"You are always talking about boring Index funds and mutual funds...
"Already because of corona, we were not able go out like in the past...
"To add spice to this boring life, we opened accounts in Zerodha, Robinhood to invest in individual stocks...
"But you have not got past talking about index funds yet..."
If that is what is in your mind, then this episode is just for you.
Before going in, we should understand certain things clearly.
Only very few can consistently beat an Index by investing in individual stocks.
Less than 1%.
Ask yourself the question of whether you are in that narrow %.
Watch this episode, only if you understand that risk and still want to try a small % of your portfolio with this approach.
Others can actually spend their time better by watching food review channel.
That is first disclaimer.
Second disclaimer is that I am sharing "my" strategy to pick a good stock.
There is no right or wrong here. It is totally personal choice and personal opinion.
Cherry pick anything that you like from this and use it in your strategy.
Now we can get into the episode.
Doing complicated research, running some numbers, checking all the financial ratios is NOT how I choose my stocks.
My process is very simple and straight forward.
The first filtering criteria I use is Largecaps.
That is, I consider only big companies.
A company's marketcap should be above 20,000 Crores in India or 10 Billions in USA.
If you don't know what a marketcap is, pause this video and watch "Understanding sharemarket" video in our channel.
So first filtering criteria is "Largecaps".
Because we are already taking a bigger risk by investing in individual stocks rather than in a mutual fund.
So it is better to invest on conservative side.
The problem with midcaps and smallcaps is, their volatility is high.
When there is a slowdown in economy, smallcaps will be the first to get hit.
Also when the economy recovers from a recession, smallcaps will be the last to recover.
When compared to US, the risks in smallcaps are even higher in India.
Because only in Indian smallcaps, all frauds happen.
Everything will go just fine, and then all of a sudden they throw a bomb saying that there is a problem in accounting.
We will not be able to even sell it. It will hit the lower circuits and goes down by 10%, 5% everyday.
We will end up losing all money.
At least in US, the small cap Index Russell 2000, even though it is volatile, it beats the S&P 500 in long term.
But in India, the smallcaps index does not beat the market index in long term.
So even for experimentation, do not buy smallcaps in India.
Stay away from it.
Another reason for avoiding small caps is that not too many know about these small companies.
So in my opinion, its valuation will not be right in the market.
For the stocks I am buying, I should not have a need to check if the price I am paying for it is right value.
To remove that valuation part from picking a good stock, we have to avoid small caps.
That is the another reason that I do not consider small caps.
The second thing that check is Revenue Growth.
This is the most important criteria for me.
We have to check how many % the revenue is growing every year.
That shows how fast that business is expanding in the market.
The revenue should grow consistently.
If the growth rate is above 10%, it is ideal. If it is above 15%, even better.
When the revenue grows, the price of the stock grows along with it automatically.
Let take Britannia for example.
For the last 5 yrs, the revenue is growing at a rate of 10% on average.
Share price is also keep moving up as well.
If the revenue is not growing or the growth is slowing down, then we have to check whether that is from economy slow down.
If the economy itself is slow, then its OK.
But if the economy is fine, but if just this company's growth is slowing down, then we should awake and try to get out of it.
Also to check the revenue growth, it is better to use annual data.
We should not use quarterly data.
Because each company has different rate of revenue growth in different seasons.
If we take Apple for example, their December quarter sales is usually 50% higher than the other quarter sales.
The additional sales is coming from Christmas sales.
So for comparing a quarterly data, we should be comparing it against the data from same quarter in the previous year rather than to the previous quarter.
Next thing we have to check is "Net Income" i.e Earnings.
We have to check if the earnings are growing at the same as revenue.
As long it is matches the growth rate of the revenue, it is good.
We can calculate P/E ratio from this earnings.
P/E ratio is Price/Earnings ratio.
If we divide the total marketcap with earnings, we get P/E ratio.
Many use this P/E ratio to check if the value of the stock is overvalued or undervalued.
High P/E ratio implies that the price of the share is higher for the earnings that it is making.
and so it is expensive.
We can see this in another angle as well.
Because it is a quality business, investors are willing to pay a premium price for it.
Personally I do not look into P/E ratio.
Like I already said, I try to avoid evaluating a company.
Because for me, valuation is like beauty.
It is in beholders eyes.
So for everyone, the valuation is different.
For some that appears as valuable might not be a valuable one for others.
So for me, market would have already evaluated a company and has assigned appropriate price for it.
In my opinion, there is no need to do any additional valuation.
Many look for unknown undervalued companies in the hope that it would appreciate in value in the future.
I do not have much interest in it.
In my opinion, when there are many successful businesses in out open, there is no need to search for undervalued business for additional risk.
So if I like a business and if it its revenue and earnings are growing at a healthy rate, I will not hesitate to buy that at current price.
Lets take the same Britannia example.
For the past 10 yrs, the revenue and earnings is growing consistently.
Stock price is also keep going up.
During the past 10 yrs, regardless of when I bought it, I will be sitting in gains now.
Same story in Apple as well.
So if you ask me, there is no need to evaluate a well established and high growth company.
Just keep buying.
The next criteria I check is "Beta".
Beta shows how the price of the stock moves compared to the market.
Beta of the whole market is 1.
i.e. Indices like S&P 500 and Nifty 50 have a Beta of 1.
Because those indices are the market.
If a stock has a Beta of over 1, then its volatility i.e its price movements will be higher than the market index.
If its less than 1, then its volatility and so the price movements will be less than the market index.
I like high growth low volatility stocks.
So all the stocks that I choose will not have a Beta of over 1.3
I will have some exceptions for this rule.
Lets say that there is a really good aggressively growing company that matches all my other criteria, but if its Beta alone is out of range,
then I might add that as an exception to my portfolio.
But I will add more than 2 out of 10 stocks under those exception rules.
That is all the critieria I use.
These criteria have worked out well for me for the past 12 years.
You will know from these criteria, that these stocks do not go up and down 3-4% everyday.
They move slowly. But would have appreciated well in long term.
Full disclaimer: 50% of my portfolio is in individual stocks.
If I have to repeat this whole thing again, I would prefer ETFs over individual stocks
Fortunately or unfortunately, I am not able to switch over to ETFs now by selling the stocks as they are all in heavy gains.
Tax problems.
I have to switch over to ETFs when I leave my job.
The reason I am saying this is because, as the portfolio grows bigger and bigger, there will be practical difficulties in maintaining individual stocks.
In case of ETFs, there is no need for following a company closely or worry about tax problems.
One more reason for not getting into individual stocks.
I will see you soon again with another interesting topic. Thank You.