(P.S. – If you’re reading this you probably shouldn’t be investing in the stock market directly)
Disclaimer(s) –
1. Investing in individual stocks for the long term requires a lot of work and research - it is advisable to stick to mutual funds and get advice from a qualified professional before you make any significant investments in equity-based instruments.
2. This document has been created by people with some experience investing in equity, but they’re by no means experts in the field – we’re just trying to highlight some hygiene factors that might be helpful based on our limited understanding.
3. This document doesn’t cover anything related to short-term trading, or switching over stocks, we are only discussing everything in the context of long-term equity investing (5+ Years of time horizon)
4. This is meant for people not from a finance background and not well versed with complex valuation techniques
5. This is the bare minimum; we highly recommend that you do much more than this rather than using this as the benchmark for stock picking
6. This is a live document, and we will be constantly adding to it to improve it. This is just a guideline and checklist formed via non-expert personal opinion and should not be the sole criteria for investment
Key Resources for Easy Information
Long-term investors need not worry about short-term news items, but look at factors that systematically affect the ability of the company to survive and grow many years into the future – generally, companies that are able to operate profitably with moderate growth even for a few decades end up giving supernormal returns to investors that stick with them. As the famous saying goes:
“ In the short term markets are a voting machine but in the long term they are weighing machine”
Place to look at information for the long term:
1. Company Annual Report – Less than 0.1% of investors ever actually look at the annual report of the company they invest in. This is a place with management commentary, detailed accounts, and all public disclosures about the company. One can go through 2-3 Annual Reports to see if the management is meeting their projections if the accounts match what is being promised, and what the priorities for the company are going forward.
2. Investor Presentation – Many companies provide Quarterly Investor Presentations on their website where management makes predictions about the business and details their plan along with providing a business update for the current quarter in a digestible format.
3. Concall Transcripts – Many companies hold quarterly calls where shareholders and analysts can ask questions from management and get them answered – listening in here or going through the transcript provides a good idea of the current state of industry and business All these documents can be found in the investor services section of website of any listed company in India.
Other Resources –
valuepickr forums website (for Indian Companies)
Screener.com – To look for Quantitative data
Checklist
Since there are so many companies listed in the market it is easier to reduce your options via elimination rather than selections. Here is a checklist of things due to which you should immediately move away from the company without a second thought:
1. Allegation of fraud/misreporting/manipulation: Many promoters are trying to unethically gain an advantage in the market using their position of power at the expense of shareholders– it is advisable to stay away from any company where the promoter, sister concern, the company itself has EVER been called out for any fishy practices, no matter how small. Reason – History tells us that the issue is never “only one small mistake”, or “baseless allegation”, or “only in 1 company in our group”. Once a crook = always a crook should be the mantra for retail investors.
2. Declining Promoter Shareholding: Declining promoter shareholding is proof that the person in control doesn’t believe in the value of the company – so why should you?
3. There is an issue in another group company of promoter: Same as point 1, the problem will never be restricted to just one company in a group, as owners try to use their good assets to save the bad ones legally / illegally. E.g > Essar (Ruia Brothers), Religare (Singh Brothers), Anil Ambani.
4. Company is Overly Leveraged: High debt makes a company fragile – it removes the room for error, survives bad economic conditions, and makes the business less likely to survive over the long term. For peace of mind, one should stay away from businesses with high debt levels.
5. Suspicious Auditors: Auditors are too small a firm / resign frequently means that some shenanigans are happening with accounts. Generally increasing the compensation of auditors is also seen as a red flag.
Other Red Flags
1. Share price rising too fast without concrete reason – Indian markets are prone to manipulation by operators and rumor mills - if any story is looking too good to be true, it generally is. Case in Point – Patanjali – Ruchi Soya, Inox Wind, Educomp etc.
2. Political Dependency – Things can go down very badly very soon if company business is dependent on relations with one political party.
3. Increasing Profits Not Becoming Cashflows – High amount of inventory/receivables and increasing as a % of sales over time is suspicious.
4. Reducing Operating Margins – Generally as industries get more competitive, it becomes better for the consumer but bad for shareholders. Very high profits in the industry lead to more investment there and thus more competition eventually reducing margins. E.g. Telecom > High Margins (only Hutch + Airtel + BSNL) led to ~12 telecom players in India which led to low margins and caused most of them to become bad businesses financially unable to manage Jio & its 4G network.
5. Overdiversification – Companies moving too much into unrelated businesses generally perform poorly and cause problems to the profitable business as well (E.g – Essel Group, Jaypee).
Good Things to look for
1. Transparency in reporting – The more management is open about business performance the better it is for shareholders - This is especially important during bad times – transparency in revealing bad news informs on the integrity of management. Quality of IP, Concall & Annual Reports.
2. Management Conservative about predictions and able to hit targets – Management that is promising high and constantly making up excuses probably are more worried about share price than growing the business. This can easily be looked up by checking past con calls / annual reports and looking at current results delivered.
3. Growing Operating Margin / Decreasing Debt / Increasing Promoter shareholding.
4. Strategic Advantage in operations due to unique assets, people, and culture. (Also known as a moat) this is a type of advantage that can’t be easily removed by new players coming in. (E.g – Tata Steel holding captive coal mines which is a key raw material for steel production makes them a cost leader in steel, Dmart’s unique model and scale makes them unbeatable in offering discounts, Amazon’s Prime makes it an unbeatable bundle for US homes.)
Guidelines for an Investor
1. Stay in your “circle of competence” – that is industry in which you truly understand the entire value chain (either via working in it or via investing time learning it). This makes it easy to understand the market dynamics and assess the performance of the company in a larger context. Also helps you realize systemic problems in the industry if they arise.
2. Look at Products that you actually use – Generally great products lead to great businesses, and you can trust your judgment on good products.
3. Think of it as a “share in business” rather than a stock. If you had the money to buy half the business would you still buy this company at this value? If you have to be invested for the long term you should think and act like an owner – this helps during opportune times like – Nestle Maggi incident, Covid – 50% fall, Demonetization fall. If you know a business that would probably survive and is available at great value, then buy it when available cheap.
4. Always compare value against peers of the company and see if is valued more and why it is valued more. Good companies bought at ultra-high valuations can still give under-par returns.
NOTES:
Here is an example of the type of research needed to invest in a company individually:
There are times even after all this effort, people get it wrong (even Professional Analysts), but in this game, if you win you win big and even a 50% hit rate would result in significant wealth creation.
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