How to look for good stocks?

by Manshu on August 22, 2011

in Opinion

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.

{ 10 comments… read them below or add one }

CA Karan Batra August 22, 2011 at 10:56 pm

Very informative article Manshu

I firmly believe that the 3rd point is the most crucial aspect to be kept in mind while buying a share. If the promoters of the company are buying back their shares, it certainly is a good sign which indicates that the owners have huge confidence in the future business prospects of the company.

This information about how much percentage holding do the promoters hold in the company is easily available on the website of NSE and before buying any share, it is highly recommended that you check the Promoter holding in that company

Reply

Manshu August 23, 2011 at 4:55 am

I use the pledging data from the NSE website quite extensively too – that’s kind of the reverse of this point and can act as an early warning system.

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pkashyap August 23, 2011 at 11:09 am

Eye opening article and a great simple guide to newbie investors as well as existing ones,

By the way is there any way i can share/recommend this article with/to my friends .

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Manshu August 23, 2011 at 6:51 pm

Thanks!

You can share it on FB by clicking Like button, or you could just email it to them. Can you please tell me what kind of option you were looking for? I’m fairly certain I can get it installed quite quickly.

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Santosh Navlani August 23, 2011 at 12:13 pm

Hi Manshu,

Very informative & useful post. All your 5 points are very important to zero-down on the company/ stock that one wants to invest. However, as you mentioned, there are 1300+ stocks listed on NSE alone. So, the important task lies also in filtering the list to a reasonable level so as to go about picking the next stock for ones investment. This first step in my opinion is critical & back-breaker.

i guess thats where screening stocks using fundamentals or financial ratios becomes handy. Many sites including moneysights does allow for screening stocks based on EPS Growth, Return Ratios like ROCE & ROE PLUS other important parameters like pricing power which to some gets factored in Operating Margins.

If 1 applies these filters well, then passing these stocks with your acid-test of 5 parameters would definitely deliver future multi-baggers 🙂

Santosh Navlani | moneysights

Reply

Manshu August 23, 2011 at 6:58 pm

Thanks for bringing that up Santosh – I’ve used the ratio feature on Moneysights and it’s quite clean and easy to use. I liked it. But so far I haven’t used it to filter stuff out, only look at data on individual stocks.

Reply

Santosh Navlani August 23, 2011 at 7:11 pm

Glad to know you liked the implementation of ratios on moneysights. However, would love to know your views about our screeners (its by the name of Advanced View ), whenever you have time to spare.

Thanks again,

Santosh Navlani | moneysights

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Mithlesh August 23, 2011 at 12:37 pm

Thanks Manshu for this excellent article. Being a stock market investor myself, i can say all the points are very relevant for any investor. A point i would like to add is related to scam hit stocks. such stocks in indian scenario loose all their fundamentals and go for a free fall as if there is no bottom.Corporate governance rates very high in my list.

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Manshu August 23, 2011 at 6:59 pm

Absolutely Mithlesh – you bring up a great point and also make me think about a headline for a future post – How to avoid bad stocks?

😉

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anon August 23, 2011 at 8:05 pm

I like to track what the big boys are buying- the big 4 funds.
I know what kind of grilling companies get!

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