How to pick good stocks?

In this post, we will understand how we can choose good stock for mid and long-term investment. This analysis could be applied to any stock and every investor should use this analysis before putting his money to work.

For reference purpose, we will select Muthoot Finance and will try to judge if the stock is good to invest for long-term or not. We will only deal with the fundamental analysis of the stock in this post.

We will divide our study in 2 parts (Fundamental and Technical Analysis).

1. Fundamental Analysis of the stock:
   

About the company: Muthoot Finance Ltd is an NBFC (Non-Banking Finance Corporation) which mainly engaged in the gold loan business. In India, they are the largest gold loan NBFC. They basically give a loan against gold jewellery as collateral.

Here is a snapshot of company financials from screener.in

1. MarketCap: It is the representation of the total worth of the company. It should be more than 10000-15000 crores so that it doesn’t come under smallcap.
   
2. Promoter Holding: This signifies that the promoter has still faith in their business and they hold a significant amount of the company.
   It should be more than 50%. 
3. Change in Promoter holding: Basically, signify promoter is getting more involved with the company. Zero or greater than 0 is considered good for a company. 
4. Dividend Yield: It is the percentage of the dividend an investor will receive an annual basis. It should be greater than 0 as this add faith in minority shareholders and company a part of the profit with them.
5. Pledged Percentage: Pledging is done to borrow money by giving company shares as collateral. Promoter often pledges shares so that they can raise fresh capital for the company or their own personal reasons. A lot of times promoter hold a significant amount of company but their shared are pledged which is a big red flag for the company. 
6. ROE (Return on Equity): It is the amount of profit percentage company is able to make against the equity. It is very important to know that the company should be able to make a substantial amount against equity. If a company is not able to make money for shareholder they why any investor should try to invest in the stock.
7. Stock P/E: It is the price to earnings ratio of the stock. Lower is the better. Usually, P/E ratio changes from sector to sector. Some company in FMCG space trade at 70+ PE. Muthoot is trading at a reasonable valuation and can be looked for investment.
8. Debt to Equity: It does not hold correct for Banking and NBFCs. As companies in this sector give loans and earn interest over that.

Profit & Loss Statement

Profit & Loss statements are easy to read and you don’t need any finance background to understand that is a company able to produce cash or not.

In the above PnL, an investor needs to see the trend,

1. Is the company able to increase its sales?
2. Is the company able to maintain OPM (operating margins)?
3. Is the company net profit increasing and showing some trend?
4. Finally, is the company paying the dividend on an annual basis?

Once you are able to answer these simple questions, you are good to go and go can go ahead with further evaluation. 

Above screenshot shows CAGR for Sales, Profit & ROE. This will provide fetch quick information for investors. 

Any growing company will have all figures of CAGR greater than 5-20%. Just by looking at these simple parameters could save your wealth from eroding. 

Muthoot Finance satisfy our fundamental analysis and we can dive deep in more detailed aspects of the company. 

What’s Next?

You need to go through management future plans and their growth aspects for the company. You can read Annual statements of the company for further analysis. Your focus should be on Chairman Message and his vision for the company. 

Further, an investor should also focus on Management Discussion & Analysis. 

Hope this post will be beneficial to you. In the next part, we will analyse  Technical aspects of the stock.