It is a proven fact that the equity asset class gives better returns over all asset classes for a period of 15-20 years. In the year November 1995, the benchmark index Nifty 50 was trading at Rs. 1000/-, now in March 2019 Nifty 50 is trading around Rs. 11000/-. Since inception, the benchmark has delivered a compounded annual growth of return of 12%. The investors who started investment back in 1995 have earned a better yield than any other asset class. So, there is a sufficient reason to make an investment in the stock market for a long-term horizon to earn better returns in the future. So, after making a proper analysis of 6 myths about the stock market, and Top 10 reasons to invest in the stock market here we will discuss how to buy stocks or equity shares.
What is a Demat Account and Trading account
Demat account can be described as an electronic account where shares and securities are held electronically in a dematerialized form. In other words, a Demat Account allows any individual to buy shares and store them safely. When you buy multiple shares of various companies, all of your holdings can be seen in the Demat account. When you buy or sell any of the stocks in the near future, the shares will be either credited to or debited from your Demat Account.
On the other hand, a trading account can be described as an account from which you buy or sell any share or stock. A trading account enables an investor to buy or sell stocks and the Demat account enables an investor to store the stocks which are bought and deduct the shares which are to be sold.
Documents required to open a Demat account and Trading account in order to invest in the stock market
To open a mutual fund account or a Demat account you need the following documents: a Savings bank Account, a cancelled Cheque of the same account, Identity Proof like PAN Card, Address Proof like Aadhar Card, Voter ID Card, etc., Income proof for Futures & Options, Two Passport size photograph.
Choose the right Stockbroker
Before you choose a broker, you should know that there are two types of brokers namely Full-service brokers and Discount brokers.
A full-service broker offers services like giving you a savings bank account, a Demat account, a trading account, a detailed analysis of stocks, investment advice, etc. The savings account, Demat account, and trading account are commonly named as a 3-in-1 account. A full-service broker gives the stock recommendation, trading calls, and future & option strategy.
A discount broker is a type of broker who gives you only a Demat cum trading account from where you can make trades i.e., buying and selling of stocks or intraday trading. Unlike full-service broker, a discount broker does not provide any research analysis or investment advice. If you want trading tips and advice you need to pay separately for that. Again a discount broker has a low brokerage charge in comparison to a full-service broker.
- Read also: If I want to buy stocks in India, what are the steps that I need to follow?
- Read also: How to Choose a Stockbroker in India Right Now
Find the stocks where you should invest
You need to choose and invest accordingly in those stocks or sectors whose business model is clear to you i.e., how the company earns money, whether it will exist after 20-30 years, what are the risk factors of the company, etc. The next thing is you need to invest your money into at least 10 sectors and 2 stocks of each sector to diversify the risk.
How to pick the best stocks
After choosing the sectors where you invest, you need to pick the best stocks for consistent returns. In order to pick the best stock, you should check out the following parameters of a company before investing in it.
Parameter #1. Revenue – Revenue or net sales of a company should be constant for at least 5 years. You may check that the company has been generating sales growth annually during the last 5 financial years of at least 10%.
Parameter #2. Net Profit – The net profit of a company increases at least 15% on a year-on-year basis.
Parameter #3. Healthy dividend payout and stable Earnings-per-share
Let’s assume, a company has a net income of $ 10,000 per year. It Pays $5,000 in a preferred dividend to investors. It has 50 shares outstanding.
It is a good idea to invest your money in those stocks that regularly pay a dividend and deliver a Healthy dividend payout. The stocks which have delivered healthy dividend-paying must have following features
- Consistent dividend payout over the past 5 years.
- High dividend yield for the last 5 years.
- Growth in dividend per share from time to time.
Parameter #4. Price to Earnings Ratio (P/E)
P/E ratio should be low as compared to the other peer companies active in the same industry.
Let’s assume, a company has a net income of $10000 per year. It Pays $5000 in preferred dividend to investors. It has 50 shares outstanding.
Now, if the stock currently trades at $1000, then
You need to choose such stocks that have P/E less than 9. But P/E varies from sector to sector. Lower P/E ratio of sectors does not mean that this sector is undervalued and is going to boom and deliver a multi-bagger return in the near future compared to that sector which has a 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. They are the core sectors of the Indian economy and have the potential to deliver a robust performance in the upcoming years.
Parameter #5. Price to Book Ratio (P/B)
P/B should be low as compared to peer companies operating in the same industry.
Let’s assume, the stock currently trades at $ 100 and the book value per share is $ 10 then,
P/B Ratio = [$100/$ 10] = 10.
You need to pick such stocks that have a P/B ratio of less than one.
Parameter #6. Current Ratio
The ratio is the snapshot of the asset and liabilities of any company. You will find the assets and liabilities a company has in its balance sheet. Find such quality stocks that have a current ratio of more than 1.5.
Let’s assume, the current assets of any company is $ 1200 and current liabilities is $ 400 then,
Current Ratio = [$1200/$ 400] = 3.
Parameter #7. Debt to Equity Ratio
This is the comparison between a company’s own capital and the debt which the company borrows from a bank or a financial institution.
Suppose a company has a capital of Rs. 100/- and it has borrowed Rs. 100 from a bank.
So the debt ratio of the company is 100:100 = 1
A debt-free company is desirable. If not so the ration must be low to 0.10 or 0.25.
If the company has marginal or low debt or it is a debt-free company, the company is worth investing. Let us illustrate what is the difference between a high debt company and a debt-free company. When a company has huge debt from the market or bank or any other commercial institutions, then the company concentrates 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. On the other hand, 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.
Parameter #8. Return on Equity (ROE) – should be greater than 20%
Parameter #9. Dividend Yield – You can ensure about good dividend yield by the company.
Parameter #10. Beta
A beta is a measurement of the volatility of a share in respect of the market. When Beta is less than 1, it means that the share is theoretically less volatile than the market. It means the common individual may invest his money for the 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.
Parameter #11. The cash flow of the company
To understand a company’s true economic condition one should check the free cash flow of the respective company. Free cash flow actually reveals the profit the company makes. It implies a broader range in the company’s functioning in overall business.
Whenever you check the free cash flow of a company, you should analyze from which source the company is gaining its capital for its day-to-day business. Usually, there are two sources, the first one is earning from running operation i.e., business and the second one is receiving debt from the market i.e., debt financing. If the company runs its operation from the profit earned by running operation you should stay invested with the company. But if the company runs its business by debt financing, naturally the debt will increase from time to time. So, stay clear of these types of companies or stocks.
Free Cash flow is one of the most reliable and widely used metrics among value investors, as it provides an accurate position of the company’s financial condition. In simple words, free cash flow is an account of how much cash a company is left with after paying for all expenses.
Companies that manage to generate consistently large cash flows without incurring much capital expenditure are always valued higher by investors. Negative free cash flows are a sign of the deteriorating health of a company.
Parameter #12. Current Inflation
In countries like India, you should watch out inflation because the P/E ratio is adversely affected by current inflation. Owing to inflation, retail consumers spend less and the expenses rise. This will decrease the Earning per share. When EPS falls, it, in turn, increases the P/E ratio making stocks overvalued. In addition, for a growing economy like India too low inflation rate also adversely affects the stocks. So, as an intelligent investor, you should analyze the following points,
- Reserves growth must be more than the current inflation rate.
- Asset growth must be more than the current inflation rate.
- Sales growth must be more than the current inflation rate.
- Cash flow growth must be more than the current inflation rate.
Parameter #13. Enterprise Value
You need to analyze whether the enterprise value of any stock is less than its market capitalization. Usually when the stock’s enterprise value is less than the market capitalization, then it is considered that the stock is undervalued.
Parameter #14. Investment Rating
There are many rating agencies which are in operation like Crisil, Morgan-Stanley, and Standard & Poor, etc. You have to follow the rating given by these rating agencies. Generally, B+ rating is an ideal investment grade in which you are free to invest your hard-earned money. The rating B+ indicates that the company is stable and likely to grow in the near future.
Parameter #15. Business Model
Ace investor Warren Buffet once suggested that an individual investor should invest in such companies or stocks whose business model or modus operandi is clear like a day to the investors. It is very important to understand what the business of the company is like. In other words, what the company sells or what services it offers and how the company makes profit from its operations are to be considered.
Investors should also see whether the demand of the product the company sells will remain constant or move upward in future. For example, food products, steel, electronic tools are inevitable for everyday life. So, the demand of these things will remain constant or increase in the future. The companies operating in these sectors will make profit.
Again, how a company operates its business influences its profit margin. It is also a part of the business model of a company to distribute the profit among its share holders. How a company produces its products, how it sells them, how the packaging of the products are attractive, the company’s marketing policies all these things form a business model.
In addition to
The source of capital or fund to run or expand the business is also very crucial. An under debt company cannot afford to distribute the dividends among its shares holders, because a lion share of the profit goes to repay the debt. On the other hand, a company which is a zero debt company can yield better dividend and better return in the future. So, the above-mentioned points are treated as the business model of a company. By reviewing the business model you can get a clear idea whether the business model is unrealistic or there is any chance that the business will succeed.
Parameter #16. Management of the company
Management is the backbone of the company. A quality management will raise a company to the pick. It is a proven fact that good management in competitive industry will yield better returns than the worst management in monopoly market. In order to access the strength of management, you need to consider the following aspects.
- The persons who manage the company’s business and the persons in key positions i.e., CEO, CFO, COO & CIO.
- You need to examine the educational and employment backgrounds and previous employment records of the personnel. Suppose, the CEO previously worked in coal sector and then he has shifted to technology. There are minimum chances that he will succeed. Ask yourself whether he is able to deliver success to the company.
- You should analyse the management’s style how the team manages the business, whether they promote the business as an open, transparent and flexible way.
- You need to analyse when the management has taken charge. Suppose, the management has remained unchanged during the past 10 years. Then this long tenure of the management is a good indication. It means the management is quite successful and has delivered the desired financial results such as compounded sales growth, compounded profit growth, a good return on equity. If you see a company is changing a management team frequently then you need to invest your money to somewhere else.
- Again, if you watch only restructuring of business or management then you need to analyse carefully. The restructuring is not always bad. There are several businesses which have turned around. You need to watch out the new management team’s members, their past achievements. When company hires management it chooses wisely who can do well for the company’s current financials.
Parameter #17. Competitive advantage
A competitive advantage allows a company to produce quality service and better price for its customers. Then this competitive advantage accelerates the company’s sales margin which increases profit margin than its competitors i.e., pear companies. While you invest your money in any company you should choose such a company that has sustainable competitive advantage in respect of cost structure, brand reorganization, corporate reorganization, product quality distribution network and superior customary support. The brand value or name of any company is in the billions of money. A portfolio of brand influences the sales and growth of the company in many ways. It is a competitive advantage than its peer companies.
Let’s understand this with an example. Whenever we talk or think about adhesive the first name comes to our mind is Fevicol, Fevistick, Fevikwik, m-seal, Dr. Fixit etc. All these are brands of Pidilite industries. The products of Pidilite Industries possess a superior quality. The company maintains vast distribution network and superior customer service to establish this company as a market leader in the adhesive Sector or Industry.
Whenever we talk or think about Trolly or casual Bags the first name comes to our mind is Aristocrat, Skybags etc. All these are brands of VIP industries. So, you need to consider these factors before making investment in a company.
After selecting the company you need to analyse the industry or sectors in which the specific company is in operation i.e., the growth potential of the industry. A mediocre company in a growth industry can generate better return on equity than a good company in a dying industry. You have to watch out which industry is growing and likely to deliver better Return on equity.
Parameter #18. Whether the industry or company creates an entry barrier
Suppose, you want to open a restaurant then you can easily open a restaurant as it does not require the best skill level and large capital. But if you want to set up a company in adhesive industry or automobile industry or pharmaceutical industry you will face a great entry barrier created by these industries. These industries however have created massive barrier to make entry like large capital expenditure, exclusive distribution network, government regulations, patents, brands reorganizations and still counting. The harder the entry barrier is better the advantage for the existing companies are.
The bottom line is that you should analyse the news coming to you from various sources. Because of JIO, internet connection has become easily available. JIO has increased the use of Smartphone. So the sale of Smartphone, as well as the number of internet users, have rapidly increased and till counting. This has increased the demand of optical fiber as optical fiber is required to spread the internet connection to every nook and corner of the country. So, companies operating in this field are direct beneficiaries and by investing in this sector you will get better returns. As a fundamental analyst you need to analyse both the fundamental as well as the qualitative analysis of stocks so that you can choose your desired investment opportunity. The qualitative analysis of stocks will help you to choose the best company among the companies operating in any industry and yield better returns.
Let’s understand this with an example.
Whenever we talk or think about adhesive the first name comes to our mind is Fevicol, Fevistick, Fevikwik, m-seal, Dr. Fixit, etc. All these are brands of Pidilite industries. The products of Pidilite Industries possess superior quality. The company maintains a vast distribution network and superior customer service to establish itself as a market leader in the adhesive Sector or Industry.
Whenever we talk or think about Trolly or casual Bags the first name comes to our mind is Aristocrat, Skybags, etc. All these are brands of VIP industries. So, you need to consider these factors before making an investment in a company.
After selecting the company, you need to analyze the industry or sectors in which the specific company is in operation i.e., the growth potential of the industry. A mediocre company in a growth industry can generate a better return on equity than a good company in a dying industry. You have to watch out which industry is growing and likely to deliver a better return on equity.
Parameter #19. Ownership Structure
You need to check out the promoters’ stake, mutual fund holdings, Foreign Institutional investors i.e., FIIs stake, etc. As you are investing in their business, you need to know the goodwill, management intelligence, etc.
Parameter #20. Future plans
The most crucial part is to check out the future plans i.e., the expansion of business, marketing policy, etc. Suppose, Titan Company is quite famous for making ornaments, jewelry, wristwatches, etc. So, you need to keep a close eye whether Titan Company enters in a new segment or makes an expansion of business which will increase its market share.
Transfer your money to your Demat cum trading account
In order to buy stocks, you need to transfer the money from your savings account to a Demat cum trading account. For this, you should have an online banking enabled savings account. Whenever you open a Demat cum trading account you will have to submit your savings account details along with the application.
How to transfer the money
At the time of opening a trading cum Demat account, you need to submit your bank details. After your submission, the broker will link the bank account along with your trading account. Whenever you will add or redeem money between the Demat account and savings account, you will be redirected to your online banking page as you mentioned earlier. Suppose I have mentioned my bank as HDFC bank. Then, whenever I want to add or redeem money then the system will be redirected to the online banking page of HDFC bank, not SBI or ICICI or Yes Bank.
How to buy stocks in India
After transfer of money from a savings bank account to the trading account you are now free to buy your desired stocks.
In the beginning, don’t invest all the money you have though you don’t need the money at the moment. Try to invest regularly in little amounts. It is suggested for the beginners or the persons who don’t have much knowledge about the share market to invest via equity sip on a regular basis month by month. It reduces the possibility of losing your money. Your patience in monitoring your portfolio increases the chances of generating great returns in the future.
How Capitalante can help you
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