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)

When you are considering stocks to buy, there are certain metrics and numbers that are more important than others.

They can’t be used as the sole qualifier to determine great stocks, but you can use them to eliminate poor performers.

You must always look at the big picture when considering a stock and that means considering a number of metrics.

Return on Assets

Return on Assets is one of the handful of really important metrics every investor should know.

Return on Assets (ROA) tells you how efficiently (or inefficiently) a company turns assets into net income. It is a way to tell at a glance how profitable a company is.

Consider that companies take capital from investors and turn it into profits, which are in turn returned to the investor in one form or another.

ROA measures how efficiently the company does this. Obviously, the more efficient a company is in converting assets (capital) into profits, the more attractive it will be to investors.

That’s about as simple as it comes: companies that make more money for the owners are worth more than companies that don’t make as much money.

ROA is made up of two components: net margin and asset turnover. When used together, these two metrics tell an important story.

Net Margin:

Net margin is found by dividing net income by sales. Net margin reveals what percentage of each Rupee in sales and company retains.

Asset Turnover:

The other component is asset turnover, which gives you an idea of how well a company does in producing sales from its assets. You find asset turnover by dividing sales by assets.

Once you have net margin and asset turnover, multiply them together to determine ROA. You now have an idea how well a company can convert assets into profits. Companies with high ROA compared to their peers, are more efficient at using assets to generate profits.

You can calculate ROA for yourself or you can use one of the Web sites that has done all the math for you.

Even if you don’t do the calculations yourself, it is important to know how the numbers are generated.

Improving Efficiency

ROA shows how companies have two choices in improving efficiency.

Companies can raise prices and create high margins or rapidly move assets through the company. Either way (or both) improves ROA.

It is important to compare companies in the same industries. Some industries traditionally have higher margins or asset turnover than other industries do.

ROA is an important measure to use and understand, but its flaw is that the metric does not consider the effect of borrowed capital.

You are going to lose money if you invest in stocks. Sooner or later, it’s bound to happen. If fact, it may have happened already and you don’t recognize it because losses can take several different forms.

Capital Loss

In its simplest and perhaps most painful form, you buy a stock then watch the price go down and stay down. At some point, you decide to end the pain and sell.

This type of loss, which involves an actual rupee amount, is called a capital loss. You can use a capital loss to offset profits (capital gains) for tax purposes. Beyond that, they aren’t worth much other than a painful investing lesson.

Opportunity Loss

There’s another type of loss that is less painful, but very real. Say you bought Rs. 10,000 worth of a hot growth stock. One year later, after some ups and downs, the stock is very close to what you paid for it.

You might be tempted to tell yourself, ‘Well, at least I didn’t lose anything.’

Not true. You tied up Rs. 10,000 of your money for a year and received nothing in return. If you had deposited the same amount in a bank, you would have at least earned a little interest.

Every stock purchase begins with a measurement against a risk-free investment. Knowing you could earn that return with no risk, how much more can you earn with some additional risk in purchasing a particular stock.

When a stock goes nowhere or doesn’t even match the risk-free return of a bond, you are losing money. What you lost was the opportunity to invest your money is something that would have earned you a positive return over and above the risk-free return - and that is a true loss.

Missed Profit Loss

This loss results when you watch a stock make a significant run up and then fall back, which may happen with volatile stocks. Few people are successful at calling the top (or bottom) of a market or a stock. You may feel that the money you could have made had you sold at the top is lost money.
Many investors will sit tight and hope the stock will “recover” and regain the high.

The problem is that may never happen and, even if it does, too many investors hold on hoping for even greater profits only to see the stock retreat again.

The best cure for this type of loss is to be happy with a reasonable profit and don’t try to squeeze every penny out of a stock risking a retreat and a “missed profit loss.”

No one wants a loss, but if it happens, don’t let your ego get in the way of making the right decision. Most of the time, the best course of action is to cut your losses and move on to the next deal.

 

As the markets keep on calling into question every single portion of your investments, even well-informed investors never stop doubting themselves!

You wonder, did I make the right decisions when I bought these stocks?

To answer yourself in any rational fashion, you need to be able to judge whether circumstances, not just psychology, have changed for your holdings.

In times like these, strong fundamental analysis becomes the most important key to your convictions. May be you have read about a company that intrigues you, or one of your friends is excited about a particular stock. Perhaps you keep seeing a stock on various "buy" lists and wonder what makes it so appealing.

Before you decide to buy a stock, you face two key research tasks:

1. Fundamental Analysis: Examining the company issuing the stock.

2. Technical Analysis: Evaluating the stock itself.

Both forms of analysis are sometimes needed. You don't want to buy a stock that looks attractively priced, only to find out that the company is on the skids.


To further clarify the difference between fundamental analysis and technical analysis, think of the market as an open-air bazaar with stocks as items for sale.

A technical analyst would get into the shopping frenzy with eyes seeking the crowd. He would ignore the goods on sale altogether. When the technical analyst notices a group gathering in front of the booth selling, say, shirts, he would scramble over to buy as much inventory as possible, betting that the ensuing demand would push prices higher.
He doesn't even care what a silk shirt is as long as some greater fool at the back of the line is willing to buy it for more than the technical analyst paid.


Fundamental analysis simply means conducting basic research on a company. When analyzing a company, you may want to choose companies that have the following qualities:

• A competitive advantage (such as key patents, a dominant share of the market or the fastest growth of new customers in a growing industry). 
• A record of consistent earnings growth or a strong indication of future growth.
• A healthy balance sheet (low debt, strong cash flow).
• Substantial ownership by management and, perhaps, recent insider buying.
• Strong minority stakes by outside investors.

Conversely, you may want to be wary of companies with:

• Substantial and growing competition and low barriers to entry.
• A shortfall in earnings, or a possible future impediment to growth, such as new regulations or tax changes.
• A weak balance sheet (high debt, declining cash flow).
• Low ownership by management and/or insider selling.
• Recent resignations of key officers.

Fundamental analysis is a lot more work, but therein lies its appeal.

Crowd psychology can be a powerful yet fickle force in the markets. As a smart investor, you've got to stay constantly alert for when the herd reverses direction.

Fundamental analysis definitely takes time, effort and hard work, but if properly done it will most certainly allow you to identify strong companies.

The price/sales ratio is one of the most important tools you can use to determine if the market is under or over valuing a stock’s price.

Clearly, you need to know whether a stock has any room to grow before you make an investment decision. If the stock is modestly priced relative to its industry peers and you believe it has solid growth prospects, then you have an investment candidate.

On the other hand, a wildly over-priced stock usually has only one way to go. It may still be an investment candidate, but only when the price is more attractive.

The Right Price

The price/sales ratio is one of the tools that will help you determine which category a stock is in and help you make an informed investment decision.

Stock prices tell you nothing. "X" company stock is selling for Rs. 93 and "Y" was quoted at Rs. 41. Which is the better buy considering both in the same sector? If you knew nothing about the companies, the stock prices give you no hint. Is X a better company because its stock is more expensive or is Y a good bargain?

The price/sales ratio creates a metric that allows you to compare companies in the same industries. You calculate it by dividing the market capitalization of the company by its revenue.

Market capitalization or market cap is simply the number of shares outstanding multiplied by the per share price. For example, a company with 100 million shares outstanding and a per share price of Rs 55 would have a market cap of Rs. 5.5 billion.

By dividing the market cap by revenues, you get a number that you can use to compare companies in the same industry. The lower the number, the better. It is important that you only use the price/sales ratio to compare companies in the same industry since there will be differences among industry groups.

Price/sales Ratio Reveals

Let’s take another look at "X" and "Y" stocks. Based on the quotes above, X’s price/sales ratio is 1.7, while Y's number is 2.2. For the industry group, the price/sales ratio is 2.8.

Both stocks were selling under the industry average, however looking at just the price/sales ratio stock "X" is the better value at 1.7.

One of the ways you can use price/sales ratio numbers is to check the other prime value metric, the price earnings ratio.

Continuing our example, X’s P/E is 20.1 and Y’s is 34.3. The industry group P/E is 33. According to the P/E, it appears that X's is still the better value.

If the price/sales ratio and the price/earning ratio contradict each other, that is a sign that something is up with the company’s books. Look for a one-time event that may have distorted the financials on a temporary basis.

Where to Find the Information 

You can find both the price/sales ratio and the price/earnings ratio along with other metrics on many websites. To name a few, you can find the relevant information at indiainfoline, moneycontrol and firstcallresearch  

Enter a stock symbol and you are taken to a detailed quote/background screen on the stock. From there you can gather all the information.

There are two parts to a successful investment

i) Picking the right company &
ii) Buying it at the right price.

The price/sales ratio is one tool that will help you determine the right price.

Cash is king - or queen if you wish. In either case, without cash a company can’t exist for long.

While that statement may seem obvious, too many investors focus solely on numbers like net income and earnings per share and ignore operating cash flow.

Operating cash flow (OCF) is not the same thing as net income, but is derived from net income through a series of adjustments to working capital accounts on the balance sheet. This is an accountant’s way of saying that OCF details how cash flows into and out of a company. If more flows in than out, the flow is positive, if not, the flow is negative.

Positive Earnings

A company could report positive earnings and still be suffering negative OCF. If a company is regularly spending more cash than it is taking it, something is obviously wrong.

This is one of the differences between accrual accounting and cash accounting. Without going into a detail explanation, accrual accounting, which is what companies use, allows companies some flexibility in how and when they record income and expenses.

This may obscure short-term problems such as burning cash, however sooner or later the company will have to face the basic issues that are causing the cash drain.

Investors

For investors, studying the operating cash flow will help you spot companies that are burning cash faster than they are taking it in regardless of what their net income or EPS numbers might be.

For those investors who like to get their hands dirty, you can find the operating cash flow on the statement of cash flows in a company’s balance sheet. You are looking for a positive number or some temporary reason for a negative one.

Another way to get at the information is to use the Price-to-cash flow ratio. You calculate the Price/Cash Flow like the other metrics using the stock price; however, the important factor here is a positive number.

The handy feature of the Price/Cash Flow is you can use it in screening stocks. This allows you to eliminate cash burners from consideration before you get started. You can also compare a company to its peers for an idea of how it is doing.

Operating Cash Flow (OCF) is not perfect. There are some ways it can be manipulated; however, it is a strong tool for your consideration. Like all tools, it is not the only one you should use, but it will sound a warning if you get too close to a cash burning company.

A financial statement is more than just a snapshot of the business’ health that company provides to shareholders or potential investors. It’s also a powerful diagnostic tool business owners can use to evaluate their firm’s strengths and weaknesses and chart the way forward.

This article will brief how to craft a balance sheet, income and cash flow statement, guiding you through the criteria and terminology, demonstrating how to calculate the ratios that reveal company’s fiscal health and its standing among the competition.

A brief explanation of the three statements

• Balance sheet: The balance sheet is often described as a snapshot of a company’s performance at a given time, such as the end of a quarter or fiscal year. The balance sheet identifies company’s assets and liabilities -- divided into near- and long-term obligations -- and stockholders’ equity.

• Income statement: Also known as a profit-and-loss statement, the income statement summarizes a company’s revenue and expenses for a given time period.

• Cash flow statement: This records the amounts of cash and cash equivalents that flowed into and out of a company in a given period. It is used to measure how much cash a company has on hand, which influences its ability to pay suppliers and employees and to meet other near-term obligations.

While evaluating company's performance, financial analysts need to look at various parameters and study different ratios derived from above statements which in turns help them to analyze the health of a company in all aspects.

The 20 most active stocks traded in terms of value of shares traded and their weekly % change.

Security Name	Close	% Change
HIND PETROLEUM	475.20	18.15
RELIANCE INDS	1068.95	0.56
BHARAT PETROLEUM	666.75	7.41
INDIAN OIL CORP	401.30	6.17
ABAN OFFSHORE	834.30	10.69
ONGC CORPN	1306.30	3.39
ICICI BANK	840.05	-1.93
STATE BANK	2265.05	-1.56
TATA STEEL	474.95	-3.09
RELIANCE INFRASTRUCTURE	1197.00	2.55
RELIANCE COMMUNICATIONS	190.85	-0.76
INFOSYS TECHNOLO	2727.50	-1.81
TATA MOTORS	766.40	-0.33
IDFC	179.80	6.70
SESA GOA	346.90	-5.58
HINDALCO INDS	143.75	-3.20
LARSEN & TOUBRO	1786.00	1.52
RELIANCE NATURAL RESOURCES	63.95	-3.04
RELIANCE CAPITAL	757.30	-1.53
OIL (I)	1429.65	5.14

Biggest Weekly % Gainers

The following list shows the stocks (over Rs.10/share) that had the biggest gains over last week. Gains are measured on a percentage basis. For example, a stock moving from 20 to 25 had a 5 point or 25% gain. Often stocks appearing on this list had some type of positive news (e.g., big earnings report, new product announcement, etc.).

Security Name	Close	% Change
TN TELECOM	13.50	58.82
ONWARD TECHNOLOG	36.30	42.91
BHARAT GEARS	69.55	36.91
AUTOMOTIVE STAMP	99.95	32.74
TT LTD	30.05	32.38
CAN FIN HOMES	125.00	31.30
MIRC ELEC	24.30	31.00
BHAGWATI BANQUETS & HOTELS	106.90	30.37
JUMBO BAG	49.35	27.85
MONET ISPAT	468.45	24.77
JINDAL COTEX	117.95	24.75
GINNI FILAMENTS	13.80	24.32
PTL ENTERPRISES	31.65	21.03
ASIAN GRANITO (I)	68.15	20.94
SALORA INTL	51.85	20.02
ASHAPURA MINCHEM	72.35	19.00
HIND PETROLEUM	475.20	18.15
IBN18 BROADCAST	101.40	17.70
BSL LTD	42.70	16.99
BHARAT BIJLEE	1260.70	16.75
MANGALAM TIMBER	29.00	16.70
ADVANTA (I)	482.20	16.64
MASTEK LTD	298.60	16.60
SHASUN CHEM	91.10	16.57
RPG LIFE SCIENCES	93.35	16.25
NUMERIC POWER SYSTEMS	376.55	16.15
PATSPIN (I)	13.75	16.03
NISSAN COPPER	58.85	15.51
GUJ ST FERTILIZE	277.65	15.35
AGRO TECH FOODS	300.35	15.10

Biggest Weekly % Losers

The following list shows the stocks (over Rs.10/share) that had the biggest losses over last week.
Losses are measured on a percentage basis. For example, a stock moving from 20 to 15 had a 5 point or 25% loss. Often stocks appearing on this list had some type of negative news (e.g., bad earnings report, lower analyst rating, product delay announcement, etc.).

Security Name	Close	% Change
PANORAMIC UNIVERSAL	25.10	-15.06
SEL MANUFACTURING CO	61.00	-14.02
STAR PAPER MILL	40.85	-13.27
XPRO INDIA	42.25	-11.52
DONEAR INDS	25.00	-11.35
KAVVERI TELECOM PRODUCTS	97.85	-11.25
ALKYL AMINES	101.55	-10.88
WINDSOR MACHINES	61.20	-10.79
REI SIX TEN RETAIL	54.85	-10.30
KIRL OIL ENG(OLD	398.75	-10.05

Determining Rate of Return

Probably the most basic calculation for investors is return on investment. Total return includes capital appreciation and income components, and assumes all income distributions are reinvested. If you automatically reinvest distributions such as interest or dividends, total return is calculated by taking the difference in an investment portfolio's ending and beginning balance, and dividing that difference by the beginning balance. In formula, it would look like this:

Total Return:

(Ending Balance [EB] - Beginning Balance [BB])

For example, Pankaj started with an investment of Rs.10,000. After five years, his portfolio's value increased to Rs.12,000. He can determine his portfolio's total return as follows: (Rs.12,000 – Rs.10,000) / Rs.10,000 = 0.20, or 20%. Therefore, Pankaj can say his Rs.10,000 has increased by 20%.

To annualize this total return, you'll need to calculate the compound annual return.

For example, Satish also originally invested Rs.10,000. However, it took his portfolio only two years to grow to Rs. 12,000. If you measure the performances of both Pankaj's and Satish's portfolios by using the formula above, both increased by 20%. To take the difference in time into consideration, calculate the compound annualized rate of return (you will need a calculator that can raise to powers to calculate this).

Compound Annualized Rate of Return = [(EB / BB) ^ (1 / # of years) - 1]

Using this formula to calculate Pankaj's annual compound return, we take Rs. 12,000 / Rs.10,000 = 1.2. Then, we raise 1.2 to the 1/5 (or 0.20) power, giving us 1.03714. Subtract out 1, and we have 0.03714, or 3.714%, which is Pankaj's annualized return. Satish's portfolio, on the other hand, performed much better, earning 9.54% on average every year. Of course, two different investments should not be judged solely on performance results for short periods of time or for different time periods. The risk of the portfolio must also be considered.

6 Steps to Explore the Best Stock 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 you stock(s) perform on the above analysis.

A relatively smaller sized construction company, J Kumar Infra Projects is expected to grow by over 50 per cent annually, over the next two years. This is primarily given by its healthy order book of Rs 1,300 crore, which is over three times its 2008-09 revenues. The order book is expected to further improve as the company has already bid for about Rs 5,000 crore worth of projects.

The company has a diversified portfolio given that it undertakes construction work for transport, irrigation, pilling, bridges, airport runways and buildings. These are basically urban infra, opportunities in the states outside Maharashtra. So we expect some kickers to come in the year 2010-2011 where the company will be diversifying outside Maharashtra that has been a concern for J Kumar Infra for a long time. Since there was a huge concentration risk only in Maharashtra, this will help the company to diversify the risk and get into other states as well.

Notably, the company mostly undertakes projects of government agencies, where investments are higher and are less affected by economic slowdown. Also, as majority of its revenues come from Maharashtra, the company is now moving into other states on the back of its increased scale and bidding capacity.

We believe that current valuations are reasonable for a company which is operating in a fast growing industry. Strong order book, high revenue growth, good margins, robust return ratios, regular dividends (paid dividend of 15% and 20% respectively in last two years with a dividend yield of approx 1%) and low debt-equity are among key factors that make a good case for investment in this company.

Being in high growth trajectory and decent track record, J Kumar Infra Projects is trading at a single digit P/E multiple of 8 and seems to be an attractive buy at current market price of Rs 207.

Note: The stocks discussed in Saral Gyan through posts are not a part of "Hidden Gems" issue which we recommend to our paid subscribers only. These are just stock specific views by Saral Gyan Team; one must do the due diligence before doing any investment based on our recommendation.

How much is a company worth & is that value reflected in the stock price?

There are several ways to define a company’s worth or value. One of the ways you define value is market cap or how much money would you need to buy every single share of stock at the current price.

Another way to determine a company’s value is to go to the balance statement and look at the Book Value. The Book Value is simply the company’s assets minus its liabilities.

Book Value = Assets - Liabilities

In other words, if you wanted to close your company operations, how much would be left after you settled all the outstanding obligations and sold off all the assets.

A company that is a viable growing business will always be worth more than its book value for its ability to generate earnings and growth.

Book value appeals more to value investors who look at the relationship to the stock's price by using the Price to Book ratio.

To compare companies, you should convert to book value per share, which is simply the book value divided by outstanding shares.

In our article on Price to Earnings Ratio or P/E , we noted that this number gave you an idea of what value the market place on a company’s earnings.

The P/E is the most popular way to compare the relative value of stocks based on earnings because you calculate it by taking the current price of the stock and divide it by the Earnings Per Share (EPS). This tells you whether a stock’s price is high or low relative to its earnings.

Some investors may consider a company with a high P/E overpriced and they may be correct. A high P/E may be a signal that traders have pushed a stock’s price beyond the point where any reasonable near term growth is probable.

However, a high P/E may also be a strong vote of confidence that the company still has strong growth prospects in the future, which should mean an even higher stock price.

Because the market is usually more concerned about the future than the present, it is always looking for some way to project out. Another ratio you can use will help you look at future earnings growth is called the PEG ratio. The PEG factors in projected earnings growth rates to the P/E for another number to remember.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = P/E /(projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 2 (30 / 15 = 2).

What does the “2” mean? Like all ratios, it simply shows you a relationship. In this case, the lower the number the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you see that what looks like a value may not work out that way. For example, a stock with a P/E of 8 and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG: 

• It is about year-to-year earnings growth
• It relies on projections, which may not always be accurate

Before you buy a particular stock, you may want to find out whether existing large shareholders are buying more or selling off their shares. This can help you evaluate the stock in the context of how their actions may influence the stock's price.

The reality for most well known stocks is institutions (mutual funds, large accounts such as retirement funds and pension funds, and so on) hold the majority of outstanding shares. You may want to consider this information when evaluating a particular stock.

Teams of Analysts

These large companies and institutions (known as Foreign Institutional Investors as well as Domestic Institutional Investors) employ teams of analysts to invest billions of dollars. It makes sense that they are going to spot good places to put their money, right?

The answer is a definite yes and no.

Of course, they are looking for a good return on their investments just like the rest of us. They look for good companies with good growth prospects, most of the time.

If the institutional investors are buying a stock, that is an endorsement of sorts that the stock has good prospects. If they are selling, it could mean something is wrong.

Where to Find Data

Before we talk about the value of this information, let us show you where to find it. The quickest way to do that is to use one of many online services that capture that data for you.

We like BSE & Moneycontrol website. Enter the stock symbol or code of the company you are researching, and then look at its share holding pattern, BSE provides information on share holding for past quarters. To see recent buying and selling of stocks by domestic mutual funds, you can use Moneycontrol.

Wrong Assumption

It is wrong to assume that institutional investors and individual investors share common goals. Institutions often have performance goals to meet, which push them to trade much more frequently than a normal individual investor.

For example, it is not uncommon for a growth mutual fund to turnover its portfolio 100% in one year. That means the fund managers have bought and sold every holding in the fund in one year.

This type of activity may drive them to buy or sell a stock with little regard to the underlying company’s fundamentals. You could see a big mutual fund dumping their shares of a stock and incorrectly assume there was something wrong with company’s future prospects.

This brings up another real danger of institutional ownership of a stock. When institutions become interested in a stock, they can drive up the price quickly with their huge block orders.

Just as quickly, the stock can collapse if the institutions decide the stock is flawed or there is a better opportunity with another stock. If they begin pulling their money out in big chucks, it will drive down the price. More institutions bail out and the stock goes into a free fall.

Could you recall Satyam story? Nobody expected that the price will fall from 170 Rs levels to a single digit price of Rs 8 in just 3 days. It was because of institutional investors, who sold off entire stake of Satyam.

What are investors to make of institutional ownership of a stock they want to buy?

First, most stocks will have some institutional ownership unless they are very small.

Secondly, watch for big changes one way or the other in ownership – are the institutions buying or selling. A change by a large number of institutions could mean something significant has changed at the company.

Finally, don’t ignore the company’s fundamentals. They still tell the best story about a company’s long-term chances for success in building value.

One way to evaluate a stock is to look at how effective the company’s management is in utilizing the resources available to them.

This measure of management effectiveness provides you with an idea of how well the company is being run relative to others in its sector and the market as a whole. Consistently low numbers are a red flag.

Unlike many comparisons, you can use these ratios to compare companies in different industries. The ratio's are:

• Return on assets 
• Return on investment 
• Return on equity 

Fortunately, you don’t have to compute these ratios yourself. Many websites provide this information.

Return on Assets

Return on assets tells you how well a company’s management uses its assets to make a profit.

You calculate the ROA by taking the net income and dividing it by the total assets. The ROA comparison works better over time so you can see a trend in how well management uses assets to the advantage of the company.

The higher the ratio, the better and the continued high level over time is even better because it indicates management makes a habit of managing with efficiency.

Return on investment measures not only the company’s contribution, but also the purposeful use of leverage or debt to extend company’s reach.

You calculate ROI by dividing net profits by long-term debt plus other long-term liabilities plus equity.

Managers choose to combine the company’s equity with outside debt to extend programs quickly and efficiently.

Skillful use of debt can change a 50 million project into a 75 million project. If everyone has done their homework correctly, the company can see additional profit from a larger project than they could have afforded without the debt.

Return on Equity

If numbers are good, return on equity is like a music for stockholders ears. It measures how well management did in earning money for them.

Unlike return on assets and return on investment, this measure goes directly to the stockholders and their stake in the company.

Unfortunately, ROE is somewhat flawed. You calculate ROE by taking net income and dividing by shareholders equity. Missing from this equation is debt and that distorts the picture somewhat.

Although ROE is somewhat helpful in looking at companies, it doesn’t provide the guidance the ROA does.

How much cash do you have in the bank? Can you pay all of your current bills and still have a positive balance?

If so you are considered highly liquid, meaning enough of your assets are either cash or easily converted to cash.

For stock investors, a company’s liquidity is an important consideration in looking for potential investments.

Companies that have good liquidity are able to ride out bumps, the economy may put in their way.

The question for stock investors is how do you measure liquidity.

Cash Ratio

The cash ratio is the most conservative ratio for measuring liquidity is often used during periods of economic turmoil.

The cash ratio is easy to calculate. It is:

Cash plus easily marketable securities divided by current liabilities.

Current liabilities are defined as those bills due within one year, such as bills to vendors, suppliers, daily operating expenses, and so on.

You can find the values for this equation on the balance sheet.

The cash ratio should be close to 1 and higher is better.

Ignores Assets: The reason the cash ratio is considered a very conservative view of a company’s liquidity is that it ignores such values as inventory (which turns over at least once a year for most companies).

The cash ratio also ignores the daily cash generation of the business as it sells products and services.

Why use the cash ratio?

In difficult times, cash is the most important asset many companies possess.

If a company has a ready supply of cash, it can survive sudden drops in sales that might put another less liquid company out of business.

The cash ratio is a good gauge of how a company can weather difficult times.

It is not a good ratio to use when considering the value of a company because it excludes valuable assets such as inventory and property. It is not a good ratio to use by itself, because much is missing from the total health of the company.

However, it is a good signal that a company is worth further consideration or a red flag that a company with a poor cash ratio may lack the liquidity to survive a difficult economy.