Beware! This market has stocks that will burn money; here's how to spot them
, ETMarkets.com|
Updated: Oct 11, 2017, 10.12 AM IST
A healthy balance sheet is often the key to spotting good stocks. If return ratios are strong and cash flow robust, that’s icing on the cake.
Balance sheet is a financial statement that captures a company’s assets, liabilities and shareholder equity at a specific point in time.
Successful investors have their own comfort zone in choosing the parameters to judge a stock.
While reading a balance sheet, look at the leverage, says Vishal Khandelwal, an investor and founder of Safalniveshak. “I keep away from companies that borrow a lot,” he told ETNow in an interview.
The second important thing to look at on the balance sheet is working capital, which is the cash a business uses for day-to-day operations and is calculated as current assets minus the current liabilities.
Working capital works like a treadmill: you keep running, running, running and you do not go anywhere, says Khandelwal. Some investors do not like companies that require a lot of it.
A balance sheet is more like an engine of a car; the profit and loss statement is the dashboard, says Khandelwal.
For that car, cash flow is the fuel.
The speed of a car depends on the power of the engine, which means power of the balance sheet can drive growth of a business over the long term. It is very difficult to grow for companies whose balance sheet and cash flow do not support them.
Khandelwal has a smart simile: the management is the driver of a company; competition is traffic and the car is the business.
Out of all the parameters, management is the most important feature of any business, says Dr Vijay Malik, a value investor. He was talking about the art of stock picking in an interview with ETMarkets.com.
“I read past annual reports, credit rating reports, media articles and other publically available resources to ensure if the company management has taken any decision in the past, which has been against the interests of minority shareholders,” Malik said.
Any sign of actions where promoter/management has attempted to benefit at the cost of minority shareholders should be the first ‘no go’ sign for investors, irrespective of how good the financial and valuation parameters may look like.
Once satisfied with the financial and management criteria, Malik uses a margin of safety framework comprising a customised ratio called the self-sustainable growth rate (SSGR) and free cash flow (FCF) to determine strength in the business and the buying range for the stock.
FCF is the surplus amount a business generates after it paying of its operating expenses and capital expenditure. It shows how efficient a business is in generating cash and if it can pay investors some return after funding its operations and expansions.
“If a company meets all my parameters and is available within my buying range, then I start investing in it,” says Malik.
Khandelwal says a lot of businesses look good in terms of growth in the present market condition. He advises investors to stay away from companies which are not achieving good return on capital, as they are like a dead business.
“Those are the businesses that will burn your money,” he added.
Balance sheet is a financial statement that captures a company’s assets, liabilities and shareholder equity at a specific point in time.
Successful investors have their own comfort zone in choosing the parameters to judge a stock.
While reading a balance sheet, look at the leverage, says Vishal Khandelwal, an investor and founder of Safalniveshak. “I keep away from companies that borrow a lot,” he told ETNow in an interview.
The second important thing to look at on the balance sheet is working capital, which is the cash a business uses for day-to-day operations and is calculated as current assets minus the current liabilities.
Working capital works like a treadmill: you keep running, running, running and you do not go anywhere, says Khandelwal. Some investors do not like companies that require a lot of it.
A balance sheet is more like an engine of a car; the profit and loss statement is the dashboard, says Khandelwal.
For that car, cash flow is the fuel.
The speed of a car depends on the power of the engine, which means power of the balance sheet can drive growth of a business over the long term. It is very difficult to grow for companies whose balance sheet and cash flow do not support them.
Khandelwal has a smart simile: the management is the driver of a company; competition is traffic and the car is the business.
Out of all the parameters, management is the most important feature of any business, says Dr Vijay Malik, a value investor. He was talking about the art of stock picking in an interview with ETMarkets.com.
“I read past annual reports, credit rating reports, media articles and other publically available resources to ensure if the company management has taken any decision in the past, which has been against the interests of minority shareholders,” Malik said.
Any sign of actions where promoter/management has attempted to benefit at the cost of minority shareholders should be the first ‘no go’ sign for investors, irrespective of how good the financial and valuation parameters may look like.
Once satisfied with the financial and management criteria, Malik uses a margin of safety framework comprising a customised ratio called the self-sustainable growth rate (SSGR) and free cash flow (FCF) to determine strength in the business and the buying range for the stock.
FCF is the surplus amount a business generates after it paying of its operating expenses and capital expenditure. It shows how efficient a business is in generating cash and if it can pay investors some return after funding its operations and expansions.
“If a company meets all my parameters and is available within my buying range, then I start investing in it,” says Malik.
Khandelwal says a lot of businesses look good in terms of growth in the present market condition. He advises investors to stay away from companies which are not achieving good return on capital, as they are like a dead business.
“Those are the businesses that will burn your money,” he added.
