Investing In
Stocks
Learn how you
should invest your money in the stock market.
WHILE stock markets go up and down,
it makes sense to look up the financial statements
of the scrip you hold or wish to invest in. You need
to treat your investments as financial babies. After
all, you expect them to take care of you when you
are older. So check their health regularly, especially
stocks.
Too many things influence a company's share price
-like liquidity of scrip, the economy, political situation,
industry outlook and quality of management. But a
three - point check is enough to give you some indication
of long term health. These points are: the return
on capital employed (ROCE), its profit margin, and
how much free cash the company is generating. They
tell you how the company is faring and help you question
the movement of the company's share price. Remember
to analyse the three criteria together.
ROCE is rate of return on the money invested in the
business. If company 'A' earns 12 per cent and 'B'
is earns 15 per cent, there should be a good reason
for choosing 'A'. If you can earn 6 per cent in fixed
deposit, then what is a company doing earning just
9-10 per cent? Find out if over the last few years
the ROCE is giving up, down or nowhere. Profit after
tax divided by long-term capital gives you ROCE. Long-term
capital is paid-up capital and reserves added to long-term
debt.
What about the profit margin? Operating margin tells
you how profitable the sales are. This is irrespective
of whether the company sales1, 000 units or just 10.
It doesn't tell you if the company has one client
or 50. But you will know that the company is in the
volumes game if the operating margins are low but
total amount of profit is large. If the margins are
high, then compare it with its peers. A high operating
margin compared to its peers over times means that
the company is doing something right that others are
not. So what is the competitive strength? Will other
players catch on quickly and force the operating margins
to go down?
Check for free cash flow. After all, cash is king!
And profit do not accurately reflect how much money
is going into keeping the company and business in
shape by way of investments in fixed assets and projects.
Also profits can be subjected to accounting tricks,
while cash in the real money. You will find the cash
flow statement in the annual report. From the cash
from operating activities subtract the cash spent
on fixed assets and projects and acquisitions. This
is the free cash that the company can invest for strategic
growth. Low or negative free cash does not necessarily
mean that the company is doing badly. For example,
companies in their early years can invest huge cash
in projects, especially companies in the infrastructure
sector and those setting up large manufacturing facilities.
A negative or low cash flow might indicate that it
will take some time before the company starts earnings
spare cash. A company churning out large free cash
is definitely low risk, but if the stock price is
very high then this baby is probably running a risk
for you. That's when referring to ROCE and operating
margins is helpful. If they are better then industry
peers, then you can book profits or stay put.
Does the company pay high dividends? Analyse this
in the context of the ROCE and free cash flow. If
the ROCE is high, and the company is investing heavily
into growth (through capital expenditure in assets
and acquisitions) then it has a good reason not to
pay high dividends. Conversely, if it is paying high
dividends then it might be running out of ideas. So
keep a tab on the news on growth taking place in the
industry and what the company is doing. If you cannot
get the annual report, be an online warrior. There
are many research reports available on financial portals
such as moneycontrol.com.
And bug your broker too.
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