Investors are those who invest in businesses they understand and they buy when the stock is available at the right price.
At some point in time, every investor is a beginner. They learn the art of investing. They spend countless hours reading books and learning everything that is needed to become better investors.
Beginner investors need to know how to research stock. There are lots of stocks out there and most of them are garbage. Your job is to find the best for yourself.
To become better at research stock you need to know many things like basic accounting, ratios analysis, you need to know how to read the financial statements of a company. To be better stock market investors, you also need to know the investing philosophies. Every great investor has their own investing philosophies.
In this article, you will learn the basics of stock market research. In this article, you will see what to look for in the business before making any investment decisions.
Now understand each term one by one.
Market capitalization of any company Shaw’s current market value of the company. Market capitalization is the current market price times the total number of shares.
This gives us an idea of the size of the stock. On the basis of the size of the stock, we divide the stock into three categories.
- Small-cap companies- market capitalization <1000 core.
- Mid cap companies- 1000 crore<market capitalization < 10000 cr
- Large cap companies- market capitalization > 10000 crore
There is one more classification called a penny stock. A company that has a very small market size is called a penny stock. If you are a beginner in the stock market, it is recommended to stay away from the stock market.
Before investing, you must decide which type of stock you are looking for. It can be either a mid-cap, small-cap, or large-cap company.
As a beginner, find a relatively big company to invest in. big company and more stable and less risky as they have good business and are there in the market for a very long time.
Price to Earnings ratio ( P.E ratio)
It is a parameter that shows how much you are willing to pay for ₹1 earnings. If the P/E ratio of any stock is 10 means you are paying ₹10 for ₹1 earrings.
While looking at the price of earnings ratio of any stock, always look for the company which has a lower price to earnings ratio. Also Compare it to Industries PE of that Company. Sometimes higher PE ratio indicates higher growth in the company, so everyone is paying a premium for that company.
Generally, look for a company with a moderate price to earnings ratio. It should be between 10 – 15.
Price to earnings ratio indicates how costly and cheap the price of the stock is. There are always ifs and but are with the PE ratio. Try to find that, if PE is high, why is it high? And if low, why is it low?
PE ratio= Current market price / Earning Per share( EPS)
Best way use of Price to Earnings Ratio
- Compare with its historical averages
- Compare with its peer companies
- Compare it with Industries P/E
The book value of any company is the net worth of that company divided by the total number of shares. when the net worth of the company will increase, the book value of that company will also increase.
Book value = Net worth / Total no. of shares
The net worth of any company is the shareholder’s money. As shareholders, we will always want the net worth of the company to increase on a regular basis.
So, look for a company with consistent growth in the book value. And the growth in the company should be with the earnings of the company.
There is one ratio called the Price to book value ratio ( P/B ratio). It is a valuation tool. It compares the price of the stock to its book value per share.
Look for a company with a low P.B ratio. This ratio is more applicable in capital intensive industries like the banking sector and manufacturing industries.
Return of Equity (ROE) and Return on Capital Employed (ROCE)
Both ROE and ROCE is a very important financial term for the investor. It is the financial term where good investors start their stock research for any company.
Return on equity = Net income / Shareholders equity
It shows how much return you get on the equity of the company. The equity is the owner’s money. As shareholders of the company. We should have kept an eye on this term.
Return on capital employed = operating profit / Capital employed
It shows how much a company generates profits from the capital employed in the business. It is a good parameter for looking at a capital intensive business.
You should work for a company that has a strong and consistent ROE and ROCE. For this, you check at least 5-year data.
Investor Warren Buffett pays a special look at these parameters.
Debt-to-equity Ratio(D/E ratio)
The debt-to-equity ratio is used for determining the risk associated with the business. The more debt the company has, the riskier it is.
To determine the debt of the company we have many ratios, but the debt-to-equity ratio is more important in all of them.
DE ratio shows how much debt the company has against the equity of the business.
The formula of DE ratio is :
Debt-to-equity = Debt / Shareholder’s equity
You should look for a business with a lower debt to equity ratio. Warren Buffett looks for businesses that have a DE ratio of less than 0.5.
Note: Do not look at the DE ratio for the banking and real estate business as they are highly debt-driven businesses. They use more leveraged cash to run the business.
High Current ratio
The current ratio is the ratio of the current assets and current liabilities of the company. A current asset is those assets that are going to convert into cash within 12 months. And current liabilities are those liabilities that are owed by the business, which have to be paid within 12 months.
Current Ratio = Current Asset / Current Liabilities
This ratio shows how much has surplus cash to run the business in the near future. Companies with more current ratios are never short in cash.
You look for a business with a high current ratio. Warren Buffett prefers businesses that have a current ratio greater than 1.5.
To analyze the management of the business, the percentage of promoter holdings are very important. The holdings of promoters show how much the management has faith in the business. The management is the person who actually runs the business.
Look for the business which has higher promoter holdings. Also, look who is the top management of the business.
Also, look for FII(Foreign institutional investors) And DII(Domestic Institutional Investors) holdings in the business, they also play a very important role in the business. A company that has higher Institutional investors is considered to be good business. But it is not always true.
Best way to look at promoters holdings:
- Look how promoters have changed their holdings in the business over the past years.
- How much institutional investors have invested in the business?
- Also, look for holdings for some great investors.
The Bottom line
For an investor, Fundamental analysis of stocks is very important. Fundamentals of the company give the idea of how the company is performing. It helps to forecast the future growth of the company. Ultimately profits are made when we hold stocks for a long time and sell when it is appreciated enough.
For better research of stocks, you must learn the fundamentals terminology of the stocks. It’s easy! Anyone can do it.
Keep learning, keep Investing!
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