We will discuss first important factor in stock selection Annual Results: Why it’s important, what to see and avoid and break few misconceptions.
As you get interested to invest in stocks. A faint voice in your brain whispers “What if you lose your investment”. This episode will haunt you and in end, you will hesitate to step into the arena of the stock market.
But you observe stock and get enticed by the price movement. So you buy the stock, which is rising for the last 3 days. Only to realize that once you invested in that stock, it started to fall. Even when the market is not falling. You realize that your nightmare is coming to reality. So you think can you save yourself from this episode.
Let’s see where you went wrong?
Did you check fundamental or balance sheet? – NO
Did you check anything which assures that the stock you picked will grow? – NO
Did you read the Annual report of the company? -NO
Always remember that you are not just buying stocks but you are buying into business of the company you are investing in.
So my next question to you would be which sort of business you would like to invest in?
I hope your answer would be a steadily growing one. So, In this blog, we will help you recognize meaningful growing stock or company.
Interested. Let’s dive in.
Annual Earnings –
Firstly, The annual earnings growth rate of the firm you picked to invest in should be at least 20% YOY for the last 4 or 5 years.
In the above figure, you can see growth in net profit of about 25% from 2013 to 2014, about 260% from 2014 to 2015, about 200% from 2015 to 2016 and about 180% from 2016 to 2017. Now as in this stock growth is exceeding more than 20% YOY, So it qualifies for the criteria.
Earning per Share (EPS)
Also, growth in EPS for the same time period is even more important than net profit.
Because EPS is an important valuation parameter in determining profits per share basis.
How it affects in detail, we will explain in the later blog.
In the above figure, the Last row show EPS and it shows a growth of more than 20% again here.
So the above stock qualifies for growth in net profit and EPS.
Furthermore, Even more, important is to investigate a growing industry group to invest in. If you choose your stock to invest in an industry that is on the growth of at least 10% for 4 or 5 years. Now what this segregation do, it helps you weed out 80% of the stocks in the market. And hence make the job of selection of stock to invest lot easier.
If you notice in the figure above: You would see the QTR Sales Var of an average of 30 % for companies in same industry. So during the selection of the industry to buy a stock from, I would choose this industry as it is already growing at a healthy rate of 20+ %.
Now in each new cycle in the stock market will catapult fresh leadership stocks, so that’s the time when you should be ready with your research to reap maximum benefits, as the market is going to support your investment.
We should avoid a company if it has shown significant growth on five-year growth record but whose current earnings in last 2 quarters have shown the significant drop. As an example, If a company was maintaining 30% of earnings growth for past 3 years, but for this year last two quarters have slowed from 30% to 15% or lower then this stock should be avoided.
As we can see in the above graph and figure, the company was able to maintain > 20 % growth from 2013 to 2015. But thereafter company seems to struggle to maintain the same growth and we see the deteriorated performance. So you have to make an informed decision in these cases.
So, we prefer annual as well as quarterly growth or at least maintain the growth trend for several past quarters. A combination of annual growth for 5 years and quarterly growth are two factors among many that have a higher chance of true success.
Misconception while selection:
There is another misconception too…
A lot of us think P/e ratio is important to judge a winning stock, but we differ in this case . We think the increase in Eps is more important in comparison to P/e ratio.
Now your next question would be Why is it so?
Wait for it. We don’t want to complicate the subject as of now so we will talk about it in later posts
But still, we discourage to buy a stock based on the P/e ratio alone.
As bull market increases the P/e ratio and bear market decreases the p/e ratio, even when company do nothing different.
You should also remember that when a small company goes through a growth scenario or situations because of the revolutionary product breakthrough. This company will have a high PE ratio. Even though it would result in a lower PE ratio eventually, as the growth continues.
My Advice :
- Select a Stock, which has annual earnings growth of at least 20 %. Also Eps annual growth should be the same as well. Also the best source for Annual growth information is Annual report.
- Go for an industry that is growing at a healthy rate. This weed out 80% of the stocks.
- Best time to make an entry or selection is whenever there is a new cycle in the stock market.
- The company you are selecting should be consistent in term of growth.
- Don’t focus on the PE ratio. Rather focus on EPS growth.
Credits – Screener.in and moneycontrol.com
Experience of 8 years in stock investment. I learned everything by making a lot of mistakes and losing a good amount of money, I am here to make sure you don’t lose on either: Hope or Money.