5 tips to shortlist good-value stocks

Blog | TRADING 101

A value stock is one that can surprise investors on the upside. But value stocks don’t happen by sheer chance. For becoming one, the company must have a solid futuristic model in place. But how do you identify one? Ask yourself a simple question: where will this company be in 5 years from now? Is it trying to do something disruptive (with a high chance of success)? If you get into the area of power or telecom at this point of time, there is limited value you can create. That is the very nature of the industry. But say, a company that is focused on a relatively new area—like artificial intelligence or machine learning—has a lot more potential to become a value stock.

Cash flows matter and they matter a lot

In an investment world that is obsessed with top-line growth and market share, the good old measures of profits and cash flows are still relevant. At the end of the day, eyeballs and foot falls are no substitute for actual customers paying for your services. Telecom companies are going to take years to get back into profits with the current pricing model and diminishing ARPUs (Average Revenue Per User). Internet companies are producing revenues but profits are still elusive. Ultimately, your value is a sum of your future cash flows.

Prefer low debt and low equity companies

Value is most likely to be found in asset-light companies. A large equity base will mean your earnings get diluted. That was the problem that Tata Teleservices faced all along. High debt puts too much pressure on your income statement—like in case of companies like Bhushan Steel, Amtek Auto, and Jet Airways. If you look at the value creators in the past 25 years, the likes of Infosys, TCS, Eicher and Havells have all been low- to zero-debt companies.

Corporate governance matters more than you can imagine

What was common between stocks like IndusInd Bank, Yes Bank, ICICI Bank, and Axis Bank correcting sharply during the last one year? Corporate governance. When the markets believe that the companies have been less than transparent about shareholder’s interest, the stocks tend to get punished. Smaller stocks like Dewan Housing, Infibeam and PC Jewellers faced a more ruthless attack on their price after the corporate governance gaps became apparent. Looked at differently, the real value creators over the last 25 years have all been companies with a focus on transparency and disclosure. As Infosys’ founder Narayana Murthy summed it up succinctly: “When in doubt, disclose!''

Stick to your area of expertise and build on it

The bottom line is that it is hard to find value in too many stocks. Value identification is a rigorous exercise. Apart from the above points, you need to track the news, financials, and charts on a continuous basis for any signals. So, it’s best to stick to your area of expertise. What do we mean by that? Most people have some area of specialization, either through their education or the nature of their jobs. Instead of scouting for stocks in the universe, focus on stocks that you understand best. That is where you are most likely to find value. With a very methodical approach, it is possible to actually create a small set of potential value-stocks to focus on, and thus ensure a better ROI, in terms of both: money and time.