1) Choosing stocks
Choosing stocks
There are many theories and techniques about how to choose
a winner, how to separate the wheat from the chaff. Some are homegrown,
others are technically sophisticated. But beyond the jargon, there are
three basic factors to look for while picking a stock:
1. The company itself
2. Its external environment
3. The behaviour of its stock
What happens to the company affects the price of its shares
on the stockmarket and, hence, your investment. The legendary investor
Warren Buffet (incidentally, once the second richest man in the world)
says that he never invests in a company whose business he doesn�t
understand. As investors, we will do well to follow his practice.
So, knowing about companies is the first essential step in
investment. You will need to know the business a company is in, and how is
it doing both in absolute terms and in comparison to other companies in
the same business. To do that, you have to look at the financial
performance of companies and pick up the star performers. You will also
need to look at the future of the business itself. Is it nearing the end
of its life cycle? As investors, we hope to participate in a business with
a lot of scope for growth.
We also need to look at the performance of the entire
sector. Whatever for? After all, we aren�t investing in sectors. We�re
putting our money in companies and we can get to know them by looking at
their performance. Right? Well, look at it this way. Take your own
profession. Doesn�t what happens to others in the same profession affect
you too? If you are a banker and you see other banks laying off employees,
you bet your last rupee you�ll start worrying whether your bank is the
next in line to start downsizing. So, what happens in the banking sector
concerns everybody with a stake in that sector.
Just like employees, investors too have a stake in the
sector in which they have invested. As an investor, you wish to know the
risks your company faces. These are of two types -- one that is peculiar
to the company and can be controlled by it (called a unique risk), and the
other which is more pervasive and often beyond the company�s control
(called a systemic risk). We need to know about both kinds of risks to
plan our investment strategy. For example, if the steel sector is not
doing too well at the moment (a systemic risk), you may wish to move your
investment out of a company in this sector.
A company operates within the broad framework of the
economy. Its future is closely linked with the performance of the economy.
This is due to the interdependence among various industries and sectors of
the economy. Take the steel industry again. To do well, it needs a good
demand for its products. Now, suppose the automotive industry or the
construction industry is not doing well. Will that affect the steel
industry? Of course, it will, because both automobiles and construction
industries use steel. If these sectors are not doing well, the demand for
steel will drop, affecting the performance of the steel industry. The
indicators on the economy allow us to track general trends in the economy.
If they don�t look very healthy, we ought to be cautious as investors.
Professional stock pickers adopt different processes to
analyse stocks. Some adopt a method in which they begin at the general and
then zoom in to the specific i.e. they would probably begin with an
analysis of the economy. While analysing the present state of the economy
they would look at interest rates, what economic outlook the finance
ministry projects for the short term and other political events that might
have a bearing on the economy. Having reached a conclusion about the
economy, the professional will choose industries that he expects will
perform well under the given economic conditions. Next, he hones in on
some of the companies in the industry, sees how the companies are
performing and then evaluates their stocks. The end product of such an
analysis is to convincingly answer one question for his investors: Is the
price at which the stock is currently selling worth it? The other method
works in the reverse way in which the professional analyst picks up a
stock, looks at the current and historic performance of the company, then
studies the industry and finally takes an overview of the economy.