How To Identify A Good Investment Pick

Knowing
your investment rationale is very important. Stock prices move on
expectations. Some expectations are general: the company management
will identify new avenues of growth, the industry will continue to grow
at 30%, the business cycle is about to change and the industry Price to
Earnings multiple is set for a re-rating. Some are specific: a foreign
company will buy out the Indian management, the company will become a
market leader in its industry, or you expect sales growth to jump from
8% to 30%. Knowing why you are buying a stock will yield a set of
factors to keep an eye on –in stock market parlance, these are called
triggers. If these factors happen as planned, you are safe, if not you
need to be careful and revaluate your decision.

A company that has
good management usually rewards its shareholders, at least in the
longer run. They know their business well, are focused on their core
competence, use company funds wisely, follow good corporate governance
principles and for them, the listed company comes first.
How do
you identify good management? Read what newspapers and analysts say
about them. Annual Reports often give an idea of whether the strategy
and outlook spelt out by the management reflect in their actions and
performance during the year. Do their actions point to concern for the
company; hiking their compensation by 100% in a year when the company
profits are down by 10% is a red alert. Are they dynamic, if the
domestic market has entered a sedate phase of growth, do they brace for
a slowdown or do they go out to other markets and succeed in
maintaining growth? Good management usually means half the work done in
identifying a good stock.

Often, people say
this company is doing very well but its share is expensive and this
company’s profits are thin, but the stock is attractive. The first one
is a growth stock and the second a value stock. There are no exact
answers to which is a better bet, but one, you should know where your
stock fits in and two, why you are buying it. Growth stocks may seem
expensive, but if the triggers are strong they will continue to remain
so, which means you will gain. Value stocks may appear cheap, and may
remain cheap if the factors that make it so –poor sales growth,
recession in its industry, cheaper imports from China- continue. So, an
inexpensive stock may not appreciate at all.

You cannot
make money by following what everyone is recommending. Instead, do your
analysis and pick stocks that suit your risk-return profile. If they
happen to be the stocks everyone is recommending that is only an
additional factor in your favour. A contrarian strategy is rewarding
but only if your logic is right and you have the patience to wait.
Contrarian plays usually take more time in bring returns, as price
appreciation happens only when the market too spots a winner in the
stock.

When you
are buying a company, identify the phase in which the industry is. If
the industry is about to enter a growth phase, companies too will do
well. If you spot this early enough you have a fair chance of making a
good packet by buying the stock. Similarly, when you see that the
industry cycle has peaked it may be time to make an exit from the
stock, or at least lower your exposure to it.

Looking
at financial numbers and analysing them to spot trends often give early
signs of a potentially rewarding investment option. A company that has
a low price to earnings multiple, with steady sales and profit growth
and a healthy balance sheet can be considered as a good long term
investment.

Peer
comparison is critical in an investment pick, why should you buy Auto
company X instead of Y should be evident. Evaluate them on various
parameters, business, management, market share and other strengths.
Then do a SWOT analysis to figure out which company offers a better
investment option.