Stocks are wealth creators in the long term as they compound your money in a good business. However they can destroy your savings if the underlying business is not generating enough revenues. Hence, you should be careful while investing money in stocks. Here are 10 things you should know about every stock you buy:
Promoter
Buying a stock means riding pillion. The promoter runs a company. The promoter’s ability to run the business decides its fate. You should also be careful about the business history of the promoter. Corporate governance issues or unfair treatment given to non-promoter shareholders are clear red flags. Do check the promoter’s skin in the game. If you buy shares of a company whose promoter does not have any other business, then the promoter has to deliver stable performance. If this is not the case, then you have to be very careful.
Business
Warren Buffett says that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. Know the business the company operates in. Gather as much information about the company and its products and target markets. If you have a long runway of opportunity, it is time to get in and sit tight.
ESG
You need to understand how a company performs on Environmental, Social and Governance (ESG) parameters. If a company has failed on some of these, then you have to be extra careful. Companies in tobacco, liquor, pornographic content, gambling are excluded by investors who use ESG or sustainable investing as their core investment framework. If you are investing in such a company then you have to be careful. This is because the market perception about such companies may not be favourable which may impact your investments.
Vulnerable dependence
It is equally important to figure out how vulnerable a company is to changes in policies. A company may be doing well. It may have shown encouraging growth in the past. But if its business is impact by government policies, then so will be your investments. Infrastructure companies in the roads space are the case in point. Be careful about companies that have only one client - say in the defence sector. Companies that are dependent on one supplier are also susceptible to disruptions.
Capital requirement
Capital-intensive businesses such as infrastructure rarely reward investors in the long-term. You should know the capital needs of a business. You should avoid a business which is in continuous need of capital. This excludes barring lending business.
Indebtedness (promoter pledge)
You must be aware of the debt of a company in which you have invested your hard-earned money. A company which has high debt may not generate high earnings in future. Most importantly, if the promoter’s stake in a company is pledged for raising loans, then you should be careful. You should keep tracking the debt on the books and repayment plans of that debt. This will help you make sensible investment decision.
Financial ratios
It is better to study the profitability of a company in detail. Net profit margin, return on capital employed and other asset turnover ratios should be tracked regularly. This will give a clear picture of the financial health of a company in which you have invested your money.
Cashflows and dividends
You need to regularly check the operating cash flow generation of the company whose shares you have bought. The company should be generating sufficient cash to pay off loans and carry out future capex whenever required. Regular payment of dividends using cashflows is a positive sign, indicating that the company values its shareholders.
Beta
This is an important indicator which gives a fair idea of how volatile a stock can be. A stock’s beta indicates how much the stock moves in line with the market. A high beta stock rewards an investor when the market is in uptrend. On the other hand, a low beta stock protects the downside of an investor’s portfolio.