INSUBCONTINENT EXCLUSIVE:
Fundamentally strong stocks offer consistent growth with less volatility.Creating an investment portfolio isn't a gamble.You can't build
your investment portfolio by asking for tips or tossing a coin to pick a stock
You need to do proper analysis and research.Everyone wishes for high returns with minimum risk
Unfortunately, that combination doesn't exist
The key to winning in the stock market is to generate consistent returns over time.What does that mean?Earning consistent returns means the
having the ability to generate returns across market cycles.Not all companies generate consistent returns
However, fundamentally strong stocks offer consistent growth with less volatility.That brings us to the most important question… How can
you select fundamentally strong stocks? You can do this by thoroughly analysing a company's business and financial health
You will also have to analyse various quantitative and qualitative factors.Here's how you can go about it…Financial statementsAnalysing a
company's past and current financial statements is the first and foremost step.Balance sheets, income statements, and cash flow statements
will help you understand the past and current operations of a business.Look at the company's revenue, expenditure, cash flow, and dividends
Consistent growth is certainly an indication the company is doing well and has good prospects.Financial ratiosThere are numerous financial
ratios that you can analyse from the financial statements
Each ratio will help you understand a company's financial health and performance trend.Here are a few…1
Profitability ratiosProfitability ratios help evaluate the ability of a company to generate income compared to its expenses
Ideally, companies with higher profitability ratios are preferred.The following ratios will help you understand the profitability of a
business:* EBITDA Margin - Earnings before interest, taxes, depreciation, and amortisation (EBITDA) represents the operating income
generated by the company.EBITDA margin is an estimation of this operating income with respect to the total revenue
It's a popular relative valuation technique, where you can compare the performance of companies belonging to the same sector.EBITDA Margin =
Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) / Revenue* Net Profit Margin - Net profit margin helps in
understanding the company's ability to generate profits from its sales
A high net profit margin indicates that a company is performing well.Net Profit Margin = Net Profit/Revenue2
Operating ratiosOperating ratios help measure the efficiency of the management in managing costs.These ratios help to assess the
effectiveness of an organisation in maintaining a lower cost of operations.Here are some operating ratios you can evaluate – * Working
Capital Turnover - Working capital turnover ratio helps in estimating the effectiveness of a business in using its working capital to
A higher ratio indicates higher efficiency of the company in leveraging its working capital.Working Capital Turnover = Net Sales / Average
Working Capital* Inventory Turnover Ratio - Inventory turnover ratio is a useful indicator of a company's ability to convert inventory into
The ratio also indicates whether management is effectively controlling inventory expenditures i.e
how many times it has sold and replaced inventory in a given period.Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory* Total
Asset Turnover - Asset turnover ratio measures the efficiency of a company in using its assets to generate revenue
A higher asset turnover ratio indicates the company is more efficient at putting its assets to use.Total Asset Turnover = Net Sales / Total
Leverage ratiosLeverage ratios help measure the company's ability to meet its financial obligations
They will also help you understand how a company is financed (equity or debt).If a company is highly leveraged and unable to generate
profits, it can be a cause of concern for the investor. Here are two leverage ratios you should consider –* Debt to Equity Ratio - Debt
to equity ratio denotes a company's debt position
A high debt to equity ratio is risky
Ideally, a ratio less than 1 is considered good, while anything above 2 is highly risky. Debt to Equity Ratio = Total Debt / Total Equity*
Interest Coverage Ratio - Interest coverage ratio helps in understanding the debt repayment capacity of a company
Higher the ratio, the better the company's ability to pay its debt.Interest Coverage Ratio = EBIT / Interest Expense4
Valuation ratiosValuation ratios are useful to determine the investment potential of a company
They help understand the stock price with respect to the company's financials
Analysts and investors widely use these ratios.Here are two commonly used valuation ratios –* Price to Earnings (P/E) - A higher P/E ratio
can indicate that the company's share is overvalued while a lower P/E indicates that a company is undervalued. Price to Earnings (P/E) =
Current Market Price / Earnings per Share* Price to Book Value (P/B) - P/B ratio of a company compares the market value of the shares to its
A higher P/B ratio indicates the stock is overvalued.Price to Book Value (P/B) = Current Market Price / Book Value per ShareYou can use
these ratios to compare a company with its peers and see where it stands
Peer comparison helps in finding financially strong companies.Corporate governanceCorporate governance helps in understanding the practices
and processes employed by a company
Good corporate governance will automatically lead to a strong business
Unethical practices cannot sustain the business for long.Yes Bank is a good example of failed corporate governance
The bank had given loans at high-interest rates to companies whose repayment capacity was low.Consequently, the bank's non-performing assets
Under the RBI's scrutiny, it was found that the company had more NPAs than it was declaring
Due to its poor corporate governance and practices, the management failed to keep the business running.As a result, the stock started
witnessing a fall in its share price from Rs 394 in August 2018
It's currently trading at Rs 13.9 (as on 7 January 2022).On the other hand, one of the best example of good corporate governance practice is
the Tata Group.The group has proven its ethical practices and has stood strong since its inception in 1868
Tata group is one of India's oldest and largest conglomerates. The group always strives to maintain the right balance between individual,
social, economic, and community goals.Future prospects of the business and industryFinancial statements, financial ratios, and corporate
governance practices all determine the company's past and present situation.However, what also matters is its future prospects
Only if the company has good opportunities in the future it will be able to generate returns for its investors.Therefore, you should
understand the business, its future prospects, expansion plans, and industry outlook
Evaluating a company in this way will help you decide if the stock is worth investing in.• Looking beyond numbers and valuation
metrics…Finding fundamentally strong stocks means going beyond valuation metrics
Numbers certainly help you shortlist companies that have been doing well, but what matters is the road ahead.As a thumb rule, always invest
in a good company with strong fundamentals rather than an undervalued stock with poor fundamentals.Here's a list of parameters that you
should consider…• Macroeconomic factorsMacroeconomic factors such as GDP and inflation can have an impact on your portfolio.GDP is the
value of all the finished goods and services in a country during a specific period while inflation is an increase in the price levels of
goods and/or services. Both offer a quick view of the economic health of the country.When the GDP falls, investors tend to stay away from
the market causing a corresponding drop in stock prices
On the other hand, when the GDP increases, investors are optimistic about the future and buy more shares which positively impacts the stock
market.While the relationship between the market and GDP is direct, the relationship with inflation is inverse.When inflation rates rise,
stock markets tend to fall and vice-versa.• Industry trendsIndustries evolve
Technologies become obsolete
We have seen technological advancements destroy certain products and companies.You need to evaluate how quickly a company is able to modify
its processes to the evolving trends and how fast it is able to generate business.This can help you understand how receptive a company and
its business model is to the ever evolving changes around it.For example, artificial intelligence and machine learning are paving the way
forward in the technology sector.Take the example of Tata Elxsi, a technology and design services leader for over three decades. The
company recently established the Tata Elxsi Artificial Intelligence Centre of Excellence to address the growing need for intelligent
systems.Swiftly adapting to the technological changes around, the company was successful in developing self-driving cars and video analytics
The company's stock has given a whopping 180% return in the last one year.• Competitive advantageA company's ability to sustain its market
share over time is what matters
A competitive advantage can be anything ranging from brand name and goodwill to patents etc. For example, IRCTC currently enjoys a 100%
It is an e-ticketing and catering company that has no competitors yet
IEX, CAMS, and CDSL are more such examples which have strong moats.Looking for fundamentally strong stocks?Have you ever wondered if there
was a stock screener that lets you find the fundamentally strong stocks quickly and easily?Equitymaster has you covered.We've recently
designed our brand new Stock Screener which screens stocks based on fundamentals, valuations along with other themes.For example, from
finding the fundamentally strongest stocks, or the cheapest stocks, or stocks that the gurus are buying...Equitymaster's stock screener has
it all.What's more, you can do your own research on these stocks
If you think stocks trading at a PE above 30 are too high, you can easily remove them from the list.We highly recommend you check out the
screener and its segments
Here are some of the top screens…To sum up…Investing in fundamentally strong companies will require you to consider all the above
parameters in conjunction
You cannot consider any of them in isolation
Every ratio and parameter has its significance in evaluating the company's business and financial health.Also, it's a popular misconception
that only largecap/bluechip stocks are fundamentally strong companies and only such companies can generate consistent returns
However, smallcaps, midcaps or even penny stocks can be fundamentally strong.Investing in a fundamentally strong stock is a long term
Hence, don't expect overnight gains.Finally, evaluating and investing in fundamentally strong stocks isn't the end
You will have to review the company and stock performance from time to time. Any irregularities will require you to reconsider your
Hence, always keep a track of your investments. Happy Investing!Disclaimer: This article is for information purposes only
It is not a stock recommendation and should not be treated as such. (This article is syndicated from Equitymaster.com)(This story has not
been edited by TheIndianSubcontinent staff and is auto-generated from a syndicated feed.)
