How to pick Stocks and build portfolio

Being a low risk operator, your leitmotif in life is to avoid anything hot. Touching anything hot will not only scald you but could well burn a hole in your pocket. Rumor mills in our bourses will always provide grist to the mill, but suggest you not to get pounded inside it. Here it would be pertinent to talk about ''momentum investing'' or buying what is going up and thus, has the momentum. Simply put, it means ''join the gang''. If everybody thinks stock “x” is a good buy, then it has to go up because everybody will buy it. Yes, it works fine for a month or two. But the only problem is that you are likely to be one of the last people to join the herd and will not know when the momentum reverses. And then the herd becomes a stampede. So, stay away from ''hot stocks''.

Look at the management quality

Thou shall keep away from a company run by management with a track record of incessant wealth dilution or corporate misgovernance. It is all the more relevant in India as there have been numerous cases where fraudulent promoters have literally flown with cheap equity money. But how do you judge management quality? The best place of course is the annual report. A company’s attitude towards minority shareholders is important. And this is not reflected in discount coupons or soft drinks at Annual General Meetings. Good indicators to consider are level of disclosures in the annual report, levels of investments in group/ associate companies, etc. However, the only exception to this commandment you can make if you have a reliable report that the management is changing for good.

Do not buy stocks of the same feather

Putting one’s eggs in a single basket is naive. So also keeping a large portfolio. This could turn unwieldy and is a sure recipe for below average returns. But how on earth would you choose stocks in a market with more than 6,000 scrips? Well, the choice will remain confined to those scrips, which are frequently traded. But then nowadays most Real estate and media stocks are well traded. So does that mean that one’s portfolio should contain only Real estate and media companies? Nah¿ To limit risks it is important that you don''t go gung-ho on some sectors as their fortunes change without taking your permission. You shall choose such scrips, which represent the broad spectrum of industries and confine your choice to those who are proven market leaders in their field of business. You buy businesses and companies. You do not buy the market or stock prices. An exception to the market leader rule can be made only if there is a big turnaround or restructuring story.


Strong industry and company position

You are known by the company you keep. Similarly, a company is known by the industry it is in. A company's performance can be as good as the industry it is in. Look at what happened to a blue chip company like Tata motors in the last 6-7 years. It is the among the largest manufacturer of commercial vehicles in the world. It is the market leader in the Indian commercial vehicles market. Telco fell to Rs. 60 from Rs. 500 due to pathetic results, What went wrong? The industry went into a recession. But as its backed by a great pedigree it came back strongly with robust numbers, the industry turnarounded, from 60 it shot up to 900.So even the best company in the sector can turn on to bad times. Hence, it is important to understand industry dynamics and industry prospects.

Positive cash flows

You shall invest only in companies that are expected to have a positive cash flow in the next 3 to 5 years. In other words, the companies that will have ''operating'' cash flows higher than their requirements for capital expenditure and investments, only merit a look. The important phrase is of course ''operating cash flows''. Operating cash flow is the profit after taxes (net profit) plus depreciation (a non-cash expense). It represents the money left with the company after meeting all its regular expenses and therefore belongs to the shareholders.


I know the devils would never listen to the scriptures. Its very easier said than done. But even if one get a bit meticulous on to these aspects, atleast he would not be in a position to loose money, guranteed...

Regards
Praveen Kumar
www.laymansfinance.blogspot.com

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