Every expert was once a beginner!
You have finally decided to step into the Stock Market. Congratulations on your journey towards long term wealth creation! But now that you are in, how to decide which stock to buy? There are currently over 7500 companies listed in BSE which makes it especially difficult for beginners to navigate which company will be the best one to invest.
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Although there is no such thing as a ‘best’ stock, these points can be used as a guide to decide on which stock to buy as your first stock –
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Find a growing sector
The most important factor to select your first stock should be the sector to which the stock belongs. Always look out for sectors which have good growth opportunities and will continue to do well down the road. Such sectors are called as Sunrise sectors. Stay away from sectors which are past their prime and are steadily declining, also know as Sunset sectors. One example of a growing sector can be the IT sector which has done well over the past decade and can continue to do well as our world becomes more and more digitalized. On the other hand, coal industry can be considered as a declining sector because every country is planning to move away from fossil fuels and looking towards renewable sources of energy.
Always select stocks which belong to a growing sector and avoid stocks from declining sectors. Even if you choose the market leaders from the declining sector, there is a possibility that the stock will underperform because there is not much room for growth available for the entire sector. However for growing sectors, even if you choose the second or third best company available, there is a much higher probability of making money. An okay company from a growing sector is better than the best company from a declining sector.
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The bigger the better
Now that you have selected your sector it is time to filter out the stock. In any particular sector, you will have three types of companies – largecaps, midcaps and smallcaps. Most retail investors get attracted towards the smallcap companies because there is a lot of growth potential. While this is generally true, smallcap companies also have a very high failure rate. Think about it! How many of your friends and family start a new business and have to stop because the business eventually fails? This is the biggest problem with smallcap companies. Smallcaps have the highest growth potential but there is a very small percentage of smallcaps which survive to become midcaps and largecaps in the future.
The best option for retail investors are the largecaps. Always go for the market leader when you are trying to select your first stock. Market leaders have been doing business for decades and have built trust with the investors. This trust is rewarded by the investors in the form of premium company valuations. These companies also have the highest probability of surviving a market crash and are the first ones to recover. If there is a market crash and every company is available at a discount, will you choose a reliable company like Hindustan Unilever or some random company which nobody knows? You now know the answer. Choose largecaps as your first stock.
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Understand company valuations
This is one of the most difficult part for new retail investors. How can I understand the valuations of the company? And what exactly are valuations? I will explain it in very simple terms. When you go for shopping you look for the biggest discounts available in the market. Get the best product for a cheap price. You have to do the exact same thing in the Stock Market. However, this is where most retail investors make a mistake. They see a stock like TCS available for Rs. 3400 (at the time of writing) and a stock like RPower available at Rs. 13.5 (at the time of writing) and think that RPower is a lot cheaper than TCS. This is a BIG mistake. Price of the stock doesn’t represent the value of the stock. Instead of the price of the company, always look for the P/E ratio of the company.
P/E Ratio = Price per Share / Earnings per Share
You do not need to calculate this by yourself! This data is easily available on most Stock Market websites. A company which has a low P/E ratio means it is available at a cheaper valuations.
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Look at the recent results
Let’s say that you have followed all the previous steps. You have found a company which belongs to a growing sector, it is the market leader of that sector and you have found out that the company valuations are pretty cheap and the company is available at a discount. But when you go ahead and check out the company results, you find is that the recent results of the company have been a disappointment! Always check the company results before you invest in any particular stock. Make a habit of checking out the previous 5 years performance of the company to make sure that the company you are investing in has a good track record.
Now if you are wondering what are the things I need to look at when analyzing company results, I would recommend a few key parameters that you need to observe. The revenue growth, profit growth and the EPS (earnings per share) of the company are some of the easiest parameters to check. You want to ensure that the company has been delivering a consistent growth over the last few years.
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Check company debt
Debt is one of the most important thing that we need to check before we buy any particular stock. Always make sure that the company you are investing in is either completely debt free or has a very small amount of debt compared to its revenue. You do not want to invest in a company which is completely debt ridden because that highly increases the chances of bankruptcy for that company. High debt would also mean that a lot of the profit which the company makes goes towards debt payment and not towards the growth of the company.
This is also one of the biggest advantage of choosing a large cap company. Most large cap companies are either completely debt free or have a very small amount of debt.
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Follow the Big Funds
One simple step by which you can choose your first stock is to follow the Big Funds. If you have to learn how to bat you are probably going to imitate great batsmen like Rahul Dravid or Sachin Tendulkar. The same thing is true for the stock market. But how can I follow the Big Funds? Should I just listen to news interviews and blindly follow the advice of experts? The answer is a big NO! There is another simple way to find out what the big funds are doing in the Stock Market.
The easiest way that the retail investors can follow the Experts is by analyzing the shareholding pattern of a company. This information is very easily available on the internet. If there is a company where Mutuals Funds or the FIIs are increasing their stake, then it means that the company is performing well. And more importantly, it means that it is expected that the company will perform well in the future.
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Check recent dividends
The next step would be to check the recent dividends which the company has given to the shareholders. You are risking your hard-earned money in the stock market to get good returns. If there is a great company which you are invested in but that company never seems to reward its investors, then it doesn’t really make sense to keep on holding such a ‘great’ company. You need to make sure that the company you are invested in has been giving out consistently growing dividends. Now, there are a few exceptions! There are some great companies such as Google or Amazon who do not provide any sort of dividends. In such cases, we need to make sure that the company is making proper use of its profits towards company growth. And to compensate for the lack of dividend, the stock should be growing at a much higher rate compared to other dividend paying stocks.
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Analyze the stock chart
The last and final step will be very difficult for some new investors. It is because this step requires an understanding of the stock charts. Once you have made sure that your selected stock passes all the previously mentioned criteria, the final step would be to analyze the stock chart. I will give a very simple method by which even new retail investors can analyze stock charts.
A stock chart which has been consistently going up for years is a good chart –
A stock chart which is not consistently growing is a bad stock chart –
This is a VERY basic example of checking stock charts to make sure you’re choosing a good company. A good knowledge of technical analysis will make sure you get better at analyzing stock charts.
Now that you have all the knowledge about picking your first stock, I wish you best of luck for your investment journey!
To get stock charts easily, visit Tradingview
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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