How to start researching stocks? Please note the weight on the word ‘start.’ At this instant, the analyst (you) is not thinking about detailed analysis. It is just a start point. How to do it?
How we commonly comprehend the process of analyzing stocks? It deals with reading financial reports, calculating ratios, estimating intrinsic value, etc. But before we can go into these details, we must prep ourselves.
How to do it? Do it by observing the company in consideration. In this article, we will talk about what we can start viewing about a company. The overall purpose should be to identify a potentially good business and then do a detailed analysis of its stocks.
The bigger idea is to build an eye for a business. We can set-up a few standard queries which can be asked and answered to know more about a company. It will also help such investors, who cannot analyze stocks on their own, to vet a company. What can be done is to deeply observe a company and gain an edge over other investors.
Deeply Observe and Start Researching Stocks
Understanding of business behind a company is essential before buying its stocks. It is a statement that experts tell us time and again. How to build this understanding? It can be done by answering four questions (see above infographics) about the company/business.
These are four parameters based on which one can judge the fundamentals of a company. The best part is, we need no reports or do any calculations to conclude. Just observe the company, and transform yourself into a pro-investor.
People who are in search of the best stocks should hone their observation skills. How to do it? It is what we will discuss in the next part of the article.
The four questions…
These four questions prepare the ground-work for a deeper analysis. But what happens if one decides to skip this step (observing a company) and do a detailed analysis straight away? It is possible to skip the step. But consider an analogy.
Suppose you want to hire a candidate (stock) in your team (portfolio). So, you will first ask for the CVs (Financial Reports) of potential candidates. But will you hire the candidate just by looking at the CV? Probably not. You will like to meet him/her in person (observe). You may also conduct an interview (query). The candidates are picked based on your observations and the answered-queries.
#1. What is the ‘goal’ of the company?
It is a basic query about any company. Talking about RIL, TCS, HDFC, Biocon, they are popular companies. Probably we’ll know their goals. RIL is into diverse businesses like energy, petrochemical, retail, telecommunication, etc. TCS is into IT services and consulting. HDFC is into housing finance, and Biocon is a pharma company.
But if we are talking about lesser know companies, we may not know their goals. It is essential to figure it out first. Knowledge about the sector in which it operates can do the trick. It will give an idea about the type of business the company is in operation.
For example, a pharmaceutical company’s ultimate goal will be the sale of medicines. An oil marketing company’s (OMCs) goal will be to sell petrol and diesel directly to consumers.
A direct way of knowing this is through the company’s annual report. Download it from its website, and read the first 5-10 pages. Then Jump to the Chairman’s message. While reading these pages, make notes of any reference made to a sector or products. This exercise can give a fair idea about the goal of the company.
2. How is the money flowing-in?
What do we want to know? How the company is converting its products and services into sales (money in-flow). It is a critical step into the way we can start researching stocks. Why?
It will give clarity about the company in consideration. It is the way we will exactly know about the company’s products and services. Moreover, we will also realize how and where they are sold to convert the inventory into sales (or cash). It may also give an insight into the other aspects of the business.
For example, a company like Tata Motors has two types of products, commercial and passenger vehicles. They are sold to the end-users through dealers. The company’s takeover of JLR from Ford in 2008 has enhanced the product development capability of Tata Motors. Moreover, it has given pricing power to the company.
Pricing advantage is evident from the price brackets in which its car models like Harrier and Safari are currently selling. Earlier, the launching of cars was done only in the economy class. But now, after the JLR deal, their vehicles could be priced much higher.
What is the point? Knowledge of how the company makes money and if it is doing enough to increase its pricing power is a critical understanding. Investors must question and seek an answer before investing in their stocks.
3. How is the company currently performing?
Analysts prefer judging the performance based on the company’s long-term financials. Why? Because a good business may not see the rewards immediately. But in the long term, benefits will flow-in. Read: Why can cause the stock price to fluctuate.
But here, we have just started researching stocks. At this stage, we need not plunge into financial reports yet. What we need to do is only observe.
How to only observe and judge a company’s performance? There are two parts to doing it. First is related to companies whose brand, products, or services are more visible.
Examples are companies operating in Sectors like FMCG, hotels, restaurants, airlines, entertainment, fashion, automobile, etc. Products of such companies are most visible. If we can look intently, it will be possible to judge their performance.
What we must look at?
- Age: Try to figure out the age of the company. Do search for the date of its incorporation. The older is the company, the better.
- Appraisal: Think about their products? Had you been a customer, would you buy its products? A yes for an answer is what will make the company score a point.
- Client Reach: Think in terms of the company’s distribution and sale. How easily available are their products or services to the end-users? You would like to target companies whose products are readily available.
- POS: Also, try to judge their Point-of-sale (POS – like a retail outlet, dealer). An impressive presentation of the products at the POS speaks loads about the quality of the company.
- Acceptability: Also, consider how readily acceptable are their products and services for the general public. Mass acceptability of a product or service can uplift the performance by leaps.
- Size: as an investor, we would like to buy stocks of the biggest companies. In this contest, try to judge the size of the company in terms of its sales or market capitalization.
Second, are the types of companies that are not as visible. How to judge their performance? Judging based only on observations is not easy. Hence give yourself some time. Go to Google alerts and set a news feed of the company. I generally take news feeds (of an unknown company) once each day for at least 30 days.
You can also check related-news of the company in we portals like moneycontrol.
You can use the trick of “Google Alerts” for type-first companies as well. It is very effective in making a first impression.
4. Judging the strength of competition
It is perhaps the litmus test for any company. A company that can maintain itself as a leader in its sector will dominate the market financially. Hence it is pertinent for investors to start researching stocks by observing the competition.
The first thing to note here is the extent of the competition. List down all the companies operating in this sector. Note their sales numbers. You can do this by visiting the stock page of BSE India. In the sidebar, you will see the option of “peer group”. Click on it, you will get a comparison of four companies with details.
Check if their sales, profits, and profit margins are close to each other. If this is the case, it means the competition is tough. If there are too many names on the list, then the business is non-capital intensive. Such a business has its challenges. In the future, more new companies will likely venture into creating more competition.
We can also think in terms of product development. How technologically difficult it is to invent or duplicate a product of the company. Is the duplication preventable by the copyright rules? How renowned is the competitor’s brand name to support the capital investment. How price-sensitive is the sale of products? Is it easy for the company to increase its price and not hamper the sale?
Observing a company for its competition is a very effective way of making an impression about it. This work will establish who are the market leaders. Moreover, you will also know where your company stands as compared to them.
Observing a company based on the above four questions may take time initially. But after one has researched few stocks like this, the exercise will become more seamless.
Expert investors may never analyze stocks in detail till they have answered the above four questions. Answering these questions will establish if it is worth spending time to do a complete fundamental analysis.
For a shorter way to start researching stocks, one can use our stock screener to identify potentially good stocks. After identifying these stocks, a detailed analysis can be done using our stock analysis worksheet.