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Criteria for selecting shares

Siva kumar (30 Points)

20 March 2020

Sir, what are the criteria, that should be born in mind, when selecting a stock?

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Dhirajlal Rambhia (SEO Sai Gr. Hosp.) (182016 Points)
Replied 21 March 2020

A market leader in its sector (Economic Moat)
High profit margins
High return on invested capital
Low debt levels
Consistent business growth and great track record.

Economic Moat: Economic Moat is defined as “A business’ ability to maintain competitive advantage over its competitors in order to protect its profits and market share”. This can be done by offering a unique product or service that is difficult to copy for other businesses. One of the best examples of economic moat is Coca-Cola.

Coca-Cola is more than 100 years old company, and has maintained demand for it’s products because of its consistency in quality (proper branding and marketing) and its ability to keep its competitors away by patenting it’s formula. This give Coca-Cola a great advantage over other soft drink makers.

High profit margins: Companies achieve high profit margins by keeping their costs and expenses low, maintaining the quality of the product, which allows them to charge a premium from their customers.Companies with low profit margins struggle to keep afloat in difficult times and suffer losses. Companies selling unique, or luxury products usually enjoy such high profit margins.

High return on invested capital: This may sound similar to previous point. After all a company that has high profit margin will ultimately enjoy better return on their capital. This may not always be true.

Imagine, a company enjoys 40% profit margin, its capital investment is Rs 100, now if in order to maintain its profitability, it has to triple it’s investment to Rs 300.

Previously, Return on capital employed was 40% (40/100) =40% now, since the capital invested has tripled, its Return on invested capital is (40/300)=13.33% which is much lower. This is not a great business to invest in, because every additional rupee invested in the business is giving lower returns.

Low debt levels: A company with high debt has to give a way a large chunk of its profits in order to service its debt, which leaves little money left for the shareholders. Companies with low or no debt not only retain larger share of profit for themselves but also give handsome dividends to their shareholders.

Consistent business growth and great track record: Companies that consistently perform well are favored by investors, as they bring some certainty in predicting the future earnings of the business.

Refer:: 1. https://www.cashoverflow.in/stock-market-investment-india/

2. https://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/slideshows/how-to-pick-stocks-7-things-you-should-know

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