How to look for good stocks?

A question that crops up from time to time is how can a retail investor find good stocks. In my opinion – most retail investors are better off buying mutual funds than individual shares because the chances of your beating a professional fund manager are low. That said, there are a large number of people who do buy shares directly (including me) and they need some sort of a filter to alert them to good stocks. With over 1,300 shares listed on the NSE – you should have some guidelines that help you narrow down the good ones.

In this post, I’m going to talk about some aspects that make me interested in a company. These are things that tell me hey – this thing can be good. That’s important – these indicators will make me interested to go and read the annual report of the company, and find out more about them. So, in that sense these measures will help in narrowing down the universe from a few thousand to a more manageable number.

Here are five such indicators that I use.

1. Great products: This is really obvious but somehow doesn’t get talked about that often. When you are buying a share in a company – you are betting on the future prospects of the company. The future prospects of the company depends on how good their products are and how much they can charge the customer for that.

When I see a good product I’m interested to know who makes it and if they are listed or not. When I see my sister in law admonish me for getting the wrong brand of glue, or my dad waiting for a week to get his car battery replaced because his brand is not available – I’m interested in finding out who makes these products, are they listed, are they making money? Are they profitable etc.

2. Lots of cash and little debt: This is another obvious sign of a company doing extremely well, and more often than not also means that the company will be able to ride out tough times when they eventually do hit it. I say that because most businesses are cyclical and it is inevitable that they hit a rough patch at one time or another. Companies with a cash cushion are much better placed than others in these times.

Also, when the stock market crashes, and everything comes down, there is a good chance of some of these stocks becoming really cheap.

If I hear about such companies then I’m always interested to carry out more research into them.

3. CEOs and founders buying shares:  CEOs and founders buying shares of their own company is definitely a positive, and something that makes me take notice. If they are willing to put their own money in the company’s stock by buying it from the stock exchange then that must mean that they think that the shares are undervalued, and this piques my interest and makes me look deeper.

4. Doing something unusual: When a company does something unusual that always catches my eye – this could be a company refusing to give guidance to equity analysts despite all the pressure, or a bicycle company holding a cross country bike rally, a company going out of its way to help an employee, or even a company with a really funky name.

It takes a lot of courage, passion, and creativity to break the mold and do something new – these are all signs of a good company, and if I find a company doing something that goes against the grain of conventional wisdom – that really interests me as well.

5. Long history of dividends: If a company pays out dividends steadily then that’s a good sign as well. It shows that the company has a good capacity of generating earnings, and also has a benevolent outlook towards shareholders. This is also a very popular way of finding stocks, and you will find entire websites devoted to picking stocks this way.

As you can probably see, these indicators reflect my belief in long term investments, and holding shares for very long periods. These are ways to find good companies that make great products because that’s the type of investing that works for me. It gives you great comfort in the time of panics  because you know that people still continue to buy the products of your companies, and usually such companies have been around for decades, and some even a century or longer and that helps you from panicking too. And of course, when the tide turns and times are good – these companies are rewarded by the market for their good financial performance.

Book Review: In the Plex by Steven Levy

I have recently finished reading In The Plex, a book written by Steven Levy which traces the history of Google right from its early days to today.

It was an incredible read, especially the first half or so that talks about the early days of Google when it was still a small and relatively unknown company, and talks a lot about the founders in those days, and how they took decisions and what things they valued and steps they took to grow the company.

Steven Levy describes the brilliance of Larry Page and Sergey Brin at several points, and they sound like mad geniuses who have a vision, intelligence and understanding about the internet and things around them that isn’t matched by anyone around them.

These are both big picture things like Larry Page thinking about the Google Books project while he was in Stanford itself, and also minute details like him being able to discern delays of 600 milliseconds!

Here is a small excerpt that illustrated this:

Buchheit remembers one time when he was doing an early Gmail demo in Larry’s office. Page made a face and told him it was way too slow. Buchheit objected, but Page reiterated his complaint, charging that the reload took at least 600 milliseconds. (That’s six-tenths of a second.) Buchheit thought, You can’t know that, but when he got back to his own office he checked the server logs. Six hundred milliseconds. “He nailed it,” says Buchheit. “So I started testing myself, and without too much effort, I could estimate times to a hundred milliseconds precision—I could tell if it was 300 milliseconds or 700….

What would have been super fast for most people was called slow for Larry Page. It’s quite amazing to think how high his standards are when it comes to user experience.

But, the book is not a story about how brilliant the founders are. It makes you feel that though the founders had a great role to play in the development of Google, there were many other brilliant people working with them who allowed the company to do the wonderful things it did.

These are not just stories about Eric Schmidt or VCs, but also about lesser known engineers who developed great products while in Google, but hadn’t got much press or publicity and are largely unknown outside Google.

These stories give a good glimpse on the attitude and culture at the company (at least in its initial days) and I’m excerpting one such story that I really liked about the engineer who developed the Google Toolbar.

Chan realized that users were ignoring the Toolbar because it provided no value to them. His idea was to implement a feature that would allow people to block annoying pop-up windows, which at the time were a plague on the net. But when he presented the idea at a meeting, Brin and Page, who had tied water bottles to the venetian blind cords and were playing a game of water-bottle tetherball, nixed the idea. “That’s the dumbest thing I’ve ever heard!” said Page. “Where did we find you?” Chan built the pop-up blocker anyway, and surreptitiously installed it on Page’s computer. (“He’d leave the computer on in his office,” says Chan.) Not long afterward, Page remarked that his browser was running faster. Chan told him that he’d installed the pop-up blocker. “Didn’t I tell you not to do that?” asked Page. “Oh, it was a 20 percent project,” said Chan. Page dropped his suspicions and okayed the feature, which helped spur millions of Toolbar downloads.

This was a great example of some really clever thinking by a Google engineer, and a good example of the brilliance that flows through Google.

Steven Levy has by and large nice things to say about Google but the book is not a mindless glorification of the company. He talks about several things that Google did which were inconsistent with their philosophy, and instances that show Google bent its views to suit its commercial position.

The best example of this is Google’s stand on Microsoft’s proposed takeover of Yahoo!

Here is the relevant excerpt.

Microsoft’s $48 billion offer included an aggressive 62 percent premium over the struggling target’s share price, and so observers assumed that the merger was sealed. But Yahoo’s chairman, Jerry Yang, resisted, and his efforts to thwart the takeover were aided by Google. Within days of the offer, Eric Schmidt called Yang and began talking about a partnership that would help the weaker company. Google also began contacting legislators and regulators about the antitrust implications of the Microsoft deal, a rather odd stance considering Google’s previous insistence that the search marketplace had no lock-in and thus wasn’t a valid candidate for antitrust action.

This is a great book, and I really loved reading it. My only criticism is that the pace slows down quite a bit from the first half to the second. The part about the young Google is a lot more exciting to read than the latter half of the book, and I found I couldn’t quite breeze through the last half of the book the way I did the first half.

That said, everything else about In The Plex is great, and I have no hesitation in recommending it.

Disclosure: Amazon links are affiliate