Want to know how to decide which stock to buy? Well you have landed on the right article.
Have you sometimes wondered how these professional traders earn their livelihood just by selecting the right stocks from stock exchanges in India? Have you come across blogs, YouTube videos and books that claim to teach you how to become a successful investor?
Have you been disappointed or confused to find that most of those sources have either incomplete information or outdated tips that do not help too much?
Over 90% of people who blindly invest in the stock market without proper knowledge lose money. They then go on to blame the stock market for being volatile and unstable.
Such people rely on advice from their friends and relatives or their broker instead of putting in their own efforts to understand the market. On the other hand, some investors have beaten Nifty to generate 30% to 60% returns on their portfolios.
If you are willing to learn the right methods of evaluating the best stocks and earning desirable income from investing in the stock market, then you have come to the right place.
Keep reading to understand all the important factors that you must consider before picking stocks or shares. Use this knowledge to your advantage while investing. Share this knowledge with your friends too.
In this article, we have covered detailed guide on how to know which stock to buy & what factors to consider when buying stock in India.
how to decide which stock to buy
Types of Investments
Before we deep dive into the technicalities of picking the right stocks, let's understand the two types of investments that you can make. One is trading and the other is value investing.
As the name suggests, trading includes frequent buying and selling of stocks in the stock exchange. BSE and NSE are the prevalent stock exchanges in India from where you can trade.
In trading, traders take advantage of the quick and volatile movements of stocks in the market. The intention is to book quick profits and to exit the trade in a short period- sometimes in the same day, of time. This is known as intraday trading.
If the market is bullish in the short run, the objective should be to buy a stock at a cheaper price and sell once it hits a higher price.
On the other hand, if the market is bearish and the stock prices are expected to fall, then to short (sell) the said stock at the higher current rate and buy it at a lower price after the price falls should be the goal.
The holding period of stocks in this form of trading is anywhere between a few minutes to a few days. The idea is to leverage volatility and the swing in the market to make short-term gains.
Traders who excel at this form of trading carry out technical analysis using statistical and analytical tools such as moving averages and stochastic oscillators to forecast the future price movement of the stocks.
Trading is risky if not done correctly, and the stock market has seen people lose thousands and lakhs of rupees every day. If one does not have a clear idea of when to enter and when to exit the trade, one can easily fall prey to huge losses.
Unlike trading, value investing is for the long term profits and is much less chaotic/ uncertain in comparison. Esteemed investor Warren Buffett once said, "If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes."
There are a few major advantages value investing has over trading. By holding a stock for longer durations, you can take advantage of dividends, stock splits, bonuses, rights issues, and the steep increase in the value of your stock.
When you hold your position in a particular stock for a long time and the company performs well in terms of revenues and profitability, it is then reflected in the market price of your shares.
Another benefit is that you are protected from temporary anomalies of the stock market as it gets corrected over some time. So temporary, sharp declines in your share price are very likely to bounce back over a period of time. Such is the play of the market.
If value investing is the body, then the power of compounding and fundamental analysis is its backbone. The power of compounding means that the value of your stock will rise significantly when you hold it for a long duration and allow the company to grow and scale-up.
Fundamental stock analysis refers to studying the basics of the business that a company carries. Is the business profitable? Are there major political, competitor, supply chain, or other threats to the business that could lower its profits? Is the business resilient to changing market behaviour?
These are some of the questions you must ask before picking a stock for a long duration.
Step-by-step approach of selecting the best companies to invest in India for beginners
Check the fundamentals of the company, Before getting into complex details of the company, it is advisable to start with a simple first check- the soundness of the fundamentals of the company.
This is important to understand the company’s ability to handle business and setbacks. If the company is not fundamentally strong, then it might be a good idea to stop looking into that company altogether.
There is no point in going through the company’s products, market size, competitors, etc. if it is not fundamentally strong. To check the fundamental soundness of any company, verify whether the following parameters are in check:
The Earnings per Share (EPS) should have been increasing for the last 5 years
The Price to Earnings ratio (PE) should be lower than the industry average and competitors
The Price to Book Value (BV) should be lower than the industry average and competitors
The Debt to Equity Ratio should be less than 1
The three-year average of return on equity (ROE) should be greater than 15%
The Price to Sales ratio should not be a big number
The Current Ratio should be more than 1
The dividends should have been increasing for the last 5 financial years
Most of these factors mentioned above are financial ratios. In case you do not understand these ratios, please make the effort to run an internet search, find reliable sites and learn the meanings of these ratios since it will help you learn about investing in the right companies.
These ratios talk more about the past performance of the company rather than offer a view of the future. They show the trend the company has followed in recent years and whether those trends have been better or worse in comparison to competitors or the industry average.
But this method, while sound, does not give you all the information that is required for you to decide whether the company is worth investing in.
It excludes other important parameters, those that talk more about the present and the future instead of giving us a dashboard view of the past performance of the company. These are discussed further.
Understanding the products and services of the company
After filtering the company through the financial fundamentals test, the next step is to ensure that you understand the products and services of the company.
You should know how the company earns money- what is its business model? Is it easy to understand? What can hamper the operations in the business model?
The most important aspect of this step is to ask yourself whether you understand the business model. Colgate, for example, works in the dental hygiene industry. It makes and sells toothpaste, toothbrushes, mouthwash, and other things related to dental care.
Since you know about the business model of Colgate and are able to explain it with ease, you can conclude that you understand the business model of Colgate. If you are not able to do the same for any other company, it is an indication that you should not invest in such a company.
For example, if you do not know what XYZ Chemicals Ltd. is into, try to find out through an online search. But even after doing your research, if you are not able to understand the business of XYZ Chemicals Ltd., then you should stay away from shares of XYZ Chemicals Ltd.
Behind every product you see around you, there is a company manufacturing and selling it. Toothpaste, clothes, jewellery, vehicles, salons, food, aggregators, hotels- the list is never ending.
If you are able to understand the company’s products and services, how big the market is, how popular the company’s product is in the market, whether the demand is rising or diminishing, etc, then you are ready to invest in that company.
The future viability of the company’s products/ services
You must do some more research regarding the company’s prospects before investing in it. The power of compounding only applies if the company stays in existence and keeps growing continuously.
To predict whether a company has the potential and the ability to survive in the future, you should consider the future demand for its products or services.
For example, will people demand fast food 10-15 years down the line? Of course, they will! Food and food trends rarely go out of trend or cease to be in demand; these businesses have existed for a long time and will continue to exist for many more years.
But can you say the same for pen drives? We have seen how CDs and floppy disks have gradually become obsolete in the past few years. Maybe a company getting most of its revenues from pen drives might not do well in the long run.
Does the company have a 'MOAT?' (Competitive Advantage)
A moat is nothing but a wide, deep ditch filled with water. In ancient times, castles used to be surrounded by moats to prevent enemies from gaining access to the castle. In stocks, a moat is a competitive advantage that it possesses.
Stocks too can have a moat, making them resilient to competitor products and strategies, cheap knock-offs, or even less expensive substitutes of their products. For example, Nestle’s Maggi is so resilient that nothing can force it out of the market.
It has survived various competitors, legal issues, public condemnation and other difficulties, and yet, is able to rule the instant noodles market with ease.
Another example is a bank. We rarely hear or see customers of a particular bank think of switching to another bank just because of a small difference in interest rates. It is this matter of convenience that has become the moat here.
Similarly, before choosing stock for longer-term investment, check whether the company has a moat. If it does not have any distinguishing characteristics that protect it from the competition, then it is not a good company to invest your hard-earned money in.
There has to be at least one moat factor in the company that ensures protection.
What is the company doing to stand apart from its competition?
The X-factor- something that the company has that none of its competitors have-is extremely important to know. You should ask yourself what differentiates this company’s products from its competitors in a way that customers prefer one over the other.
It is important to do your research on this too. For example, Apple’s iPhone is unbeatable, especially in the US market.
What is the iPhone’s USP that allows it to dominate the smartphone market in the USA? It could be its easy-to-use user interface, superior camera, security and privacy features, aesthetic design etc. These are Apple’s moat.
If the company you want to invest in has a fantastic product/ service but is doing nothing to protect itself from external competition, then consider it a red flag.
It means that the company will not be able to defend its revenues and profits if a competitor with deep pockets copies the business with changes to branding and a better, more competitive price.
For example, Xiaomi in India was doing extremely well until brands such as Realme, Oppo, and Vivo caught on and started imitating the Xiaomi business model of making affordable smartphones for the masses.
Today, Xiaomi is no longer the only leader in the most affordable smartphone segment and is seeing its revenues decline in the segment where it once reigned and was seen as the undisputed leader. So while picking a stock, ensure that you pick the one which has its moat in place.
How is the company handling debt?
Many great companies meet all the aforementioned criteria. But, due to poor financial discipline, they are unable to improve their bottom line (net profits). A huge debt is like a rapidly growing hole in a boat.
If you don’t fix it soon, you will sink. Be sure not to invest in companies with huge loans and debts. A debt-equity ratio of less than 2 is considered decent, but this ratio differs across industries.
Just ensure that the company you invest in has enough operating income to compensate for short-term and long-term debt. Also, before investing in shares of any bank or financial institution, check their NPAs.
The company’s management and leadership
The management of a company is the captain that steers the ship. Great management can help a company reach tremendous heights.
On the other hand, if the management has poor decision-making and indifferent adherence to compliances, then the company could sink in no time.
It is the people who run the company, not machines and offices. So, it becomes even more important to evaluate the quality of the top-level management of any company before investing in it.
Are the directors knowledgeable, have they committed any frauds in the past, do they have enough experience and expertise to benefit the company, etc. are just some of the questions you should consider.
Also get to know the qualifications and experience of the CEO, CFO, MD, and CIO for better decision-making. Some other factors that you should look out for are as follows:
Strategy and Goals
Visit the company’s website and take a leisurely glance at each section. Pay special attention to the mission, vision, and value statements of the company.
These statements clearly indicate where the company sees itself in the future and encapsulate the goals and values of the company for itself. These statements help the investor decide what their plan of action should be.
Tenure of Management
The length of tenure of the top-level management of the company shows stability in an organisation. Frequent changes in the CXO position of the company is a bad sign.
When the leadership is stable, the company is able to reach its goals and missions sooner and systematically, as envisioned by the very people instrumental in drafting the mission and vision statements of the company.
However, sometimes a change in management is necessary to pivot the company in a better direction.
Promoter’s buying and share buybacks
Promoters are initiators of the company and have the best knowledge regarding the business of the company. If the promoters of the company do a share buyback, it means that they have a lot of confidence in the future success of the company.
It means that they want to concentrate their holdings and are smart enough to want a bigger piece of the pie from those future profits.
On the other hand, if the promoters sell a small part of their holding, it does not necessarily mean that the company is underperforming. Promoters might do so for partial liquidity for alternative investments or to start another business.
In short, promoter’s buying and buybacks are signs of a strong company. However, we cannot assess the company's prospects just based on the promoter selling a few stocks.
Please note that if the promoters are selling a large number of stocks without stating why this is something that should be looked into further.
Perks and Compensations to Staff and Workers
Good benefits to personnel and employees can also indicate successful management. The performance of a company's personnel and employees has a significant impact on its results. Happy employees are more likely to deliver their utmost effort.
On the other hand, frequent strikes or rising worker union demands show the inability of the management to meet the needs of its workers and employees and can be a potential red flag for investors.
ROE and ROCE
To estimate a company’s future growth and success, ROE and ROCE are two of the best financial ratios that can be benchmarked against industry average or competition.
Return on Equity (ROE) is nothing but the net income of a company divided by the total funds of equity shareholders. It basically shows the returns a company has generated using the shareholder’s money.
Return on Capital Employed (ROCE) is calculated by dividing the company's net profits by total funds raised in the form of debt and equity. It shows the investors how much profit the company is able to make from the funds available at its disposal.
If this ratio is too low, investors can understand that the company is failing to generate decent profits from the funds deployed by the company.
This is the last but most significant factor to consider while evaluating management. The company's growth is dependent on the integrity of the management; its responsibility is to be fair and to provide quarterly and annual results to shareholders honestly and without manipulation.
Just like the management takes credit for the company's achievements, the management should also explain poor performance to shareholders. Good management ensures that the organisation is always transparent.
Is the company in the news and why?
People's feelings are reflected in the stock market. Overly popular stocks that are frequently in the news have an impact on the public's expectations and decisions. The media's excitement has the potential to inflate these stocks.
People anticipate bigger outcomes from such firms; their stock values may decline even if they provide outstanding profits.
As a result, try to avoid investing in such firms for quick profits. Trendy stocks are more vulnerable to market volatility, while dull stocks offer the highest returns.
how to select stocks for investment in india at the right price
If you have tick marked all the criteria explained above, then congratulations on having picked the right stock. This stock has had a steady past with an impressive track record and has great future profitability potential.
But how will you know what the right price for the stock is? It is important to know whether the stock is overpriced, undervalued, or at that sweet spot for you to buy.
Your goal should be to pay the minimum price for the maximum value that you desire from your shares. If the stock you have selected meets all the above criteria but you end up buying it at too high of a price, then you might not get the returns that you expected.
More often than not, the right price of the stock is way lower than the intrinsic value of the stock, or the actual worth of the stock. How to calculate the intrinsic value of a share?
We will show you how in just a bit. But remember, the aim is to be able to buy the stock at a huge discount - at a price way lower than what it should have been.
One of the many ways of calculating the intrinsic value of a stock is by using the Discounted Cash Flow method (DCF). This method discounts the value of future cash flows of the company to present value.
For beginners, another method to calculate the intrinsic value is to use Benjamin Graham’s original formula.
It is as follows:
V- Intrinsic Value of the stock
EPS- Earnings per Share for one financial year
8.5- Assumed P/E ratio for any stock
G- Expected Annual Growth Rate for the upcoming 7-10 years
Let’s calculate the intrinsic value with the help of an example. Let’s assume that the current market price of a TCS share is Rs. 3118.
The expected annual growth rate (G) can be calculated through the following formula:
G= [(EPS at end of year/ EPS at beginning of the year)^(1/ No. of years)]-1
In the case of TCS, this is calculated as under:
Ideally, you should take 5 years of data if possible, but since we had only 4 years of data for the calculation, we have taken N=4.
G=0.171 or 17.1%
Therefore, the intrinsic value of a TCS share becomes V= 133.8*(8.5+1*1.71)= Rs.3425
However, at the beginning of this calculation, we saw that the current market price of a TCS stock on NSE was Rs. 3118. This means that a TCS stock that actually should be valued at a higher rate of Rs. 3425 is available in the market at a great discounted price of Rs. 3118! Definitely a good buy for an investor.
The stock of TCS is undervalued by 9.8% below its intrinsic value.
Please note that the method explained above is not a sure-shot way of identifying the intrinsic value of a stock. It is advisable for investors to also look at the discounted cash flow method and other methods to evaluate the intrinsic value of a stock through different lenses.
Also, merely using the formula to calculate the intrinsic value of the stock without having done the fundamental analysis above would be a futile exercise.
It is necessary for an investor to first look into the fundamental soundness of the company before getting into intrinsic value calculations.
Portfolio construction can be understood with the analogy of keeping all your eggs in a single basket. A diversified portfolio would represent spreading your eggs (saved income) across multiple sectors and stocks.
It includes thinking about what percentage of your investments you allocate, to which stocks, and in which sector for maximum returns.
You can have two approaches for portfolio construction:
- Diversified portfolio of many stock
- Concentrated portfolio of few stocks
While investors pick strategies based on their preferences, if you are a beginner, it is advisable to start with the second method; a concentrated portfolio of 5-10 stocks that you track closely on a daily basis.
You can mitigate risks and learn more about those stocks by tracking them regularly. This will train you to be able to switch to the first approach with some experience.
The focused strategy is good for building wealth, while the varied one is good for preserving it. It is recommended to concentrate your portfolio's worth on a handful of high-quality stocks.
You can start with a sum of INR 10,000, to begin with. Ensure that you read the financial statements of all the companies in which you are willing to invest.
You should cultivate a habit of tracking the financials, news, press conferences, etc. of a few selected stocks that you are interested in investing in regardless of whether you actually end up investing in them or not.
This habit will truly benefit you in the long run to become a savvy investor.
Please ensure that you do not allocate more than 20% of your entire portfolio to a single stock. For example, if you start with a total investment budget of INR 10,000, then you should not invest more than INR 2000 in stocks of a single company.
If you feel that there is a higher risk in a given stock, you can choose to allocate 5-10% of your portfolio to that particular stock.
Also, do keep in mind, that once you start investing, you will have to calculate the allocable amount to invest based on the present value of the stocks and not the cost at which you invested.
For example, if you started with INR 10,000 to invest in stocks and bought INR 2,000 worth of stocks in a single company, you are left with INR 8,000.
Now, assume that after a few months, the price of that share increases and the shares that you bought at INR 2,000 are now seen on Nifty at INR 2,500.
Then, your new portfolio value is INR2,500 +INR 8,000 cash = INR10,500
Before allocating 20% of your portfolio to a new stock, keep in mind the new limit of 10500*20% = INR 2,100 and not 2,000.
Tips for how to pick a stock to invest in Indian Market
Before picking the right stock for your portfolio, you should have a set of goals and realistic expectations. You should also be clear about how much capital you can afford to invest in the market without dipping into your savings and taking other expenses into account.
Once you are clear about this, you can use the following guide to pick the right stock for your portfolio:
There are numerous strategies for you to pick the right stocks for your portfolio. You can start by filtering the sectors and industries that you are passionate about or interested in.
For example, if you are interested in the energy sector and renewables, there is a lot that you can do. You can read industry reports, analyse companies that are leading the change, actions of traditional coal companies to mitigate risks, etc.
Monitor Financial News:
Another recommendation is to closely follow current affairs, especially the latest financial and economic news. Well-researched opinions, in the form of interviews, blogs and informative articles can help narrow down your options.
Do keep in mind that this form of news can sometimes be speculative, so be sure to do your own research to confirm.
Follow Public Interest and Events:
Trends in culture or lifestyle can lead to a new interest in a particular product or service. This, in turn, can lead to increased demand which then translates to pretty significant price fluctuations in certain stocks.
You can take advantage of such opportunities by tracking them when they occur and investing in relevant stocks.
Finally, as an investor, you should practise patience and prudence while selecting companies for your portfolio. To increase your chances of favourable market outcomes, choose your investing priorities, undertake appropriate research, and follow the rules as outlined above.
It is a humble request to never give into a market frenzy or hype just because everyone else is doing it. For example, rumours about a company’s operations could lead to people buying its stock without even checking about its potential or the company's soundness. Please do not fall into such practices.
Also, stock markets are volatile. You might make some losses even after following all the above steps perfectly. Do not panic. If the stock is falling, but the company is fundamentally sound and you have done your research correctly, then there is quite a good chance that the stock prices will bounce back.
Apart from this, you need to register an online trading and Demat account with a reputable financial institution or a broker. Many online easy-to-install and paperless investing platforms have risen in India in the last few years, given the increasing interest in share markets.
Ensure that you choose the services of a reliable platform. This means that it should not charge hefty trading fees and service charges as that would simply lower your profits from your trades.
I hope you liked our article on how to decide which stock to buy, if you have any comments or suggestions do share them in the comments below.
Frequently Asked Questions
1. What is the best PC for beginners?
There cannot be one best stock or a few best stocks for beginners. You must follow all the steps mentioned in this blog to understand which stock is best suited for your portfolio.
This is because what is best for you depends on many factors. This includes your research, goals, your capital, etc.
2. How can I learn stock market?
To learn more about how the stock market operates, it is advisable to pick a few stocks and get better acquainted with them. Stay updated with current affairs and news related to those companies and the industries in which they operate.
Then, look at some important financial ratios of those companies as explained in the blog above to learn about their track record.
3. How do I choose my first stock?
The blog above has a step-by-step guide for you to learn how to choose your first stock. Please read the blog carefully and understand what mistakes to avoid before picking your first stock.
It is important that you check the fundamental soundness of the stock and the company before getting into its track record and the future profitability of that stock.
4. Who is the biggest stockbroker in India?
Zerodha, Upstox, Angel Broking, IIFL, Sharekhan, etc. are some of India’s biggest stockbrokers. Before choosing one, please ensure that you have read the terms and conditions thoroughly.
Also, make sure that you have compared the brokerage rates and convenience charges and related fees of these platforms before choosing the most suitable one for yourself.