Company Selection for Buying Shares in Indian Stock Market

Company Selection for Buying Shares in Indian Stock Market: Here are some of the important tips for getting good long term benefits from investing in fundamentally good stocks for medium or long term.

How to Select Good Stocks?

From among the are thousands of stocks that trade in the stock market how do you know which ones you should buy for medium to long term investing. Here are some of the guide lines to follow.

• Sector - Most of stocks rise or fall based on the sector in which it operates sometimes irrespective of the strength the stock itself. Even weak stocks in a strong sector can some times give you good profits than a good stock in a week sector. So look out for the sectors that have good future. Currently sectors like Infrastructure, Banking, Retail, FMCG, Pharmaceutical are looking good.
• Promoters holding: The higher the promoters holding the better it is for retail investors. High Promoter holding indicates the confidence of the promoters in the future of the business. (Promoters - who run the company). Companies that indicate a constant decline in the promoter holding are not good.
• FII holding between 20 to 25% is safe for retailers. More FII investment means more volatility. FIIs will come and go from the market based on their immediate financial goals. FIIs generally don’t hold long term interests in the company.
• Liquidity - The companies with sufficiently high liquidity (daily trade volume) are good in case you want to exit from the stock.
• Consistent earnings: Your company has to generate profits consistently year after year.
• Earning per share (EPS): EPS indicates the annual earnings of each share of the company. You should look for companies that record constant Y-o-Y growth in EPS.
• P/E Ratio: P/E ratio tells you how much you paid for the stock for every rupee that it earned. For example if you bought a stock at P/E=10, that means, you paid Rs 10 for buying the stock that earns Rs 1 every year. EPS is a great way to compare earnings across companies, but it doesn’t tell you anything about how the market values the stock. That’s why fundamental analysts use the P/E ratio, to figure out how much the market is willing to pay for a company’s earnings. Higher the P/E ratio means more people are convinced to pay high for that share expecting higher growth in coming future. Generally don’t for stocks that have too high P/E ration (generally not more than 20) unless you have a strong reason for doing so.
• Dividend yield: It is calculated by taking the amount of dividends paid per share over the course of a year and dividing by the stocks price. Its percentage return a company pays out to its share holder in the form of dividends. The higher the better.
• Price/Book ratio: The higher the ratio the higher price the market is willing to pay for the company above its assets. Its more useful to value investor than growth investor.
• Price/Sales ratio: As with earning a book value, you can find out how much the market is valuing a company by comparing the company’s price to its annual sales. Low Price/Sales ratios (below one) are usually thought to be the better investment since their sales are priced cheaply.
• Returns on Equity (ROE): It is used as a general indication of the company’s efficiency, in other words, how much profit it is able to generate given the resources provided by its stockholders. Investors usually look for companies with ROE that are high and growing.
• Debt to equity ratio: This should not be more than 1, and less than 1 indicates company has very less debt. This is very important during market down trend as company has to pay lots of interest ratio beside low profitability. So its good sign, if company has less debt and that is debt equity ratio.