How to pick a stock?

After knowing what stock market is and reading about successful investers and there journey, you also finally decided to enter the stock market.

You open your demat and trading account with broker and ready to make your first investment, you look for the company to invest in. There are around 5000 companies listed on National Stock exchange (NSE) and around 3000 companies on Bombay Stock exchange (BSE)

Now the main question arises, which company should you invest your money into?
Which company will give you good returns?
How to select a good company which can give you good returns?

Remember buying a stock of company make you part owner of that company, it means that you are buying a company. So before selecting the stock to invest, first understand about the company you want to invest in , know about its business model and it's history.

To analyse about the company you want to invest your money into , one has to look at few parameters before coming to conclusion.

This parameters are -
1 PE ratio
2 price to book value
3 EPS
4 Debt to Equity ratio
5 Operating profit margin (OPM)
6 Return on equity (ROE)
7 Dividend yield

This are some of parameters you have to analyse before selecting the stock, this will give you better knowledge about companies performance and about its future.

Let's understand this parameters in some detail :-

1 PE ratio

Price to earning ratio or PE ratio, shows how much investors are paying for each rupees of earning of the company. It shows whether underlying stock is overvalued or undervalued.

One can know the ideal pe ratio by comparing company's current PE ratio to its historical PE ratio and PE ratio of sector to which company belongs. For instance PE ratio between 13-20 is considered to be good, if it is above 20 it may be because of two reasons, first that company may be overvalued and second that it is going to give good profits in future.
If PE ratio is below 13 it means that company is undervalued or that it is not going to perform well in future.

One very important point to remember is that , one cannot compare PE ratio of companies of two different sectors, for example comparing PE ratio of Wipro which of IT sector stock to HDFC from bank sector will be of no use. You can compare Wipro with another IT sector stock like Infosys or TCS and HDFC with any bank like SBI or ICICI.


2 Price to book value


The price-to-book value (P/BV) ratio is used to compare a company's market price to its book value. Book value, in simple terms, is the amount that will remain if the company liquidates its assets and repays all its liabilities.

 P/BV ratio values shares of companies with large tangible assets on their balance sheets. A P/BV ratio of less than one shows the stock is undervalued (value of assets on the company's books is more than the value the market is assigning to the company). It indicates a company's inherent value and is useful in valuing companies whose assets are mostly liquid, for instance, banks and financial institutions. 


3 Earning per share 

Earning per share (EPS), also called net
income per share, is a market parameter that measures the amount of net income earned per share of stock outstanding. In other words, this is the amount of money each share of stock would receive if all of the profits were distributed to the outstanding shares at the end of the year.
Earnings per share is also a calculation that shows how profitable a company is on a shareholder basis. So a larger company’s profits per share can be compared to smaller company’s profits per share. Obviously, this calculation is heavily influenced on how many shares are outstanding. Thus, a larger company will have to split its earning amongst many more shares of stock compared to a smaller company.

4 Debt to Equity ratio

It shows how much a company is leveraged, that is, how much debt is involved in the business vis-a-vis promoters' capital (equity). A low figure is usually considered better. But it must not be seen in isolation.

5 OPERATING PROFIT MARGIN

The OPM shows operational efficiency and pricing power. It is calculated by dividing operating profit by net sales.
It measures the proportion of revenue that is left after meeting variable costs such as raw materials and wages. The higher the margin, the better it is for investors.

6 Return on equity (REO)

The ultimate aim of any investment is returns. Return on equity, or ROE, measures the return that shareholders get from the business and overall earnings. It helps investors compare profitability of companies in the same industry. A figure is always better. The ratio highlights the capability of the management. ROE is net income divided by shareholder equity.

7 Dividend yield

It is dividend per share divided by the share price. A higher figure signals that the company is doing well. But one must be wary of penny stocks (that lack quality but have high dividend yields) and companies benefiting from one-time gains or excess unused cash which they may use to declare special dividends. Similarly, a low dividend yield may not always imply a bad investment as companies (particularly at nascent or growth stages) may choose to reinvest all their earnings so that shareholders earn good returns in the long term.


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