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DoItYourself: Spotting an investment worthy business

Updated: Sep 29, 2019

Equity investment is a true wealth generator for investors if done properly. As an investor we should not aim to maximise our profits across all our investments, but instead we should aim to be profitable in majority of our investments, i.e. you don't need to make all the right choices in stock market, even if you are right 50% of the times your profit will outweigh your limited losses. It does sound fancy that we don't need to be always right but then there is a catch, you shouldn't be over-exposed to sub-optimal/loss making investments. This can be achieved through portfolio diversification (learn here).

Tip: Just buying a good business is not important, buying it at the right price is what makes it a good investment.

Thus your focus should be at spotting great businesses and then at undertaking prudent analysis to see if they present an investment opportunity at the current point in time and price. Even before an investor starts analysing the stock, question arises which stocks should an investor analyse, i.e. what should be the starting point of picking stocks for analysis? There are multiple ways of shortlisting stocks for analysis and we will be discussing a collection of techniques compiled from legendary investors like Warren Buffett, Peter Lynch, John Templeton to name a few.

Tip: Check out our research backed stock recommendations here.

Ways by which investors can spot great business and shortlist stocks for analysis:

  • Companies with a significant competitive advantage: These companies are also termed as "companies with a moat" and are generally the market leaders in their respective segments. These companies are relatively easy to identify because when you think of a sector these companies would be the first ones to come in your mind, for example: Interglobe aviation in airlines, Maruti Suzuki in Automotive, Apollo/MRF/Ceat tyres in Tyre segment, ACC in cements, Nestle in FMCG etc. These companies generally trade at a significant premium over their peers and this premium is something which investors are willing to pay for the brand strength. An investor should look at buying opportunities in these companies on sudden dips and should expect moderate returns from his/her investment in these.

  • Spotting great companies early on at your near-by departmental/medical store: If this is done right, these are stocks which can be multi-baggers for investors and can multiply investors wealth multiple times. These companies are the ones which have huge growth potential but are relatively not known because they are not big enough yet. However, by the time these firms will become big enough they will start commanding premium valuations and won't be a high return generating investment anymore.A lot of investors think spotting profitable businesses is a complex task, however, I am here to say that it's not. A lot of good businesses can be identified if we just become a bit more curious in our day to day lives. Spotting businesses in this way requires a change in our perspective towards how we process information in our day to day life. Please go through the following examples and use them as a training data to ask the right questions, spot the right information in your day to day interactions. Example1: Next time if someone is buying a flat ask about the builder and why the buyer went with that builder only versus all the others in the market. Does that builder offers superior quality , value price ? I came to know about Embassy group through this technique. Example2 : Check out the pharmaceuticals company at the back of the medicines you buy from your nearby medical shop. Ask the shopkeeper why is he/she recommending that new drug? Does that company offers better margins to shop-keeper/doctors? I found out Glenmark through this. Example3 : Next time when you go out in market or for a movie, checkout which new shops are opening in your area, which bank is expanding it's branches in your area? I found Yes bank through this technique. Example4 : While you are out with your significant other or wife or female friends, check out which shops they want to buy their dresses from and why, is that a company you would want to invest in. I found TCNS clothing this way. Example5: Look at the company when you are buying pillow covers or towels (or clothes) next time @ hypermarket. I spotted Trident and Welspun India through this.

  • Investment journals, websites, news, magazines: There are a number of portals (including the one from yours truly @ lifehacks-investments) which you can use to find out about good businesses and factors which make them great. That being said an investor should always do his/her own research before investing into a business.

  • Competitor analysis: This is again an interesting approach, where you first find a market leader from a sector and then look at similar companies or competitor companies for the market leader. Often these competitor companies are trading at a non-premium valuations and have better growth rate than the market leader (owing to their agility, small-size and/or competitive advantage).

  • Check out government's policy push and do a Google search to find companies which might benefit from that: A good example to explain this is government's recent Electric Vehicle push, with this all the companies making Li ion batteries, electric bikes etc. will become beneficiaries. It doesn't take time to do a Google search to know which are the Li ion battery manufacturers or Electric vehicle manufactures in India.

  • Companies which are manufacturing products which will be in high demand in future: For example, given government's push towards cleaner energy, obviously companies in electric mobility or LPG delivery will have improved sales as government push will develop infrastructure and market for such products.

  • Part(OEM)/raw-material suppliers to market leaders or good businesses: This is often an under-rated way of picking good businesses. Most of the investors miss this in their analysis and that is exactly where you can benefit, by picking up businesses earlier than anyone else does. Example1: If tyre sales are on a rise and you have already missed investing in Apollo tyres or JK tyres, then look for the companies which supply raw materials to these firms, because if tyre manufactures are expecting a good year, indirectly raw material suppliers to these manufacturers will have an exceptional year as well. In fact, raw material suppliers can even have a better year than actual manufacturers because generally same raw material suppliers exist for different manufacturers. In the case of tyre manufacturers, it's NOCIL a firm which processes rubber before it gets consumed as a raw material by the tyre manufacturer. Example2: Another related example can be, if next year is going to be a great year for Automotive segment, then all those vehicles will require tyres/seat/airbags/ headlight/gear/brake as well, so if automotive stocks are already trading at premium then why not invest in tyre/seat/airbags/headlight/gear/brake suppliers, if that is also at premium then let's go down the supply chain (like to rubber suppliers in case of tyres). If an investor understands how businesses are interlinked in economy, he/she stands to be rewarded very generously. Example 3: If it is a great sector for housing finance companies then where do you think these loans are being consumed? It can simply mean that companies in real estate sector are next line to report improved cash flows and therefore move in stock charts.

Thus investors need to diversify the sources through which they pick stocks, most of the primary news sources publish information often too late and doesn't actually present sound investment recommendations. You would have often seen news articles like: "if you would have invested Rs. X in this company it would have become Rs. 5X" or "this company multiplied investor wealthy over last 5 years". All these articles are useless for an investor because they tell us what has already happened versus telling investors what is going to happen. A good research spots trends and opportunities in future by looking at the data from past. Thus I recommend investors to look at the bigger picture, take time to think through the information you are receiving from multiple sources, do your own research and take calculated risks.

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