How to select stocks for investing in 2022. How to select great companies for investing for beginners.

How to select stocks

 This is how beginners can analyze a stock before investing. Important things a person checks in the company’s balance sheet and profit and loss statement before stock selection.

There is always a business behind a stock. Understanding the business and its potential is very important. In the Stock market, we need to find businesses that have strong fundamentals and are available at a good price. A thorough business operation and its profitability develop faith in us. To hold stock even when they are down needs a firm belief In the company.  After all, when we are investing in a stock, we own a part of that company, so we should be aware of what the company is doing. The company should be a well-established firm, running its business for at least 10-15 years.

Role of financial ratio stock selection

Market capitalisation 

market capitlization
Market Capitalization- formula

 It is the total value of all the company’s shares of stocks.

MCap= Number of shares X  current market price of the share.

 this is used to categorize companies into large-cap,  midcap, and small-cap.

 a new investor should focus on large-cap companies and big mid-cap companies, which have the potential to turn into large-cap companies can also the considered. The bigger the company, the lesser the risk.  The returns are also nominal.  This is a safe way of investing, as a beginner would not like to take a vigorous risk. 

Investing in aggressively growing small-cap companies, 1-2 out of 10,  may give huge gains while others prove failures where capital can be lost. Read More.

So as  beginner we should go for large and known companies. Please make sure that as an investor, you can understand its business model.

P/E ratio or Price to Earning ratio

P/E Formula
P/E formula

P/E Ratio is calculated by dividing the Price of the share by earnings per r share.

It can be e also calculated by dividing market capitalization by the net profit of the company. The P/E ratio reflects the company earning potential or its value over time. It is the number of years it would take to accumulate the earnings equal to the cost of investment. 

 In simple terms, if P/E  is 10, It will take 10 years to double your money.  this was surprising because most of the companies trade at a P/E of more than 15 or 20 to 135 in the case of Avenue supermarts.  does that mean Avenue supermart is a bad investment??

No, definitely not. P/E  has no relevance in today’s scenario.  High growth Companies usually trade at high P/E.

If P/E < 15 Is good for us for choosing stock and

P/E > 15 would make no difference.

Book value

            Book Value is used to describe how much is the worth of the business according to its   Financials. 

Book Value= Value of tangible assets – liabilities.

It is used to find out whether a company is overvalued or undervalued. 

If CMP ( Current Market Price) < Book Value, Then it is a positive matrix in decision making.

If CMP > Book Value, It doesn ‘t matter.

ROCE- Return On capital employed

            ROCE Is the efficiency with which a company earns probability using the capital   employed.  Capital employed includes both share capital and borrowings.  It shows how good is a company at generating profits from its capital.

ROCE= EBIT/( share capital + Borrowings)

It is a reliable measure for analyzing a company for investment.

If ROCE<15 Company has very low margins. Do not trade in such companies.

If ROCE> 15, Company is efficient in generating profits.

If ROCE>30, Company is great, it is having high margins and brands. eg:- Nestle

For the Banking and NBFC sectors we do not use ROCE, here we look at ROE.

Promoter’s Holding

The percentage of shares of the company that is owned by its promoters is called  Promoters holding. It can be a  Maximum of 75%. If the promoters increase their Holdings, that means they believe in the future growth of the company.

Retailers holding

   It should not be more than 35%, because then the question arises why FII and DII are  not participating in the growth story of the company.

Debt to equity Ratio-

Deby To equity ratio shows the proportions of equity and debt a company is using to finance its assets. The more the debt to equity ratio, the greater the risk of bankruptcy, if the business hits hard times.  this is because of minimum interest even if the company has not profited enough. Low Debt is always a good attribute of a growing firm.

Always opt for companies that are debt-free or D/E ratio < 0.5 %. 

CWIP Capital work in Progress

CWIP means company is expanding.

CWIP is the cost incurred to date on a fixed asset that is still under construction. It denotes the growth in production and hence sales when the construction is complete. CWIP is always better as the company is believing in its growth story and hence expanding.

Cashflow By operating activities

cash flow
Cashflow from operating activites should be equal or near to net profits

 cash flow should always be positive and near to the net income. this means whatever the company is earning, is coming back to it in the form of cash

These were the important parameters we should analyze before investing. We need not be professional accountants scrutinizing each and every entry. We should also Have a glance on any other abnormalities in form of increase or decrease in the tax,  or unexpected other incomes . We should Also check the cash lying with the company.

Frequently asked Questions

How do you earn money from stocks?

I usually choose a company which is debt free, high ROCE, increasing sales and net profits, and potential to grow at 52 week low and sell them at 52 week high.

How to know what stocks to buy for beginner?

Always go for large cap companies, trading at downtrodden prices.

How to pick good stocks for short term?

Picking stocks for short term needs knowledge of technical analysis. Buy stocks if you see cup and handle or reverse head and shoulder pattern.

What is good ROCE?

ROCE> 20 % is a good ROCE.

What is good promoter’s holding?

Instead of looking at only promoter’s holding we should look collectively at promoter’s holding ,FII,DII. It should be more than 70%

Use the link to open a Demat account in Zerodha

Also read

  1. Want to invest in Stock Market, but don’t have time and skills, try SWING TRADING
  2. Market capitalization-Which companies qualify to be in my portfolio?
  3. छोटी-छोटी आदतों से खुद को सुधारें
  4. Power of your subconscious mind. Explanation .आपके अवचेतन मन की शक्ति|व्याख्या हिंदी में| Treasure house within you| आपके अंदर निहित खजाना| Chapter 1

Books on Investing

Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!

Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!

Learn to Earn: A Beginner's Guide to the Basics of Investing and Business

Learn to Earn: A Beginner’s Guide to the Basics of Investing and Business

One Up On Wall Street: How to Use What You Already Know to Make Money in the Market

The Intelligent Investor

Disclaimer- All investments and trading in the stock market involve risk. Any decision to place a trade in the financial markets, including trading in stock should only be made after thorough research. Trading strategies or related information mentioned in the article is for informational purposes only. Use your due diligence before investing.

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