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Tuesday, February 17, 2009

Several way of picking stocks

When one thinks of personal finance and investments,stock is the first thing which strikes the mind for quick accumulation of wealth.Its quite explicable the first love for stocks as stock market is the most exilerating place to delve in.If any one stands at the Flore of the stock markets and observe the scrolling up and down of stocks,he may feel of the anxiety surrounding in its environment.But on the financial merry-go-round rise,we all want to experience the ups without the downs.

Though,the world of stocks sounds interesting and pleasing,yet,it would be unwise to jump into these without any knowledge or understanding of the subject.Here i will explore the stock picking techniques based on the tested and pr oven theories of investments.The criteria for the selection of stocks are based on so many factors that it is nearly impossible to construct a formula that will predict success.There is no watertight system,which assure you arriving at a rate of interest that is greater than the markets overall average.

At this point,you may ask yourself why stock picking is so important.Why worry so much about it?Why spend hours doing it?The answer is simple-Wealth.A good stock picker can increase his personal wealth exemplarily.Mind you even your"s truly of 20 years has struggled a lot over the years in applying theories in stock picking.

Any stock is picked on the basis of company's creditability over a period of time.The quantitative aspects of a company,such as profits,balance sheets and report on its agm are easy enough to find.However one can never guess on the qualitative aspects of any company such as company's staffs,its competitive advantages,its reputation and so on?One ma find such sort of in formations highly intangible that cannot be measured.The divergence between tangible and intangible aspects of any company makes the task of stock picking highly off-centered and instinctive process.

Human element is considered to be highly irrational and when this human element gets involved into the volatile stock markets,it can turn out to be a highly dangerous place to play on the bourses.Emotions are an integral part of human element,which are highly unpredictable just like the bourses on the bourd.And when emotions becomes overbearing it can turn the confidence into fear.During such time,it is the emotions only which can either make one flourish or devastate depending upon his state of mind.

The credential of any company is known by its management and the way it functions.Ultimately,it is the people at the strategic decision making positions determines the fate of any company.A strong management plays a crucial factor in the success or failure of any company.To assessthe strength of management and company,investors can simply ask the standard five stuffs-Who,where,what,when and why.


Who is managing the company?
You must know about the management structure of the company and also must keep a close eye on the persons positioned in that structured.If you opt for a company which has got college dropout aspirants like me decent trouble awaits you for sure.Lolz,jokes apart.Do a proper research work about who is the companys ceo,cfo etc.The educational qualification and professional experiences of the people appointed at the highest position in the company must also be verified.The purpose behind is to see whether they are competent enough for the post held by them.

What the company does and how it makes money?
Another important factor to consider about while analyzing a company"s qualitative factors is it products and services.Whats the actually activity of a company?In other words,the company earns its profits from which source?Knowing how a company's activities will be profitable is fundamental to determining the worth of an investment.Try to explore the growth potential of the company.Any customary company in a great industry can provide a solid return,while in a poor industry it is likely to shrink your portfolio.Market share is another important factor.Assessing a company from a qualitative standpoint and determining whether you should invest in it are as important as looking at its sales and earnings.

Where the company stands?
An important factor to look upon-where the company is standing within the industry.Whether the company have any positive points that provides an edge to the company over its competitors.A company's fundamental helps one to pick up a good stock as it enables to find out the "intrinsic value of any company.If the intrinsic value is more than the current share price,your analysis is showing that the stock is worth more than its price and that makes sense to buy the stock.


When does the management take decision?
Now what is the philosophy of management?It is the style in which management intend to manage the company.You can get a glimpse of the style of management by looking at its past performances or going through the annual report"s MD&A section.If a company is showing negative results,one of the actions taken is management restructuring.Which is often termed as "change in management structure" due to poor results.But if a company performs continuously poor then its a warning sign to switch over to other investment options.Altough restructuring may be due to the poor performance of the management,it does not necessarily mean that the company is going through a downfall.Management restructuring might be a positive sign,which shows that the company is endeavouring hard to change its outlook for good cause.

Why?
Finally,an investor must investigate over the capabilities of managers appointed t decision making levels.Never hesitate to ask questions like does this person's the qualities you believe are needed to make someone a good manager for this company?Has he or she has been hired because of past successes and achievements or has he or she acquired the position through questionable means,such as self appointment after inheriting the company?

Merely knowing the strength of company and its management is not enough to guarantee a success in investing.There are certain theories to be looked upon before taking any final decision.If any decision is taken without considering these theories and principles,the investor may end up with losses.

Greater fool"s theory
A company is worth the sum of its discounted cash flows.This means that a company is worth all of its future profits added together.Though several analysts evaluate it by their own means but to me its just what got defined now.Now its up to you to go with me-the cool kid or not.Anyways the continuation of DCF-These future profits must be discounted to account for the time value of the money.One of the assumption of the DCF theory is that people are rational,nobody would buy a business for more than its future DCF.Since a stock represent ownership in a company,this assumption applies to the stock markets.Now you may ask,why do then stocks exhibit volatile movements as it doesn't make sense for stock price to fluctuate so much when the intrinsic value is not changing every minute?Well the the fact is that many people do not view stocks as represention of DCFs,but as trading vehicles.Misanthropists have labelled it as the "Greater fool"s theory".Since the profit on a trade is not determined by a company's value but about speculating whether you can sell it to some other investor(the fool.On the other hand,the trader would say that investors relying solely on fundamentals are leaving themselves on the mercy of the market instead of observing the trend and the tendencies.

Value investing:-
Stocks carrying strong fundamentals attract value investors the most.A strong fundamental may include earnings,dividends,book value and cash flow-that are selling at a bargain price,given their quality.Value investing doesn't mean just buying any stock that fall off and therefore seems"bargain basement priced".Vale investors have to do their homework and be confident that they are picking a company that is cheap given its high quality.A value investors considers the supremacy of a company to double up his profits.He believes in forseeing the company's potential rather making profit through trading.He does not care much about the external factors affecting the company but determines the worth of the underlying value of its assets.The factors like market volatility or day to day price fluctuations are not coherent to the company and therefore are not seen to have any effect on the value of the business in the long run.

While the efficient market hypothesis claims that prices are always reflecting all relevant information therefore are already showing the intrinsic worth of the companies,value investing relies on a premise that opposes that theory.Value investors also disagree with the principle that high beta necessarily translates into a dicey investment.A high beta does not scare off value investors.As long as they are confident in their intrinsic valuation,an increase in downside volatility may be a good thing.

Growth investing:-
Growth investing could be defined By contrasting it to value investing.Value investors look for stocks that are trading for less than their apparent worth.Growth investors focus on the future potential of a company,with much less emphasis on its present price.Unlike value investors,growth investors opt for companies which are trading higher than their intrinsic worth-but this is done with the belief that the company's intrinsic worth will grow and therefore will exceed their current valuations.Growth investors are concerned with a company's future growth potential,but there is no absolute formula for evaluating this potential.Growth investors use certain methods or criteria as a framework for their analysis,but these methods must be applied with a company's particular situation in mind.

The first question a growth investor should ask is whether the company,based on annual revenue,has been growing in the past.Projected 5 year growth rate of at least 15-20%,although 25% or more is ideal for investors like me.These projections are made by analysts,the company or other credible sources.When a growth investor sees an ideal growth projection,he or she before trusting this projection,must evaluate its creditability.This requires knowledge of the typical growth rates for different sizes of companies.There are many examples of companies with staggering growth in sales but less than stupendous gains in profits.High annual revenue growth is good,but if EPS has not increased proporitinately,its likely due to a decrease in profit margin.By putting side by side a company's present profit margins to its past profit margins and its competitor profit margins,a growth investor is able to gauge quite accurately whether or not management is controlling costs and revenues and maintaining margins.A good rule of thumb is that if a company surpasses its previous five year average of pre-tax profit margins as well as those of its industry,the company may be a good growth candidate.

Screening for value stocks
Altough value stocks can be located anywhere,they are often located in industries that have recently fallen on hard times or are currently facing market overreaction to a piece of news affecting the industry in the short term.Keep in mind that these are the guidelines used by value investors and these are not hard and fast rules.

Share price should be no more than 2/3 of intrinsic worth.
Look at companies with PE ratios at the lowest 10% of all equity securities.
PEG should be less than 1
Stock price should be no more than tangible book value
There should be no more debt than equity(D/E Ratio<1)
Current assets should be 2 times current liabilities
Dividend yield should be at least 2/3 of the long term AAA bond yield.
Earnings growth should be at least 8% per annum compounded over the last 8-10 years

The PE and PEG ratios
Value investing is not simply about investing in low PE stocks.Its just that stocks that are underrated will often reflect through a low PE ratio,which should simply provide a way to draw a distinction between companies within the same industry.Another popular gauge for valuing a company's intrinsic worth is the PEG ratio.It is calculated as stocks PE ratio divided by its projected year-over-year earnings growth rate.In other words,the ratio measures how cheap the stock is while taking into account its earnings growth.If the company's PEG ratio is less than 1,it is considered to be undervalued and is a growth pick for value investor.

An investor should also use margin of safety concept which is simply the practice of leaving room for error in the calculations of intrinsic worth.If the stocks intrinsic value were lower than that of what the investor estimates,the margin of safety should avert investor from paying too much of the stock.

In the nutshell,an investor should try to look at basic principles of investment and should not be carried away by biases like windfall gain but rather concentrate on the company's fundamentals,its management and other theories guiding towards right investment.

Remember that’s its your money at stake-so pick stocks wisely



Regards,
ARUN
I can be reached at:arunanalyst@rediffmail.com

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