Money Matters: A Guide To Build Your Stock Market Mus(cles)kills
On Nov 19, 2014
The last 'Money Matters' article discussed how India is on the cusp of a rapid development cycle. The new government has initiated a slew of reforms and if it continues adopting the mantra that action speaks louder than words then we are going to see an unprecedented and steady run up in stock prices.
This might sound too good to be true, but the Stock market is an emotional beast; hope is its accelerator and fear its brake. The current wave of hope should last at least for the next 5 years. The government has already shown it means business and growth is its priority. So if hope is the foundation then growth is the building block. They make a heady mix. When a country starts growing you will see optimism brimming and with this optimism comes loosening of purse strings by consumers, grandiose plans by entrepreneurs and corporates and speculation by investors.
The next 3 years is the best time for learning the ropes in the stock market. Markets will be volatile but will show a steady uptrend. This article is for beginners and those of you who know a little but lack the confidence. Investing in the stock market does not require any in depth knowledge of mathematics nor is it rocket science. It can be slowly developed with a disciplined approach, a little bit of reading and application of thought. But the most important part is self control and humility. In a rising market prices are driven by optimism and not reality. So tread carefully. A few winning picks do not make you an expert. The day you start believing you are a good stock picker and make decisions based on that belief, you have joined the ranks of many people who have lost money.
It is very important that you know at all times that you do not participate on optimism or fear but understand it and take advantage of it. Warren Buffet says it in a civilized way, be fearful when others are greedy, and be greedy when others are fearful. So however good or bad we are at analysis, the timing of buying and selling will determine our success.
Reading: The most important way to get a perspective of the stock market is to be aware of what is happening in the corporate world. Reading a Business news paper and/or a business magazine is a must. The articles in these newspapers/magazines give you an idea about the operations of many mainstream and upcoming companies, their expansion plans and also business confidence levels and general economic outlook. If you read up regularly it will help a great deal to pick the sectors and also to time the market.
Quarterly results’ Analysis: The feedstock for any budding analyst is the quarterly result analysis. You will come across quarterly result statements in all business newspapers or in magazines like Capital Market or Dalal Street. Another easy way is to check websites like moneycontrol.com where you can see data over many quarters. This is usually best as you understand the trends. Equity Master Website has an eight quarter analysis with a graphical representation which is an excellent perspective on the trends.
Many books have been written on financial analysis. But we are amateurs. So forget those complex ratios and formulae. Basic mathematics is all you need. If you are not good with numbers a calculator will help. We are going to use growth and movements of some key matrices. The quarterly financial statements should be followed regularly every quarter and over time you will get the feel of how the company you are tracking is doing. A regular analysis of quarterly results usually throws up consistent performers.
I will try to give some quick pointers. You do not have to be a financial wizard to analyze nor do you need complex calculations. The important trick is to identify trends over time.
What are the matrices that you need to check?
Sales and Profit Growth: Check quarter to quarter growth and with previous quarter. Check quarterly trends for 5-6 quarters. Steady growth means it has passed the first test. A minor dip in a couple of quarters may happen.
Interest: An important figure that you should watch. A rising interest cost without a significant rise in sales in the subsequent quarters will indicate that the capital is not being deployed efficiently.
Other Income: If other income is contributing to a big chunk of the profit, be cautious.
Companies publish their balance sheet in business newspapers when they publish their 6 months’ results in Oct-Nov and full year results in April-May. The balance sheet can be accessed on websites which I mentioned earlier in the article.
Increasing Borrowings without consequent increase in capital assets should be noted. A quick check of the annual report [in company website] may give clues.
Increasing Debtors and Creditors – The growth of these should match the growth of sales or be always below it. These are the two key matrices which can allow you to spot trouble early. Debtors are people who owe the company money. To increase sales, the age old trick is to push sales by giving more credit period. This locks up cash which is needed for running the company. So if you see that debtors are increasing without sales increase then alarm bells should ring. A good yard stick is to check the number of months of sales. Quarterly sales divided by 3 gives the monthly sales and this figure should be compared with debtors. If it is more than 3 times monthly sale and increasing on the quarter we stay away. Creditors are people whom the company has to pay. If the finances of the company start to unravel then creditors suffer first as the company will pay late and as little as possible. In a slow down scenario these two matrices are powerful to spot trouble early.
Price trend: Many of the readers would have come across technical analysis used in Stock Market investing. You would have heard of Fibonacci numbers, Elliott’s waves, candlesticks and what not. Worry not. I am not asking anybody to learn the art of technical analysis. The price graph of a stock gives you a perspective when you see it with other information of the company and industry. If you read a Business newspaper you will see these graphs often. One year price graphs give you a good idea of the stock movement. A five year graph should also be viewed. What do you have to look for? If you observe a 5 year graph you will see the price line moving in an irregular pattern but look more carefully and you will see that the price on the downward movement hits a certain level and then moves up again. If you see several instances of this repeating then that is a safe place to invest. Try not to invest if the price line is at the peak or very near the peak. Price Trend should be analyzed only after you have done your research of the company and have a good idea about the company.
PE Ratio – Price to Earning ratio of a share is the price divided by its earning calculated per share. In simple layman terms it shows the growth rate at which the company should grow in order to maintain the share price. The lower the better, and hence the possibility of the stock price rising. A very low PE also needs more research as the management may be suspect or the company is in trouble.
Do not procrastinate over buying and selling once you make up your mind about a particular share. Do not chase stocks when you see that the stock you identified is suddenly shooting up nor should you get into the habit of averaging prices of a share that is falling fast. Keep a limit for quarterly sales to make it worthy of your time. My limit is Rs.10 crores per quarter. While buying the selected company fix an amount you would like to commit to a particular stock and allot about 50% of the money and then watch the movement.
Stock market investing if done with discipline, can give extremely good returns. With diligence and patience you can easily get the hang of picking up stocks. Practice makes perfect. Happy Investing.
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