1. ROE (Return of Equity) is the most important metric. The ROE approach helps us filter and identify high-quality stocks. 7%-8% of ROE represents a fair price that equals one-time book value. If a company earns 24% ROE, do not mind paying three times its book value.
2. Price at which the stock is trading is another important parameter. A quality stock may be a very good buy at price X which it may not be an appropriate buy at price 2X. (from the perspective of Returns)
3. Timing is difficult, especially when it comes to purchasing high-quality stocks. In a bearish market, there is a flight to quality which pushes the prices higher; whereas in a bull market such stocks are mostly neglected.
4. Growth, generally, has two components: inflation and volume. Even if a company is not growing by volumes, it can still show some growth on account of inflation. In nominal terms, the ‘average’ growth in sales and profits should equal the growth in GDP plus inflation.
5. A track record that is at least 10 years old. preferable 15 years
6. As far as possible, no issuance of new equity or convertibles
7. Tax payout at the highest corporate rate of taxation applicable
8. Consistent dividend payout
9. Promoter holding of at least 30% is ideal
10. No pledge of promoter holdings
11. Low debt. I prefer total debt to be less than half of shareholders’ funds
12. As few subsidiaries as possible
13. Not more than one acquisition of another company in a 10-year span. If there are more than that, examine each, on a case by case basis
14. No merger of wholly-owned promoter companies
15. Increase in year-on-year turnover should exceed the increase in fixed assets
16. A stable business should not demand much capital expenditure on an ongoing basis
17. No change in auditors
18. If the Annual reports of the last 10-15 years are read chronologically, validate whether the company's thought process has been coherent or not. Also, whether the management keeps the promises it makes in the previous years or not
19. It is very important to observe as to how the company is reacting the to changes in the Macro environment and how smoothly it is adapting itself to the change without compromising with its value
20. Business are run by Men and Women and ultimately it is their character which manifest itself as the Character of the Business. Hence, important to assess the character of the people running the business
Understanding of fundamental, market technical and patience are required as well, to invest successfully. Stocks should not be bought simply because one has money to invest. Keep the money in a liquid fund until you spot opportunities.
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Here are 10 Reasons on Why you Should be Investing in Stock :
1.) Market Positioning :- Company is the No:2 Player in its Area of Operations along with a Strong Market share. The company is also the Fastest growing amongst its Peers, outperforming its competitors in a big way. Company Brand Name is consistently improving and closing on the Market Leader.
2.) Strong Business Model :- The company has a very strong Business Model where there is very little CAPEX involved and there is regular growth. The Business also works on Relationships and Credibility which gives the companies an Edge over new players.
3.) Long Term Opportunity :- Company is tapping into a huge Opportunity and the Management has just scratched the Tip of an Iceberg. India's Long term Structural story gives this company's Business a big boost and the Growth of its Target Market is a necessity for India to become a Large Economy.
4.) Financial Parameters :- C**Z**E has very strong Financial Parameters where the company has very Strong Margins upwards of 50% which is there in very few Businesses. Also the company has a Clean Balance Sheet with Zero debt which will help it in tough times.
5.) Consistent Track Record :- Company has a strong Track Record of Performance. The company's revenues has grown at over 35% CAGR for the last many years and the Margin performance has been very stable during this period highlighting its Performance.
6.) Growth Prospects :- Company has recently diversified into attractive Sub-Niches of the area it operates in and we believe these would emerge as Big Revenues generators going forward. Company also has gone into Acquisition route to boost its growth Inorganically.
7.) Business Moats :- The Market has a limited set of players as this Business inherently has a lot of Moats in the form of Client Relationships and Credibility which is hard to Build. Also the Knowledge base which it has accumulated over a period of time is difficult to replicate, thus acting as a good Moat.
8.) Cash Flows :- Company generates very strong Cash Flows from its Operations regularly. The Free Cash flow component is high as there is very little Investments required. This allows the company to consistently target Niche companies for Inorganic growth.
9.) Management/ Corporate Governance :- The company is promoted by a set of Institutions which are Highly credible and the company has a very strong Corporate Governance and most importantly, a Share-Holder friendly policy.
10.) Valuations :- In spite of so many advantages, the company is quoting at very attractive Valuations of less than 10x.
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Speaking about the mindset the following steps are very important.
1. Buying a stock is buying an ownership interest in that business
It is very important to have this perspective while investing in stocks. Are you ready to evaluate a stock as if you are planning to invest in that particular business? If not it is better to invest in some Index Fund or some Equity Mutual Fund with proven track record. It is very important to behave like an owner to a particular business, so that you can rationalize the functioning of that business and evaluate it's decisions more pragmatically.
2. If you can’t explain the business to a five year old or your grand mother, you don’t understand it.
You should be absolutely comfortable in understanding the day to day operations and other facets of the business of the stock you plan to invest in. Absolutely, no negotiations with this.
3. When purchasing an interest in a business, only use those funds which are not needed in near future.
Do not use reserve funds or day to day money. Create a separate fund for Equity Investment. Very very important to be disciplined.
4. If you value your leisure time, do not invest in stocks.
Investment in stocks require time to time re-evaluation of the business and to keep yourself updated of the geo-political macro conditions and their possible implications on the business. It is a tedious job and requires considerable amount of time. Evaluate this aspect before making a decision to invest.
Golden Rule of the market.
Buying is best done when others are desperate. Selling is best done when others are euphoric.
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Here is how to judge a promoter:
1. Reputation of fairness in dealing with all, including
shareholders;
2. Promoter holding is at least 30% for family-run companies;
3. A high RoE that is consistent over at least 10 years;
4. Low level of debt (unless it is a banking or finance business);
5. Good track-record with all their promoted ventures;
6. Built profitable business with scale and leadership positions;
7. Good capital allocation decisions, so far.
Acknowledgement - Some parts of this article is based on an article of MoneyLife.
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Two ratios which will be very useful for Banking and NBFC stocks
LCR, Liquidity Coverage Ratio
The LCR measures a bank’s liquidity risk profile, banks have an adequate stock of unencumbered high-quality liquid assets that can be easily and immediately converted in financial markets, at no or little loss of value. This category would include, for example, central bank deposits, corporate promissory notes or guaranteed bonds. The goal is to ensure that the institution can meet its liquidity needs for a 30 day hypothetical financial stress scenario.
The LCR is the percentage resulting from dividing the bank’s stock of high-quality assets by the estimated total net cash outflows over a 30 calendar day stress scenario. Total net cash outflows is defined as the total expected cash outflows minus total expected cash inflows (up to an aggregate cap of 75% of total expected cash outflows).
Total expected cash outflows are calculated by multiplying the current balance of liability products (such as accounts and deposits) and off-balance sheet commitments (such as credit and liquidity lines to customers) by the rates at which they are expected to run off or be drawn down in accordance with the aforementioned stress scenario.
As of January 1, 2019, the minimum liquidity coverage ratio required for internationally active banks is 100%. In other words, the stock of high-quality assets must be at least as large as the expected total net cash outflows over the 30-day stress period.
The LCR measures a bank’s liquidity risk profile, banks have an adequate stock of unencumbered high-quality liquid assets that can be easily and immediately converted in financial markets, at no or little loss of value. This category would include, for example, central bank deposits, corporate promissory notes or guaranteed bonds. The goal is to ensure that the institution can meet its liquidity needs for a 30 day hypothetical financial stress scenario.
The LCR is the percentage resulting from dividing the bank’s stock of high-quality assets by the estimated total net cash outflows over a 30 calendar day stress scenario. Total net cash outflows is defined as the total expected cash outflows minus total expected cash inflows (up to an aggregate cap of 75% of total expected cash outflows).
Total expected cash outflows are calculated by multiplying the current balance of liability products (such as accounts and deposits) and off-balance sheet commitments (such as credit and liquidity lines to customers) by the rates at which they are expected to run off or be drawn down in accordance with the aforementioned stress scenario.
As of January 1, 2019, the minimum liquidity coverage ratio required for internationally active banks is 100%. In other words, the stock of high-quality assets must be at least as large as the expected total net cash outflows over the 30-day stress period.
NSFR, net stable funding ratio
The NSFR requires banks to maintain a stable funding profile in relation to their off-balance sheet assets and activities. The goal is to reduce the probability that shocks affecting a bank’s usual funding sources might erode its liquidity position, increasing its risk of bankruptcy. The NSFR standard seeks that banks diversify their funding sources and reduce their dependency on short-term wholesale markets.
The NSFR is defined as the ratio between the amount of stable funding available and the amount of stable funding required. Available stable funding means the proportion of own and third-party resources that are expected to be reliable over the one-year horizon (includes customer deposits and long-term wholesale financing). Therefore, unlike the LCR, which is short term, this ratio measures a bank’s medium and long term resilience. The stable funding requirements for each institution are set based on the liquidity and maturity characteristics of its balance sheet asset’s and off-balance sheet exposures.
Basel III requires the NSFR to be equal to at least 100% on an ongoing basis. In other words, the amounts of available stable funding and required stable funding must be equal.
The NSFR requires banks to maintain a stable funding profile in relation to their off-balance sheet assets and activities. The goal is to reduce the probability that shocks affecting a bank’s usual funding sources might erode its liquidity position, increasing its risk of bankruptcy. The NSFR standard seeks that banks diversify their funding sources and reduce their dependency on short-term wholesale markets.
The NSFR is defined as the ratio between the amount of stable funding available and the amount of stable funding required. Available stable funding means the proportion of own and third-party resources that are expected to be reliable over the one-year horizon (includes customer deposits and long-term wholesale financing). Therefore, unlike the LCR, which is short term, this ratio measures a bank’s medium and long term resilience. The stable funding requirements for each institution are set based on the liquidity and maturity characteristics of its balance sheet asset’s and off-balance sheet exposures.
Basel III requires the NSFR to be equal to at least 100% on an ongoing basis. In other words, the amounts of available stable funding and required stable funding must be equal.
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