A growth stock, by definition, is a stock that has a growth rate much superior to average growth rate of the stock market. Ideally, the earning growth demonstrated by a growth stock should be growing at far higher rate than an average stock in the stock market. When people talk about growth stocks, they invariably talk about value stocks in the same breath. The key difference is that much of the valuation of a growth stock depends on its future performance and the valuation of a value stock depends primarily on its past performance.
You should be very clear about two things. First, what growth a growth stock is, and second, whether what people are claiming as a growth stock is really a growth stock.
Let’s try to first understand what a real growth stock is. A real growth stock is a stock that has been showing an above average growth rate in its earning and sales over the last 4-5 years consistently without compromising on its business fundamentals and financial future. If a company has been funding its growth through unsafe loans, which will cripple its earning capacity in near future, it can’t be called a growth stock. You should also pay attention to growth in per share earning on diluted basis ( earning per share after taking into account preferential shares, warrants, stock options, etc). The earnings overall might have grown, but have earnings per share grown? If not, then, the stock can’t be called a growth stock. After all, you will pay premium for the expected growth of earning per share in future. If the company management has not grown per share earning in the past, you can’t just trust it to do so in future.
A growth stock should never be considered for its growth alone. Consistent growth in earnings could be a reason why you want to evaluate it for investment purpose. However, make sure that you analyze the stock thoroughly the way you will analyze any other stock. You can be a little liberal in assessing a growth stock in a few parameters like Price to Earning Ratio or Dividend Payment. However, there should not be any let up in the assessment of the financial stability and management quality.
In a growth stock, the earning growth should more than make up for the liberal PE ratio or lower dividend payment. While evaluating a growth stock, be especially careful to take into account a few other factors like:
· Net Current Asset Value in order to determine the financial viability of the firm in question
· Current Asset Value in order to determine short-term financial viability of the firm
· Debt to equity ratio
· Quality of the Current Assets.
· Performance and the credibility of the management
· Change of management in recent years and its impact
How should you find whether a so-called growth stock is really a growth stock or not? If you browse through recommendations of many investment analysts in the current environment, you will find that many of them claim that they are following growth-investing philosophy while recommending stocks. Most of them have favorite stocks that have shown promise in recent years. These stocks would have grown their sales and earnings at exponential rates in the last 2-3 years. Based on this sudden spurt in their performance in the recent past, analysts start recommending these stocks as growth stocks. As is expected, many lay investors blindly jump in to investing in these so called ‘growth stocks’ without even understanding the businesses behind these stocks. These stocks are not growth stocks; instead they are fashion stocks. Every once in a while stock markets come up with their favorite fashion stocks which are bought and sold blindly without any consideration to their underlying business value. A little peek into the history should keep us sane as most often these misinformed investment result in disastrous returns and heartbreaks. Before investing in any stock, you need to analyze it thoroughly to be confident of its value as explained in this post earlier.
Sunday, April 5, 2009
Privacy Policy
I recognize that privacy is important to you and I am committed to safeguarding your privacy while online at stockinvestmentbasics.blogspot.com. Here are the details of how I gather and disseminate information on this blog:
RSS Feeds and Email Updates
If a user wishes to subscribe to my RSS Feeds or Email Updates (Feedburner), I request for contact information such as name and email address. Users may opt-out of these communications at any point of time. Your personal information will never be sold or given to a third party.
Log Files and Stats
Like most bloggers I use log files (Statcounter). This stores information such as internet protocol (IP) addresses, browser type, internet service provider (ISP), referring, exit and visited pages, platform used, date/time stamp, track user’s movement in the whole, and gather broad demographic information for aggregate use. IP addresses etc. are not linked to personally identifiable information.
Cookies
A cookie is a piece of data stored on the user’s computer tied to information about the user. This blog doesn't use cookies. However, some of my business partners may use cookies on this site. I can't access or control these cookies once the advertisers have set them.
Links
This Blog contains links to other sites. Please be aware that I am not responsible for the privacy policies of these sites. When you visit these sites, please read the privacy statements of each and every site. This privacy statement applies only to information collected by this Blog.
Advertisers
I may use external companies to display ads on this blog. These ads may contain cookies and are collected by the advertising companies and I do not have access to this information. Please check the advertisers websites for respective privacy policies.
This website/blog uses third-party advertising companies to serve ads when visiting this site. These third parties may collect and use information (but not your name, address, email address, or telephone number) about your visits to this and other websites in order to provide advertisements about goods and services of interest to you. If you would like more information about this practice and to know your choices about not having this information used by these companies, you can visit Google's Advertising and Privacy page.
If you wish to opt out of Advertising companies tracking and tailoring advertisements to your surfing patterns you may do so at Network Advertising Initiative.
Google uses the Doubleclick DART cookie to serve ads across it's Adsense network and you can get further information regarding the DART cookie at Doubleclick as well as opt out options at Google's Privacy Center .
Contact Information
If you have any questions or concerns please contact Virgo.One1@gmail.com.
This privacy policy updated April 2009.
RSS Feeds and Email Updates
If a user wishes to subscribe to my RSS Feeds or Email Updates (Feedburner), I request for contact information such as name and email address. Users may opt-out of these communications at any point of time. Your personal information will never be sold or given to a third party.
Log Files and Stats
Like most bloggers I use log files (Statcounter). This stores information such as internet protocol (IP) addresses, browser type, internet service provider (ISP), referring, exit and visited pages, platform used, date/time stamp, track user’s movement in the whole, and gather broad demographic information for aggregate use. IP addresses etc. are not linked to personally identifiable information.
Cookies
A cookie is a piece of data stored on the user’s computer tied to information about the user. This blog doesn't use cookies. However, some of my business partners may use cookies on this site. I can't access or control these cookies once the advertisers have set them.
Links
This Blog contains links to other sites. Please be aware that I am not responsible for the privacy policies of these sites. When you visit these sites, please read the privacy statements of each and every site. This privacy statement applies only to information collected by this Blog.
Advertisers
I may use external companies to display ads on this blog. These ads may contain cookies and are collected by the advertising companies and I do not have access to this information. Please check the advertisers websites for respective privacy policies.
This website/blog uses third-party advertising companies to serve ads when visiting this site. These third parties may collect and use information (but not your name, address, email address, or telephone number) about your visits to this and other websites in order to provide advertisements about goods and services of interest to you. If you would like more information about this practice and to know your choices about not having this information used by these companies, you can visit Google's Advertising and Privacy page.
If you wish to opt out of Advertising companies tracking and tailoring advertisements to your surfing patterns you may do so at Network Advertising Initiative.
Google uses the Doubleclick DART cookie to serve ads across it's Adsense network and you can get further information regarding the DART cookie at Doubleclick as well as opt out options at Google's Privacy Center .
Contact Information
If you have any questions or concerns please contact Virgo.One1@gmail.com.
This privacy policy updated April 2009.
Saturday, March 21, 2009
What is the right time to buy a stock?
How should an investor decide the right time to buy a stock? Many investors are interested in entering the stock market, but are not very sure about their timing.
Let’s try to work around this problem.
In the short term, nobody knows which direction a stock price is going to move in. It can go up or down depending on various factors including stock market sentiments, liquidity in the market, etc. However, if you have done a good amount of research on a stock and are convinced that the stock is undervalued presently and offers good margin of safety, you should go ahead and buy the stock. Here, I am assuming that you are not a short-term investor (that’s an oxymoron though- an investor can only be for long term. For short term, you have speculators) and you have sufficient patience to be able to reap the rewards of your efforts in future. If you keep holding the stock and your research on the stock was sound, the market will discover the true value of the stock and reward you with good return on your investment. The key here is to buy cheap and have patience.
If you are looking to make money in short term, there is no sure fire strategy. You can as well try your luck in a casino.
Many retail investors start thinking about entering the stock market when the market is in a bull phase. This is a general tendency of beginners as they see many people making profits (some realized and much unrealized!) on their stock market investments. During the peak of a bull phase, stock markets see entry of all kind of investors and speculators. At this stage, you will see that anybody and everybody, who doesn’t know anything about stocks, is talking about purchasing shares and giving tips on which stocks to buy. At such times, stock prices get very heated as there is huge demand for stocks and many stocks see unrealistically high prices that do not justify their underlying business valuation. You will still see promising companies but you will rarely see any stock that can be bought at a cheap price with a good margin of safety. In such times, you should not buy a stock or think about entering the stock market. In fact, this is the time to get out of the stock market, as a fall may not be far away.
A corollary of the above discussion is that a bear market is a good time to buy stocks for a long-term investor. You will find that many good businesses that are generating good returns consistently have come under the spell of bears. Fortunately or unfortunately, investors act in hordes. Even great businesses can be found trading at huge discounts in a bear market. As an investor, you should hunt for bargain stocks in a bear market. You will not be disappointed. The key again is to ensure that you are confident about the value of the stock and the business behind it.
Let’s try to work around this problem.
In the short term, nobody knows which direction a stock price is going to move in. It can go up or down depending on various factors including stock market sentiments, liquidity in the market, etc. However, if you have done a good amount of research on a stock and are convinced that the stock is undervalued presently and offers good margin of safety, you should go ahead and buy the stock. Here, I am assuming that you are not a short-term investor (that’s an oxymoron though- an investor can only be for long term. For short term, you have speculators) and you have sufficient patience to be able to reap the rewards of your efforts in future. If you keep holding the stock and your research on the stock was sound, the market will discover the true value of the stock and reward you with good return on your investment. The key here is to buy cheap and have patience.
If you are looking to make money in short term, there is no sure fire strategy. You can as well try your luck in a casino.
Many retail investors start thinking about entering the stock market when the market is in a bull phase. This is a general tendency of beginners as they see many people making profits (some realized and much unrealized!) on their stock market investments. During the peak of a bull phase, stock markets see entry of all kind of investors and speculators. At this stage, you will see that anybody and everybody, who doesn’t know anything about stocks, is talking about purchasing shares and giving tips on which stocks to buy. At such times, stock prices get very heated as there is huge demand for stocks and many stocks see unrealistically high prices that do not justify their underlying business valuation. You will still see promising companies but you will rarely see any stock that can be bought at a cheap price with a good margin of safety. In such times, you should not buy a stock or think about entering the stock market. In fact, this is the time to get out of the stock market, as a fall may not be far away.
A corollary of the above discussion is that a bear market is a good time to buy stocks for a long-term investor. You will find that many good businesses that are generating good returns consistently have come under the spell of bears. Fortunately or unfortunately, investors act in hordes. Even great businesses can be found trading at huge discounts in a bear market. As an investor, you should hunt for bargain stocks in a bear market. You will not be disappointed. The key again is to ensure that you are confident about the value of the stock and the business behind it.
Saturday, March 14, 2009
How to select a stock- Part VII- Finding the right price of a stock
In this post, we will learn about how to find the right price for a stock. Many people confuse good companies with a good stock. If they like a company’s business model, they purchase its stock without any consideration of the price it is trading at. What matters more in investment is that you have bought a stock at the right price. If you have bought stocks of a great company at a very high price level, it may not turn out to be a great investment. On the contrary, if you have bought stocks of a good company at a good price level (cheap), you may get good return on your investment. It’s important to buy cheap.
A stock price is supposedly an indicator of net present value of future earnings for the stock on per share basis. This is also called the intrinsic value of a stock. However, the problem with this concept is that one needs to predict the future to be able to arrive at the right stock price. Millions of people have tried predicting future in the past, but rarely have we seen anybody doing so accurately. This very concept leads to a lot of investing mistakes by millions of people. A lot of analysts get into the game of predicting future earnings through various esoteric mathematical formulae. Nobody gets it right!
A good approach for stock selection could be following what legendary Investment Guru Benjamin Graham advised- follow the principles of ‘margin of safety’ and ‘diversification’.
The margin of safety concept says what you are buying should be worth more than what you are paying by a wide margin. Such a simple thing, but it’s really difficult to act on it considering the problem in assessing the value of a stock. Graham says you shouldn’t get into the business of predicting the future; instead, use the past performance to assess the ability of the company to keep producing decent earnings in future. Hence, if the company has a current earning of about 12% of the stock price (i.e. a PE ratio of 8), and meets all our criteria of selection as mentioned in my previous posts, and risk free return (of a 10-year government bond) is 6%, you have a good margin of safety in the stock. There is no general formula for all industries. However, in most of the cases, the PE ratio should not go beyond 15. The higher the PE ratio, the more future growth dependent your return on the stock becomes. Never buy a stock if you believe it is fully priced even if it is of the best performing company.
Diversification is linked with the concept of margin of safety. Let me explain. If you are playing dart, and you are good at it; what are your chances of hitting bulls eye once if you have only once dart? What if you have ten darts? Of course, you will have much better chances of hitting Bull’s Eye at least once if you have ten darts. Do you understand the difference? If you have margin of safety in your favor, your chances of making good returns or at least not incurring loss in a portfolio of diversified stocks becomes pretty high. However, there is a caution here. Diversification will work to your favor if you have diversified in stocks with good margin of safety. It will hurt you badly if you have bought all losers. Diversification in overpriced stocks will ensure that you most likely incur loss on your investment. So, be careful. Don’t buy costly stocks. Always maintain a diversified portfolio of good stocks bought with a margin of safety.
With this, the series on ‘how to select stocks for investing’ ends. I hope I have been able to give you a few basic guidelines on how to go about picking stocks for investment. I must add that these are indicative guidelines and by no means exhaustive. You will do well if you use these guidelines along with your own research and experience backed by some sound reasoning.
A stock price is supposedly an indicator of net present value of future earnings for the stock on per share basis. This is also called the intrinsic value of a stock. However, the problem with this concept is that one needs to predict the future to be able to arrive at the right stock price. Millions of people have tried predicting future in the past, but rarely have we seen anybody doing so accurately. This very concept leads to a lot of investing mistakes by millions of people. A lot of analysts get into the game of predicting future earnings through various esoteric mathematical formulae. Nobody gets it right!
A good approach for stock selection could be following what legendary Investment Guru Benjamin Graham advised- follow the principles of ‘margin of safety’ and ‘diversification’.
The margin of safety concept says what you are buying should be worth more than what you are paying by a wide margin. Such a simple thing, but it’s really difficult to act on it considering the problem in assessing the value of a stock. Graham says you shouldn’t get into the business of predicting the future; instead, use the past performance to assess the ability of the company to keep producing decent earnings in future. Hence, if the company has a current earning of about 12% of the stock price (i.e. a PE ratio of 8), and meets all our criteria of selection as mentioned in my previous posts, and risk free return (of a 10-year government bond) is 6%, you have a good margin of safety in the stock. There is no general formula for all industries. However, in most of the cases, the PE ratio should not go beyond 15. The higher the PE ratio, the more future growth dependent your return on the stock becomes. Never buy a stock if you believe it is fully priced even if it is of the best performing company.
Diversification is linked with the concept of margin of safety. Let me explain. If you are playing dart, and you are good at it; what are your chances of hitting bulls eye once if you have only once dart? What if you have ten darts? Of course, you will have much better chances of hitting Bull’s Eye at least once if you have ten darts. Do you understand the difference? If you have margin of safety in your favor, your chances of making good returns or at least not incurring loss in a portfolio of diversified stocks becomes pretty high. However, there is a caution here. Diversification will work to your favor if you have diversified in stocks with good margin of safety. It will hurt you badly if you have bought all losers. Diversification in overpriced stocks will ensure that you most likely incur loss on your investment. So, be careful. Don’t buy costly stocks. Always maintain a diversified portfolio of good stocks bought with a margin of safety.
With this, the series on ‘how to select stocks for investing’ ends. I hope I have been able to give you a few basic guidelines on how to go about picking stocks for investment. I must add that these are indicative guidelines and by no means exhaustive. You will do well if you use these guidelines along with your own research and experience backed by some sound reasoning.
Sunday, March 8, 2009
How to Select a Stock- Part VI- Management Quality
While investing in stocks, one very important issue is that whether you can trust the management of the company for taking it to greater heights in future. If you can’t trust the management, you can’t trust the stock for giving you good returns. Let me explain. Imagine that you are going on a cruise, and, suddenly, you found out that the captain of the ship has been through three shipwrecks earlier; and on all three occasions he saved his life and left all passengers to die. What will you do? Of course, you will cancel your plans of going on that cruise. You got the point. Even if the business fundamentals are strong for a company, poor management can, and will, take it down.
There are a few things that you need to assess in the management of the company.
Focus: A sound management focuses on key issues that drive value for the business. If a management understands its role and the requirement of a business well, it will focus on taking actions that will drive growth and profitability of the business. However, if you notice that the management is focusing on unimportant or inexplicable issues, you should be wary of investing in such companies. If you notice that the management is not able to do justice to its current business and is trying to diversify into seemingly unrelated businesses, this could be an indication that the management is indulging in diversionary tactics to avoid attention to their non-performance in the existing line of business. A sound management knows its business well and focuses on building it by venturing into territories it can traverse well.
Past record & Consistency: Check out the past record of the management and see how they have grown business in the past. Go through past annual reports, dig into the management discussion and analysis section and see how they have been faring on their plans and promises on year-on-year basis. If you see lack of consistency on promises, plans, actions and results, there is a reason for you to investigate further.
If the management has been indulging more in media activities than on business, there might be a need to look into the capabilities of the management further. If there has been
a change in the top brass of the company recently, you need to check the past records of the recently joined management personnel.
Do look into the share buy-backs announced by the company. If the share buy back has happened at the time when the stock prices are down and below the ‘intrinsic value’, it’s a great thing for a stockholder. It will most probably result in increased value for shareholder in future. However, if the share buy-backs have been announced in a bull market when the prices are hyped and beyond the reasonable value of the stock, you should be careful.
Check out how the management has grown the company year on year. If the company has allocated its retained earnings well and increased its profit with better-than-usual market rate, it’s a sign of a good management. However, if the company has not been able to grow its profits on consistent basis, and has not shared its earnings with the shareholders in the form of dividend, you have a reason to question the ability of the management.
Integrity: Make sure that the company you are investing in has got a management with unquestionable integrity. With many corporate frauds being discovered in these days, you don’t want to get trapped in a company that has falsified its records or has got management that can go to any extent to hide their actual performance. A little bit of internet search on the names of the management along with key words like ‘fraud’, ‘court case’, ‘criminal case’, etc will unearth enough details for you to consider.
Instances of crises actually give you a very good understanding of the character of the management. If the management has been candid in accepting the issues, handled the situation with maturity, and proactively taken steps to overcome difficulties, you can rest assured about the quality of management.
You should also check out management rewards announced by the company. If there are instances of management rewarding itself with plump bonuses and obscene stock options without a credible link to growth in profits of the company, you have a reason to worry.
In conclusion, though judgment on the management quality of the company is based on many qualitative factors, you should do everything in your limits to understand this factor as it going to be the key factor that will decide the future earnings through your stock.
In the next post, which is going to be the last post in this series of ‘how to select a stock for investing’, I will explain a few basic things that will help you decide how you can identify a right price for a good stock.
There are a few things that you need to assess in the management of the company.
Focus: A sound management focuses on key issues that drive value for the business. If a management understands its role and the requirement of a business well, it will focus on taking actions that will drive growth and profitability of the business. However, if you notice that the management is focusing on unimportant or inexplicable issues, you should be wary of investing in such companies. If you notice that the management is not able to do justice to its current business and is trying to diversify into seemingly unrelated businesses, this could be an indication that the management is indulging in diversionary tactics to avoid attention to their non-performance in the existing line of business. A sound management knows its business well and focuses on building it by venturing into territories it can traverse well.
Past record & Consistency: Check out the past record of the management and see how they have grown business in the past. Go through past annual reports, dig into the management discussion and analysis section and see how they have been faring on their plans and promises on year-on-year basis. If you see lack of consistency on promises, plans, actions and results, there is a reason for you to investigate further.
If the management has been indulging more in media activities than on business, there might be a need to look into the capabilities of the management further. If there has been
a change in the top brass of the company recently, you need to check the past records of the recently joined management personnel.
Do look into the share buy-backs announced by the company. If the share buy back has happened at the time when the stock prices are down and below the ‘intrinsic value’, it’s a great thing for a stockholder. It will most probably result in increased value for shareholder in future. However, if the share buy-backs have been announced in a bull market when the prices are hyped and beyond the reasonable value of the stock, you should be careful.
Check out how the management has grown the company year on year. If the company has allocated its retained earnings well and increased its profit with better-than-usual market rate, it’s a sign of a good management. However, if the company has not been able to grow its profits on consistent basis, and has not shared its earnings with the shareholders in the form of dividend, you have a reason to question the ability of the management.
Integrity: Make sure that the company you are investing in has got a management with unquestionable integrity. With many corporate frauds being discovered in these days, you don’t want to get trapped in a company that has falsified its records or has got management that can go to any extent to hide their actual performance. A little bit of internet search on the names of the management along with key words like ‘fraud’, ‘court case’, ‘criminal case’, etc will unearth enough details for you to consider.
Instances of crises actually give you a very good understanding of the character of the management. If the management has been candid in accepting the issues, handled the situation with maturity, and proactively taken steps to overcome difficulties, you can rest assured about the quality of management.
You should also check out management rewards announced by the company. If there are instances of management rewarding itself with plump bonuses and obscene stock options without a credible link to growth in profits of the company, you have a reason to worry.
In conclusion, though judgment on the management quality of the company is based on many qualitative factors, you should do everything in your limits to understand this factor as it going to be the key factor that will decide the future earnings through your stock.
In the next post, which is going to be the last post in this series of ‘how to select a stock for investing’, I will explain a few basic things that will help you decide how you can identify a right price for a good stock.
Subscribe to:
Posts (Atom)
Posts
