This article is just a short and quick pointers, giving you many important and quick parameters to notice, understand and analyse before investing in any company. It will give you useful insights of areas to focus on before putting your money in any company, when to buy the stocks, how to manage your portfolio, what to look into a company. It is very short article, so do expect useful pointers but no detailed explanation.

Learning 1: Timing the Market:

Bull Markets and Bear Markets, investing quick and slow. It is noticed that, when people invest in bull markets they tend to lose money more often than people investing money in bear markets. Bull markets do not give us time to analyse and perform due diligence before investing, because when we do spend time doing research, the share price would already rise so much that investing at such high value becomes difficult. Whereas the truth is, while investing in bull market, you should actually do detailed due diligence before investing, because everything are at high price, chances that you will pick overvalued and wrong stock are very high. On the other hand, investing in bear market with minimal due diligence, there are very acute instances that you will lose money, because everything are already priced too low. “Hence, bear markets with least due diligence provide more market returns than bull market with higher due diligence.”

Learning 2: Great Wealth Creation Formula:

Compounding Interest. It is great formula to make your money grow huge and huger over a long period of time. It is basically, interest on interest earned. So, simple terms, a 1 lakh FD will give you 10% interest for the first year making it total of 1.1 Lakh. But, usually that 0.1 Lakh will be credit to bank rather than getting reinvested. Hence, original FD of 1 Lakh remains and you keep on earning 0.1 Lakh every year. But, instead, if you reinvest interest amount of 0.1 Lakh, you will additionally earn 10% more on interest amount as well, apart from principle amount. This goes on year on year when you keep reinvesting the interest amount. At end of say 20 years, your Rs. 1 Lakh converts to Rs. 6.72 Lakh if you reinvest (Compounding Interest) compared to Rs. 1 Lakh converting to Rs. 3 Lakh, if you do not reinvest (Simple Interest). “Hence, to create long term wealth, focus on Compounding Interest.”

Learning 3: High Priced stock is not necessary expensive:

Two companies, one trading at Rs. 27 and other at Rs. 9,785. Both companies are similar in almost all aspects (ignoring share capital and market cap.). Company trading at Rs. 27 got bankrupt and Company trading at Rs. 9,785 moved to Rs. 11,000/- in 6 months and currently the price is trading at more than Rs. 50,000 a share. Well, you might have guessed the name of company but the point it “Higher the stock price is not necessarily a bad buy w.r.t. lower stock price.” You might have seen people saying “Suggest me a share below Rs. 100 that will turn multi-bagger”, such a wrong and incorrect mentality.

Learning 4: Track your investments:

If you invest your own hard earned money, you surely want to be it safe and moreover earn some reasonable returns. So, suggestion is make excel sheet. In that sheet, type down the investment amount, date you invested, on what basis you invested or reason for your investment, and the target price or expectation from the stock in stipulated time horizon. At least, you remember your investment and reason behind it. Also, it will help you in discovering all the wrong reasons you invested and lost your money.

Learning 5: Portfolio Classification:

Classify your total investment into different categories, the way you are comfortable with. Just for an example, I would invest 75-85% of my fund on high conviction stock, 10-15% on unsure but worth looking into stocks, and rest on some technical and trading purpose. This will keep a good track of your money, and will also avoid any unnecessary losses by over allocation to some other areas then defined by classification.

Learning 6: Reading Basic Financial:

• Consolidated v/s Standalone.
  Consider seeing consolidated number, because shares are priced on whole company’s value basis. Hence, consolidated number is preferable than standalone. Also, we should look for enterprise value (value of whole company) rather than only market cap.
  
  
• Cash Flow Statement v/s Profit and Loss v/s Receivables (Debtors)
  Most of the adjustment for manipulating profit is done only through Profit and Loss statement, and so studying trends in profit and sales growth may still be useful but Profit and Loss on standalone basis does not give meaningful conclusions.What is more important for any company is, if they make profit on anything, they should realise cash on it. Hence, seeing net profit and Cash Flow from operation (CFO) both in similar context is more important. When year on year net profit is approximately matching with the Cash Generated (CFO), we can reasonably conclude that company’s profit are being realised in cash.
  However, when despite good profits, CFO is not generating, there might be some issue. Often, excess sales are recorded to increase profit, but sales value in cash is not received, nor any time soon. This can be evidently seen from rising Receivables level and lower CFO levels. When you spot this, you can conclude that management is unnecessarily stuffing up the sales to increasing profit, a case of fraud to make up (manipulate) Financial Statements.

• Positive Cash Flow and its manipulation
  Cash is King. And also, if company wants to survive for long term, it should generate enough cash to keep on running its business out of its own profit rather than loan. Hence, consider companies which generate Positive Cash Flows. Even CFO can be manipulated by some cash entries and adjustments, however, if companies keep on manipulating it, the amount of adjustment will be so high in future years that it will be difficult to manage, and the fraud might get discovered. Hence, adjustment in Cash Flow by manipulation is not a long term solution, and we hardly see any company manipulating Cash Flows.
  
  
• Interest Payment v/s Net Profit.
  When company has taken loan, it should also generate enough profits to pay the interest. Hence, net profit and interest amount are compared to check whether they can be sufficiently paid or not. On Rs. 10 of profit, Rs. 4-5 of interest is preferable as well as manageable. Hence, if ratio is above 0.4/0.5, this might be considered as warning signs, keeping in mind if future profits are not generated, then servicing interest as well as principle can by difficult task.
  
  
• Interest Expense v/s Debt.
  When interest amount is way too low as compare to debt, it might be possible the company is capitalizing its interest or hiding it on the face. Also, presence of foreign debt available at lower interest rate makes this ratio less. Hence, if interest to debt percentage is too low, there are potential problems in the company.
  
  
• Tax Paid v/s Provision for tax comparison.
  We should see the tax amount in Profit and Loss a/c with Tax actually paid in cash flow statement. Analysing the amount of tax paid, w.r.t. only the provision, we will understand how much tax is to be paid more/less in future. Analyse the impact of amount of outflow in future w.r.t tax provisions.
  
  
• Equity Dilution and Debt Levels
  When company, on continuous basis are diluting their equity for raising funds, it might be warning signs. Good companies value their equity more, and hence consider raising debt rather that diluting away equity at cheap rates. Hence, when you see quite often the equity is diluted, it is not a good sign.
  Debt levels should be reasonable. It should be manageable by the company. Company making cash profits have greater ability to service its debt. Hence, if debts are present, we should also check the amount of CFO generated.
  If CFO is not enough to repay debt, coupled with rising level of debt, low interest to profit ratio and continuously diluting equity. Stay away from the company, as the risk associated with it is extremely high.

Learning 7: Understanding Basic Non-Financial information:

• Companies Line of Business.
  Analysing this on small companies is more important and crucial then larger companies. See what the business of company is. Example: there is one company (actual example) manufacturing speaker, amplifiers, and headphones. However, it deals in fabric as well. Why the hell will anyone do fabric business and electronic business both, a completely different line of business and requiring different domain of expertise. Although it is more in speaker’s business, its fabric business might be like ‘selling across 56 countries and 6 continents, Indian arm has a dealer network of 300-400, with open store on these many cities.’ Basically, what? This company should be both, Bosch as well as Raymond.
  “Conclusion is simple, the line of business they do and level of exaggeration they have done, shows the quality of business, STAY AWAY.”
  
  
• Chairmen’s and CEO speech.
  Good companies give genuine information and straight to the point explanations. So, a good speech will share you the company’s performance, its risk, opportunities, and future plans. Do verify, what they have claimed as “Future Plans”, have been executed or not, shows how much honest are the management.
  On the other hand, a bad companies find ways to promise its investors which are false. Unnecessary using fancy information, showing big potential industry numbers, promises which never get fulfilled, etc.
  
  
• Director’s Salary and Qualification.
  Director’s salary with proportion to the profit earned is important. We should make sure they are not overly compensated, and if they are, it is like directors are taking money home indicating company is not run professionally. Also, see trends in profits and % of salary increase.
  Also, check whether independent directors are truly independent or not. Instance that, a company has kept independent director whose age is 27 only. His qualification is no more than B. Com, and who knows he is pursuing MBA or not. And his job is to look over the companies operation in all domain. You see, the level of independence that independent director will have, and the companies false claim.
  Also, check whether directors are attending the meeting consistently or not. Another important aspect to be considered, as when they attend all meetings, it is considered they being interested in business operations.
  
  Here is an excerpt of independent director being described in one off the annual reports: “Director is a commerce graduate from Delhi University and creative personality by passion. He has a sound knowledge and experience in GST and Taxation. He is appointed as director of the company with an objective to handle at best of his skills in every domain. He is currently pursuing MBA and doing soft drinks business in UP.” Company went bankrupt soon.
  
  
• Promoters Holding.
  Firstly, promoters holding should only be considered for unpledged shares. Pledged shares are often considered as sold, because they can be sold anytime and promoters gets its money safe but retail are stuck. Hence, when comes to promoters holding, only unpledged shares should be considered.
  
  Important aspect to cover, again. If holding of promoter is at near 70%, shows promoter is interested in its own business and will work to take it forward. More than 50% holding is considered good. Anything between 35% to 50% promoters holding needs further analysis of promoter. But, when holding is less than 35%, often is considered as risky. However, there are certain exceptions like regulatory requirement, very professionally managed companies, etc.
  Promoters, may over the time increase its stake or might even reduce. Reducing the stake should not always be considered a bad sign. When promoters are invested in the company for so long, it is know if they book profit and take money home. However, a huge chunk of selling and making its holding below 50% or such levels should be considered a danger sign. Also, promoters increasing stake during bad times is more better, shows promoter is confident is business and hence buying stake at lower values.
  
  
• Auditors term and Remuneration
  Auditors retiring before its term, is considered as warning sign. This is because they will only retire when they don’t sign some documents or ongoing issues with the management. Which means management are not corporative or auditors are not ready to sign false documents. Hence, some auditor might agree to sign for more compensation and overly high auditor’s remuneration is also considered a warning sign.
  
  
• Other FII’s, M.F and Institutional investors holding.
  Many of FII’s, M.F and even institutional reputed investors have lost their money in markets. Hence, they holding certain % of holding of certain company is not enough in concluding that our bet on such companies will be safe.
  Also, who knows, there might be some backend adjustments done between companies and these investors to lure away retails money, whereas both company and institutions money being safe. So, do your own analysis, because it is your money. Don’t put on someone else’s assurance.
  
  
• Small Cap, SME companies specific issues.
  SME platform was launched for a purpose of supporting these companies to raise fund through a better way of equity, and also getting them listed on stock exchanged. But, the whole purpose is defeated, as these days, the companies on SME platform are only launched for the purpose of stealing the money.
  We only see 3-4 companies out of 100, listing on SME sector, are on good purpose. Also, out of these genuine 3-4 companies, 1-2 companies’ business actually fail. Hence, the probability of you earning money in SME sector is very acute at 2-3%. Hence, why to bet your money there? Logical as it seems.

Closure:

A lot of emphasis of this article is put on Directors Independence, salary and qualification; Promoters unpledged holding; Debt levels v/s interest, Cash Flow v/s Net Profit, Interest v/s Net Profit and equity dilution. All forms very important aspect in analysing any company.
These are starter pack, before you dig in to the company for detailed investment. If you find these parameters reasonable, you can go ahead for complete analysis. Else, ignoring such companies is best to save your efforts.

Credits to Niteen Dharmavat’s video posted on YouTube, link: https://youtu.be/NUZ2MTJjvnU