There is hardly anyone who does not know Warren Buffett; he inspires every investor who has a little interest or knowledge in the field of stock market or equity investing. We hear his views quite often on global economy on leading TV channels or read his opinions in newspapers on various sides of stock market and equity investment. Many of us simply read it but some people take his advice seriously and more importantly apply his Do’s and Don’ts experiences of investing in the stock market to select quality equity stocks.
Successful investors always advice to buy only quality stocks but do we really understand about quality stock! Have you ever pondered over these given below questions?
- What is quality stock?
- How should we buy quality company stocks?
- Do we know the factor which influences quality stock?
- Are we aware of that, how the successful investors select quality stocks?
If, we try to come close to these queries and find out the answers, trust me no one can stop you to become a successful investor. So, I want to share some of my investing experiences with you on key parameters which select quality stocks and we should consider it before investing in the equity market.
Company debt: It does not matter whether we are investing a little or a big; we must check how much the debt is on the company in which you wish to invest.
Let’s understand this in depth; take a scenario — In case, if you have a home loan and for some reason you lose your job for a small period of time, during that time the EMI of your home loan becomes a burden on you and if your job is discontinued for a long time, you will come under tremendous financial pressure. In the same way, if the company has a large debt, and for any other reason their earnings get reduced, it would be difficult to pay back the bank loan and if it continues for a little long time, the company generates losses and then you will notice that stock price has started to fall. Therefore, smart investors should avoid such company and must not put their hard earned money into it. So, try to prefer debt-free companies or low debt burden companies for safer investment and better return.
P/E Ratio: PE Ratio is one of the most widely used tools for stock selection; it is calculated by dividing the current market price of the stock by its earning per share (EPS). PE = Market price/ EPS.
Actually, it indicates that the sum of money you are ready to pay for each rupee worth of the earning of the company. But PE Ratio is quite debatable and need to understand in details. The Questions that always comes to mind is that:
- Should we invest in low PE ratio stocks or high PE ratio stocks?
- How can we justify PE ratio value while selecting the stock to buy?
This is truly tricky and therefore, PE ratio value must match with the company’s other parameters like revenue growth and earnings growth. That’s why the value investor does not pick the stocks just on the basis for low or high PE ratio value. Usually, we have seen that high PE ratio stocks are rated as a growth stock but it is not always true. During bull market I have observed that many equity stock valuation goes high without having earnings growth; this can be overvalued stocks and one must avoid these stocks strictly, as these stocks can deeply get corrected at any point of time. But, yes, sometimes high PE ratio stocks are truly growth stocks. Let’s take an example:
Suppose a Company A is an auto sector company and you find that, their couples of newly launched models get successful in the market and increases company revenue by 25-30% and hence improve their PE Ratio, in such case the high PE ratio is justified and one can select such stocks for investment.
The P/E ratio is further categorized into Forward P/E ratio and Trailing P/E ratio as explained below:
Forward P/E ratio: The Forward P/E ratio calculates the price-to-earnings ratio that uses projected future earnings.
Trailing P/E ratio: The Trailing P/E ratio is the standard form of Price-to-earnings ratio, is calculated using recent past earnings.
Earnings per share (EPS): It is one of the important tools that tell investors about company’s profitability. So, if the company EPS improves quarter-on-quarter then company’s earnings are in line and investor money is bound to grow. Earnings per share (EPS) serve as an indicator of a company’s profitability and calculated as:
EPS = (Net Income – Dividends on Preferred Stock)/Average Outstanding Shares.
In the end, we all need to understand one thing, your investment can yield returns only when the company generates profit and that is the reason why one should check the equity stock through various tools as discussed above before making an investment in stock market.
Great article with in-depth analysis, Vinay keep posting such informative articles.
Thanks Anand, appreciation from our readers keeps us motivated, keep reading and keep on giving such good compliments 🙂