I have got a good response and quite a few questions on my last blog post outlining how I select my stocks and at what price do I look at buying them. As getting back to each person individually is difficult, I have decided to look at the main issues raised, in this post along with some explanations.
On what basis do I select the market leaders?
- As I said before the worth of a company is best proven by its market capitalization. However, it is enough for you to select 2 of the top 3-5 companies in a sector. For example in the IT sector, you cannot go wrong if you are selecting TCS, Infosys, Hcl Tech etc.
- Which company to select can be on the basis of PE ratio and also your own knowledge gained from different sources. Note that there is no need for you to reas Balance Sheets etc for this.
- It is not mandatory to select the top company in each sector though I see no harm in this at all.
How to select the Emerging companies in each sector?
- This is a little more difficult and you will need to understand something about the business of the sector as well as how the companies in them are doing.
- Try to look at companies that are trying to do something different. For example, in IT a few years back investing in companies that were focusing on product development would have been a good idea. In E-commerce today, look at companies that are creating logistical capabilities as part of their plans.
- Read a lot about what the analysts and other people are recommending but make sure that you understand the basic issues and do not get swayed by the jargon.
- If you are not comfortable that the company will be successful or are not sure whether you would like to be a customer yourself avoid investing in it.
Why PE and not other ratios like ROI, ROCE etc?
- I believe that Market capitalization, Earnings and future outlook are the 3 most important parameters that need to be looked at to understand the health of the company.
- ROI and ROCE will get covered by the first two of the above parameters.
- While many other ratios can be considered, the ones I have recommended are enough to make a decision.
What is the logic of using PE and DMA as parameters for pricing?
- PE will tell you whether you are buying the stock at a reasonable valuation or not.
- The immediate price of the stock is a function of demand and supply as we have noted in an earlier post. I think the 200 DMA is a good reflection of the demand and supply for a particular stock. If the stock is something that I want to buy then any price lower than 200 DMA will be an attractive price.
- Again, there can be many systems – I have only written about what I use for my investments.
I hope that gives some more clarity on what I had written about in my last post. At a later date when I do a series of posts on Stock investing, I will get into more details of sectors and individual stocks in those sectors. Do remember the caveat that you have to gain enough knowledge to be able to use the methods properly – a guide can only show the path but we still have to make the journey on our own.