A Deep Scan on How to Pick Stocks
Created on 15 Mar 2021
Wraps up in 6 Min
Read by 3.9k people
Updated on 05 Apr 2023
"Risk hai, to Ishq hai"
This sentence, from the ultra-popular web series- Scam 1992, became so legendary that it not only created a phenomenon in the Indian web series industry but also in the Indian share market!
When Harshad Mehta's character said in the series, "Share Market Itna Gehra Kuaan Hai Jo Poore Desh Ki Paise Ki Pyaas Bujha Sakta Hai!" it was as if the audience took it to heart and took the straight road to Dalal street! A record number of Demat accounts were opened after the series was launched.
Of course, these record demat account openings were also caused by the pandemic-induced lockdown, which compelled a lot of people to look for alternate sources of income and also as a result of boredom and the need for finding something new to do.
Out of all these new demat account openings, there was a large number of people who opened accounts as a result of the 2020-frenzy, but in reality, they have no idea about how the stock market works. And as a result, a lot of them are buying stocks randomly without any analysis or calculations.
Stock picking is an art that even the market experts sometimes fail to excel at. And for this reason, it becomes all the more important, especially for new investors, to know how to select a good company for investment so that you don't end up losing your hard-earned money.
So, are you also someone who finds it difficult to pick stocks and is confused about where to invest?
Take a look at this unique technique that can help you 'deeply scan' any company before investing so that you can pick just the right stock for investment.
The DEEP SCAN
Learning how to perform this deep scan can help you filter out the good stocks from the bad stocks while picking a company to invest. Let's break it down:
D- Discount to Intrinsic Value
Would you want to buy a shirt at its MRP, or would you want to buy it at a discounted price? Exactly! So why would you buy a share at its MRP?!
As an investor, you must check if the company's shares are available at a discounted price or not. And for this, you must know its fair or intrinsic value.
If the shares are indeed undervalued from their fair value, they can be the right buy.
E- Efficiency Ratio
Indian consumers are most known for their price-sensitiveness. The most important thing about a product that attracts us is its price, which in some cases, is also looked for over the product's quality.
So while selecting a company to invest in, one must look at the product/service it is offering and at what cost. The product/service should have good quality as well as a low price. For this, one must have a look at the company's efficiency ratios. You can read more about them here.
E- Ethical Conduct
Remember why Kingfisher Airlines failed? Its promoter/management was incompetent and were unethical in their practices. On the other hand, its fierce competitor Indigo Airlines is still leading the industry because of the skilful, competitive practices and ethical conduct of its management.
Hence, the skills, practices and conduct of a company's management play a key role in defining its success. And so, investors must also look at details like warrants and promoter holdings in order to get an idea of how ethical the management is.
P- Pricing Power
Even in a highly competitive industry, a successful company would be able to sell its product at a higher price as compared to its competitors. For instance, the mobile industry, as you'd know, is extremely competitive. Despite this, Apple Inc has managed to sell its products at seemingly exorbitant rates and has become a leader in the industry. This is known as pricing power.
So, while choosing a company to invest in, one must also look at its pricing power and see how it is facing its competitors when it comes to product pricing.
And now, we've already reached the "Depth" of this master technique. It's now time to "Scan" it all the way through!
So, let's begin the SCAN!
Contrary to what newbie investors usually do, looking at just the company is not enough to make a deduction about its true condition. It is extremely important to also look at the industry it's functioning in.
For instance, the insurance industry has a market penetration of about 3%, which is why the companies operating in this industry have high chances of volume growth and scalability. And thus, this property can make insurance companies a good investment option, given that the other criteria are also met.
Hence, it is important to look at how much an industry is growing in order to understand if the company operating in it will be able to grow its sales or scalability.
C- Competition Analysis
Remember, Sony's mobile phones? They weren't always too popular, were they? Have you thought about why they couldn't stand out like its competitors Apple, Samsung, or MI did?
Let's take a look. Apple provided a unique interface in the form of IOS, which separated it from the other mobile phones. Samsung's phones had a new innovation every time they launched a new model. And Xiaomi's MI phones stood out because of its unreasonably affordable prices. And well, among such fierce competitors, Sony couldn't stand out.
A company should be able to differentiate its products from its competitors in order to survive in the market and manage to stay on as a key player. And so, while picking a company's stock, one must analyse its competitors in order to understand if the company they've chosen will be able to outsmart them or not.
A- Appropriate Margin of Safety
A bridge is constructed; it is built based on the capacity of vehicles it can handle at a single time. However, if it is said that a bridge can handle 1000 tonnes of weight, it means that it can actually handle a little more, lets say, 1300-1500 tonnes. This extra number is actually kept as a margin of safety.
No matter how many calculations you've made or how many expert recommendations you've received regarding a particular stock, even if you are a market guru, mistakes are bound to happen in the stock market.
And because of this uncertainty, it is important to ensure your funds' safety before putting them into any investments.
N- No Biases
One of the most basic concepts of behavioural finance says that a trader or an investor must always take into consideration of their personal behaviour.
Like the Scam 1992's hero Harshad Mehta said in the series, "Emotion mei insaan hamesha galti karta hai," one must not be blinded by personal biases and prejudices.
Also, following a herd mentality often leads to decisions going wrong in the long run.
One trick can be to select those companies which are not the market's favourites. To put it simply, one should ideally consider companies that are being ignored by the market despite being good and avoid those companies which are getting insane amounts of investor attention.
Here are two bonus tips for staying with us till here!
Tip 1: Check the company's Operating Leverage.
Meaning, the earnings of the company should be on a growth run, but its costs should be stable or, ideally, should not increase. A good business is the one whose customers are increasing along with its revenue, but its costs remain stable; so that both the company's growth as well as the profit margin increase.
Tip 2: Pick a company with a business so simple that even a fool can run it.
For instance, companies like Coca Cola are successful because they run on the efficiency of their product, whereas companies like Indigo Airlines are successful because of their efficient management.
So while choosing between two such companies, investors must avoid picking that company that is extra dependent on its management and would not be able to function in case something happens to it.
Deep Scanning the stock market: It's not that complicated!
See? Stock picking is not rocket science; rather, it's an art, an art that depends on the skillset of the artist. And as we said before, the stock market can be quite unpredictable, and even the experts might fail at picking the right stocks. But, with the right techniques and their effective application, anyone can become an expert stock picker!
You don't have to be a financial expert or a mathematician to pick the right stock for investing. All you need is a "Deep Scan!".
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