“More than 7000+ Companies listed with both NSE and BSE, out of the them few roughly around 2000 Companies are in active status.”
Investment in stocks requires careful analysis of financial data to find out the Company’s true valuation. This is generally done by examining the Company’s Annuals reports, Ratios, Profit and Loss statement, balance sheet of multiple years, etc. This is a bit time consuming and tried-some work. Hence an easier way to analyze the true value of the Company, through Fundamental Analysis.
How to Pick a Stock?
There are more than 7000+ Companies listed with both NSE and BSE, out of the them few roughly around 2000 Companies are in active status. To pick few stocks for portfolio building, we need to do filtering.
There are around 10 sectors in NSE, such as Auto, FMCG, PSU Banks, Pharma, Financial service, IT, Metals, Reality, Private Banks and Media.
Selection of two or three companies from each of the sector mentioned above will be a better and risk free portfolio.
|Type of Company||Market Capitalization (MC)|
|Small Cap||MC < Rs. 1,000 crores|
|Mid Cap||MC between Rs. 1,000 crores to Rs. 100,000 crores|
|Large Cap||MC > Rs. 100,000 crores|
How to do fundamental analysis of a stock?
Perform step by step procedures as mentioned below:
Step :1 Check Price to Book value ratio (P/B ratio
This helps to compare the market capitalization value with the book value of the Company. Book value is tangible net value of a Company calculated as total assets – Intangible assets and Liabilities.
Ratio to be computed : Current market price per share/ Book value price per share.
Conclusion: P/B ratio greater than 5 is expensive/Over-valued
P/B ratio between 2 to 5 is Normal
P/B ratio less than 2 is Undervalued.
Step:2 Check Debt to equity ratio (D/E ratio)
This ratio is used to evaluate the financial leverage of a Company. Percentage of debt over the equity. It often means that the Company taking debt as a means of leveraging its assets. A high debt/equity ratio is associated with High risk.
Ratio to be computed: Total debt (both secured and unsecured)/ Total equity of the Company.
Conclusion: Lesser the ratio is better.
Step:3 Check Interest coverage ratio (IC ratio)
This ratio is used to see the number of days earnings are available to settle current interest payments. Companies need to have enough profits to cover interest payments in order to survive future financial hardships.
Ratio to be computed: Profits before Interest and tax (PBIT)/ Total interest expense.
Conclusion: Ratio below 1 or negative are avoided. Higher the number is preferable.
Step:4 Check operating profit margin (OPM %)
Operating profits arrived from Gross sales – Operating expenses. Operating expenses does not include Other income, Interest expense and Depreciation. Avoid negative operating margin companies.
Conclusion: Consider OPM over the last 5 years if available.
Step:5 Check Earnings per share yearly growth rate over last 3 years.
EPS is computed by total earnings after taxes divided by no of outstanding equity shares. Check the growth of EPS comparing EPS of 3 years earlier and current year EPS which gives actual growth in EPS on yearly basis.
Conclusion: Consider higher EPS
Step:6 Check Price to Earnings ratio (PE ratio)
PE ratio is the market expecting returns from the Industry/ Company. PE ratio is computed by dividing Market price per share/ Earnings per share.
Conclusion: Avoid PE ratio less than OPM.
Step:7 Check Fair Value Multiplier (FVM)
To arrive the value of the Company, Multiplier to be computed by dividing Yearly actual growth EPS by PE ratio.
Step:8 Compute Fair Value of the Company
Fair value of the Company is computed by multiplying Current market price with FVM.
Step:9 Compute PEG ratio
Means price earnings to growth ratio. Factoring the Company’s expected growth. IT gives better picture than the PE ratio. It is also considered as indicator of Stock’s Future true value. Lower PEG ratio indicate that stock is undervalued.
Ratio: PEG fair value is computed by considering market price divided by PEG ratio.
Conclusion: PEG ratio from 0 to 1 is considered as Undervalued.
PEG ratio from 1 to 2 is fairly valued.
PEG ratio more than 2 is overvalued.
Each stock need to pass through all the steps mentioned above and a point is to be awarded to each step for all the stocks. Select the stock which receives more point. Fundamental analysis is one part of selection criteria. One should also look into qualitative data of each Company before considering the same into Portfolio. Qualitative data consists of the following:
- Promoter’s background
- Nature of products
- Years of establishment
- Mission, Vision of the Company
- Product types
- Patents available
- Awards received
- Dependency on Single supplier/ Customer
- Board and their portfolios., etc.