Fundamental Analysis of Stocks For Beginners

A common dream of our society is how to become rich. Sincere persons set a target to be achieved in upcoming 20 years. I am 28 years old and have set up a target to earn Rs. 5 crore INR in the next 22 years with a lump sum investment of Rs. 7 lack. To achieve the target I need to invest in such companies which yield 22% CAGR. Before investing one should be done the fundamental analysis of stocks. One should be sure whether the company will be able to give that huge return in long-term perspective. There are many points to check on the basis of which you can make an investment in various companies.

• Read also: Fundamental Analysis – Investopedia

How to Do Fundamental Analysis of Stocks

Debt: Net Worth ratio

If the company has the marginal or low debt or a debt-free company, the company is worth investing. Let us illustrate what is the difference between a high debt company and debt-free company. When a company has huge debt from the market or bank or commercial institutions then the company will concentrate on the debt and its effort goes to pay the debt. It cannot be sincere about the service, quality of the product or any other important aspects needed in the business. If the company is debt free, the company will concentrate not only on product quality but also service and customer satisfaction. That is why a debt-free company is better than a high debt company.

Debt: Net Worth (Equity)> 3

It means that the company has a capital of 100 &its debt from the market is 300. These types of companies are highly debt company and not worth investing.

The main concern of highly debt companies is that any kind of hike in interest rate by banks or financial institutions increases the expense ratio for the highly debt companies. Then naturally, this additional expense affects the net profit margin and dividend payment of its shareholders. Let us illustrate what the difference is between a highly debt company and debt-free company. When a company has a huge debt from the market or bank or commercial institution, then the company concentrates on the debt and its effort goes to repay the debt. The respective company cannot be sincere about the service, quality of the product or any other important aspects needed for the business.

If the company is debt free the company can concentrate on product quality, service and customer satisfaction only. That is why a debt-free company is better than a high debt company. From the above discussion it is concluded that at the time of investment in any stock one common individual must be aware of the stocks’ Debt ratio.

Debt: Net Worth (Equity)> 2

It means that the company has a capital of 100 &its debt from the market is 200. These types of companies are not also worth investing.

Debt: Net Worth (Equity) = 1

It signifies that the company has a capital of 100 and its debt from the market is 100. This condition is satisfactory for housing or financial companies. These companies give easy loans and in return receive the loan back with an interest. Again when the ratio is equal to one the companies operating in consumer durable or engineering sectors worth choosing. They normally use the debt in innovation & research. If they get patent for such innovative ideas, they are the only companies in the production with a monopoly.

For example, if Motherson Sumi or Minda Industries get a patent of such an engine which consumes less petrol/ diesel or the engine works on solar energy or tidal energy or any other natural resources which are cheap in price, they will be the only sellers of the engine or any other thing which they have to get the patent. Finally, they will enjoy the monopoly in the sector.

Debt: Net Worth (Equity) < 0.50 then the company has a capital of 100 and it has a debt from the market 50. This type of company is worth investing in.

Debt: Net Worth (Equity) < 0.25 then the company has a capital of 100 and it has a debt from the market 25. This type of company is worth investing in.

Debt: Net Worth (Equity) =0 then the company has a capital of 100 and it has no debt from the market i.e., it is a debt free company. This type of company has a huge potential to give you a better return.

Company	Market Cap	Debt Ratio	Return
Titan Company	71520 Crore	0.00	29.17%
Minda Industries	8,029 Crore	0.17	26.03%
Pidilite Industries	50469 Crore	0.00	27.19%
Asian Paints	121002 Crore	0.00	25.46%

The benefits of investment in debt free companies

The Debt free companies are capable to deliver better returns just because they are self-reliant. Debt is a temporary solution for the financial crisis. Debt costs larger in the long run. Your task is to choose a company or stock which is debt free. A debt free company allots good dividend yield, better return on equity to its share holders. As a retail investor of that respective stock, you will receive a good dividend yield or dividend payout from that company or stock you have invested in. So, smart work is to analyse a stock’s debt ratio first before investing.

Banks also prefer those companies which have low debt ratio or which repay the loan within the scheduled time. In addition to banks charge lower interest rate to those companies which have low debt in comparison to highly debt companies or stocks. Bankers also fear that these highly debt companies may increase the bank’s NPA.

Finally,

In addition to Debt free status, you need to keep a close eye on what the management policy or road-map a company maintains to pay off the debt in the future. With an appropriate road-map, a company can clear out the debt it receives for business. Then after the complete repayment of loan, the company can now use its profit for restructuring and expansion of the company i.e., setting up production units all around the country. With this business expansion, the sales and the profit margin increase over the long term. So, when the profit margin increases the company will deliver good numbers and have good dividend yield to its shareholders.

Compounded sales Growth

Select a company that has been generating sales Growth annually for the last 5 financial years of at least 10%. When a company’s sales increase then naturally the company will make more profit. So this will affect its share price.

Profit after Tax (PAT) growth

Choose a company whose profit growth increases at least 15% on year-on-year basis. Titan Company’s profit growth in 2018 increases 72% on year-on-year basis.

Return on Equity

If a company fails to give you a yearly return of at least 20% you may stop investing in that company and move to another one.

The price-earnings ratio (P/E ratio)

When a company’s sales & profit margin increase naturally its share price also increases. This is commonly known as the Price-Earnings Ratio or P/E Ratio. Companies with a high P/E ratio are growth stocks that achieve higher share price on a year-on-year basis. However, their relatively high multiples do not necessarily mean their stocks are overpriced and cannot give better returns for the long term.

In addition to, the lower P/E ratio of sectors does not mean that this sector is undervalued and they are going to boom and deliver multibagger return in the near future with compared to that sectors which have higher P/E ratio. These sectors have higher valuation just because the market is bullish on these sectors and their future potential like Automobile, FMCG, Petroleum, etc. As they are core sectors of the Indian economy and have the potential to deliver robust performance in the upcoming years.

Inventory

Inventory is the stock or ready to sell products. A company that has large inventory supplies its products at the time of sale. It is considered to be the portion of a business’s assets that are ready or will be ready for sale. Inventory data is important for a consumer durable sector i.e., garments, ornaments, mobile, gadgets, jewelry sector. Our country has many festivals throughout the year. So, Companies with huge inventories offer a sale on discount on several items. They can do so because they have available inventories to fulfill such a huge demand for the festive seasons. That is why inventories are good for such type of companies.

A beta of a Stock

A beta is a measurement of the volatility of a share in respect of market. When Beta is less than 1 means that the share is theoretically less volatile than the market. It means the common individual may invest his money for long term. Again, if Beta is more than 1 means that the share is theoretically more volatile than the market. For example, if a stock’s beta is 1.2, it means the stock is 20% more volatile than the market. So, a lesser beta means people are investing in that specific stock with a long-term perspective.

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