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20 Questions to Answer Before Investing in an Equity Scrip!

Covid-19 has changed the way we live. From working remotely to transacting online to taking hour-long work breaks for home chores or taking care or our kids, we all have adjusted ourselves to this pandemic. Investment is no exception to this. In the Indian financial market, we’ve seen a preferable shift towards financial assets since the pandemic began. We had 40.10 million trading accounts in February 2020 and that number rose to 47.6 million in October 2020. We’ve also seen the benchmark indices move northwards since April 2020.


While one of the reasons is the pandemic, there are many more reasons that have contributed to the growth of the financial market in India. Technology and discount broking being two more on the list of reasons to make things easier for the investor. Having said that, it is very important to answer these 20 questions (points) before investing in an equity scrip. And honestly, it’s not very difficult. Just a bit of common sense.


To make this simple for our readers, we have categorised these questions in four segments - 1x, 2x, 3x and 4x factors, each segment containing five questions.


If the answer to the question in 1x factor is positive – the scrip scores one point. In the case of 2x factor, the scrip scores two points for each question and thrice and four times respectively for 3x and 4x factors. So, the maximum points scored (including 3x and 4x) would be 50. Let us now understand those 20 questions. And don’t forget to keep a pen and paper beside you to keep your score track.


1x factors


Q1. Brand: Does the company's business rely on recognisable branding truly valued by its buyer base?


While the brand holds its own value, it also has its own impact in terms of sales growth, pricing power and repeat business. One must understand what kind of brand they are investing in?


Q2. Raving fans: Does the company, on the whole, receive positive word of mouth from its customers?


While advertising is normal, it is the word of mouth that makes the product and its business sustainable in long term.


Q3. Diversification: Has the company diversified its buyer base so that no single customer accounts for more than 20 per cent of revenue?


Apart from this the segment wise diversification and geographical diversification also plays an important role.


Q4. Disclosure: Does the company maintain a high standard of disclosure, consistent with Securities and Exchange Board of India (SEBI) guidelines and other regulators?


Compliance may be a subjective and qualitative factor. However, if the compliances are followed righteously, such companies enjoy a premium over the peers on bourses.


Q5. Transparency: Would an intermediate investor find the company's financial statements and management ownership disclosures relatively easy to sift through and understand?


2x factors


Q6. Insider Stake: Do any key insiders have at least a 5 per cent stake in the company?

Especially in case of mid-cap companies or small cap companies. There are few large-cap companies where the insider’s stake is lower than five percent. However, such companies score better in other parameters and hence it is not necessary to put it.


Q7. Not an Underdog: Is the company free of any direct competitors that have substantially greater financial resources?


If there is a competition with deep pockets it not only affects the pricing power but also affects the margins severely. An example of this would be Reliance’s Jio taking on other telecom players in the country.


Q8. Goliath: Is the company free of any disruptive upstarts visibly challenging its business model?


Here one must understand if the business model is easily replicable and technology can disrupt that segment. For instance, online discount brokers are becoming the largest players in terms of active customers compared to traditional broking houses.


Q9. Moat: Would potential new competitors face high economic, technological, or regulatory barriers to entry?


Moat not only makes businesses sustainable but also scalable. Lesser the number of new entrants in the business, higher is the sustainability of margins.


Q10. Ownership: Does the promoter/promoter group hold more than 33 per cent stake for the past 6 quarters?


A higher share of the promoters holding gives more confidence to the investors.


3x factors


Q11. Cash Flow: Was the company cash flow-positive during the previous quarter and past 12 months?


It is stated that top line (revenues) is vanity, Bottom-line (net profit) is sanity and the only reality is cash flow. Check how the company scores here.


Q12. Experience: Does the top management have more than 15 years of combined leadership at the company?


This helps the company endure the different economic peaks and troughs.


Q13. Market Cap: Does the stock have a market cap of more than at least 500 crore?

Anything less would mean there is not enough liquidity to either enter or even exit the counter.


Q14. Beta: Is this stock's beta less than 1.3 for the past 12 months?


A beta of 1.3 means – if Index moves up by 1 per cent, the stock would move 1.3 percent. It is applicable to decline in index also.


Q15. Self Sufficiency: Can the company operate its business in the next three years without relying on external funding?


If the company has the ability to fund the expansion on its own funds, it is a major positive. While others may find it difficult to expand when interest rates are higher, self-sufficient companies would go ahead with expansion.


4x factors


Q.16 Profitability: Was the company profitable during the previous 4 quarters?

While sales growth is important, consistency on bottom-line is also essential.


Q17. Earning per share (EPS): Is the EPS growth visible in 4 out of 5 immediate preceding years?


EPS is calculated as (Net Profit / Number of outstanding shares).


Q18. P/E Ratio: Price-to-earnings ratio is calculated as (Market Price / EPS).


Try to find out if the stock has a positive price-to-earnings multiple that is 10 percent above or below it's 5 year average?


Q19. Growth: Did the company increase its sales in the range of 10 percent to 30 percent annually in the previous three years?


Growth is the only constant in terms of business. Unless the sales volumes increase, it would not be taken as a consistent growth.


Q20. Well-Managed: Did the company report a return on equity (RoE) of more than its 2 year's average in the previous year?


The return on equity means how much the business is generating on the invested capital by equity shareholders. If it is on a declining path – it is advisable to avoid such investment.



Wondering whether to invest or exit based on your score? We’ve demystified that for you here:


Should I invest?


On a 50-point scale, if your point scales points out to

>42 – Invest immediately

>36 & <42 – Wait for 42 to invest (2 Quarter’s)

>30 & <36 – Do more research!

<30 – Stay away from the stock

Should I Exit?


On a 50-point scale, if your point scales points out to

>42 – Stay invested

>36 & <42 – Hold

>30 & <36 – Profit booking

<30 – Exit and stay away from the stock

 

Conclusion: Quantitative parameters have higher points and qualitative parameters have lower points. However, most of the questions need a clear yes or no.


Pro Tip: Focus on subjective qualitative factors. Numbers (quantitative factors) can be manipulated easily, but one cannot manipulate the qualitative aspects.



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