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Showing posts with label Stock Gyan. Show all posts
Showing posts with label Stock Gyan. Show all posts

Tuesday, October 24, 2023

How to Value a Stock - Cheap or Expensive?

Dear Reader,

If you’re new to investing, learning how to choose stocks and investing in the stock market can be overwhelming. Probably the largest mistake that young investors make is to look at the price of a stock as a measure of its worth. In fact, the price of a stock is virtually worthless when trying to value a company.

So what metrics should investors use when evaluating a potential stock investment opportunity? While there are numerous factors to take into consideration, the most popular and well-known metric is known as the price to earnings ratio, or the P/E ratio. But before we get into explaining this ratio, let’s look at why the price of the stock doesn’t tell the whole story.

Stock Prices – Cheap Vs. Expensive

Think about something in your life that you know very well. Maybe you’re obsessed with computer upgrades and performance. You know everything there is to know about computers and when you go to a computer store; when you look at the prices and the specs, you truly know what represents a bargain.

If you were helping a friend pick out a computer, you might tell them that a computer on sale for Rs 20,000 may be a better bargain than a computer on sale for Rs. 18,000. Maybe the Rs. 20,000 computer has a bigger screen, more storage space, and Rs. 5000 of preloaded software on it. With the Rs. 18,000 computer, not only is the hardware pretty shoddy, but there is also no preloaded software, meaning you’ll have to shell out extra money once you buy the computer. You might say “you get more bang for your buck” with the Rs. 20,000 computer. It is this same line of thinking that should be applied to stocks.

Unfortunately, many young investors do not apply the same logic to stock picking. Instead, they look at a Rs. 1800 stock like TCS and call it expensive. So they head to a little known penny stock that is selling for Rs. 0.50 and buy it up like it’s pure gold. The fact of the matter is that if you only have Rs. 1800, there’s a good chance that you’ll make more money purchasing 1 share of TCS rather than 3,600 shares of that cheap company. Why? Because TCS is a much more stable company with not only a proven track record of making investors money, but also strong growth potential.

The P/E Ratio Defined

Now that we’ve fixed the flaw in the young investor’s logic, let’s look at how to measure value. It’s a little more complicated to evaluate stocks than it is to evaluate computers since there are so many different factors involved.

However, there is one metric which, while it doesn’t make up the entire story, offers an important piece of the puzzle when valuing a company: the price/earnings ratio, often referred to as the P/E ratio or P/E multiple. This ratio, while only one of many that sophisticated investors use, is the most popular and discussed ratio in many investment books.

So how does the P/E ratio work? Think of it this way: let’s say you are considering investing in two public companies, both of which are selling for Rs. 200 per share today. One way of deciding which company to invest your money in is examining how much you will need to pay for Rs. 10 of earnings from each company. If last year, Company A earned Rs. 50 per share and Company B earned only Rs. 40 for share, it would intuitively make sense to choose Company A over Company B since it represents a cheaper trading opportunity. Without even realizing it, you’ve made this decision by calculating each company’s P/E ratios.

The P/E ratio is calculated by taking the current price and dividing it by the earnings per share. In the example above, you would take the price of Rs. 200 and divide by Rs. 50 for Company A and Rs. 40 for Company B, yielding ratios of 4x and 5x, respectively. If you’re not good with math, you can also easily find the P/E ratio in the fundamental analysis section of your broker’s research screens for the stock you’re reviewing or on various stock market investment news and research sites.

Disadvantages of the P/E Ratio

While the P/E ratio is a valuable metric for investors, you don’t want to make the mistake of thinking that a P/E ratio alone tells the whole story. Here are the main limitations of the P/E ratio:

1. Healthy P/E ratios may differ between industries: The concept of using a set P/E ratio to determine if a stock is overpriced fails to take into account the individual nature of the underlying company. Stocks in high-growth industries like the technology industry tend to have higher P/E ratios. On the other hand, some industries such as utility companies tend to trade at much lower multiples. Before you can decide if a stock is under or overpriced, you need to take into consideration the industry in which it operates. Continuing with the example above, let’s say Company B was a high-growth tech company forecasted to earn Rs. 100 per share next year and Rs. 150 per share the following year, while Company A was a low-growth oil company that was forecasted to earn Rs. 60 per share next year and Rs. 70 per share the following year. Now that you have a fuller picture of the two companies, it becomes clear that Company B would in fact be the better company to invest in due to its massive growth potential. Company B’s stock price will likely skyrocket if the forecasts are correct, while Company A’s stock price may not budge by much over the next couple of years. Thus, by ignoring other aspects of the company, an investor might have falsely assumed that Company A represented the more valuable stock opportunity.

2. Fails to consider the debt of a company: The price of a stock reflects the equity value of a company. However, it is also important to consider how much debt the company holds. An investor should never ignore a company’s debt position when buying a stock since debt is a strong indicator of a company’s financial health and future.

3. Earnings can be manipulated easily: Clever accountants have a million and one ways to make companies look more attractive. This can involve changing depreciation schedules, using different inventory management strategies, and including non-recurring gains. These strategies are not limited to corrupt organizations, as firms are given some legal flexibility in how they choose to report their earnings. As a result, because companies have an incentive to make earnings look as attractive as possible, P/E ratios can be presented as being artificially low.

4. Growth companies trade at higher P/E ratios: Since P/E ratios represent not only a company’s current financial situation but also it’s future growth potential, growth stocks trade at significantly higher P/E multiples than value companies. Thus, without understanding what type of company you are considering as an investment, you might carelessly overlook some valuable growth companies simply because of their P/E ratios. In fact, some of the biggest winners of all time have been companies with high P/E ratios. According to Investors Business Daily, in a recent analysis, the top 95 companies had an average P/E ratio of 39 before gaining momentum and reaching an average P/E ratio of 87 at their peak. Yet according to the models of most investors who rely solely on P/E ratios, all of these companies would have been ruled out as being overpriced.

5. False assumption that low P/E ratios represent cheap trading opportunities: Many investors assume that a company trading at a P/E ratio must represent great value. As we know, because of many of the factors stated above, low P/E ratios do not necessarily make the best investments. For example, Suzlon was a company that was trading at single digit P/E ratios before it crashed.

P/E ratios are a valuable tool for investors, but they are not sufficient to identify the feasibility of an investment unless used in combination with other metrics and company characteristics.

Regardless of your opinion on the P/E ratio, you should always examine other ratios as well before buying a stock. These metrics, which help investors evaluate other aspects of a company, include Enterprise Value/EBITDA, Enterprise Value/EBIT, Enterprise Value/Revenue, Price/Cash Flow and Price/Book Ratio.

Final Word

The P/E ratio is a great start to understanding a company’s value proposition as a potential investment. With that said, don’t forget that there are many other ratios and factors to consider other than the P/E ratio. The P/E ratio is just one piece of the puzzle. And if you only take one lesson from this post, remember this nugget of information: the price of a stock is not an indicator to identify value of it!

If you have patience and want to add extra power in your portfolio, start investing some portion of your savings in fundamentally strong small and mid cap companies - Hidden Gems and Value Picks.

Moreover, if you have invested in stocks and believe that your investments are not performing well, subscribe to our Wealth-Builder service and get your portfolio reviewed by us. We will review fundamentals of the companies you are holding and guide you which stocks to hold and which to exit. We will also review your equity investments across sectors and companies to ensure that your portfolio allocation is right and outperforms major indices giving you better returns in medium to long term.

We do update our members in terms of profit booking / exits depending upon various factors like overall Industry / Sector outlook, fundamentals of the company, management action plan and annual performance in terms of top line, bottom line, operating margins and other important parameters.

Wish you happy & safe Investing!

Regards,
Team - Saral Gyan.

Saturday, June 17, 2017

Evaluate P/E before Stock Purchase

A question that every investor must ask is when should I buy a particular stock?

The answer will vary somewhat depending on whether you are investing in a growth stock or a value stock.

Growth investors expect the company to continue a steep rate of earnings (or in some cases, revenue) growth in the near future. They buy with a certainty that, if growth continues as anticipated, the price of the stock will rise also.

Value investors look for stock trading at a price lower than it is inherently worth. They are willing to hold the stock for an extended period and reap a large profit when the market discovers this hidden gem and bids the stock price up.

Price/Earnings Ratio

Investors often turn for part of their decision-making to a close look at the stock’s price/earnings ratio or P/E.

The P/E is a measure of how much investors are willing to pay for the company’s earnings. You calculate the P/E by dividing the current stock price by its earnings per share.

It is important to note that using the P/E by itself doesn’t give you a complete (or in some cases accurate) picture of the stock’s value.

Several factors can change the P/E. First, earnings per share may not show a true picture of the company’s earnings thanks to monkeying around with the numbers.

How P/E Is Calculated

Second, P/E can be calculated using the previous four quarters of earnings or it may use projections for the next four quarters. The difference can be dramatic.

You also must remember that various economic and market factors can raise or lower the price of the stock.

Given all that, the P/E is still helpful as part of the process of deciding whether to buy a stock.

A stock’s P/E tells you what other investors are willing to spend for the company’s earnings. For example, a P/E of 15 says investors are willing to spend Rs. 15 for every Rs.1 of earnings.

A high P/E says that investors expect the stock to be a strong performer and are willing to pay a premium. A low P/E says the market has less confidence in the company’s long-term potential.

A low P/E may indicate investors sense trouble ahead for the company. It also may indicate that other investors have overlooked this stock and are not placing the correct value on it.

The Right P/E

But, what is high and what is low for a P/E?

The P/E becomes more meaningful when it is compared to a benchmark. In most cases, you will want to see how other companies in the same industry rank.

If other companies in the same industry, are reporting P/Es in the low 20s, but the company you are considering has a P/E of 10, you need to find out why.

This may be a buying opportunity if you don’t uncover problems.

A stock with a P/E higher than its peers may be overpriced.

So, the answer to the question of when to buy a stock (in particular, a value stock) is when the P/E is lower than its peers and you can find no significant problems with the company.

Wednesday, December 18, 2013

How to Pick Winning Stocks for Investment?

It is very important to evaluate company using vital parameters before finalizing it as an investment candidate. Many investors who are new to stock markets simply look at share price, its 52 week high & low and put their hard earned money in equities to work. And as we all know, most of the times this approach never works.

We always suggest our readers to a proper & thorough research before taking any exposure in riskier asset like equities. Below are the 9 important parameters which are broadly used as tools for doing fundamental analysis of a company. Using these key parameters, Investors can pick winning stocks for their portfolio to get rewarded in long term.

1. Company’s History & Promoter's Credentials

This is one of the most important factor when one is looking to buy stock in an unknown company. It is best to look up the accounts for a couple of prior years and also read up the directors’ report. One should also do a Google search on the company and its promoters to see if they have ever been involved in shady or dubious deals.

2. Cash Flow

Cash flow is the amount of money coming in or going out of the business in a given period of time, say, one financial year. It helps to determine how much liquidity the company has. If a company is “cash flow positive”, it means that it is generating more cash from the business than it is paying out. This is a positive sign because it means the company has bargaining power. It is selling to its customers and receiving payment early while it is buying from the suppliers and paying them late.

If a company is “cash flow negative”, it is a dangerous sign because it means that the company has no liquidity and is desperately dependent on its suppliers and creditors. They can hold the company to ransom by choking its credit limits.

3. EBITDA 

EBITDA stands for “Earnings before interest, taxes, depreciation and amortization”. EBITDA tells the investor, the profit that the company is making from its operations. If the EBITDA is negative, then it is a very negative sign because it means that the company is losing money in its core profitability.

The EBITDA margin is computed as a percentage of sales and EBITDA. For instance, in a company had sales of Rs. 100 and an EBITDA of Rs. 12, its EBITDA margin would be 12%. The higher the margin, the better it is.

Example: Hawkins Cookers’ EBITDA in the year ended 31.3.2013 was Rs. 55.49 crores. Its sales were Rs. 446.82 crores and so the EBITDA to Sales margin was 12.42%.

4. EPS (Earning Per Share)

EPS (Earning Per Share) = Net Profit / Number of Outstanding Shares

There are variants such as the “Diluted EPS” which means that even the shares that will be issued in the future pursuant to outstanding warrants or bonds are also considered.

Example: Hawkins Cookers’ net profit for the year ended 31.3.2013 was Rs. 34.10 crores. The number of equity shares were 52.88 lakhs and so the EPS is Rs. 64.49.

“Cash EPS” is worked out by taking the operating cash profits (without reducing non-cash expenditure such as depreciation).

5. P/E Ratio

The Price-Earnings (PE) Ratio is a valuation ratio of the company’s current share price compared to its earnings per share (EPS). In other words, how of a multiple of the EPS is one paying to buy the stock.

This criteria helps to identify, how cheap or expensive a stock is compared to its peers. It is calculated with the formula: 

Market Value per Share / Earnings Per Share (EPS)

For example, if the stock is available at Rs. 20 each and the EPS is Rs.5, the PE ratio is 20/5 = 4.

The PE is usually calculated on the EPS of the previous 12 months (the “trailing twelve months” (“TTM”).

The PE ratio can be used to benchmark companies within the same Industry or sector. For example, if one is comparing two PSU banks, if one has a PE of 5 and the other has a PE of 8, the question is why one is paying a premium for the second one and whether there is a valuation aberration somewhere that an investor can take advantage of.

Example: Hawkins Cooker’s EPS in the year ended 31.3.2013 was Rs. 64.49 (as calculated above). The market price per share is Rs. 2,016 and so the PE ratio is 31.26.

6. Return on Equity (ROE)

ROE or Return on Equity indicates how efficiently the management is able to get a return from the shareholders’ equity. ROE is calculated with the following formula:

Net Income / Shareholders’ Equity

Example: Suppose a company earned Rs. 1,000 in profit and the total equity capital is Rs. Rs. 2000. The ROE is 1000/2000 = 50%.

Suppose another company in the same sector/ industry earned a ROE of 30%. You know which company is a more efficient utilizer of capital.

A variation of the same concept is the Return on Net Worth of RONW in which we take in not only the equity capital but also the retained earnings (reserves).

7. Debt Equity Ratio

Debt Equity Ratio is the proportion of debt to equity used to run the company’s operations. It is calculated with the following formula:

Total liabilities / equity share capital + reserves

When examining the health of your business, it's critical to take a long, hard look at company's debt-to-equity ratio. If Debt Equity ratios are increasing, meaning there's more debt in relation to equity, Company is being financed by creditors rather than by internal positive cash flow, which may be a dangerous trend.

The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as capital goods, auto manufacturing tend to have a debt/equity ratio above 2, while IT companies / Consumer Goods companies with high brand equity have a debt/equity of under 0.5.

8. Market Capitalisation

It is the value for the entire company can be bought on the stock market. It is derived by multiplying the total number of equity shares by the market price of each share.

This helps to determine whether the stock is undervalued or not. For instance, if a stock with a consistent profit of Rs. 100 is available at a market cap of Rs. 200 is undervalued in comparison to another stock with a similar profit but with a market cap of Rs. 500.

Example: Hawkins Cooker’s has issued 52.88 lakh shares. The price per share is Rs. 2,016 and so the market cap of the company is Rs. 1066 crores. This means, theoretically, that if you had Rs. 1066 crores, you could buy all the shares of Hawkins Cooker.

9. Dividend Yield

‘Dividend Yield’ is a financial ratio that shows how much the company pays out in dividends each year relative to its share price. It is calculated by the following formula:

Interim + Annual Dividends in the year/Price per share x 100

If you find that company is paying consistent dividend year after year with dividend yield of above 7%, you can think to invest in such stocks instead of blocking your money in fixed deposits. Here, you can think of some appreciation in stock price along with 7% returns on yearly basis through dividend payment. 

Example: Hawkins declared a dividend of 500% (Rs. 50 per share). Because its market price is Rs. 2016, the dividend yield is 50/2016×100 = 2.48%.

Hawkins have given more than 100 times returns to investors in last 10 years. Rs 1 lakh invested in Hawkins on 24th July 2003 is worth more than Rs. 1 Crores today, that too excluding dividends received by Investors. Hawkins share price was Rs. 19.80 on 24th July 2003 and today after completing 10 years, Hawkins share price is at Rs. 2016 giving astonishing returns of 10057% to investors.

Also Read: How to Value a Stock - Cheap or Expensive?

Do write to us in case of any queries.

Regards,
Team - Saral Gyan. 

Monday, December 2, 2013

Are you Investing by Listening to TV Analysts?

There are many analysts whom you see oftenly coming up on screens with their stock picks and P. N. Vijay is one of them.

P. N. Vijay was confident about his pick when he announced Zylog Systems as his multibagger stock pick on 10th February 2012. “This is a stock that Obama will like“, he said with pride in his voice. “Its a bit different from all other I. T. companies like Infosys and TCS“, he said. “It has an excellent billing rate of $58 per hour“, he added.

P. N. Vijay was also impressed by Zylog’s performance in FY 2011-12 and he expected it to close the year with an EPS of about Rs. 100. “Zylog will get re-rated and has a price target of Rs. 1100 (Rs. 550 after the stock split) in 12 months“, P. N. Vijay said.

On that date, 10th February 2012, Zylog was quoting Rs. 245 (adjusted for split). After hitting a series of lower circuit breakers, Zylog is trading at Rs. 14 today with a whopping loss of 94.3% from the price of recommendation!

Interestingly, after P. N. Vijay’s stock recommendation, the stock soared to a high of Rs. 328 on 2nd May 2012 and went on to touch Rs. 340 on 9th July 2012 in the wake of the stock split announcement but later it started hitting lower circults and stock price came down to Rs. 120 on 2nd Nov'12.

Also interestingly, P. N. Vijay disclosed that he was Zylog’s “financial adviser“. Did P. N. Vijay have no inkling at all that something was not right with Zylog or its promoters?

Was this a classic “Pump & Dump” story?

The problem appears to be that the promoter company, Sthithi Insurance Services Pvt Ltd, has pledged 54.41% of the shares held by it (22% of the total promoter holding). Disaster struck all of a sudden on 18th October when Karvy Financial Services suddenly dumped 3.73 lakh shares at the price of Rs. 226 per share. Apparently, Karvy had made a margin call which had not been honoured by the promoter. That heavy selling triggered off the lower circuit filter. After that, every single day was met by heavy selling, either by Karvy or by the other lenders of the pledged shares, including JM Financial.

Nervous investors, scared out of their wits, also tried to bail out, worsening the situation. Though Sripriya Srikanth, of the promoter group, valiantly bought 1,78,200 shares, it was of no avail in stemming the steep slide that the stock suffered.

Sudarshan Venkatraman, Zylog’s Chairman & CEO, issued a statement last year that attributed the stock price fall to “panic” created by speculators. “Promoters and large institutions have increased their share holding over the past two weeks, coinciding with the fall in the share price.” He said there was no adverse impact on the company’s business.

Sudarshan Venkatraman’s statement is not convincing at all having regard to the ground realities of heavy selling by Karvy & J. M. Financial.

Sudarshan Venkatraman preferred not to say why the promoters had borrowed so heavily by pledging the shares of Zylog. The borrowed funds have not been used for Zylog. So, what were they used for? Also what is the promoters current position? Do they have the funds to arrange for funding the margin requirements.

Investors who are tempted to dip their toes into Zylog must remember that the total shares sold during last year by Karvy, J. M. Financial and other lenders was only a fraction of the total shares pledged by the promoters. This year more no. of the pledged shares entered the market and the carnage took the share price to Rs. 14.

One of the important factor to look at is the % of pledged share by Promoters. This can make stock a risky bet if lenders decide to offload the shares like what Karvy and JM Financial did in case of Zylog Systems.  

Friday, October 4, 2013

Why Share Price is Not Important?

Why is a stock that cost Rs. 50 cheaper than another stock priced at Rs. 10?

This question opens a point that often confuses beginning investors: The per-share price of a stock is thought to convey some sense of value relative to other stocks. Nothing could be farther from the truth.

In fact, except for its use in some calculations, the per-share price is virtually meaningless to investors doing fundamental analysis. If you follow the technical analysis route to stock selection, it’s a different story, but for now let’s stick with fundamental analysis.

The reason we aren’t concerned with per-share price is that it is always changing and, since each company has a different number of outstanding shares, it doesn’t give us a clue to the value of the company. For that number, we need the market capitalization or market cap number.

The market cap is found by multiplying the per-share price times the total number of outstanding shares. This number gives you the total value of the company or stated another way, what it would cost to buy the whole company on the open market.

Here’s an example:

Stock price: Rs. 50

Outstanding shares: 5 Crores 

Market cap: Rs. 50 x 50,000,000 = Rs. 250 Crores

To prove our opening sentence, look at this second example:

Stock price: Rs. 10

Outstanding shares: 30 Crores 

Market cap: Rs. 10 x 300,000,000 = Rs. 300 Crores

This is how you should look at these two companies for evaluation purposes. Their per-share prices tell you nothing by themselves.

What does market cap tell you?

First, it gives you a starting place for evaluation. When looking a stock, it should always be in a context. How does the company compare to others of a similar size in the same industry?

The market generally classifies stocks into three categories:

• Small Cap under Rs. 1000 Crores 

• Mid Cap Rs. 1000 - Rs. 10000 Crores

• Large Cap - Rs. 10000 Crores

Some analysts use different numbers and others add micro caps and mega caps, however the important point is to understand the value of comparing companies of similar size during your evaluation.

You will also use market cap in your screens when looking for a certain size company to balance your portfolio.

Don’t get hung up on the per-share price of a stock when making your evaluation. It really doesn’t tell you much. Focus instead on the market cap to get a picture of the company’s value in the market place.

Friday, September 20, 2013

Dont Count on Stocks for Short Term Goals

Over the short-term, stocks can be battered or buoyed by any number of market-changing events. Announcements about inflation, interest rates and other economic news – good or bad – can push the market up or down.

World and domestic events can also have a negative or positive influence on the market.

None of these events are within the control of companies or investors. Good, financially-strong companies can watch their stock fall with the rest of the market or their sector through no fault of their own.

This is why stocks are not appropriate investments for people who will need access to their money in the near future. Volatility can shrink your investment at just the time when you need to cash out.

Savvy investors know that stocks are for the long run and are willing to watch the day-to-day fluctuation knowing that good stocks will prove their worth over time.

As you approach the time when you will need to cash out of stocks, you should begin shifting assets into more secure investments such as fixed income instruments like bonds, bank FDs or other more stable products.

A good rule of thumb is to begin the transition from stocks to more stable products when you are two to three years away from needing the money. Use your good sense and judgment on when to begin the transition.

If you don’t have to move all your cash out of stocks at once, you can stagger the transition over a period of months and years.

Don’t let yourself be trapped in the situation of needing a big gain in your stocks at the last moment to reach a financial goal. This risky behavior may make achieving your goal out of reach if the market moves against you.

Its always wise to invest in equities for medium to long term i.e for atleast 2 to 5 years and if stocks performs well in short span of  time and you believe that valuations are stretched, you can get out of the stock early as well. But if you are looking to make quick bucks than do not get into equities, as you are not investing, you are gambling without giving sufficient time to your stock to perform.

Tuesday, July 2, 2013

Peter Lynch: Making Money by Investing in "Fast Growers"


“The investor of today does not profit from yesterday’s growth.” Warren Buffett

Most of us have relatives who like to fashion themselves as ‘stock-gurus’, with their stories revolving around how they ‘could have been’ millionaires now, if only they had held their nerves. The stock that comes up frequently in these conversations is Infosys. If you had invested Rs. 9,500 to buy 100 shares of Infosys in the IPO (that went undersubscribed in 1993), 12,800 shares (adjusted for bonus issues) worth sum of Rs. 3,15,26,400 would be in your kitty. But, is Infosys still the key to riches? As often repeated, past performance is no guarantee of future results. So, how does one find out the next ‘Infy’?

A Fast Grower is a small yet aggressive & nimble firm, which grows roughly at 20-25% a year. This is an investment category which can give investors a return of 10 to as much as 200 times the investment made by them. No doubt, it remains a favourite of Peter Lynch!

In 1950s, the Utility & Power Sector were the fast growers with twice the growth rates to that of the US GDP. As people got more power-hungry gadgets for themselves, the power bills ran through the roof & the power sector surged with booming demand. Post the Oil Shock in 70’s, cost of power generation became high with power tariffs going up; people learnt to conserve electricity. Demand, thus, fell and power sector witnessed a slowdown. Prior to it, similar decline was observed in the Steel Sector & Railroads. First, it was the Automobile Sector, and then the Steel, followed by Chemicals & Power Utility & now the IT Sector is showing signs of slowing down. Every time, people thought, rally in the fast growers of the age would never end, but it did end, with people losing money as well as their jobs. Those who thought differently like Walter Chrysler (founder of Chrysler Corporation), who took a pay cut and left the railroads to build new cars in the turn of the last century, became the next millionaires.

Three phases involved in their life cycles, are:

1. The Start-Up Phase: Majority of the companies either burn up all the cash or run out of ideas by the end of this phase. Maximum casualties have been observed here, making it one of the riskiest phases. However, maximum returns can be made from them, if one enters near the end of this phase.

2. Rapid Expansion Phase: The Company’s core proposition has worked now, with the strategy being replicated by expansion of product/service portfolio or consumer touch points.

3. Mature Phase: Growth slows down, either due to high debt or low cash, owing to the massive expansion witnessed in early stage. Fall in demand or legal restrictions might also contribute to faltering growth.

The trick is to track, which phase the organization is in, at the moment. If the firm is in late start-up phase with possibility of moving to rapid expansion phase, buy the stock when it is still cheap. Once firm’s earnings start falling with its products witnessing poor demand, it’s time to bid goodbye to the stock.

The key parameters involved in Peter Lynch’s ‘two minute drill’ are:

1. P/E Ratio: avoid stocks with excessively high P/E
2. Debt/Equity Ratio: should be low
3. Net Cash per Share: should be high
4. Dividend & Payout Ratio: should be adequate
5. Inventory levels: lower the better

Stay away from companies which are being actively tracked, followed & invested in by large institutional investors. News about buy back of shares or internal stakeholders increasing their stakes should be construed as positive.

Checks specific to Fast Growers:

1. The star product forms a majority of the company’s business.
2. Company’s success in more than one places to prove that expansion will work.
3. Still opportunity for penetration.
4. Stock is selling at its P/E ratio or near the growth rate.
5. Expansion is speeding up Or stable

One must judiciously walk the tightrope between the unquestioning belief that made the stock to be held for so long and the fear of the end from nose-diving prices due to a one-off bad year. The key is to always keep revisiting the story & ask some pertinent questions like ‘What would really keep them growing?’, ‘What is their next offering? or ‘Are their products & services still in vogue?’ It is here, that one must track the point of time when the phase 2 of the firm’s expansion comes to an end. This is usually the dead-end for organizations as success is difficult to be replicated. Unless, innovation happens, downfall is imminent & thus, an exit is necessary. P/E of these stocks is drummed up to unrealistically high levels by the madness of crowd towards the end. One must keep one’s eyes & ears open to signs, which mark the end of the road for these fast growers. A great case in point is Polaroid which had its P/E bid up to 50, only to be rendered obsolete later by new technologies.

A sure shot sign of a decline is a company which is everywhere! Such a company would simply find no place to expand any further. Sooner, rather than later, such a company would see its ‘Manhattans’ of earnings reduced to ‘plateaus’ of little or no growth, simply because no space is left to expand further.

1.The quarterly sales decline for existing stores.
2. New stores opening, though results are disappointing: weakening demand, over supply.
3. High level of attrition at the top level.
4. Company pitching heavily to institutional investors talking about what Peter Lynch calls ‘diversification’.
5. Stock trading at a P/E of 30 or more, when most optimistic estimates of earning growth are lower than 15-20%, thus, unable to justify the high price.

Fast Growers, which pay, are ephemeral & one misses them more often than not. It is a High Risk & High Gain Category of Stocks. One must remember along the classic risk & return principle, that when one loses, one loses big! So, if you are in the quest for magnificent returns, a Fast Grower can be your bet provided you know when to bid Goodbye!

Sunday, January 13, 2013

How to Time your Purchases & Exits in Stock Market?

Dear Reader,

We think everyone has this question in their minds i.e. How to time their purchases and exits from the stock market.

The above question is more important for you if you have been selling your stock investments after the recent run-up of Sensex to 19800. The question is should you be exiting just because Sensex is approaching the holy figure of 20,000, the 2008 highs or should you remain invested considering the fact that valuations of the overall market are much lower than what they were in 2007-08?

In our opinion, you should not, because if you are selling now you will most likely to re-enter when the Sensex will be at say 35000-40000 some years down the line and will therefore miss all the gains in between.

Do not believe us that you will commit the above mistake, click here and you will understand.

Coming back to the main question of how to time the markets, here’s what Mr. Prashant Jain (fund manager of HDFC Asset Management) had to say in one of his recent interviews:

Q: Do you think retail investors are making a mistake by constantly redeeming from equity funds instead of putting money in now?

A: I have been in this market for 20 years and I have seen three cycles now. Unfortunately, in each of the cycles, the timing has been quite bad. The bulk of the money has always come in at higher than 17-18 P/Es and we have seen that repeatedly.

Almost 80-85 percent of the money comes in above 17-18 P/Es. It is probably unfortunate, but in my opinion, these are the signs that history is going to repeat itself again.

(Our view: The above is the basic irony. Most retail investors exit at low valuations and re-enter when there’s too much hype around any asset class and then they get trapped for a long period with below average returns)

Q: Are you beginning to see any nascent signs of that in any fund because it is the mid-caps that have begun to perform etc? Are you beginning to see more interest perking up in some of these sector-specific or vertical funds?

A: Broadly, the industry has been losing money. We never see inflows at low P/Es and when markets begin to recover, we see outflows because people who feel they have been trapped and now some returns are there, they are taking out money. Almost 80-90 percent of the money over a cycle comes in above 17-18 P/Es and that is why investors are time and again disappointed with equities.

Q: The feeling from a lot of retail investors seems to be that we are approaching 20,000; this is a level where you should be booking out and not making the mistake of getting into another high. Is that kind of an approach a mistake?

A: I think so. When you look at the history of the SENSEX, it has delivered 15-17% compound annual growth rate (CAGR). It started off at 100 back in 1980s. At any point of time, we thought 1000, 2000, 5000 was high; it was a wrong way to look at the markets.

The correct way to look at the markets to my mind is to focus on the P/E multiples (basically valuations). Investor should simply practice low P/E investing and whenever P/Es are below average, they should keep on investing with two to three-and-a-half year’s view. They should either reduce allocation to equities or not invest more money when P/Es are high again with a two-three-four year view. That will lead to better timing than what they have historically been able to achieve.

At the end we would like to add that if you are more than 22-25 years of age, working somewhere or run a business, and able to consistently save some amount every month from your earnings, feel blessed because this is one of the best times to invest in stocks of good companies from a 3-4 years perspective.

Regards,
Team - Saral Gyan

Thursday, December 27, 2012

Do Not Invest in Indian Equities

An advice to investors who are still cashing out and staying off from Equities.

Are you investing in equities? If we look at current scenario, many retail investors are either afraid of investing in equities or have been cashing out after the recent run-up in stock market.

Many experts and advisers on television and other media advise retail investors to invest in equities, but to no avail. There is absolutely no interest in equities at the retail level and mutual funds, too, are seeing record redemptions.

As it happens, retail investors are helping markets more by staying out than by investing in equities, so, from a purely selfish point of view, we (current equity market participants) do not mind if you stay away from equities. Keep your money in low-interest bearing savings accounts and this will help bank raise cheap funds. Then, while you earn taxable 9% per year in fixed deposits and 4% in savings accounts, we will continue to buy HDFC Bank, IndusInd Bank, Yes Bank and the like, which are up 3.5 times, 11 times, and 5.9 times, respectively since December 2008. Also, remember to pay all your EMI installments on time so that retail loans made by the private banks do not get into trouble and we can continue to do well owning their stocks.

Indian retail investors are more or less completely out of equities, and would rather buy gold instead. So, keep buying gold so that we can do better than you by owning stock in Titan Industries and other jewellery companies. You should not care at all that while the gold that you bought is up 2.58 times in four years, the stock of Titan Industries, which sells gold to you, is up 6.9 times during the same period. If Rakesh Jhunjhunwala had bought physical gold instead of shares in Titan when he did, he would not be a billionaire today.

In fact, go ahead and buy real estate, taking mortgages from HDFC and LIC Housing Finance. How else would we have made 2.8 and 5.7 times in these stocks in five years? And when you do buy these apartments and houses, do insist on using the best construction material – cement, sanitary ware and so on. It is only because you do not buy equities and spend on real things that we could make 192% on ACC and 4.5 times on Hindustan Sanitary ware since 2008. A house is not done until it’s painted, so remember to keep a good budget for decorative paints from Asian Paints (stock is up 4.8 times in four years).

Why should you invest in equities when you can buy insurance products? This world is interesting precisely because we think differently from each other – while you are happy buying insurance, we are happy owning shares in companies that sell you insurance. Thanks to you, shares in Bajaj Finserv are up 6 times in value and shares in Max India are up 2 times in the past four years.

Follow your heart and we will follow you. If you like going to malls and spending time there please do some shopping as well – some of us own shares in Phoenix Mills, which is up 2.7 times since 2008. In fact, it may be time for you to upgrade your car. Why buy equities when you can spend the same money on a new car or motorcycle? Let us do the more boring job of continuing to own stocks in Maruti and Bajaj Auto, which are up 2.9 and 10.8 times, respectively, since 2008. Why not add your name to the waiting list for an Enfield this year while we own shares in its manufacturer, Eicher Motors, which is up 12 times since 2008?

Life isn’t just about making and investing money; it’s important to enjoy life’s little pleasures. So go watch a movie at the multiplex and much some popcorn while you are there. Meanwhile, we will buy shares in PVR (up 3 times in four years). You’d rather spend time at home in front of the television? We’ll still love you – shares in Zee Telefilms and Sun are up 3 and 3.5 times because of loyal viewers such as you. Call for pizza delivery at home – Jubilant Foodworks (which owns Domino’s) is up 5.4 times since its IPO in 2010.

While you’re in the mood to be sinfully self-indulgent, don’t make any resolutions to give up smoking or drinking. You may not want to invest in equities, but spare a thought for investors in these stocks. Your actions so far have helped these investors make 3.8 times in ITC, 10.3 times in United Breweries and 2.2 times United Spirits in four years but they still look for your continues patronage of these businesses.

We wish you a very happy and healthy 2013. In case if you fall sick in 2013, take comfort in the fact that you are helping investors in stocks of companies such as Dr Reddy’s (stock up 4 times) and Cipla (stock up 2.3 times).

We invite you over to our side in 2013 but still love you for choosing instead to be loyal customers of the businesses we own.

Now it’s up to you to decide who you would rather be – part owners of Indian companies or just their loyal customers.

Wednesday, November 21, 2012

Look at Value not at Momentum while Buying Stocks

Many investors seem to give more thought to which television to buy than they put into buying a stock. Perhaps that is a bit harsh, however you have to wonder sometimes. Investors sometimes fail to grasp the concept that stocks are not priced like, well televisions.

If a retailer puts a 42" television on sale and attracts a bunch of buyers, you can bet that competitors will soon counter the offer with a lower price or extra features. The result of this competition is the price of televisions go down, not up with popularity.

In the stock market, the more popular a stock (more buyers), the higher price new buyers will have to pay. Unfortunately, as excitement around the stock builds, more investors want in and they often end up paying too much for the stock.

What this illustrates is the need for a plan that identifies quality stocks at great prices and ignores the hype around Dalal Street's latest darling.

If you want to buy a stock, you should be able to state, in writing, the reasons. This is known in the business as a "buy case". A buy case is a simple, to-the-point summary of why this stock makes sense for your portfolio.

It covers five important points about the company and the stock and forces you to do your homework before investing. If you follow this procedure or one similar to it, you'll avoid buying (or selling) as an emotional response.

5 Points of a Stock Buy Case

Here are the five points your buy plan should cover:

1. What does the company do? If you can't explain the major business activity of the company in two or three sentences, you shouldn't be investing in it.

2. What part of the economy does this business serve and is it growing or does the company own a large share of that market? You invest in a company anticipating long-term growth. Companies that are built on fads or outdated technology are not good prospects. The technology sector is more volatile than consumer staples, but also offers more growth potential.

3. Is the company riding a demographic or economic trend that has long-term implications? Companies that serve retirement needs of Baby Boomers have all new babies population as market. Companies that define their market too narrowly limit their potential growth.

4. How do you value the company using standard market ratios? Using many of the tools of fundamental analysis how does the company compare to its industry peers? How does is compare to the overall market? Why do you believe it is under valued?

5. What do you see that makes you believe the company has room for sustained growth? Why do you believe the company is in a good position to grow and the stock is not priced to reflect this potential? Whatever reason, you should have a reasonable answer for why the stock price is lower than it could or should be. This is your growth margin.

When you have built a convincing buy case (at a certain price), you are ready to invest.

Retain the buy case and review it at least once a year or more often if the stock takes a big hit to see if any of your assumptions or conclusions have changed.

Remember, when you build a buy case before buying a stock, you force yourself to make a rational decision.

Investing on instinct is like guessing, sometimes you'll be right and sometimes you'll be wrong - not a great way to a solid financial future.

Saturday, November 3, 2012

Are you Investing by Listening to TV Analysts?

There are many analysts whom you see oftenly coming up on screens with their stock picks and P. N. Vijay is one of them.

P. N. Vijay was confident about his pick when he announced Zylog Systems as his multibagger stock pick on 10th February 2012. “This is a stock that Obama will like“, he said with pride in his voice. “Its a bit different from all other I. T. companies like Infosys and TCS“, he said. “It has an excellent billing rate of $58 per hour“, he added.

P. N. Vijay was also impressed by Zylog’s performance in FY 2011-12 and he expected it to close the year with an EPS of about Rs. 100. “Zylog will get re-rated and has a price target of Rs. 1100 (Rs. 550 after the stock split) in 12 months“, P. N. Vijay said.

On that date, 10th February 2012, Zylog was quoting Rs. 245 (adjusted for split). Today, 2nd November 2012, it closed at Rs. 120, after consecutively hitting a series of lower circuit breakers. The loss: A whopping 51%!

Interestingly, after P. N. Vijay’s stock recommendation, the stock soared to a high of Rs. 328 on 2nd May 2012 and went on to touch Rs. 340 on 9th July 2012 in the wake of the stock split announcement.

Also interestingly, P. N. Vijay disclosed that he was Zylog’s “financial adviser“. Did P. N. Vijay have no inkling at all that something was not right with Zylog or its promoters?

Was this a classic “Pump & Dump” story?

The problem appears to be that the promoter company, Sthithi Insurance Services Pvt Ltd, has pledged 54.41% of the shares held by it (22% of the total promoter holding). Disaster struck all of a sudden on 18th October when Karvy Financial Services suddenly dumped 3.73 lakh shares at the price of Rs. 226 per share. Apparently, Karvy had made a margin call which had not been honoured by the promoter. That heavy selling triggered off the lower circuit filter. After that, every single day was met by heavy selling, either by Karvy or by the other lenders of the pledged shares, including JM Financial.

Nervous investors, scared out of their wits, also tried to bail out, worsening the situation. Though Sripriya Srikanth, of the promoter group, valiantly bought 1,78,200 shares, it was of no avail in stemming the steep slide that the stock suffered.

Sudarshan Venkatraman, Zylog’s Chairman & CEO, issued a statement that attributed the stock price fall to “panic” created by speculators. “Promoters and large institutions have increased their share holding over the past two weeks, coinciding with the fall in the share price.” He said there was no adverse impact on the company’s business.

Sudarshan Venkatraman’s statement is not convincing at all having regard to the ground realities of heavy selling by Karvy & J. M. Financial.

Sudarshan Venkatraman preferred not to say why the promoters had borrowed so heavily by pledging the shares of Zylog. The borrowed funds have not been used for Zylog. So, what were they used for? Also what is the promoters current position? Do they have the funds to arrange for funding the margin requirements.

Investors who are tempted to dip their toes into Zylog must remember that the total shares sold so far by Karvy, J. M. Financial and other lenders is only a fraction of the total shares pledged by the promoters. If more of the pledged shares enter the market, who knows where the carnage will end?

One of the important factor to look at is the % of pledged share by Promoters. This can make stock a risky bet if lenders decide to offload the shares like what Karvy and JM Financial did recently in case of Zylog Systems.
  

Wednesday, October 26, 2011

Shop for Discounted Stocks in Falling Market


The market is in the dumps and everyone is headed for the exits – what’s a smart investor to do? You might consider going on a shopping spree for discounted stocks.

When the markets are down and the mood pessimistic, people tend to sell even if there is no specific reason to let go of an individual stock.

This common trading mistake costs investors dearly. When the talking heads on television and the wags in print and online begin talk of doom, many investors dump their stocks in favour of cash or other “safe” investments.

Rushing Back

As soon as the same crowd gets excited about the market again, the cash investors rush back to the market and buy stocks.

The problem with this approach is that the investor is frightened out of the market when prices are depressed and lured back in when prices have rebounded. In other words, sell low, buy high.

The thoughtful investor always asks why the price of a stock is moving before making a decision.

• Has something changed in the company?
• Has something changed in the company’s primary market?
• Has there been a negative or positive regulatory or legal change?

These are not all the questions you should ask, some will be specific to the industry or sector, but you get the idea.

When you can find nothing in the answers to questions specific to the company, you look to the market.

Is this stock dropping (or rising) because the overall market is moving dramatically in that direction? It can work both ways, although a down market seems to depress overall prices more than an up market raises overall prices.

Shopping Trip

If you are looking to add to your portfolio, consider a down market a great shopping opportunity. A thoughtful investor is going to buy on the potential of a company and if he or she can pick the stock up at a discount so much the better.

This investing approach takes some courage and confidence in your ability to distinguish between a stock price depressed by a down market and a stock that is fundamentally flawed.

However, if you do your homework, you’ll find bargains in down markets that may reward you handsomely in the future.

Don’t be frightened off a stock just because the overall market is sour. If the fundamentals of a company are solid, a down market may be a great time to do some discount shopping.

Sunday, September 4, 2011

6 Important Steps to Identify Best Stocks to Buy

Are you in search of finding the best stock to buy?

There is no perfect answer actually to this question as there are various trading styles that fit different investors needs. A day trader may think that a penny stock is the best stock to buy now whereas a long term dividend investor has a completely different opinion. The fact is that there are many good stocks to purchase for all types of investors as well as bad stocks to avoid.

In order to truly identify the best stock to buy, an investor needs to understand a few basic principals and define their investment strategy. To find out stocks for investment purpose requires research and time, below are the important six steps which will help you to identify the best stock you can own:

Step-1: Find out how the Company makes Money

Step-2: Do a Sector Analysis of the Company

Step-3: Examine the Recent & Historical Performance of the Stock

Step-4: Perform Competitive Analysis of the Firm with its Competitors

Step-5: Read and Evaluate Company’s Financial Statements

Step-6: Buy or Sell

(Click on the above links to read the step wise approach to find best stock in detail)

Wednesday, June 8, 2011

Why Share Price is Not Important?

Why is a stock that cost Rs. 50 cheaper than another stock priced at Rs. 10?

This question opens a point that often confuses beginning investors: The per-share price of a stock is thought to convey some sense of value relative to other stocks. Nothing could be farther from the truth.

In fact, except for its use in some calculations, the per-share price is virtually meaningless to investors doing fundamental analysis. If you follow the technical analysis route to stock selection, it’s a different story, but for now let’s stick with fundamental analysis.

The reason we aren’t concerned with per-share price is that it is always changing and, since each company has a different number of outstanding shares, it doesn’t give us a clue to the value of the company. For that number, we need the market capitalization or market cap number.

The market cap is found by multiplying the per-share price times the total number of outstanding shares. This number gives you the total value of the company or stated another way, what it would cost to buy the whole company on the open market.

Here’s an example:

Stock price: Rs. 50

Outstanding shares: 5 Crores 

Market cap: Rs. 50 x 50,000,000 = Rs. 250 Crores

To prove our opening sentence, look at this second example:

Stock price: Rs. 10

Outstanding shares: 30 Crores 

Market cap: Rs. 10 x 300,000,000 = Rs. 300 Crores

This is how you should look at these two companies for evaluation purposes. Their per-share prices tell you nothing by themselves.

What does market cap tell you?

First, it gives you a starting place for evaluation. When looking a stock, it should always be in a context. How does the company compare to others of a similar size in the same industry?

The market generally classifies stocks into three categories:

• Small Cap under Rs. 1000 Crores 

• Mid Cap Rs. 1000 - Rs. 10000 Crores

• Large Cap - Rs. 10000 Crores

Some analysts use different numbers and others add micro caps and mega caps, however the important point is to understand the value of comparing companies of similar size during your evaluation.

You will also use market cap in your screens when looking for a certain size company to balance your portfolio.

Don’t get hung up on the per-share price of a stock when making your evaluation. It really doesn’t tell you much. Focus instead on the market cap to get a picture of the company’s value in the market place.

Thursday, January 27, 2011

Are you Investing in Stocks for Quick Returns?

Did you buy a stock to turn Rs. 1,00,000 into the Rs. 3,00,000 you need to purchase your 4-wheeler next year?

If so, you’re not investing, you’re gambling, and, unless you are incredibly lucky, you will not meet your goal.

The expectation of a high return in a short time frame is not realistic. Do stocks every shoot up like rockets?

Yes, some do. However, you must understand that the market works on a rigid risk-reward basis. If there is little risk to the investor, there will be a lower potential reward.

Investments that offer an extremely high potential reward invariably come with a high level of risk.

For the investor, this means if you are after the big returns, you must be prepared to suffer more losses than rewards.

As an investment choice, stocks have historically returned 10 to 12 percent. Does that mean that every stock should return in that range?

Not at all – that is simply an average. You need to assess the risk of investing in a particular stock before deciding what an acceptable return is.

An investment in a young high tech company should have a higher potential payout than putting your money in a “blue chip” company that posts modest growth and pays a regular dividend.

What would be the risk factor for a stock that could potentially triple in price over a short period? The answer is very high – in fact, so high that the odds of it succeeding would be very slim.

There is no safe (or legal) way to earn a very high return on your money over a short period.

Investing in stocks is best done as a long-term effort, which allows your money to grow and permits time for course corrections and adjustments.

Tuesday, January 11, 2011

Truth Behind Free Research Reports

Highly Qualified Stock Analysts are hired to provide free research work, not it surprises you? Why is it so?

Most of us have a brokerage account. Most of us also receive free research reports from our brokers.

Of late though, the quantum of free research from brokerages seems to be on the uptick. Most brokerage houses employ a research team that is dedicated to coming out with stock picks and publishing research reports on the same. A lot of money is spent on setting up these research teams. People, databases, office premises are just a few areas where expenses are made.

So we ask ourselves, when the brokerages spend so much in setting up these teams, then why do they dish out the reports free of cost? Do they get anything in return? Or are they putting up reports to just educate and help their investors?

The truth is far from this.

"A leading daily has conducted a study of leading brokerages to establish the reasons for giving out free research. The main reason cited is that the stock based research reports help to generate momentum in the concerned stocks. For example if a brokerage gives a 'Buy' report then the prices of that particular stock are seen rising."

By generating this momentum, the brokerages earn their brokerage fee.

So the next time you receive a free research report, ask yourself. Are you being given an advice on a stock based on its fundamentals and valuations Or are you just helping the brokerage house in earning more income for itself?

Considering a "Buy" call given by a brokerage firm, retail investors get into the stock at a higher price. 

We suggest all our readers to do ensure that free research reports should not be expensive for your investments.

Note: Saral Gyan equity analysts team will release "Hidden Gem - January 2011" on 16th Jan 2011.

This month Hidden Gem has recently made its 52 week high and is now available at cheap evaluations due to recent market correction. At current market price its looking highly undervalued and has the potential to deliver 10 times returns in next 3 years based on domestic demand driven consumption in India.  

Friday, November 19, 2010

Investing In Stocks Versus Mutual Funds

You are a savvy investor. You read a lot about personal finance and investing, and therefore you know very well that equities give the best long term, inflation beating returns among all asset classes.

You need to save for some long term financial goals, and obviously, stocks are your first choice. You decide to invest in a disciplined manner to achieve your goal. So, you open a depository account, a trading account, and start investing in stocks.

The question is - Is this approach correct? Should one invest directly in stocks, or take the help of experts?

Well, the answer would vary from person to person. So, let us compare the two methods of equity investment, to help you find your own answer.

Factor 1 - Time

Many small investors "invest" in stocks for the short term based on tips and rumours, and that is the most inappropriate "investment" strategy. This is trading, and this methodology can suit only traders. They are the ones who invest huge capital and trade with large positions, such that even a 5 paise increase in a stock's price is very profitable for them. But for small investors, it is a losing battle.

Investment in shares should be done only for the long term, keeping in mind the soundness of the company's strategies and management. Investment in stocks, therefore, needs a lot of research. It involves fundamental analysis - a study of the fundamental factors that affect the performance of a company. These factors may include the industry in which the company operates, growth rate of the industry, domestic and international competition, overall economic scenario (interest rates, inflation, exchange rate, etc), and so on.

This research needs to be done not just before choosing a stock, but even for its continuous tracking during the entire holding period. This kind of research needs a heavy investment of time. Do you, as a small investor, have this kind of time to spare?

Factor 2 - Expertise

Researching a company requires a thorough knowledge of valuation and accounting principles, and interpretation of various financial ratios like RoE, RoCE, RoNW, etc. It would also require access to latest financial results and other financial information about companies.

Fundamental research would also require knowledge of the industry in which the company operates.

Do you have such access and expertise?

Factor 3 - Transaction Costs

As a small, individual investor, your transaction volumes would be very modest. This also means that most of the brokers would charge you the highest brokerage - remember, at most brokerages, the brokerage cost as a percentage of trade value decreases as your trade volumes increase.

This transaction cost has a direct and significant impact on your ultimate returns.

Are you prepared for this?

Factor 4 - Reaction Speed

If there is a sudden change in economic factors, and it changes some of the fundamental factors affecting the company, would you be able to think in a dispassionate, level-headed manner.

Would you be able to act fast and react?

Factor 5 - Control Over Investment

How important is "control" to you?

Do you want to decide how much is invested where? Or you can trust an external expert for your investments?

These are some of the factors that would help you in deciding whether to invest directly in the stock markets, or through mutual funds (MFs).

If we consider the profile of a typical small investor, he would have a full time job, and would be investing only to achieve his financial goals. He would not be an expert in valuation and accounting. He would also not have the time to research companies thoroughly.

So, as a general principle, it is advisable for small investors to invest half of their equity investments through mutual funds and for rest of the sum, get stock analysts and experts advise to invest directly in stocks.

After a due course of time, you can evaluate your returns on your mutual fund as well as stocks comparing it with index like Nifty and Sensex. Your selection of mutual fund scheme and  stock experts for direct investment in stocks would be correct only if your investments outperform major indices over a period of 3-5 years.