Tuesday, May 23, 2023

#TIL: How to enter and exit a stock using Fundamental Analysis

I have been a stock market investor for more than 8 years now and generally shy away from short term trading OR intra-day. I just believe it sips out a lot of energy every-day and with the limited time I have with me managing everything else, it wasn't really worth it..

I had always been a fan of Zerodha's Varsity series and had used them back in 2018 for deep learning about the Indian stock market. Now, they have launched the Video series on similar concept which I would highly recommend you check out in case you are interested to know about the Indian stock market OR want a jargon-free exploration.

I will try to summarize what I could gain from their Fundamental Analysis section here:

  1. Essential items to look at under the P&L statement are;
    • Revenue
    • Heavy Expenses
    • Tax Rate
    • Profit After Tax [PAT]
  2. Essential Items to look at under the Balance sheet are;
    • Long term Borrowings
    • Accounts Receivable
    • Cash in hand/Bank
    • Profit after Tax flows from P&L to Balance sheet.
    • Cash & Cash Equivalents flow from the Cash Flow Statement to the Balance sheet
  3. Profitability Ratio: How profitable a company is
    • Operating Margins
    • Profit after Tax Margins
    • Return on Equity
  4. Leverage Ratios: Debt the company has taken to run it’s operations and how well the business can sustain its day to day operations
    • Interest Coverage Ratio
    • Debt to Equity Ratio
  5. Valuation Ratios: Compares the stock price with the valuation of the company. To get a sense of the stock value (cheap or expensive) currently
    • Price to Sales: For every 1 Rs in sales, how much is each share valued at currently
    • Price to Book
    • Price to Equity
  6. EBITDA is the amount of money the company makes after subtracting the operational expenses of the company from its operating revenue
  7. Ensure the PAT Margins and OPM Margins are trending upwards YoY & ROE > 25%. Gross Profit Margin should be > 20%
  8. Return on Equity (ROE) is a precious ratio. It indicates how much return the shareholders are making over their initial investment in the company. A high ROE and high debt is not a great sign
  9. Interest Coverage Ratio should always be on the higher side, lower the number, riskier it is for the shareholder
  10. Debt to Equity Ratio should ideally be the lowest.. Prefer less than 0.5
  11. Compare Price to Sales Ratio of a company to it’s peers to see how cheap OR expensive the stock is to buy currently. If it is on the higher side, pay attention to the PAT margin to see why is it expensive
  12. A higher Price to Book Value indicates the company is overvalued w.r.t company’s book value
  13. Higher the PE Ratio, the overvalued the stock is currently.
  14. For the ratios to be useful, it should be analyzed compared to other companies in the same industry.
  15. The DCF (Discounted Cash Flow) method is one of the best techniques to identify the intrinsic value of the business
I would recommend a FREE platform like Screener which can help you all the above criteria's and experiment on your own to evaluate a stock based on strong fundamentals.