How to choose right stocks to optimize returns from share market

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Photo source: PTI

A view of the Bombay Stock Exchange (BSE) building on Thursday, February 24, 2022 in Mumbai.

The collapse of a stock market provides a fair opportunity for retail investors to buy quality stock. The Indian market has seen a handsome correction in the last three months following the unilateral rally, with the Sensex touching 62,245 and the Nifty touching 18,604.

With so much stock, it can be a daunting task for investors to cherry-pick and add the best to their portfolio. “While it may be easy to find the right stock, it can be difficult to get the right amount of diversity. Always remember to choose quality over quantity, “said Anand Mehta, VP of asset management at Koppr.

Mehta advises choosing the right stock for investing which can help investors to optimize returns.

1. Basics – Start with the basics

A strong balance sheet is like a company with a strong backbone! Look for companies that have good earnings and increased margins. Low debt, a good set of assets, however, has different parameters for determining each industry, it is always easier to make a comparative analysis and choose the one that gives the right signal.

Scheme through product / service lines and competitive landscapes, if the company works with a set of products / services that are consistent, with low options and peers. These companies have an unparalleled competitive advantage.

Pro Tip: Although there is no ideal timeline for viewing, at least 5-year past data should give you a fair idea of ​​how the company is performing.

2. Invest in what you know

This is one of the basic principles that advocates like Peter Lynch, Warren Buffett, advise people to invest in what they already know. If you do not understand the business, then it is not right to spend your money By understanding the business, we mean the key drivers, risks or threats to the business

Pro Tip: However, this does not mean that you invest in businesses that you understand, which will lead to a highly fragmented portfolio.

3. Management Discussion and Analysis (MDNA)

MDNA is a very important part of the balance sheet, however, before you look at this section, look at the management of the company, their experience, skills and track record. Whether management is able to take the company’s business to the next level is a key question you should be able to answer.

Pro Tip: Look at the MDNA section on the balance sheet for the past 3 years and make sure they have the vision, the key milestones they have created and evaluate whether they have tried to achieve these key milestones in the recent past.

4. Avoid momentum stocks

If certain stocks keep popping up in your feed or your friends talk about it, it is only natural to be attracted to such stocks. They can be an upward trend, however, buying a stock based on the recent ability to provide very modest returns can be quite risky. Also, finding the business model attractive is not a good reason to keep your money there.

Pro Tip: Always look at the prospects of the company before you invest, do your research, understand the key revenue drivers, risks and competitive landscape.

5. Understanding leverage

Another key aspect of looking at a company is how it has managed debt over the years. Instinctively, there are some sectors that have more debt. Real Estate, Power / Infrastructure Builders etc.

Pro Tip: All these capex heavy companies have a tendency to high leverage, for such companies it is important to look at the EBITDA margin and the quality of their assets to determine their ability to repay their loans.

For other sectors like retail, footwear, etc., where loan requirements may be comparatively less, we need to look for companies with less debt and strong revenue growth.

6. Topline driven or bottom driven

As mentioned earlier, it is important to identify the companies with the main revenue drivers, understanding the type of expenditure and how the margin playout for the sector needs to be understood. If the company is volume-based (retail, footwear, etc.), revenue growth needs to be strong.

Companies that operate in specific areas (e.g. branded cosmetics, branded clothing) need to show a sustainable increase in margins.

Pro Tip: So, understanding the type of cash flow of the business, the dynamics of the business and what aspects to look for can be the key to finding the right set of stocks.

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