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Chapter2
Module7DoityourselfBasicinvestmentstrategies
AfewbenchmarksforstocksAquickandeasymeasuringtool.
TheP/Eratioasaguidetoinvestmentdecisions
FundamentalAnalysis
Value,GrowthandIncome
Keepinvesting,panicnotonyourexistingstocks.
Goforqualitystocksandnotquantity
Somemorestocktips

AfewbenchmarksforstocksAquickandeasymeasuringstick.
Theseareafewbenchmarksthatcanhelpyoudecideifyoushouldspendmoretimeonastockornot.Theyare
easilyavailableandcanbeofgreatuseinscreeninggoodstocks.
Revenues/Salesgrowth.
Revenuesarehowmuchthecompanyhassoldoveragivenperiod.Salesarethedirect performance indicators
for companies. The rate of growth of sales over the previous years indicates the forward momentum of the
company,whichwillhaveapositiveimpactonthestock'svaluation.
Bottomlinegrowth
Thebottomlineisthenetprofitofacompany.Thegrowthinnetprofitindicatestheattractivenessofthestock.
The expected growth rate might differ from industry to industry. For instance, the IT sector's growth in bottom
linecouldbeashighas6570%fromthepreviousyearswhereasfortheoldeconomystockstherangecouldbe
anywhereinrangeof1015%.
ROIReturnonInvestment
ROIinlaymantermsisthereturnoncapitalinvestedinbusinessi.e.ifyouinvestRs1croreinmen,machines,
land and material to generate 25 lakhs of net profit , then the ROI is 25%. Again the expected ROI by market
analystscoulddifferformindustrytoindustry.Forthesoftwareindustryitcouldbeashighas3540%,whereas
foracapitalintensiveindustryitcouldbejust1015%.
Volume
Manyinvestorslookatthevolumeofsharestradedonadayincomparisonwiththeaveragedailyvolume.The
investor gets an insight of how active the stock was on a certain day as compared with previous days. When
majornewsareannounced,astockcantradetensoftimesitsaveragedailyvolume.
Volumeisalsoanindicatoroftheliquidityinastock.Highlyliquidstockscanbetradedinlargebatcheswithlow
transactioncosts.Illiquidstockstradeinfrequentlyandlargesalesoftencausethepricetorise/falldramatically.
Illiquid stocks tend to carry large spreads i.e. the difference between the buying price and the selling price.
Volume is a key way to measure supply and demand, and is often the primary indicator of a new price trend.
When a stock moves up in price on unusually high volumes it could indicate that big institutional investors are
accumulatingthestock.Whenastockmovesdowninpriceonunusuallyheavyvolume,majorsellingcouldbe
thereason.
MarketCapitalization.
Thisisthecurrentmarketvalueofthecompany'sshares.Marketvalueisthetotalnumberofsharesmultiplied
bythecurrentpriceofeachshare.Thiswouldindicatethesheersizeofthecompany,it'sstocks'liquidityetc.
Companymanagement
The quality of the top management is the most important of all resources that a company has access to. An
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investor has to make a careful assessment of the competence of the company management as evidenced by
the dynamism and vision. Finally, the results are the single most important barometer of the company's
management.Ifthecompany'sboardincludescertaindirectorswhoarewellknown for their efficiency, honesty
and integrity and are associated with other companies of proven excellence, an investor can consider it as
favourable.AmongthedirectorstheMD(ManagingDirector)isthemostimportantperson.Itisessentialtoknow
whethertheMDisapersonofprovencompetence.
PSR(PricetoSalesRatio)
This is the number you want below 3, and preferably below 1. This measures a company's stock price against
thesalespershare.StudieshaveshownthataPSRabove3almostguaranteesalosswhilethosebelow1give
youamuchbetterchanceofsuccess.
ReturnonEquity
Supposedly Warren Buffet's favorite number, this measures how much your investment is actually earning.
Around20%isconsideredgood.
DebttoEquityRatio
This measures how much debt a company has compared to the equity. The debttoequity ratio is arrived by
dividing the total debt of the company with the equity capital. You're looking for a very low number here, not
necessarilyzero,butlessthan.5.Ifyouseeitat1,thenthecompanyisstillokay.AD/Eratioofmorethan2or
greater is risky. It means that the company has a high interest burden, which will eventually affect the bottom
line. Not all debt is bad if used prudently. If interest payments are using only a small portion of the company's
revenues, then the company is better off by employing debt pushing growth. Also note capital intensive
industriesbuildonahigherDebt/Equityratio,hencethistoolisnotarightparameterinsuchcases.
Beta
TheBetafactormeasureshowvolatileastockiswhencomparedwithanindex.The higher the beta, the more
volatile the stock is. (A negative beta means that the stock moves inversely to the market so when the index
risesthestockgoesdownandviceversa).
EarningsPerShare(EPS)
This ratio determines what the company is earning for every share. For many investors, earnings is the most
importanttool.EPSiscalculatedbydividingtheearnings(netprofit)bythetotalnumberofequityshares.Thus,
if AB ltd has 2 crore shares and has earned Rs 4 crore in the past 12 months, it has an EPS of Rs 2. EPS
Rating factors the longterm and shortterm earnings growth of a company as compared with other firms in the
segment.Takethelasttwoquartersofearningspershareincreaseandcombinethatwiththethreetofiveyear
earningsgrowthrate.Thencomparethisnumberforacompanyto all other companies in your watch list within
eachsectorandratetheresultsonhowitoutperformsallothercompaniesinyourwatchlistintermsof earnings
growth.Itsadvisabletoinvestinstocksthatrankinthetop20%ofcompaniesinyourwatchlist.Thisisbased
on the assumption that your portfolio of stocks in the "Watch List" have been selected by using some basic
screening tools so as to include the best of the stocks as perceived and authenticated by the screening tools
thatyouhadused.
Price/EarningsRatio(P/E).
Readaboutthismostimportantinvestortoolinthenextpartofthismodule.
Top
TheP/Eratioasaguidetoinvestmentdecisions
Earningspersharealonemeanabsolutelynothing.Inordertogetasenseofhowexpensiveorcheapastockis,
youhavetolookatearningsrelativetothestockpriceandhenceemploytheP/Eratio.TheP/Eratiotakesthe
stock price and divides it by the last four quarters' worth of earnings. If AB ltd is currently trading at Rs. 20 a
sharewithRs.4ofearningspershare(EPS),itwouldhaveaP/Eof5.Bigincreaseinearningsisanimportant
factor for share value appreciation. When a stock's PE ratio is high, the majority of investors consider it as
pricey or overvalued. Stocks with low PE's are typically considered a good value. However, studies done and
pastmarketexperiencehaveprovedthatthehighertheP/E,thebetterthestock.
A Company that currently earns Re 1 per share and expects its earnings to grow at 20% p.a will sell at some
multiple of its future earnings. Assuming that earnings will be Rs 2.50 (i.e Re 1 compounded at 20% p.a for 5
years).AlsoassumethatthenormalP/Eratiois15.ThenthestocksellingatanormalP/Eratioof15timesof
theexpectedearningsofRs2.50couldsellforRs37.50(i.ers2.5*15)or37.5timesofthisyearsearnings.
Thusifacompanyexpectsitsearningstogrowby20%peryearinthefuture,investorswillbewillingtopaynow
for those shares an amount based on those future earnings. In this buying frenzy, the investors would bid the
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priceupuntilasharesellsataveryhighP/Eratiorelativetoitspresentearnings.
First, one can obtain some idea of a reasonable price to pay for the stock by comparing its present P/E to its
pastlevelsofP/Eratio.OnecanlearnwhatisahighandwhatisalowP/Efortheindividualcompany.Onecan
compare the P/E ratio of the company with that of the market giving a relative measure. One can also use the
average P/E ratio over time to help judge the reasonableness of the present levels of prices. All this suggests
that as an investor one has to attempt to purchase a stock close to what is judged as a reasonable P/E ratio
basedonthecomparisonsmade.Onemustalsorealizethatwemustpayahigherpriceforaqualitycompany
withqualitymanagementandattractiveearningspotential.
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FundamentalAnalysis
Fundamental Analysis is a conservative and nonspeculative approach based on the "Fundamentals". A
fundamentalistisnotsweptbywhatishappeninginDalalstreetashelooksatathreedimensionalanalysis.
TheEconomy
TheIndustry
TheCompany
Alltheabovethreedimensionswillhavetobeweighedtogetherandnotinexclusionofeachother.Inthis
sectionwewouldgiveyouabriefglimpseofeachofthesefactorsforaneasydigestion
TheEconomyAnalysis
Inthetablebelowaresomeeconomicindicatorsandtheirpossibleimpactonthestockmarketaregiveninanut
shell.

Economicindicators

Impactonthestockmarket

1.

GNPGrowth
Decline

Favourable
Unfavourable

2.

PriceConditionsStable
Inflation

Favourable
Unfavourable

3.

EconomyBoom
Recession

Favourable
Unfavourable

4.

HousingConstructionActivity
Increaseinactivity
DecreaseinActivity

Favourable
Unfavourable

5.

EmploymentIncrease
Decrease

Favourable
Unfavourable

6.

AccumulationofInventories

7.

PersonalDisposableIncome
Increase
Decrease

Favourableunderinflation
Unfavourableunderdeflation
Favourable
Unfavourable

8.

PersonalSavings

9.

InterestRateslow
high

Favourable
Unfavourable

10.

Balanceoftrade
Positive
Negative

Favourable
Unfavourable

StrengthoftheRupeeinForexmarket
Strong
Weak

Favourable
Unfavourable

11.

12.

Favourableunderinflation
Unfavourableunderdeflation

CorporateTaxation(Direct&Indirect

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Low
High

Favourable
Unfavourable

TheIndustryAnalysis
Everyindustryhastogothroughalifecyclewithfourdistinctphases
i)PioneeringStage
ii)Expansion(growth)Stage
iii)Stagnation(mature)Stage
iv)DeclineStage
Thesephasesaredynamicforeachindustry.Youasaninvestorisadvisedtoinvestinanindustrythatiseither
inapioneeringstageorinitsexpansion(growth)stage.Itsadvisabletoquicklygetoutofindustrieswhicharein
thestagnationstagepriortoitslapseintothedeclinestage.Theparticularphaseorstageofanindustrycanbe
determinedintermsofsales,profitabilityandtheirgrowthratesamongstotherfactors.
TheCompanyAnalysis
Theremaybesituationsweretheindustryisveryattractivebutafewcompanieswithinitmightnotbedoingall
thatwellsimilarlytheremaybeoneortwocompanieswhichmaybedoingexceedinglywellwhiletherestofthe
companiesintheindustrymightbeindoldrums.Youasaninvestorwillhavetoconsiderboththefinancialand
nonfinancialaspectssoastoformaqualitativeimpressionaboutacompany.Someofthefactorsare
Historyofthecompanyandlineofbusiness
Productportfolio'sstrength
MarketShare
TopManagement
IntrinsicValueslikePatentsandtrademarksheld
ForeignCollaboration,itsneedandavailabilityforfuture
Qualityofcompetitioninthemarket,presentandfuture
Futurebusinessplansandprojects
TagsLikeBlueChips,MarketCaplow,mediumandbigcaps
Leveloftradingofthecompany'slistedscripts
EPS,itsgrowthandratingvisvisothercompaniesintheindustry.
P/Eratio
Growthinsales,dividendandbottomline
Top

Value,GrowthandIncome
Growth,Value,IncomeandGARPareoneofthemostrationalwaysofstockanalysis.Abriefoneachof them
isgivenhereforyourunderstanding.
GrowthStocks
The task here is to buy stock in companies whose potential for growth in sales and earnings is excellent.
Companies growing faster than the rest of the stocks in the market or faster than other stocks in the same
industry are the target i.e the Growth Stocks. These companies usually pay little or no dividends, since they
prefer to reinvest their profits in their business. Individuals who invest in growth stocks should make up their
portfoliowithestablished,wellmanagedcompaniesthatcanbeheldontoformany,manyyears.Companieslike
HLL,Nestle,Infosys,Wiprohavedemonstratedgreatgrowthovertheyears,and are the cornerstones of many
portfolios.Mostinvestmentclubssticktogrowthstocks,too.
ValueStocks
The task here is to look for stocks that have been overlooked by other investors and that which may have a
"hiddenvalue."Thesecompaniesmayhavebeenbeatendowninpricebecauseofsomebadevent,ormaybein
anindustrythat'slookeddownuponbymostinvestors.However,evenacompanythathasseenitsstockprice
decline still has assets to its namebuildings, real estate, inventories, subsidiaries, and so on. Many of these
assets still have value, yet that value may not be reflected in the stock's price. Value investors look to buy
stocksthatareundervalued,andthenholdthosestocksuntiltherestofthemarket(hopefully!)realizesthereal
value of the company's assets. The value investors tend to purchase a company's stock usually based on
relationshipsbetweenthecurrentmarketpriceofthecompanyandcertainbusinessfundamentals.TheylikeP/E
ratiobeingbelowacertainabsolutelimitdividendyieldsaboveacertainabsolutelimit
Totalsalesatacertainlevelrelativetothecompany'smarketcapitalization,ormarketvalue.TempletonMutual
fundsareoneofthemajorpractitionersofthisstrategy.
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Growthisoftendiscussedinoppositiontovalue,butsometimesthelinesbetweenthetwoapproachesbecome
quitefuzzyinpractice.
Income.
Stocks are widely purchased by people who expect the shares to increase in value but there are still many
people who buy stocks primarily because of the stream of dividends they generate. Called income investors,
these individuals often entirely forego companies whose shares have the possibility of capital appreciation for
highyieldingdividendpayingcompaniesinslowgrowthindustries.
Top
Keepinvesting,panicnotonyourexistingstocks
Here'sthebesttipwecangiveyouifthevolatilityinthemarkethasspookedyouorifyouhadseenalargeprofit
wash away in the falling market: ignore your stocks right now and keep your investing attention to something
else.
Focus all your efforts and time on the company your stock represents. That's because there are really two
elementsatworkwheninvesting:thestock,whichispartofthestockmarket,andthecompany,somethingthe
stockissupposedtorepresent.Butthecompanyworksinadifferentuniversefromthestockmarket, involved
moreintherealworldofprofitsandlossesratherthantheemotionaltideoffearandgreed,thetwomajorforces
behindthestockmarket.Withtheuncertaintyprevailinginthemarket,fearisrampantandsomeofitis justified,
buttherearelotsofgoodcompaniesthatmightbehammeredbythatemotion.That'swhyyou'lldobetterifyou
researchyourcompaniesindepthratherthantryingtofigureoutifthemorningselloffisthebeginningoftheend
or just a hick up on the road to true wealth. But let's say you've done all your numbers, and everything looks
great.You'vecheckedforthelatestnewsandyoustillcan'ttellwhyyourstockisdown.Thenyoumightwant to
call the company directly and ask for the Investor Relations department. Don't expect the investor relations
person to tell you any secrets or unpublished information but you can ask a few questions and get a better
feelingaboutthecompany:
1.Whyisthestockdownsodramatically?Arethererumorsthecompanyhasheard?
Ifso,whatisthecompany'sresponsetothem.
2.Isthereanythingthecompanycansayaboutthestockbeingdown?
3.Aretheofficersofthefirmbuyingorsellingthestock?
4.Isthecompanybuyingitsownsharesrightnow?
You will hence get a sense of how the company is responding to its stock being down, and maybe hear about
news that has just been published but you haven't read. Then, when you've done all you can to determine that
thecompanyinwhichyou'veinvestedisindeeddoingeverythingwell,youcanignorethestockandbeassured
thatthistooshallpass.Ifyoudeterminethatthestockisdownforagoodreasonandseemstobegoinglower,
then you can sell it and move on to another company. In either case, you can make a decision based on the
companyandnotthestock.
Top
Goforqualitystocksandnotquantity
Newinvestorsoftenwanttomakeaquickbuck(someoldinvestorsdo,too).Sometimesyoucandothatifyou
getlucky.Butthereallybigmoneyininvestingismadefromholdingqualitystocksalongtime.Manyinvestors
askforinformationoncheapstocks.The usual premise is that they don't have much money, and they want to
ownthousandsofsharesofsomething,thatwaywhenitgoesup,they'llmakebigmoney.Theproblemisthese
stocksdon'tgoup.They'reascamforthebrokers,andthespreadbetweenthebidandtheaskonthesestocks
isenormous,makingitimpossibletosellthemataprofit.
InsteadoftryingtobuythousandsofsharesofaworthlessstockforRs10000,let'sseewhatelseyoucando
with it. These examples are all split adjusted and show what that Rs. 10000 can do when you buy the right
stocks.
IfyouhadboughtInfosysin1991forRsshare(splitadjusted),youwouldownnshares
Obviously it's easy to look back to find great stocks. And you had to hold onto these volatile issues to reap
these rewards. But the point is that quality stocks are worth holding. In the above examples, the owners have
paid no taxes because there have not been any gains taken. The only commission paid was the original one.
Andaslongasthestockscontinuetoproducegoodearnings,there'snoreasontosellthem.Again,it'seasyto
pickthegoodoneslookingback,goingforward,whichstocksarethebestonestoown?
Do your research thoroughly. Build a portfolio of stocks, one stock at a time, even with Rs 10000. Be sure to
diversifyoverseveralindustriesovertime.Andonlybuythebest,nomatterhowfewsharesthatmightbe.Then
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bepatient,keepupwiththenewsonthestock,andletthestockgrow.That'sthewaythebigmoneyismade.
Top
Howmanystocksshouldyouown?
Buying a large number of stocks is timeconsuming and will distract you from focusing on the absolute best
stocks.Mostinvestorssimplycannotkeeptrackofalargenumberofstocks,soconcentrateonjustafewofthe
best.Usethissimpleguidelinetodeterminethenumberofstockstoown:
LessthanRs.20,000
Rs.20,000toRs.50,000
Rs.50,000toRs.2,00,000
Rs.2,00,000toRs.5,00,000
Rs.5,00,000ormore

1or2stocks
2or3stocks
3to5stocks
5to7stocks
7to10stocks
Top

SomemoreStocktips
1.Newproducts,services or leadership. If a company has a dynamic new product or service, or is capitalizing
onnewconditionsintheeconomy,thiscanhaveadramaticimpactonthepriceofastock.
2. Leading stock in a leading industry group. Nearly 50% of a stock's price action is a result of its industry
group'sperformance.Focusonthetopindustrygroups,andwithinthosegroupsselectstockswiththebestprice
performance.Don'tbuylaggardsjustbecausetheylookcheaper.
3.Highratedinstitutionalsponsorship.Youwantatleastafewofthebetterperformingmutualfundsowningthe
stock.They'retheoneswhowilldrivethestockuponasustainedbasis.
4. New Highs. Stocks that make new highs on increased volume tend to move higher. Outstanding stocks
usually form a price consolidation pattern, and then go on to make their biggest gains when their price breaks
abovethepatternonunusuallyhighvolume.
5. Positive market. You can buy the best stocks out there, but if the general market is weak, most likely your
stocks will be weak also. You need to study our "The market talks. Listen, to spot the best." Module 8 and
learnhowtointerpretshiftsinthemarket'strend.
6. You should not buy on dips. This is a strategy that doesn't give you a strong probability of making a profit.
Rememberastockthathasdipped25%needstorise33%torecoverthelossandastockthathasdipped50%
needstodoubletogetbacktoitsoldhigh.
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