Important Parameters for Stock Selection in Investing - FINAL Summary

Important Parameters for Stock Selection in Investing - FINAL Summary :

Preparing a tasty dish requires a perfect combination of ingredients for a good outcome. Similarly for identifying a multi-bagger stock or a stock with good upside potential requires a perfect combination of ingredients which will substantially increase probability of stock turning out to be a good one. Below stated are few major ingredients which will help any investor in identifying and understanding whether the stock has good investment potential or not. Detailed analysis has been done for each point and it is prepared in a very user-friendly language so that even a common man can understand the same. If an investor understands and follows below stated points in his due diligence then chances of failure in investment will be reduced. Further diversification and risk management will also help investor reduce risk to the portfolio even if somehow a bad stock has been selected in the process of evaluation. In future we are going to publish more articles on diversification and risk management. Summary of Important parameters in stock selection process are as below. CLICK HERE has been provided for detailed view of each point

1. Sector/Business -> CLICK HERE

2. Promoters -> CLICK HERE

3. Returns -> CLICK HERE

4. Valuation -> CLICK HERE

5. Expansion of Activity -> CLICK HERE

6. Operating Profit Margins -> CLICK HERE

7. Debt/Borrowing -> CLICK HERE

Returns and it's importance on Investing in Shares

Returns and it's importance on Investing in Shares 

Introduction

Average nominal GDP growth rate of India was around 12% for the past 5 years. 

(Nominal GDP includes both prices and growth, while real GDP is pure growth. Real GDP  is what nominal GDP would have been if there were no price changes from base year. As a result, nominal GDP is higher than real GDP)

A return on capital in excess of nominal GDP can be considered as a good return from investor perspective. Return on Capital Employed (ROCE) helps an investor understand what is the level of profitability with respect to total capital employed in the business. Return on equity (ROE) and return on assets (ROA) are also important ratios to asses the efficiency of the business with respect to owners fund and assets deployed respectively. The higher these ratios the better. Again these ratios are measure of efficiency of business. We want to invest in companies/shares which are most efficient and thereby will yield investor maximum returns

Investing activity is normally undertaken with objective of capital appreciation. Returns which the underlying business generates has a substantial and direct impact on the share prices of the company. Higher the return a business generates with consistency the better share price appreciation will be reflected. Investing in equity (shares) comes with it's inherent risks. When capital is invested in shares a return which is in excess of risk-free rate has to be generated otherwise there is no rationale of taking the risk.

Formula for calculating Return on Capital Employed (ROCE) : 

Return on Capital Employed (%) = Earnings before Interest & Taxes / Capital Employed

Capital Employed = Total Assets - Current Liabilities

Formula for calculating Return on Asset (ROA) : 

Return on Assets (%) = Profit After Tax / Average Total Assets

Average Total Assets = (Assets at beginning of year + Assets at End of Year) / 2

Important points in respect of Returns : 

• ROCE and ROA are two important return ratios for evaluating investment in shares of a company. Companies with lower ROCE and ROA must be altogether avoided. ROCE must be always greater than weighted average cost of capital employed.

• Return on Capital Employed (ROCE) is a better assessment ratio for returns compared to Return on Equity (ROE) because it is possible to inflate Return on Equity (ROE) by taking high levels of debt which may not be sustainable for business

• By using ROCE, investor can compare whether company is employing it's capital efficiently in comparison to peers in the sector as well as on standalone basis

• News and media normally talks about profit and turnover figures. However for an astute investor it is important to verify how much capital has been employed to generate the amount of profits. Eg. Business A and Business B both in same sector have generated profits of 40 crore for the year. But Business A has employed 250 crore of capital and Business B has employed 175 crore of Capital. With this data we can easily determine that investor will be willing to invest in Business B because it is more effective

• Return on asset (ROA) is higher for companies with asset-light business model rather than capital intensive businesses. Eg. Sectors like Steel, telecom, defense etc. have low ROA while consumption companies are likely to have higher ROA 

Quality of Promoters and Impact on Share price in Investing

Quality of Promoters and Impact on Share Price in Investing 

Introduction

A promoter is an individual or an entity who does the preliminary work incidental to the formation of a company, including its promotion, incorporation and flotation and solicits people to invest money in the company, which is being formed. The entire lot of people and other companies that control a company in this way is called its promoter group. Their combined shareholding is called promoter holding. Higher the promoter holding in a company,greater is the promoters control over it. Promoters exercise their control by taking key decisions of the company and appointing people in various positions of its management and board. They also provide the visions for the existence of the company. It is, therefore necessary that the promoters continue to hold a dominant shareholding position in the company. A large promoter group also provides stability to a company. Generally, promoters are in a fiduciary relationship with the company and its investors and shareholders, and must avoid conflicts of interests and exercise reasonable care in performing their duties. They must refrain from self-dealing or other types of abuse to take advantage of their position as a promoter. 

When money is invested in shares of a company, Quality of Promoters is the most important aspect. It is because promoters are the people who are going to be involved with the day to day activities of business and is at the foundation of success of entire business. If promoters carry out their duty with integrity and efficiency then every stakeholder of the business including shareholders can flourish and wealth maximization takes place.

In India a lot of companies which had corporate-governance issues have been the biggest wealth destroyer from shareholders perspective. In many cases it was not possible to identify the symptoms until it was very late for shareholders to exit. However, if few aspects are kept in mind while analyzing a company, shareholders can save their capital.All the mechanisms put in place by a company to protect stakeholder rights, in particular shareholders rights, is referred to as its corporate governance structure. It consists of policies, procedures and regulations that define how the management must deal with its stakeholders, and the remedies available to them in case of a violation. 

Important Points in Respect of Quality of Promoters from Investment Perspective :

• Educational qualification, age, experience in the sector or elsewhere, role assigned etc. are the important points to be checked to determine quality of promoters while investing in a company

• Shareholding of promoters group greater than 51% in the business shows the interest of promoters as well as it helps in proper implementation of business decisions due to majority ownership. Knowingly and willingly promoters are unlikely to take decisions which are not in the interest of the company in which majority of their personal wealth is invested

• Regularity of reporting to regulatory authorities and stock exchanges is very important. Failure in timely reporting of financial statements and necessary disclosures as required by stock exchanges can be considered as a red-flag on the part of promoters. Eg. If a company does not report it's quarterly results within time limit set by regulations it is a red-flag

• Avoid companies where promoters have pledged substantial part of their stake to raise funds. In case promoter makes a default, then banks/financial institution which has given loan will sell the pledged shares in open-market to recover it's loan which can lead to meltdown in share prices

• Integrity on the part of promoters is very important. Promoters remuneration for the time and energy they contribute to the business must be analysed thoroughly by investor to determine whether it is reasonable or not.

• Personal transactions of promoters or relative of promoter or any related entity  with the company shall be on fair terms. Investor has to ensure that related party transactions are not of such nature which exploit resources of company for personal gains

• Concept of "Independent director" was introduced by SEBI some 17-18 years back to ensure that board of directors also have people who are outsider (unbiased) and take decisions in the interest of stakeholders at large. Listed companies are compulsorily required to have one-third composition of board to comprise of Independent directors as per regulations. Investors have to ensure that independent directors are appointed and removed as per the policy and also check whether they are really independent or related to promoters

• Necessary information related to promoters remuneration, related party transactions and independent directors etc is available in the annual report of the company which is available on the website of the company as well as on the stock exchange website

• Violation of rules of stock exchanges, companies act, taxation act etc can be considered as a red-flag from investor perspective. Violation of internal policies,guidelines and procedures established by the company is also a red-flag from investor perspective

Sarveshwar Foods Ltd : Emerging Value Play in FMCG

                            Sarveshwar Foods Ltd : Emerging Value Play in FMCG

CMP : 39

ISIN: INE324X01018

Market Cap : 96 Crore

LISTED ON : NSE SME Emerge Platform

Lot Size : 1600

Time Frame : 18-24 Months 

History of the Company :

Sarveshwar Foods Ltd was incorporated in 2004 and is primarily engaged in the business of processing and marketing various types of Basmati and non-Basmati rice in the domestic and international markets. The operations are based out of the Jammu Region in the State of Jammu and Kashmir. 

The latest venture of the Company has been into organic farming where the Company does contract farming for rice, dry fruits, cereals, pulses in addition to a variety of superfoods and has 22,000 acres of certified organic farming land with the company.

The Company has presence in export markets such as the USA, Europe, Middle East, Australia etc. Company was listed on the NSE Emerge platform in March, 2018.

Company owns 2 USFDA and BRC approved manufacturing facilities in Jammu and Kashmir for the processing of rice that have recently also got requisite approvals from Chinese authorities

Well-known clients and distributors of the company include names like walmart, Ebro, Big Bazaar, Costco, Nifol, Veetee, Vaishnav Devi Shrine Board Etc.

Main Business Activities : 

• Food Processing/ Presence across entire Rice Value Chain

Financials of the Company : 

• Profit After Tax (PAT) for the year ended on 31st March,2019 has been reported  at Rs 18 Crore and turnover at Rs 566 Crore. (Consolidated Basis)
• As per the numbers as on 31st March,2019 the company has generated Return on Equity of approx. 16% , Return on Capital Employed of 15% and Return on Assets of 6%
• Debt to Equity ratio is below 2 and is reasonable in nature

Investment Rationale : Why to Invest in this Stock ??

• Shareholding of the promoters in the company is 74% indicating strong interest of promoters in the business as on 31st March,2019
• Market Cap to Sales Ratio : 0.20  is very attractive
• Book Value of Stock at present is 56 Rs per Share, which is 30% discount to current market price of the stock. Such a discount to book value provides a margin of safety to investors making investment in the company at current market price
• Technically on chart the stock appears to have completed the process of bottom formation
• At current price of 39 Rs per share and EPS of 7 Rs on trailing basis, the stock is presently trading at an attractive P/E ratio of 6
• At a forward reasonable P/E of 15 and EPS of 10.00, we expect the stock price to soar higher atleast to 150 and higher levels in coming time.

Attaching Investor presentation for more detailed analysis which is shared by the company in the investors section on it's website : CLICK HERE --> INVESTOR PRESENTATION 2018

Disclaimer Note: The above is not a research report but information as available on public domain and it should not be treated as a research report. Registration status with SEBI: I am not registered with SEBI under the (Research Analyst) regulations 2014 and as per clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations.

Disclosure: It is safe to assume that I might have Sarveshwar Foods Ltd  in my portfolio and hence my point of view can be biased. Readers should perform own due diligence before investing. We do not assume any responsibility or liability resulting from the use of information , judgments and opinions for Trading or Investment purposes on the Blog.

Operating profit margins and its importance in investing in shares

Operating profit margins and its importance in investing in shares

Introduction 

Operating profit margin (OPM) is derived when direct expenses are reduced from total sales. OPM in excess of 10-12% is considered to be good. Higher the OPM the better. In business environment lot of factors keep on changing in real-time which affects the margin of the business. If a company has higher OPM it will be able to withstand and sustain adversity due to change in business environment. Regulatory changes, demand-supply changes , currency fluctuations, commodity cycles, change in rate of interest etc. are some of the changes that can affect a business.

Business with very low operating margins shall be altogether avoided. Because even a slight change in business environment can hamper the growth of business negatively impacting shareholders value. To improve operating profit margin companies can focus on cost reduction steps or increase sales of products which have high margins by changing the sales-mix of products.

Operating Margin (%) = Operating Profit / Net Sales

Operating Margin Important points : 

• Businesses which are having high competition or which are approaching end of life cycle are likely to have lower operating profits and should be avoided. Eg. Wires Business or Computer hardware business

• Businesses which have monopoly or very high market share in a sector or some form of competitive advantage which cannot be easily replicated will normally have higher operating margins and shall be good for investment objective Eg. Alcohol industry due to barriers on entry of new players or Any Government enterprise having monopoly in a sector

• Operating margins of a sector can be altered substantially due to change in business environment which can make a new investment advisable or an old investment obsolete. Eg. Demand for Automobiles is slowing down due to rise of cab industry and is likely to go down further in future. So investment in auto sector may not likely be advisable.

• While evaluating an investment in shares, one has to ensure whether there is consistency in operating profit margins for a certain period of time to say like 3 or 5 years. Companies which have very volatile operating margins can have wild share price fluctuations regularly is unlikely to delivery good returns to shareholders

• To improve operating profit margins, company can eliminate or outsource products with low profit margins. Increasing proportion of products with higher margins or introducing newer products with higher margins can also help

• Cost-reduction program can be undertaken to improve operating profit margins. Reduction of cost can be done in various domains like packaging, transportation, raw material procurement, automation to replace costly labor etc.

• Operating profit margin of companies with similar size and similar business model can be compared to identify which one is efficient