Fear or greed may move the market over the short term, but sooner or later economic fundamentals take control.

Stock market bubbles happen when greed (or at least the excitement of money to be made) pushes prices to unrealistic heights.

Conversely, bear markets, when there is more pressure on the sell side than the buy side, happen when investors become disillusioned with over-priced equities.

Bull and bear markets tend to raise or lower all stocks, but often hit some sectors harder. Not surprisingly, the stock sectors that take the biggest hits are often those previously floating on the bubble.

We all have experienced last bubble which was lead by Realty Stocks. Stocks like Unitech, DLF, HDIL which were the darling of many Investors in last bull run are making new lows today. These stocks have massively eroded the capital of investors since 2008.

HDIL - A mumbai based realty company, was trading at 4 digit price in Jan 2008, made all time high of Rs. 1114 on 10th Jan 2008, couple of months after listing in stock exchanges, today trades at price of Rs. 103. Investors who bought this stock on that day have lost almost 90% of their capital as on date, Rs. 1 lakh invested in HDIL in Jan 2008 is less than Rs. 10,000 today. Investors during that period was fascinated to invest in these companies.  Every thing was rosy in terms of realty stocks, huge land bank, mega township projects, expansion in tier 1, tier 2 cities etc. No body wants to think and analyse the changed scenario as of today.  

It is easy to assume that markets are either driven solely by fear or greed. While that may be the case when markets are expanding or contracting, it doesn’t explain how the markets behave in between raging bulls and roaring bears.

Stock Fundamentals Rule

During these times, fundamentals rule rational investing - there will always be those who impulsively jump into and out of the market.

It is easy to overlook the fundamentals, both economic and market related, in the heat of a soaring or crashing market, but you do so at your own peril if you are a long-term investor.

Just as in the dot.com boom, companies still need to earn a profit and pay their bills to prosper. There is no excuse for dismissing these fundamental truths.

Point to Ponder

No matter what the market is doing, companies that have a sustainable business model, strong cash flow and little debt are going to come out of any boom or bust in good shape.

Investment Truths

It is worth repeating these investment truths:

• The economy is not the stock market

• Stock prices may or may not represent a company’s true value

• Good companies are long-term good investments

A stock’s price is only important in establishing when is a good time to buy or sell.

Long-term investors have time on their side - time to let aberrations in the market work themselves out. Take advantage of time and let good companies show their true value. Don't be in a hurry to make lot of money from stock market.

Like the fabled tortoise that beat the hare in the race, the investor who stays in for the long term is more likely to achieve his or her goals than the investor who chases “hot tips” for quick profits in the stock market.

Time is an investor’s best friend (or worst enemy if you wait too long) because it gives compounding time to work its magic. Compounding is the mathematical process where interest on your money in turn earns interest and is added to your principal.

Consider the following four investors ages 25 – 55. Each invests Rs 2,000 per year and earns 8%.

At age 65:

The investor who started at age 25 has over Rs. 585,000

The investor who started at age 35 has just Rs. 250,000

The investor who started at age 45 has just Rs. 98,800

The investor who started at age 55 has just Rs. 30,700

The results are quite dramatic and, as you might expect, the youngest investor comes out the best. However, look at the difference starting 10 years sooner can make. The fewer years invested the more dramatic the difference with the next youngest age. The investor who starts at age 45 still earns over three times as much as the investor who starts at age 55. Of course, part of the difference is the 45-year-old investor has 10 years (Rs. 20,000) more to invest, but the rest of the difference is the power of compounding.

This may not be the most “real life” example, since we can’t go back to age 25 and start over. Let’s look at the power of long-term investing from a different goal. What will it take for each of these investors to accumulate Rs 750,000 at age 65, assuming they all earn 8% and ignoring inflation and taxes?

The investor who started at age 25 needs to invest Rs 213 per month

The investor who started at age 35 needs to invest Rs 500 per month

The investor who started at age 45 needs to invest Rs 1,650 per month

The investor who started at age 55 needs to invest Rs 4,072 per month

While all four investors reach the goal of Rs 750,000, it is obvious that the younger investors get a lot more “heavy lifting” from their investments. The lesson is clear: The earlier you start the less you have to invest to reach your goal.

Problems & Corrections

The examples above describe the mathematical advantage of starting early, however they don’t represent a “real world” situation. It is highly unlikely that you could achieve a constant return of 8% over a long period. The reality is there will be times when your investments earn less and other times when you earn more or loose money. There may also be times when you will earn upto 30% annualized returns, obviously by investing in equities and not in FDs.

The investor with a long- term perspective can also correct for mistakes along the way. For example, that stock you thought was going to soar like an eagle turned out to be a turkey. If you have a long-term perspective, you can change investments that aren’t working for other alternatives. However, if you will need the money from your investment in the near future (fewer than 5-7 years), a mistaken investment can create real problems in meeting your goals.

Long-term investors, especially those who invest in a diversified portfolio, can ride out down markets like the one that began in March of 2000 without dramatically affecting his or her ability to reach their goals.

However, for the investor just starting out at age 55, a market downturn can be disastrous. There is no room for error with only 10 years left before retirement at age 65. The reality of investing is that the market will go up and the market will go down. Investors that begin early and stay in the market have a much better chance of riding out the bad times and capitalizing on the periods when the market is rising.

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.

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 31.3.2012 was Rs. 49.61 crores. Its sales were Rs. 383.72 crores and so the EBITDA to Sales margin was 12.92%.

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 31.3.2012 was Rs. 30.08 crores. The number of equity shares were 56.88 lakhs and so the EPS is Rs. 56.83.

“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 31.3.2012 was Rs. 56.85 (as calculated above). The market price per share is Rs. 1,687 and so the PE ratio is 29.66.

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).

Example: Hawkins Cooker’s Net Worth (equity + reserves) as of 31.3.2012 was Rs. 51.59 crores while its net profit was Rs. 30.08 crores. The Return on Net Worth is 58%.

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.

Example: Hawkins Cooker’s equity + reserves as of 31.3.2012 was Rs. 51.59 crores while its debt was Rs. 12.20 crores. The debt equity ratio is 0.24.

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 52.90 lakh shares. The price per share is Rs. 1,819 and so the market cap of the company is Rs. 962 crores. This means, theoretically, that if you had Rs. 962 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: Oil India declared a dividend of 475% (Rs. 47.50 per share). Because its market price is Rs. 489, the dividend yield is 47.50/489×100 = 9.7%.

• In 1981 company declared 1:1 bonus = you have 200 shares
• In 1985 company declared 1:1 bonus = you have 400 shares
• In 1986 company split the share to Rs. 10 = you have 4,000 shares
• In 1987 company declared 1:1 bonus = you have 8,000 shares
• In 1989 company declared 1:1 bonus = you have 16,000 shares
• In 1992 company declared 1:1 bonus = you have 32,000 shares
• In 1995 company declared 1:1 bonus = you have 64,000 shares
• In 1997 company declared 1:2 bonus = you have 1,92,000 shares
• In 1999 company split the share to Rs. 2 = you have 9,60,000 shares
• In 2004 company declared 1:2 bonus = you have 28,80,000 shares
• In 2005 company declared 1:1 bonus = you have 57,60,000 shares
• In 2010 company declared 3:2 bonus = you have 96,00,000 shares

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. 1250 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. 2500, there’s a good chance that you’ll make more money purchasing 2 shares of TCS rather than 5,000 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!

Also Read: 4 Hidden Gems of 2011 which doubled investors money in one year.

Below are the 6 Important Steps to Explore Best Stocks for Investment

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

Step-1: Find out how the company makes money

Before you decide to invest in a company’s stock, find out how the company makes money. This is probably the easiest of all the steps. Read company’s annual and quarterly reports, newspapers and business magazines to understand the various revenue streams of the firm. Stock price reflects the firm’s ability to generate consistent or above expectation profits/earnings from its ongoing/core operations. Any income from unrelated activities should not affect the stock price. Investors will pay for its earnings from its core operations, which is its strength and stable operation, and not from unrelated activities. Thus, you need to find out which operations of the firm are generating revenues and profits. If you do not know that you are bound to get a hit in future.

Warren Buffet once said that “if you do not understand how a company makes money, do not buy its stock- you will always end up loosing money”. He never invested even a single penny in technology stocks and yet made billions and billions of dollars both during tech bubble and bust.

Step-2: Do a Sector Analysis of the Company

First is to figure out which sector the stock is in. Then, figure out what all factors affect the performance of the sector. For example, Infosys is in IT services sector, NTPC is in Power sector and DLF is in Real Estate sector. Half of what a stock does is totally dependent on its sector. Simple rule-Good factors help stocks while bad factors hurt stocks.

Let’s take an example of airlines industry. The factors that affect it are fuel prices, growth in air traffic and competition. If fuel prices are high, tickets would be expensive and hence fewer people will fly. This will hurt the airlines sectors and firms equally. This would make the sector less attractive because there would be less scope for growth of the firms.

The idea is to find out the good and bad factors for the sectors and figure out how much they will affect the stock and how. What we are really looking at are reasons that will make stock price good or bad or a company look more or less valuable, even though nothing about the company changes. This will give you a broader view whether the stocks will do well or poorly in the future.

Step-3: Examine the recent & historical performance of the Stock

By performance we mean both operational and financial performance of the company. Take out some time to find out how the company has done in its business over the years. Were there issues with its operations such as labor strike, frequent breakdowns, higher attrition or lagging deadlines? If any company has a history of serious problems, it does not make a good buy because chances are high it may have similar problems again. History is a good predictor of future! It is also extremely important to find out the historical financial performance of the company – growth in revenues, profits (earnings), profit margins, stock price movements etc.

Step-4: Perform competitive analysis of the firm with its Competitors

This is most important step in analyzing a stock. Unfortunately, most of the retail investors do not bother to do this. It takes time to do this step but it worth trying if you don’t want to loose your money. Many investors buy a stock because they have heard about the company or used the products or think companies have excellent technologies. However, if you do not evaluate or compare those features of the company with other similar firms, how will you figure out whether the firm is utilizing them effectively or is better/worse than others? We also need to find out whether company is growing rapidly or slowly or has no growth. We would like to cover couple of financial ratios here in brief and explain how to use them to figure out a good stock.

P/E: Price-to-earnings ratio is the most widely used ratio in stock valuation. It means how much investors are paying more for each unit of income. It is calculated as Market Price of Stock / Earnings per share. A stock with a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to the overall market, as investors are paying more for today's earnings in anticipation of future earnings growth. Hence, as a generalization, stocks with this characteristic are considered to be growth stocks. However, P/E alone may not tell you the whole story as you see it varies from one company to another because of different growth rates. Hence, another ratio, PEG (P/E divided by Earnings Growth rate) gives a better comparative understanding of the stock.

PEG = Stocks P/E / Growth Rate

We do not want to go into the calculation part as values for P/E are available on internet for most of the companies.

A PEG of less than 1 makes an excellent buy if the company is fundamentally strong. If it is above 2, it is a MUST SELL. If PEG for all the stocks are not very different, one with lowest P/E value would be a great BUY.

Step-5: Read and evaluate company’s Financial statements

This is the most difficult part of this process. It is generally used by sophisticated finance professionals, mostly fund managers who can understand different financial statements. However, there are few things that even you should keep in mind. There are three different financial statement- balance sheet, income statement and cash flow statement. You should focus only on balance sheet and cash flow statement.

Balance Sheet: It summarizes a company’s assets, liabilities (debt) and shareholders’ equity at a specific point in time. A typical Indian firm’s balance sheet has following line items:

• Gross block

• Capital work in progress

• Investments

• Inventory

• Other current assets

• Equity Share capital

• Reserves

• Total debt

Gross block: Gross block is the sum total of all assets of the company valued at their cost of acquisition. This is inclusive of the depreciation that is to be charged on each asset.

Net block is the gross block less accumulated depreciation on assets. Net block is actually what the asset is worth to the company.

Capital work in progress: Capital work in progress sometimes at the end of the financial year, there is some construction or installation going on in the company, which is not complete, such installation is recorded in the books as capital work in progress because it is asset for the business.

Investments: If the company has made some investments out of its free cash, it is recorded under it.

Inventory: Inventory is the stock of goods that a company has at any point of time.

Receivables include the debtors of the company, i.e., it includes all those accounts which are to give money back to the company.

Other current assets: Other current assets include all the assets, which can be converted into cash within a very short period of time like cash in bank etc.

Equity Share capital: Equity Share capital is the owner\'s equity. It is the most permanent source of finance for the company.

Reserves: Reserves include the free reserves of the company which are built out of the genuine profits of the company. Together they are known as net worth of the company.

Total debt: Total debt includes the long term and the short debt of the company. Long term is for a longer duration, usually for a period more than 3 years like debentures. Short term debt is for a lesser duration, usually for less than a year like bank finance for working capital.

One need to ask-How much debt does the company have? How much debt does it have the current year? Find out debt to equity ratio. If this ratio is greater than 2, the company has a high risk of default on the interest payments. Also, find out whether the firm is generating enough cash to pay for its working capital or debt. If total liabilities are greater than total assets, sell the stock as the firm is heading for disaster. This debt to equity ratio is extremely important for a company to survive in bad economy. What is happening now-a-days should make this extremely important. Companies having higher debt ratio have got hammered in the stock market. Look at real estate companies- their stocks are down by almost 90%. This is because they have high debt level which means higher interest payments. In the current liquidity crisis and global slowdown, it would be extremely difficult for them to survive. Remember, a weak balance sheet makes a company vulnerable to bankruptcy!

Step-6: Buy or Sell

Follow all the steps from 1 to 5 religiously. It will take time but worth doing it. If you do it, you won’t have to see a situation where you loose more than 50% of stock value in a week! Buying or selling will depend on how your stock(s) perform on the above analysis.

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When the word "Small Cap" is mentioned in the investor community, lack of interest and confidence is observed which shows the disillusionment that investors have towards this category.

Most of the retail investors keep themselves away from investing in small and little known companies which they never heard of and find themselves comfortable investing in companies which they are aware and keep a close watch on price movement instead of looking at important parameters like recent performance of the company, its quarterly results, debt on books, earning per share, dividend yield, PE ratio, ROE ratio etc along with future prospects considering macro and micro environment for the industry to which stock belongs to.

The aversion towards this category will be more evident in the present context when there is gloom, both at the domestic and global front. The prevailing negative sentiments have made stock market investing a nightmare for all those who have parted with their hard earned savings into this sector, fondly called the barometer of the economy.

However, at this juncture, we would like to differ from the general view and recommend risk taking investors not to follow the herd but rather they can consider taking a small exposure into the small cap stocks.

Small cap stocks offer a lot of potential to generate additional return in your portfolio. Experts and Guru's of stock market should put in extra effort to create more awareness about benefit of investing in small cap stocks during choppy markets. Actually there is a need to calm down the investors during market downturns and advise them on the positives of investing into this category when markets are range bound.

Small Cap stocks are known to deliver impressive performance when bulls rule the markets, but they get battered during a bearish regime. For instance in 2009, Sensex was one of the best performing markets vis-a-vis its peers. This was on account of the positive impact of the stimulus released by the Government and the election results, which led to confidence among investors and corporate India that a stable government at the centre will be able to bring in a lot of reforms. This saw the index posting a superb return of 81% while the BSE Small Cap Index actually delivered an impressive 126% during the same time horizon.

This could be attributed to the fact that during market upturns small cap companies normally outperform their larger peers, since the latter would have already reached their peak in terms of the potential to grow in the future, while the former actually gets to unlock its growth potential as there is a long way for them to reach the maturity stage.

There are a lot of reasons why investors should not directly get into small cap stocks as some of them can be illiquid and concerns may arise about the way the company is being professionally managed. Moreover, these companies have limited media coverage and they are largely unknown among investors, which means the information in public domain will be very limited.

Hence in this scenario, investors who want to invest in small cap stocks should go by advise of professionals who have the expertise to spot these hidden gems. We believe that with BSE Small Cap Index trading at 55% below its all time high, this is the right time to get into small cap stocks. However, this category is recommended only to investors who are ready to take the extra risk to get the additional upside in their portfolio and also have the patience to wait to reap the benefits.

Saral Gyan offers Hidden Gems - Unexplored Multibagger Small Cap Stocks Research reports. The research done by our equity analysts in small cap companies is authentic and unbiased and help investors to make an educated investment decision based of facts. Its result of dedication and passion of our equity analysts that when all indices gave negative returns in last one year, Saral Gyan Hidden Gems gave average positive returns of 24%, outperforming small cap index by whopping 35%.

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P = Principal amount
r = Rate of interest, expressed in %
n = Number of years
P = 100
r = The annual growth rate (that we want to find out)
n = 4 years
P = 9250
r = Rate of return to be found out
n = 20 years,

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.

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.

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.

Fear or greed may move the market over the short term, but sooner or later economic fundamentals take control.

Stock market bubbles happen when greed (or at least the excitement of money to be made) pushes prices to unrealistic heights.

Conversely, bear markets, when there is more pressure on the sell side than the buy side, happen when investors become disillusioned with over-priced equities.

Bull and bear markets tend to raise or lower all stocks, but often hit some sectors harder. Not surprisingly, the stock sectors that take the biggest hits are often those previously floating on the bubble.

We all have experienced last bubble which was lead by Realty Stocks. Stocks like Unitech, DLF, HDIL which were the darling of many Investors in last bull run are making new lows today. These stocks have massively eroded the capital of investors since 2008.

HDIL - A mumbai based realty company, was trading at 4 digit price in Jan 2008, made all time high of Rs. 1114 on 10th Jan 2008, couple of months after listing in stock exchanges, today trades at 2 digit price of Rs. 92. Investors who bought this stock on that day have lost almost 91% of their capital as on date. Investors during that period was fascinated to invest in these companies.  Every thing was rosy in terms of realty stocks, huge land bank, mega township projects, expansion in tier 1, tier 2 cities etc. No body wants to think and analyse the changed scenario as of today.        

It is easy to assume that markets are either driven solely by fear or greed. While that may be the case when markets are expanding or contracting, it doesn’t explain how the markets behave in between raging bulls and roaring bears.

During these times, fundamentals rule rational investing - there will always be those who impulsively jump into and out of the market.

It is easy to overlook the fundamentals, both economic and market related, in the heat of a soaring or crashing market, but you do so at your own peril if you are a long-term investor.

Just as in the dot.com boom, companies still need to earn a profit and pay their bills to prosper. There is no excuse for dismissing these fundamental truths.

No matter what the market is doing, companies that have a sustainable business model, strong cash flow and little debt are going to come out of any boom or bust in good shape.

It is worth repeating these investment truths:

A stock’s price is only important in establishing when is a good time to buy or sell.

Long-term investors have time on their side - time to let aberrations in the market work themselves out. Take advantage of time and let good companies show their true value. Don't be in a hurry to make lot of money from stock market.