How To Find Best Shares To Buy – A Beginners Guide
Whether you’re new to the stock market or thinking of getting back into it or a seasoned investor, one question must have troubled you always i.e. How To Find Best Shares To Buy. If it’s true, then this article is for you.
Every year thousands of people lose their hard earn money in buying and selling stocks without actually knowing the right method of investing in them. Reasons commonly seen for losses are emotion-driven buying and selling stocks, or investing on some pity WhatsApp tip, etc.
This article will not only help you in stopping those loses but it will also help you in getting a command on share market basics (for beginners) or on how to invest money in share market. But most importantly it will educate old and serious investors about science behind Finding Best Shares To Buy.
Before beginning, we would like to inform that learning’s of this guide is based on Four Basic Principles Of Value Investing coined by world most successful investor i.e. Warren Buffett, they are:
- Share must have long term prospect.
- Share / Company must be managed by vigilant leaders.
- Share must be stable & understandable.
- Share must be undervalued.
NOTE : We advise investment only in those shares only who have passed all the screening test mentioned in our guide.
So, let’s begin & enlighten yourself with knowledge on How To Find Best Shares To Buy
Step 1 : Primary Screening
It’s the first step of screening, which is very broad but fundamentally very important. For this step, we will be using any stock screener (I prefer screener.in, as we can download relevant data in excel form for free) & filter shares on basis of below benchmarks.
- Market Capitalization Greater than Rs. 500 Cr
Rationale : investing in start-ups & new companies are the job of venture capitalists or big investors, but for retail investors like us a company size should be optimum.
- P/E Ratio (Price to Earning) Less than equal to 30
Rationale : P/E ratio shows how much money has to be invested for earning Re. 1 from a share, higher the P/E number the more you will have to spend for earning money on that share. According to Warren Buffett, a value investor always invest in those opportunities who give higher return against the least investment cost. For developed countries like US or UK ideal P/E ratio is less than 15, but a country like us which is still developing and the market is not mature ideal P/E for us should be 30 & below.
- P/B Ratio (Price to Book Value) Less than equal to 3
Rationale : Book value in gross terms means if company get liquidated today its per share value will be equal to its Book Value, in other way we can say it is the actual value of the company. Like P/E and P/B also tell how costly our investment is in real terms, so for our country it’s ideal value should be 3 & below.
- Long Term Debt to Equity Ratio (D/E) Less than equal to 1
Rationale : one of the Warren Buffett core principles is share/company must be managed by vigilant leaders, this can be gazed by how leaders/owners are handling companies debt. It’s a proven fact that if an organization continuously remains under debt it can’t generate free cash for itself, thus affecting it’s future growth prospects. So for any company, ideal Debt to Equity ratio is less than 0.5, but considering our nation economic status ideal value for us should be less than 1.
- Current Ratio Greater than 1.5
Rationale : this ratio shows the liquidity status of any company to pay its short-term (less than 1 year) obligations. Ideal value for us is 1.5, which means the company have enough cash to pay its short term debts. The formula for Current ratio is Current Assets divided by Current Liabilities.
These two ratios i.e. Debt to Equity & Current ratio are very useful ratios which tell the investor about company (share) long & short term health (debt) status. Names like Kingfisher, IIFL, DHFL, Yes Bank, will tell you how important these ratios are, as even seasoned kept on investing their hard earn money in these debt ridden companies resulting in a complete loss.
At this juncture, our tip to a new investor on questions like how to invest in share market or how to buy shares will be; always follow these five benchmarks for true value investment.
Want’s to learn more about value investing, please study this must read book The Intelligent Investor By Benjamin Graham.
Once we execute the above standards in Screener.in, we will get the desired results (as given in fig 1 below). Now we will have to test these companies further on other parameters.
One important aspect you should keep in mind before moving forward is that you will be seeing names of many companies who are well known & tempting but do not get driven by your emotions on buying them at this stage. Remember, this is just the first step of screening there are two more steps for finding our best shares to buy.
Step 2 : Secondary Screening
In this step, we will test our shares further on Warren Buffett basic principles.
- Finding the share having long term prospect:
From the list of shares filtered in step 1 (fig 1) select the companies whom do you think will exist after 20 to 30 year from now, to simplify filter the companies whose products will be of use many years from now. Example products like software, news, pharmaceuticals, educational courses, etc will exist no matter how much scenario of world changes. It can be assessed just analyzing company profile, product catalogue, etc.
Rationale : share must have long term prospect is the founding principle of value investing. For value investor companies whose products have relevance even after 20-30 year are the right candidate for best shares to buy list. It just like someone investing in typewriter companies early 1900 (1900 – 1960) and not investing in same during late 1900 (1980 to 1999).
Need more clarity consider this, a company who manufactures candies could be considered having long term prospect as this products will be consumed even after many years from now. So, buying shares of such a company will give confidence to an investor that share has good future & it will stay in the market for long.
|S. No||Company||Industry||Long Term Prospect|
|1||Wipro||Information Technology & Consulting||Strong|
|2||Finolex Cables||Electrical & Communication Cables||Medium|
|3||Jubilant Life Sciences||Pharmaceutical & Bulk Drugs||Strong|
|4||Star Cement||Cement Manufacturing||Week|
Like the above table you could make a list of shares having strong long term prospect for further analysis. For this guide & for better understanding the concept we will use Wipro Ltd as an example for further steps.
- Finding Share Stability :
Now from the list of shares having strong long term prospective, we will evaluate Wipro on further steps & benchmarks. Here we will analyse the stability of share on the basis of its returns.
Jot down Wipro Earning Per Share (EPS) for last 10 years. After jotting it down take out YOY EPS growth (as given below), here we are looking for the positive trend in EPS growth, as given below. As you can see in our example of Wipro YOY EPS growth rate is near to ideal, as in the last 10 years is has de-grown just once, so Wipro passes this stability test.
NOTE: if you are seeing any –ve sign (degrowth) in EPS Gr only once or twice in 10 year that too in small numbers we could safely ignore it.
Rationale : EPS is the important criteria for any value investor, as it is the actual amount which an investor earns on per share investment. As per Warren Buffett we should only invest in those shares that have proven track record of giving returns, it is just like putting your money on winning horse. Moreover, as an analyst you could get a clear idea of how much return your investment will give in the coming years. For our current example of Wipro its average 11% for the last 10 years.
- Finding Share Intrinsic Value :
In real terms this fundamental aspect shows us whether our selected share is cheap or costly to buy. For calculating the intrinsic value of share we need to calculate the last 10 to 15 years share’s P/E ratio. For that jot down last 10 year EPS & market price, then divide Market Price by Earning Per Share for calculating P/E ratio. Do this for all the years as given below.
Further, take out the average of P/E for these years, which come out to be 17 for Wipro. Multiply 18 with latest EPS number which is 17, which come out to be 295. 295 is the Intrinsic Value for Wipro, on comparing it with present market price (Rs. 190), it is much lesser than share intrinsic value.
So, we can safely say that our share is undervalued. And as a reference, its Margin of Safety (the difference between Intrinsic Value & Market Price) is 106.
Rationale : the most important Warren Buffett principle is buying share when it is undervalued, even from an investor point of view we should buy instrument only when it is cheap (i.e. When Intrinsic Value Is More Than Market Value). From this step, one more thing we could observe about share, that it’s P/E value has come down from 22 to 17 in last 10 years, which means Wipro share is becoming cheaper.
- Analyzing Share Sales Parameters :
Although it’s not that important, but it will be wise to take note of it, as it gives us an idea about how company sales are performing. Here we looking for positive figure under company sales & profit heads. For Wipro it is 8.67% & 8.89% sales n profit growth respectively, which is certainly a decent number for such a big & prominent company like Wipro.
Rationale : a company which have a YOY growth in its sales & profit head, shows that its product is accepted in the market & have relevance to customers.
Step 3 : Tertiary Screening
By this stage we will get almost certain whether to buy a share or not, so for our sample share Wipro Ltd all parameters have been passed by it. But for a true Value Investor plugging all gaps before investing is most important because most basic investment strategy is “Not Losing A Single Penny”. So let’s move to our last screening lap:
- Return On Equity :
here we will calculate the last 10 years average Return On Equity of Wipro. Minimum expected value should be more than equal to 14%. For Wipro it stands around 17% so this is too a green signal for us.
- Price To Sales Ratio (PSR) :
It can be calculated through following steps; first divide annual sales (in Rs.) by the number of outstanding shares for calculating Sales Per Share (SPS). Then divide Wipro Market Price by SPS, which come out to be 1.93. It is to be noted that ideal PSR value is less than 1.50, but for our economy any value less than equal to 2 is acceptable.
Rationale : PSR measures the relative valuation of a company against its revenues, it is quite useful for evaluating companies in cyclical industries. So lesser the value healthier the company.
- Free Cash Flow Analysis :
Now it’s the time to analyse company cash flow, for that we have to record last 10 year (March 20 value not available) value of cash flow from Operating Activity and Capital Expenditure (usually termed as CAPEX it’s the investment done on building fixed assets for the company). Both can be extracted from the cash flow statement, Capital Expenditure can be seen under the Investing activity head.
|Operating Cash Flow||5,100||4,044||4,009||6,394||6,790||7,840||7,887||9,277||8,423||11,632|
After jotting these figures as above, we have to calculate two values i.e. Free Cash Flow (FCF) & FCF ratio. FCF can be calculated by subtracting the value of Capital Expenditure from the value of Operating Activity, this number (FCF) should be highly positive. Moving forward divide FCF by value of operating activity & multiply by 100 giving us FCF ratio, it’s should be more than 50% for these years.
For Wipro both FCF & FCF Ratio is positive & above 50% respectively, which is a positive sign for us.
Rationale : for a company whose leaders have sound knowledge about market basics, pay huge emphasis on free cash flow. This free cash flow can be invested for business growth or can be used to stabilize the organization during risky market situation, etc. So this number (FCF) should always be highly positive & improving. Whereas a constant capital expenditure shows that leaders are thinking long term & building fixed asset for company future. So, the green signal under these numbers gives a positive outlook for the companies future & internal health.
To know in-depth about stock screening please read The Autobiography of a Stock by Manoj Arora.
So, through our three step analysis we could safely say that Wipro has passed all the screening benchmarks and thus we can recommend it for rewarding investment.
In here for explanation sake we have taken just one example, but you could evaluate many such shares on given benchmarks in the same way as we have done. By doing this you could prepare your own list of Best Shares To Buy.
NOTE: To make your work easy we have designed a Stock Analysis Excel. In which you just have to enter the required numbers and it will automatically inform you on whether to buy this share or not.
If it sounds interesting! please Click Me to subscribe & our Stock Analysis Excel will be sent directly to your mailbox.
We will continue our learning on shares in our subsequent blogs in which we will discuss on topics like How to Do Advance Analysis of Shares, How to Track your Shares, When To Exit From Share, How To Choose Best Mutual Fund & many more. Stay tuned!Tags: best shares to buy, best shares to invest, buying and selling stocks, how to invest in share market, share market basics for beginners, share market for beginners, stock market for beginners