caps, but don’t have a strict no policy against large caps.

Ok we identified a good stock … then what

We buy it. We keep tracking news and financial statements to keep monitoring the business prospects. In reality we keep checking if.

  1. The stock with a good business is becoming better
  2. If the business is really making good money
  3. If the above two conditions are being met then we sit tight and wait patiently till we see the stock price we like.

In the long term stock price is an outcome of the quality of the underlying business. so rather than monitoring the stock price we keep monitoring the business fundamentals, because that helps us make lots of money without losing much.

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