Best Ways to Avoid Bad Stocks

Do you know what’s the most crucial trick to ensure the selection of the “right stocks”? It’s the creation of a stock analysing method. But, before analysing a company’s financials, it’s essential to learn how to avoid the stocks unfit for your portfolio.

You see, there are over 6,000 companies listed in India. So, how will you find the companies worth investing in, and how will you stay clear of the bad stocks?

This article will equip you with a powerful tool: a personalised stock screening method tailored to your unique goals and risk tolerance. I will explain how to create one without the complex jargon and complicated steps that analysts and finance websites provide.

By following this strategy, you can avoid those bad stocks that are harmful to your portfolio’s health.

Expert Ways to Avoid Bad Stocks

Many stock screening techniques and tools are available in the market. Despite this, people make errors in choosing stocks and often get stuck with the wrong choices. Ever wonder why this happened?

Let me list down 2 of the most basic issues you might be encountering:

1. Inefficient Screener: Among the screeners present, some are way too simple, with fewer features and commands to utilise. Some are way too advanced, making the screening procedure too complicated.
2. Lack of a Plan: How much you earn or save differs from that of your acquaintances or family. Your needs and wants would also differ, and so should your financial plan. But we often miss this simple fact.

We will discuss the strategy utilised by expert investors like Pranjal Kamra to avoid bad stocks. For this, I have used the screener from Ticker. You can also use any other screener of your choice.

Financial Health: Calculations of Profits & Debt

It's not a surprise that a company's financials should be the first thing one should check, right? Let's see what you should see to weed out all the unwanted companies from your list.

a. Debt-to-Equity Ratio:

Debt is the first thing PK likes to be wary of while screening stocks. After all, a company that’s facing difficulty in managing its debt can be a red sign for your portfolio.

Hence, a high D/E ratio suggests a company relies heavily on debt, which can increase financial risk. On the other hand, there are certain situations where having a little debt is not that big a deal. For sectors like IT, D/E ratios are rarely 0.

So, keeping that scenario in mind, you must look for companies with a D/E ratio of 0-0.5. It will help you weed out all the high-debt companies with ease and restore some options with better possibilities.

b. Profitability & Valuations:

To assess earnings potential, examine metrics like Net Income, Return On Equity (ROE), Return on Capital Employed (ROCE), Earnings Per Share (EPS), and operating margins. After all, a profitable company can reinvest earnings, attract investors, and potentially pay dividends to shareholders.

All the above financial metrics have different parameters based on your financial goal and risk metre. Such an ROCE of 15-20% is considered safe for investors with low- to mid-risk appetites.

Apart from this, there are many other financial metrics that you can look at while filling out your screener box ⬇️. Go check them out from this link here.

Business Prospects: Operations & Growth

The kind of plans a company has and the potential the industry can achieve also affect the movements of the stock market.

a. Industry Growth:

Is it a growing or declining industry?
What are the key drivers of growth?
Are there any potential headwinds or challenges that could impact future growth?

These are some of the essential questions you must ask before betting your money on any company. This rule applies especially to long-term investments, as the company’s growth prospects will be dependent on the industry’s growth.

Like, the pharmaceutical industry grew fabulously after 2020 due to the COVID-19. People started becoming more and more aware and concerned about their health, and this mentality was reflected in the rising charts of the industry.

So, make sure to evaluate the industry's overall outlook and potential for expansion.

b. Competitive Advantage:

After choosing an industry, it’s time to screen the best players in the arena. For this, the most suitable method is to do a peer comparison. Just like the image below, you can check the competitors’ financials and other fundamentals side by side from Ticker.

Assess whether the company has unique strengths that differentiate it from competitors. This way, you can know of the better & the best ones along with the good ones in the sector.

Technical Indicators: Charts Movements Tell a Story

Chart patterns and technical indicators can help identify stocks that are trending downward or showing signs of weakness. Moving averages, support and resistance levels, and volume patterns can be used to assess a stock's momentum and potential for future price movements.

Although this particular strategy is not as commonly utilised by retail investors like you and me, it is recommended by many experts.

You can learn how to simplify technical analysis by reviewing the article: Technical Analysis Tools for Long-Term Investing.

Extra Tips: Additional Considerations

Apart from the strategy, it’s important to consider 2-3 little aspects. Think of it like the dessert after a full-course meal. It would be satisfactory and will help you out a lot. 🥞

1st Tip: Stay informed about company-specific news, industry developments, and macroeconomic factors that could impact stock performance. You don’t want to go down the drain with a company if a bad event unfolds.

2nd Tip: Review research reports and ratings from reputable analysts and trustworthy websites to gain insights into a company's prospects. Recipe by Finology provides detailed and unbiased reports on many companies. You can check them out from here.

3rd Tip: This is one of the most essential tips and should not be ignored. Consider your own risk tolerance and investment goals when choosing stocks. Every one of us has a different appetite for both food and risk, and that amount should always linger in the front of our minds.

The Bottom Line

By incorporating these factors into your selection process, you'll be better equipped to navigate the market and make informed investment decisions. Still, it's important to remember that stock screening is not a foolproof method for eliminating risk.

Always be vigilant while investing and think with your best interests in mind.

*Disclaimer: The stocks and companies discussed above aren't a recommendation from Insider by Finology and shall not be construed as a replacement for professional advice. Consult a professional or conduct the necessary research before making investment decisions.