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There are many theories and techniques about how
to choose a winner, how to separate the wheat from the chaff. Some are
homegrown, others are technically sophisticated. But beyond the jargon,
there are three basic factors to look for while picking a stock:
1. The company itself
2. Its external environment
3. The behaviour of its stock
What happens to the company affects the price of
its shares on the stockmarket and, hence, your investment. The legendary
investor Warren Buffet (incidentally, once the second richest man in the
world) says that he never invests in a company whose business he doesn�t
understand. As investors, we will do well to follow his practice.
So, knowing about companies is the first essential
step in investment. You will need to know the business a company is in,
and how is it doing both in absolute terms and in comparison to other
companies in the same business. To do that, you have to look at the financial
performance of companies and pick up the star performers. You will also
need to look at the future of the business itself. Is it nearing the end
of its life cycle? As investors, we hope to participate in a business
with a lot of scope for growth.
We also need to look at the performance of the entire
sector. Whatever for? After all, we aren�t investing in sectors. We�re
putting our money in companies and we can get to know them by looking
at their performance. Right? Well, look at it this way. Take your own
profession. Doesn�t what happens to others in the same profession affect
you too? If you are a banker and you see other banks laying off employees,
you bet your last rupee you�ll start worrying whether your bank is the
next in line to start downsizing. So, what happens in the banking sector
concerns everybody with a stake in that sector.
Just like employees, investors too have a stake in
the sector in which they have invested. As an investor, you wish to know
the risks your company faces. These are of two types -- one that is peculiar
to the company and can be controlled by it (called a unique risk), and
the other which is more pervasive and often beyond the company�s control
(called a systemic risk). We need to know about both kinds of risks to
plan our investment strategy. For example, if the steel sector is not
doing too well at the moment (a systemic risk), you may wish to move your
investment out of a company in this sector.
A company operates within the broad framework of
the economy. Its future is closely linked with the performance of the
economy. This is due to the interdependence among various industries and
sectors of the economy. Take the steel industry again. To do well, it
needs a good demand for its products. Now, suppose the automotive industry
or the construction industry is not doing well. Will that affect the steel
industry? Of course, it will, because both automobiles and construction
industries use steel. If these sectors are not doing well, the demand
for steel will drop, affecting the performance of the steel industry.
The indicators on the economy allow us to track general trends in the
economy. If they don�t look very healthy, we ought to be cautious as investors.
Professional stock pickers adopt different processes
to analyse stocks. Some adopt a method in which they begin at the general
and then zoom in to the specific i.e. they would probably begin with an
analysis of the economy. While analysing the present state of the economy
they would look at interest rates, what economic outlook the finance ministry
projects for the short term and other political events that might have
a bearing on the economy. Having reached a conclusion about the economy,
the professional will choose industries that he expects will perform well
under the given economic conditions. Next, he hones in on some of the
companies in the industry, sees how the companies are performing and then
evaluates their stocks. The end product of such an analysis is to convincingly
answer one question for his investors: Is the price at which the stock
is currently selling worth it? The other method works in the reverse way
in which the professional analyst picks up a stock, looks at the current
and historic performance of the company, then studies the industry and
finally takes an overview of the economy.
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