12.1 – Taking stock
Over the last few chapters, we understood how to read the financial statements and calculate a few important financial ratios. These chapters have laid the foundation for this module’s final objective: – To use fundamental analysis to identify the stocks to invest. If you recollect in the earlier chapters, we had discussed investable grade attributes. Investable grade attributes define a company’s prerequisites that need to be validated before making an investment decision. Think of the investable grade attributes as a checklist based on the fundamentals of the company. A company that satisfies most of the items in the checklist is considered investment-worthy.
Now, this is where few differences come up. For instance, what I consider as an investable grade attribute may not be so important to you. For example, – I may pay a lot of attention to corporate governance, but another investor may choose not to pay so much attention to corporate governance. He could brush it off saying “all companies have shades of grey, as long as the numbers add up I am fine investing in the company”.
So the point is, there is no prescribed checklist. Each investor has to build his own checklist based on his investment experience. However, one has to ensure that each item on the checklist is qualified based on sound logic. Later in this chapter, I will share a checklist that I think is reasonably well-curated. You could take pointers from this checklist if you are starting fresh. We will keep this checklist as a guideline and proceed further in this module.
12.2 – Generating a stock idea
Now before we proceed further and generate a checklist, we must address a more basic issue. The process of investing requires us first to select a stock that looks interesting. After selecting the stock, we must subject it to the checklist to figure out if the stock matches all the checklist criteria, if it does we invest, we look for other opportunities.
So in the first place, how do we even select a stock that looks interesting? In other words, how do we generate a list of stocks that seems interesting enough to investigate further? Well, there are a few methods to do this –
- General Observation – This may sound rudimentary, but believe me, this is one of the best ways to develop a stock idea. All you need to do is keep your eyes and ears open and observe the economic activity around you. Observe what people are buying and selling, see what products are being consumed, keep an eye on the neighbourhood to see what people are talking about. In fact, Peter Lynch, one of the most illustrious Wall Street investor, advocates this method in his book “One up on Wall Street”. Personally, I have used this method to pick some of my investments – PVR Cinemas Ltd (because I noticed PVR multiplexes mushrooming in the City), Cummins India Limited (because I noticed most of the buildings had a Cummins diesel generator in their premises), and Info Edge Limited (Info Edge owns naukri.com, which is probably the most preferred job portal).
- Stock screener – A stock screener helps to screen for stocks based on the parameters you define and, therefore, help investors perform quality stock analysis. For example, you can use a stock screener to identify stocks with an ROE of 25% and PAT margins of 20%. A stock screener is a beneficial tool when you want to shortlist a handful of investment ideas from a big basket of stocks. There are many stock screeners available; I personally like the Google finance’s stock screener and screener. In.
- Macro Trends – Keeping a general tab on the macroeconomic trend is a great way of identifying good stocks. Here is an illustration of the same – As of today, there is a great push for infrastructure projects in India. An obvious beneficiary of this push would be the cement companies operating in India. Hence, I would look through all the cement companies and apply the checklist to identify which cement companies are well-positioned to leverage this macro trend.
- Sectoral Trends – This is sector-specific. One needs to track sectors to identify emerging trends and companies within the sector that can benefit from it. For example, the non-alcoholic beverages market is a very traditional sector. Mainly, three kinds of products are sold: coffee, tea, and packaged water. Hence, most of the companies manufacture and sell just these three products. However, there is a slight shift in the consumer taste these days – the market for energy drink is opening up, and it seems promising. Hence the investor may want to check for companies within the best-positioned sector to leverage this change and adapt to it.
- Special Situation – This is a slightly complicated way of generating a stock idea. One has to follow companies, company-related news, company events etc., to generate an idea based on a special situation. One example that I distinctly remember was that of Cox & Kings. You may know that Cox & Kings is one of India’s largest and the oldest tour operator. In late 2013, the company announced Mr Keki Mistry (from HDFC Bank) to its advisory board. Corporate India has immense respect for him as he is known to be a very transparent and efficient business professional. A colleague of mine was convinced that Cox & Kings would benefit significantly with Mr Keki Mistry on its board. This alone acted as a primary trigger for my colleague to investigate the stock further. Upon further research, my colleague happily invested in Cox & Kings Limited. Good for my him, as I write this today I know he is sitting on a 200% gain
- Circle of Competence – This is where you leverage your professional skills to identify stock ideas. This is a highly recommended technique for a newbie investor. This method requires you to identify stocks within your professional domain. For example, if you are a medical professional, your competence circle would be the healthcare industry. You will probably be a better person to understand that industry than a stockbroker or an equity research analyst. All you need to do is identify the listed companies in this space and pick the best based on your assessment. Likewise, if you are banker, you will probably know more about banks than the others do. So, leverage your circle of competence to pick your investments.
The point is that the trigger for investigating stocks may come from any source. In fact, as and when you feel a particular stock looks interesting, add it to your list. This list over time will be your ‘watch list’. An essential thing to note here is that a stock may not satisfy the checklist items at a particular time, however as the time progresses, as business dynamics change at some point, it may match up to the checklist. Hence, it is important to evaluate the stocks in your watch list from time to time.
12.3 – The Moat
After selecting a stock, one has to run the checklist to investigate the stock further. This is called “Investment due diligence”. The due diligence process is critical, and one has to ensure maximum attention is paid to every aspect of this exercise. I will shortly present a checklist that I think is reasonable. But before that, we need to talk about ‘The Moat’.
Moat (or economic moat) is a term that was popularized by Warren Buffet. The term refers to the company’s competitive advantage (over its competitors). A company with a strong moat, ensures the company’s long term profits are safeguarded. Of course, the company should not only have a moat, but it should also be sustainable over a long period of time. A company that possesses wider moat characteristics (such as better brand name, pricing power, and better market share) would be more sustainable. It would be difficult for the company’s rivals to eat away its market share.
To understand moats, think of “Eicher Motors Limited”. Eicher Motors is a major Indian automobile manufacturer. It manufactures commercial vehicles along with the iconic Royal Enfield bikes. The Royal Enfield bikes enjoy a huge fan following both in India and outside India. It has a massive brand recall. Royal Enfield caters to a niche segment which is growing fast. Their bikes are not as expensive as the Harley Davidson nor are they as inexpensive as the TVS bikes. It would be tough for any company to enter this space and shake up or rattle the brand loyalty that Royal Enfield enjoys. In other words, displacing Eicher Motors from this sweet spot will require massive efforts from its competitors. This is one of Eicher Motors’ moat.
Many companies exhibit such interesting moats. In fact, true wealth-creating companies have a sustainable moat as an underlying factor. Think about Infosys – the moat was labour arbitrage between US and India, Page Industries – the moat was manufacturing and distribution license of Jockey innerwear, Prestige Industries – the moat was manufacturing and selling pressure cookers, Gruh Finance Limited – the moat was small ticket size credits disbursed to a certain market segment…so on and so forth. Hence always invest in companies which have wider economic moats.
12.4 – Due Diligence
The equity research due diligence process involves the following stages –
- Understanding the business – requires reading the annual reports
- Application of the checklist and
- Valuation – to estimate the intrinsic value of the business
In stage 1, i.e., understanding the business, we dwell deep into the business to know the company inside out. We need to make a list of questions for which we need to find answers to. A good way to start would be by posting a fundamental question about the company – What business is the company involved in?
To find the answer, we do not go to Google and search, instead look for it in the company’s latest Annual Report or their website. This helps us understand what the company has to say about itself.
When it comes to my own investing practice, I usually like to invest in companies where the competition is less, and there is very little government intervention. For example, when I decided to invest in PVR Cinemas, there were only 3 listed players in that space. PVR, INOX, and Cinemax. PVR and Cinemax merged, leaving just 2 listed companies in that space. However, there are a few new players who have entered this space now. Hence it is time for me to re-evaluate my investment thesis in PVR.
Once we are comfortable knowing the business, we move to stage 2, i.e., applying the checklist. At this stage, we get some performance-related answers. Without much ado, here is the 10 point checklist that I think is good enough for a start –
| Sl No | Variable | Comment | What does it signify |
|---|---|---|---|
| 1 | Gross Profit Margin (GPM) | > 20% | Higher the margin, higher is the evidence of a sustainable moat |
| 2 | Revenue Growth | In line with the gross profit growth | Revenue growth should be in line with the profit growth |
| 3 | EPS | EPS should be consistent with the Net Profits | If a company is diluting its equity, then it is not good for its shareholders |
| 4 | Debt Level | The company should not be highly leveraged | High debt means the company is operating on high leverage. Plus the finance cost eats away the earnings |
| 5 | Inventory | Applicable for manufacturing companies | A growing inventory, along with a growing PAT margin is a good sign. Always check the inventory number of days |
| 6 | Sales vs Receivables | Sales backed by receivables is not a great sign | This signifies that the company is just pushing its products to show revenue growth |
| 7 | Cash flow from operations | Has to be positive | If the company is not generating cash from operations, then it indicates operating stress |
| 8 | Return on Equity | >25% | Higher the ROE, better it is for the investor, however, make sure you check the debt levels along with this |
| 9 | Business Diversity | 1 or 2 simple business lines | Avoid companies that have multiple business interests. Stick to companies that operate in 1 or 2 segments |
| 10 | Subsidiary | Not many | If there are too many subsidiaries, it could sign the company siphoning off money. Be cautious while investing in such companies. |
Lastly, a company could satisfy each point mentioned in the checklist above, but if the stock is not trading at the right price in the market, there is no point buying the stock. So how do we know if the stock is trading at the right price or not? Well, this is what we do in stage 3. We need to run a valuation exercise on the stock. The most popular valuation method is called the “Discounted Cash Flow (DCF) Analysis”.
Over the next few chapters, we will discuss the framework to go about formally researching the company. This is called “Equity Research”. The focus of our discussion on equity research will largely be on Stage 2 and 3, as I believe stage 1 involves reading up the annual report in a fairly detailed manner.
Key takeaways from this chapter
- A stock idea can come from any source.
- Circle of competence and General observation is a great way to start.
- It is advisable to have a watch list which includes stocks that look interesting.
- Once a stock is identified, we should look for sustainable moats.
- The due diligence process involves understanding the business, running the checklist to understand its financial performance, and the valuation exercise.
- When it comes to an understanding the business, one should be completely thorough with the company’s business operation.
- The checklist should be improvised as and when the investor gains investment experience.
- The DCF method is one of the best techniques to identify the intrinsic value of the business
This is great stuff….Presented beautifully…..The author mentions “equity Research” as the next topics but it doesnt seem to be here…..Is it waiting to be added over time?
Thanks Prashant. Fundamental Analysis is work in progress, there are 4 more chapters pending before we wind up FA. Equity Research (Part1) will be uploaded in a day or 2 I guess. Please stay tuned for more.
Hi Karthik
The fundamental analysis write up was very useful. Got so many insights on checking companies performances.One question I have is- I have a few great companies equity like ACC, AShok leyland, Tata Motors etc, inherited IPO’s. how do I make out I still hold on to them or sell them? Cos even though the share prices go down, they rebound with time
Thanks, Rekha. I’m glad you liked the content here. The decision to hold or not really depends on the conviction, if you see the company progressing in terms of year on year growth, then fair enough, else you may want to think of selling them.
Sir, you mentioned that high P/E stocks must be avoided whatever sector may be. But, you have purchased PVr wchich has high P/E of over 65. Pl. clarify
I picked up PVR around March 2013, when the stock was trading ard 250 sorts. The PE was much lower then. Of course the PE has shot up now, but I would not worry about it for few reasons (1) My investment horizon is quite large (multi year) (2) Even if the stock cracks, I have a reasonable cushion (3) I will stay invested as long as the business moats continue to sustain.
Needless to say, if I were to buy PVR now, I may not have done so.
sir,
what is EV/EBITDA, how it works in identifying stock. what is EV. Thanks
EV is the enterprise value of the firm. It can be calculated as follows –
EV = Market Cap of the stock + Debt – Cash. For example Bajaj auto has a market cap of 59239crs, Debt of 57Crs, and Cash if Rs.106crs. Hence EV would be
= 59239+57-106
=59190
Bajaj’s EBITDA is 4837 Crs
Hence EV/EBITDA
=59190/4837
=12.23 times
EV/EBITDA is a valuation metrics. In case of Bajaj Auto example it is telling me that at current price market price of Rs.2037, an investor has to payg 12 times Bajaj auto’s operational income (EBITDA). This can be considered expensive or cheap by comparing with its peer companies. For example TVS Motors is trading at 22.2 times, Eicher is trading 34 times.
So what is your view? As the EV/EBITDA compare to peers is cheap is it worth investing during march 2015 in Bajaj Autos? From only EV/EBITDA ratio
You cannot invest based on this one ratio alone 🙂
I’d suggest you look at the business in detail and then make a call on investment.
Sir how to find the intrince value(actual value) of the stock??
Please do check the DCF chapter – it has the required details.
Karthik,
Sincerely appreciate the efforts that you and Team Zerodha are taking to educate retail investors like me. Keep doing the great work. Looks like Zerodha is in a mission with symbiotic values where every one will end up getting profits 🙂
Thanks Again,
Pankaj
Thanks for the kind words and encouragement Pankaj 🙂
hi karthik,
I am new to trading, each and very module from varsity is helping me shape my trading strategy. I am more confident day by day. thanks for doing the great work.
Is it wise for freshers to invest in IPO?
Thanks Priya. Glad you are liking Varsity!
If the IPO is good then if does make sense to invest in the IPO. But please do make sure that the company qualifies all the required criteria.
Were can any one find the order books of a public limited company and how to get AGM and Conference reports?
Check this – http://www.bseindia.com/corporates/ann.aspx?expandable=0
I need to shortlist the stocks using Stock screener in google finance.Please advise what are the criteria worth to be considered?
I use Beta,Volume,P/E. Is it okay? which is the most important ?
The screener design changes according to the trading requirement. For long term investments I’d look at things like margins, growth, ROE, ROC etc. But for active trading I’d look for support, resistance, indicator values etc.
Hi Karthik,
The second point in 10 point checklist, “Net Profit Growth” !! Should it not be “Net Revenue Growth” or “Net Sales Growth”?. It is contradicting with “Revenue growth should be in line with the profit growth” in last column.
Ah, let me look into this. Thanks.
Hello Karthik, Can you please let me know if you had a chance to look at my above query? Thanks.
Thanks for the follow up and also for pointing this out, I just made the changes.
Many thanks for your confirmation and quickly changing it.
Should have done it earlier itself 🙂
Why and how dilution it is not good for shareholder?
When you dilute the number of shares increases and therefore ratios such as EPS, ROE etc also dilute.
Thank you so much Karthik sir for educating all of us here..:)
Could you elaborate point 6 of checklist “Sales backed by receivables is not a great sign” and also how to check debt level (point 4) ????
Receivables is like a credit sale….wherein you sell your goods today but you receive your money much later. But when you sell, the company will acknowledge it as revenue….however, the real money will flow in much later. This is not a great thing as it would squeeze the company’s day to day operations.
To check the debt level, just look at the long term and short term borrowings.
In the earlier ROE chapter you said high ROE ( after 22% ) is not good but here in the stock screener. com you said. The ROE must be 25% along 20% PAT
Please clear it
Thanks
Can you please help me identify the chapter in which I;ve said high ROE is not good? It must be a mistake.
A high ROE is very desirable, especially if the business is not leveraged.
In Chapter 9th key takeaways 8no.
If you mean both of high ROE & DEBTS are not good then what should be the ratio of these?
Thanks a lot
If the debt is high, then ROE tends to increase. So if a company has high ROE, make sure its debt is low. Maybe you can look at debt to equity ratio….something like 0.5 or lower is desirable.
Krathik, Thank you once again for the neat explanation.
1) What is your advice in a > 22+ PE market? Do I need to stick with my positions or do i need to sell part/all of it ? Also what is your take on actively manged Debt funds / Equity portfolio?
2) I was looking at a company called PAUSHAK limited. Till 2015 earnings were growing at 20% + but after that it became flat and the price dropped. is there any hints that I can use to find if the earnings is going to slow down.
Thank you!
1) A PE of 22 can be justified in many ways (industry, margins, quality etc). There is no hard and fast rule here. You will have to judge the company from many different angles and not just PE. In fact, personally PE is the last thing I look at.
2) You will have to investigate – is it a cyclical business? How are the peers doing? Is the industry dependent on a commodity? Threat from cheap replacements from outside?
Dear Karthik, your material is the best one I have ever seen. It will be helpful for investors like me if you add a module on Mutual Funds also. Apart from that kindly have a separate module on small cap, mid cap and large cap stocks, investment strategies in these stocks etc.
Thanks Akash. I’d love to put up a module on personal finance which will include mutual funds. Will also have a module on financial modelling soon where all these stocks can be discusses.
Hi Karthik,
You are doing amazing job by helping small retail investors like me to avoid lots and lots of pitfalls that we face in the market. I came to know that you will have a module on financial modelling, it will be of great help to us. Your explanation style makes many complicated topics into simple ones. Once again thanks a lot from the bottom of my heart
Happy to hear these words, Sandeep. Yes, we will have a module on Financial Modelling sometime this year.
Really thanks for effort, Karthik. Any updates on the Financial Modelling Module?
Plan is to put that up by mid of this year.
Hi Karthik,
Greetings!!
First of all, thanks a lot for this excellent firsthand information. Would like to understand, what company reports to refer in case the latest annual reports are not available. Example: If am looking to invest now, I do not have the latest annual reports.
Regards,
Mohit, the latest AR will be made available within 30 days of filing the annual returns. Check on the company’s website under the investors section.
Hi Karthik,
Thanks for the detailed explanation on each section. It seems simple to understand.Can you please upload articles on how to select the mutual funds based on risk and time lines? It would be of great help to small investors like me 🙂
Content on MF is long overdue. We will work towards getting this out sometime soon.
Hi Karthik,
What should be our approach while studying Quarterly Reports of the Company?
Is it exactly same process as studying Annual Report ?
Please guide.
Thanks & Regards 🙂
Santosh
Yes, its just that in qtrly reports, you will not have balance sheet. Only the P&L is provided. Look for the guidance on the future business prospects, the company provides.
Thanks a lot. 🙂
Welcome!
Really nice explanation, specially practical explanation with examples like PVR, Echer Motors, etc which makes understanding lot easier.
I only have one question, can u pl tell me how to know what amounts of ratios r to be maintained in each and every category. like debt/equity ratio should be less than 0.5 and gross profit margin should be more than 20%…etc
I want to know how will I ever know what are the correct ratio amounts I should maintain .
There are no hard and fast rules here, Rushikesh. This is because not two companies are the same – sector, business profile, dynamics etc – everything varies.
sir i have been reading a lot these days,preparing myself to invest when the market corrects!i have been shortlisting companies that i wish to own based on above 25 percent return on equity and return on capital employed,low pe ratio and low price to operating cash flow!and then i would take up the AR’s of these companies.
does this approach seem sound one!
my criteria has been based on books i have read-
1 one up the wall street
1 the warren buffet way
3 little book that beats the market
thank you!
It is sound and you are reading the right books. Stay focused and look at investing for the longer-term. Good luck.
Hi Jay Jain,
Nice to hear that you have read these books. So, by now you must be having a fair enough idea of picking up stocks.
I am new to investing, and specially to Stocks. Although I am going through Zerodha’s Varisity, understanding the concepts but yet not able to implement them practically.
Its like theory is complete but practical is not [just like education in our country].
Would like to know out of 5k listed stocks how to pick any one?
Minimum amount of money I should have to start investing?
Would like to hear from Karthik also on these line.
Prateek, the content that you are reading here is anything but ‘bookish’. It comes from multiple years of trading and investing experience. It is quite practical and concise. I’d like to know why you are not able to start. What prevents you?
U must be the kind of player who could never lose money in stock market.
If we do lot of homework with creating our own checklist by points given by you the one cannot lose money.
One more thing which i feel is that horizon for holding a stock must be 2 to infinity years.
Thank you,although some of us people knows these point but a few people apply this in real
Thanks once again for sharing this.
There is no player in the stock market who sees only profits! Everyone has their streak of losses 😉
Good luck, Rishi!
How to know the intrenaic value of any stock by using screener.in .
Not sure, Ankur. You will have to touch base with Screener’s support team for this.
A company if launches products out of domain raises red flags ….
Given in understanding the business point 10
But in a manner diversification is good a business is spreading its investment and not dependent only on a single business for income
Diversification within the domain is great – for example, a stockbroking firm diversifying into NBFC and lending against shares. But something that is radically different raises eyebrows – for example, a stockbroking firm getting into organic farming.
Please add my number i.e. 7404370868 in whatsapp group, if there is any.
Zerodha does not have any whatapp group or does not endorse any such groups on any medium.
Hi Karthik,
I have Couple of Queries about PE Ratio,
1. If Company A having PE Ratio of 20 & Company B under same industry having PE Ratio of 10, Does it mean Company B is undervalued and Company A is overvalued or we need to look some other factor also to consider whether stock price is undervalued or overvalued and please mention some of those factor if possible
2. What is Trailing PE Ratio & How to use it in stock market ??
3. What is Forward PE Ratio & same how to use this in stock market ??
4. is there is any combination of PE Ratio & Trailing PE Ratio & Forward PE Ratio that should be considered for stock ??
Thanks in advance
Waiting for reply
1) It means the market is more bullish on A – maybe for a better product line or better quality of products or simply better management. But yes, if everything else about the two companies is similar then B is considered undervalued.
2 & 3) PE is based on earnings, if we are considering the past earning of the company, then it is called trailing PE. If you consider the future earnings, then it is the forward PE
4) Not that I know off.
Thank you Sir
Welcome!
Karthik,
The way you are sharing such valuable insights on stock markets from your own experience is truly commendable. Been following all your modules and it is really helpful. Keep up the good work…!!
Thanks for the kind words and encouragement, Gurpreet!
Hello,
loved all your stuff, it has made very easy and simple to understand.
just wanted to know how to know how to perform Sectoral Analysis?
what is the process and which websites that i can refer to?
which websites or research reports will help me to get insights into upcoming sectors or the performance of current Sectors.
Thank you
Ameya, here is a simple guideline to do a sector analysis –
1) Identify the top 3 and bottom 3 companies the sector
2) Have their Anual reports handy for at least 3 consecutive years
3) Read the Management discussion and analysis section – and pay particular attention to what they have to say about the industry and about their business
At this stage, you will get a great understanding of the business. Now, move the numbers –
1) Add up the revenues of all companies – this will give you a good sense of how big the industry is
2) Add up other numbers from the financial statements, this will give you a deeper perspective.
Thank you Sir,
Have started with healthcare and NBFC.
Have a nice weekend ahead.
Good luck and you have a great weekend too!
hello karthik, pl let me know what should be the optimum rate for operating profit margin just like GPM 20% as u said…can i take decision based on OPM instead of GPM for checklist point#1
We can only due diligence from our side before buying a stock. But we can not get to know all the inside information about the companies. For example, fundamentals of both PC Jeweller and and Vakrangee are good. Constant increase in sells and profits. Low debt equity ratio. No pledge shares. Still both the scripts are bleeding. Companies are assuring the investors and could be lying as well.
The investors in these companies did no mistake while choosing these companies. But due to unethical managers, people lost there 50% of their money before they know within some days. Then how can an investor be confident in stock market. Why SEBI is not taking any action.
I’ve not really looked at these companies, Deepak. I generally avoid business where the scope of ‘cash transaction’ is high, like in PCJ. Also, I would be concerned when a company like Vakrangee makes a serious investment in a business which is totally non-related.
Thanks Karthik. Then which sector companies are good for investment?
There are many exciting sectors Deepak. Really depends on how well you understand them.
I noticed stop loss needs to be set daily in zerodha. Why it cannot be done once? I don’t think big ace investors put daily stop loss for their stocks. Please guide.
I don’t think the big ace investors need to place SL daily 🙂
They have deep pockets to take cover.
Btw, yes, we need to place SL on a daily basis, unfortunately, this is both a technical and regulatory challenge.
Is it true that Google Finance Screener, that you talked about and used, does not exist now?
What’s the status of google finance as I can’t find and access it?
Link:
https://www.marketbeat.com/press-room/google-finance-changes-and-alternatives/
I guess you are better off using screener.in for fundamentals.
Thanks for suggestion, Sir.
It’s just that I’ve had an impression that Google finance might be like Varsity, put up by you……Simple and To the point !!
I’ll take that as a compliment, thanks 🙂
I want to know what criteria should be taken into consideration while screening stocks (tech. analysis)
This really depends on what you are looking for. For example, if you want to screen for stock which is above their 50-day average, then you will compare the closing price with the 50-day average.
How is growing inventory along with an increase in PAT margin a good sign ? It is obvious that an increase in inventory will increase the gross profit of the company. The company can manipulate it’s inventory. Could you please justify ? Thanks Karthik !
Increase in inventory + Increase in PAT (and PAT margin) indicates that the company has a growing demand for the product they are trying to sell.
But when the inventory increases it means that the product is not getting sold right ? That part of unsold goods gets accumulated in the closing stock which in turn increases the GPM.
Yes, it can mean that. It can as actually mean several other things, for example, the management maybe want to show a slowdown in the inventory, just to even the revenues across years to show consistency.
Hello.
I am just concerned over pts. 9 & 10 in the checklist as it conflicts with my observation.
I am observing “Reliance Industries” from a long time and my views are bullish in long term. RIL is a company with many subsidiaries – Reliance Petro, Reliance Jio, Reliance Retails, Money control, TV18,Saavn etc. RIL is also very much diversified – petrochemicals, telecom, entertainment & media, retail etc.
So based on pts. 9 & 10, is RIL a good one to invest ?
I personally may not want to Uday. I’m averse to such large conglomerates, simply because there are just too many moving parts. I’d rather prefer a simple company with 2-3 products on offer. As I said, this is my personal preference.
Thanks but one more thing related to RIL.
Many other conglomerates like L&T, Aditya Birla etc have there subsidiaries listed on exchange but RIL is listed as a single entity.
What could be the reason for this and according to you, is this good or bad ?
In my opinion, they could probably unlock value at some point in the future….at least for Jio.
Hey KArthik,
I just checked screener.in tool. It’s good with protraying the data, I am mean it shows most of the data from PL, balanced sheet and Cash flow. It also shows some basic ratio’s like ROE and PE. is this data reliable or is there any mixing of data here in this tool? Can I use this tool for fundamental analysis?
I think their data is quite reliable, Kiran. I’d suggest you randomly double-check this across a few companies statements in the annual report, just to be sure.
Can you please explain the sales vs receivables variable in the checklist?
Dear Sir, could you please shed some light on Infosys moat? Couldn’t get the clarity here.
Thanks!
Please revert to the above question, sir 🙂
Hi Karthik,
1. I found from my Circle of Competence that some of international companies will do perform well but i am not sure how to invest
them on our Indian stock market. So being retail investor and newbie i am unsure how can i invest in US market ? What is the
procedure to invest their like we do in our Indian market ?Is there any platform like Zerodha through which i can invest? can you
just please let me know?
2. Once I found a company which satisfies all the checklist then how to decide how much capital should we invest in it?(i.e minimum
capital) .and also how to decide how long should we invest in it and how much return can we expect ? so that i can have clarity on
by the end of day how much i am going to earn by investing in it?
Thanks
1) We don’t have a platform yet, but I guess there are few domestic brokers who allow you to invest in foreign companies
2) Capital depends on the availability of your funds. The time period depends on how well you understand the business. Btw, no one can tell you the potential to which you can earn before you invest. This is just not possible.
Sir what does a negative EPS indicates?
There is no earning 🙂
1) On a scale of 1 -10, how much trustworthy are the financial numbers on screener? 1 being least trustworthy and 10 being the most.
2) When is Zerodha gifting us an extensive module on Financial Modelling ?
3) P/E Ratio vs EV/EBITDA , which one is better to analyse ?
4) Please share your interpretation and views on price to cash flow ratio ?
5) Sun Tv is Asia’s largest TV network. It got listed in 2006. It has been doing amazingly well over the years. 0 Debt. ROE is 27% ROCE is 42%. Promoter holding is 75%. P/E is 11.09 P/B is 2.71. Since last 6 years, its revenue, PAT is consistently increasing with no dip at all. Current Ratio is 7.5. ROA – 3YR AVG is 23%, price to cash flow ratio is 8.56 and rest all the factors are very very good. Till date the company has not given any stock split, rights. It’s current stock price is 385rs. Its highest was 1077 in Jan, 2018, After that it came down and now at 385. So if something like this happens with me, that I have invested and the company is good and all etc, then in this case should i hold on to it ow what ? Kindly reply as clearly as you can. Thank You
1) I’m guessing 7-8
2) Right after personal finance module, hopefully, sometime this year 🙂
3) Both, depending on the context
4) It is just a multiple of the ‘number of times’ you are paying for the stock given the cash flow of the company
5) You should be fully aware of the growth drivers for the company. As long as you do, and you continue to be convinced, then you should stay invested.
Hello sir, a huge respect for you. How u have so much patience for answering all the questions and such a beautiful content. Great job.
I am CA final student, we have a subject SFM. I do find all the theory understandable, but coming to the problems part lot of formulas are used and every sum is like a new model. So is it possible for u to help me in any way, in solving these problems, also when ur free can u even concentrate and put ur efforts towards CA student friendly problems solving book ? Thanks 🙂
I’m not a CA myself, so I really dont know if I’m qualified to do something like this 🙂
Hi karthik,
First of all thanks a lot for this very well written content I got to learn a lot it makes much more sense to get a hold of this kind of content in the youtube world where everything is explained but hardly understood.
I have two parameters you have mentioned in this chapter which I am not probably able to grasp correctly.
1.) Govt intervention is considered as negative parameters could you explain, is it only for PSU banks or for companies which frequently gets impacted due to tax intervention like ITC?
2.) Companies which have more than 2 subsidiaries are considered negative however there are some prestigious group like L&T & Bajaj, what is the rationale behind considering it negative?
1) It is mainly from the perspective that it could curb innovation in companies.
2) True, hard to generalize, better to analyse this from a case to case basis.
Remember my name
What are the most important constituents to look for when one analyze sector specific businessess. Is the approach same as provided to fundamentally analyze the company in every sector. And how to estimate the fair price of the stock ( and the growth rate of company in the near future).
Thankyou
Each sector has its own metrics to gauge how well the business is doing. The framework I’ve provided is a generic one which is applicable across all businesses. You need to use this along with industry-specific metrics.
valuable lessons
Sir, could you please explain the phrase, “sales backed by receivables is not a good sign” briefly with an example? thanks in advance.
This is basically sales without receiving cash, but a promise to receive cash in the future.
Hi Karthik, Thanks again for this wonderful article. Can you please elaborate more on what it means exactly “If there are too many subsidiaries, it could sign the company siphoning off money. Be cautious while investing in such companies.” ? If possible with practical example will be more helpful.
Satyam was a classic example of this 🙂
Sir, growing inventory with growing PAT margin is a good sign as you said, so more inventory number of days will indicate growing inventory OR less number of days?
Just growing inventory is not sufficicient. You need to match that with PAT.
Hello Sir,
Can you explain the reason companies create holding companies?
Are they just there to siphon money and pay less tax via related party transactions etc? Is there another reason for a holding company?
For example Alembic Ltd is a holding company of Alembic Pharma a large cap company and Paushak Ltd a small cap company.
What about Bajaj Holding, HDFC Ltd. These are holding companies whose main venture is to invest in their subsidiaries and purchase stakes in other companies?
The reason is just that to – to hold the company shares and benefit from efficient taxes and dividends.
Sir how to calculate intrinsic value using the Graham’s method?
Is it reliable?
It is, maybe I’ll try and include it in the financial modelling module.
Hi Karthik,
Is it possible to evaluate the Moat of the company through its financial numbers? If so, what are the numbers that you personally look at?
Thanks
Sandesh Shetty
Moats eventually translates to numbers, so yes, when you look at the financial statement and compare it to the financial statements of the company’s peers, you can guesstimate that the company has a moat. But the nature of the moat itself is usually qualitative and you can establish that by looking at the business model.
What is DCF analysis?
Its a method to value a business.
Sir, in the above checklist you mentioned a growing inventory is a good sign. How? Because a growing inventory always indicate more cash tied up for inventory . And during economic breakdown or cyclicality, PAT margins are severely impacted , so it may prove to be a catastrophe. Need some elaboration upon the same.
Just growing inventory is not a great sign, but growing inventory with growing sales is a good, Sumith.
Also Sir, since banks and NBFC’s have a completely different revenue generation models and ratios analysis, I would request you to make a seperate module for banking fundamental research (like the key ratios to analyze for banks , key aspects to consider while investing in banking stocks, ROE & ROCE calculations for banks, key valuation metrics). That would definitely comprehend the entire fundamental analysis course.
Sure Sumit, it’s been on the list of things, will try and do that.
So, growing inventory is a good sign only when there is an industry/sectoral boom. Right, Sir?
Yes, always match it with the other aspects of the business.
I would really appreciate if you come with such module, as I find it challenging to undertake comparative analysis of banking/financial industry.
Noted, Sumit.
Thank you Sir for addressing both the concerns.
Good luck, Sumit!
Sir why valuation-estimation of intrinsic value of stock-came as third step. Can we do it as a first step?
Linesh, it is just that the intrinsic value calculation is an elaborate process and before getting started you need to be sure about a few basics.
Zerodha initiative is really commendable.
Specially Karthik sir rocks…
Thanks for the kind words, happy learning 🙂
Sir as I notice one thing in stock market understanding peoples mind helps you alot.
What you say?
Of course, it does 🙂
Sir, In the generating a stock idea, special situations section, you mentioned how Cox and Kings delivered great return at the time of writing the article. However it has liquidated since and promoters sent to jail. How do you think one can avoid being in situations like this.If you can please update the article about what went wrong in the selection and the lessons learnt. Thank you.
One of the key things to track in an investment is to see how the investment pans out, post-investment. YOu need to constantly reevaluate if the investment thesis still holds true.If you do this every quarter, you will know whats working and whats not working for a given company, Navin.
I have some smallcap holdings, which have increased their capex, and at the same time have negative free cash flows due to capex. I understand that this is quite common in smallcaps. Although valuation looks cheap, I don’t want to fall into the ‘value trap’ concept. How should I approach such a situation. Wait and see how the capex cycle plays out or exit the moment you see negative Free cash flow? Would like to know your way of approaching this. Thanks.
Yes, wait to see how capex cycle plays out. Also, how are they funding the capex? Debt or internal accrual? If debt, at what rate and what is the interest coverage? These are a few things to note.
I used to exit just on the basis of negative FCF only to find out later, that those companies are starting to do well. I was a little hesitant at first to ask these type of off topic questions, but you have really helped me. Thanks a lot for letting me know this.
Please do feel free to ask, I will be happy to help if I know the answers.
Hey Karthik,
I recently started reading varsity. I got to know about varsity/zerodha over a beer with a friend. I am so grateful to him for introducing the varsity to me! The only things which keeps coming to my mind is all these modules have been written back in 2014-15, does that mean I am late to everything? 😅
Btw I wanted to know why did you say “When it comes to my own investing practice, I usually like to invest in companies where the competition is less, and there is very little government intervention” ? I know government involvement means not having full control over the company and restrictions as per government requirement like the US gov is doing to semiconductor industries over their trades to China. So apart from these what other factors do you have in mind for not getting involved in companies with gov intervention ?
sir how we find the gross profit margin?
Divide the PAT by revenues.
“If there are too many subsidiaries, it could sign the company siphoning off money. Be cautious while investing in such companies” .Can you please elaborate on this why do u feel so?How many subsidiaries is the ideal u feel (as a limit).
This statement of mine is not entirely true. There are companies with many subsidiaries that are managed well. However, whenever there are corporate frauds, the presence of subsidiaries is there. So this is something you will have to watch out for.
Reading varsity in 2024….Its really funny to see Cox&kings in the note:)
Power and magic of stock market is top.
Yup! You bet 🙂