If you’ve landed on this page, it means you’ve searched for the best shares to buy today in India. If you want to go straight to the point, here is your list of stocks. But if you want to know more, please continue reading.
What will be better for you, a quick list of ready-made stocks, or knowing the process of finding such stocks on your own.? Yes, you can do it. This article is about it. I’ll share the golden seven steps that will help you find the best shares available for investing right now.
Which are those shares? One thing is common among all good stocks, they all belong to quality companies.
Quality companies are like looking for a needle in a haystack. Why? Because most of the businesses around us are either plagued by weak business models or are poorly managed. This is the reason why, in the world of the stock market, avoiding is more important than investing. First, learn to avoid bad stocks, and then from what is remaining, select the best one.
#1. A Consistent-Profit Making Company
The roots of best shares must be soaked in profit-making companies. What number should we look at? At this stage, net profit (PAT) numbers will suffice. But looking only at the last twelve months’ data is not enough. Because only one year’s data is not reliable, it might change.
Our goal is to find a profitable company that will remain like this for times to come. How to establish such a sense of surety? It can be done by looking at the historical PAT (Profit After Tax) numbers.
I’ve plotted the PAT numbers of the last 10-Years of Hindustan Copper. The company has reported positive PAT, except for Mar’20 due to corona. So, in terms of positive net profit, it suffices our requirement.
But it’s trends is not what investors would like to see. Check the below chart.
In Mar ’12 the company’s PAT was Rs.323 crore. In Mar’21 it reported a PAT number of 109 crores. The PAT is not consistent. It is showing a falling trend. Personally, I would avoid investing in such a company.
So, a profitable company whose PAT is showing an upward trend will qualify to be the best share to buy today.
But there are other factors that must also be considered in shortlisting the best share. Let’s talk more about other parameters.
#2. Profitable Business
A company may report positive net profits, but it may not be sufficiently profitable.
Suppose you’ve some spare cash available for investing. If the money is invested in a Bank’s fixed deposit, it will yield a 6% p.a return. The significance of Bank FD’s is that it is risk-free. One is almost sure of the safety of the principal and the promised interest rate.
In this scenario, suppose you’ve decided to buy some shares. Investment in shares is risky, for sure they are not risk-free like a bank FD. As an investor, why would you buy shares instead of a safe bank FD? Because shares promise much higher returns.
But not all shares yield high returns. There are several factors that decide if a stock will yield higher returns than a bank FD. All these factors are related to the fundamentals of the underlying business of the said stock. Some common factors are profitability, growth, price valuation, etc.
In this section, we will talk about the profitability aspect of the business. I use two particular return ratios to shortlist stocks, ROE and ROCE.
- ROE: highlights the ability of the company to yield net profits for every Rupee invested by the shareholder.
- ROCE: highlights the company’s capability to payback to the creditors, shareholders, and the government (taxes).
If ROE and ROCE are higher than the bank’s FD rates, by two times, it is a good indicator of profitability. To make the use of ROE and ROCE more effective, the use of a 5-Year average is better. Furthermore, establishing a historic ROE and ROCE trend gives further insights.
Our example company has seen a decline in ROE and ROCE for the last 10 years. For me, stock showing such a trend will not be my best share to buy.
Another example of a stock showing positive ROE and ROCE 10-Year trend is shown below. Though the numbers are not so consistent, the long-term trajectory is upwards. Hence, such stock can be considered a contender for best shares to buy for the long term.
#3. A Growing Company
We’ve heard the idea of growth stocks. Investors like Peter Lynch have become legends by practicing and promoting growth investing. Why is growth so important in stock investing? Because among other factors, growth has a dominating influence on the company’s intrinsic value.
There is an article on this concept of growth driving intrinsic value. If you are interested, I’ll suggest you spend a few minutes on it. Anyways, I’ll explain it briefly in this section.
What you see above is an intrinsic value formula. Though experts will not use it as a mathematical model to express intrinsic value, it works. How? Beginners can use it to understand the influence of profit and its growth rate on a company’s intrinsic value, and hence its stock price. The price of a share will grow sustainably if its intrinsic value is also growing.
As you can see in the formula, the future intrinsic value of the stock depends on the EPS growth rate. The faster will be the EPS growth, the higher will be the future intrinsic value.
Two metrics that are most relevant to the growth of a company are revenue and EPS. In order to search for the best shares to buy today, I look at these two metrics. Data on both of these metrics are also easily available on any financial portal.
Why is revenue consideration essential? Because for sustainable EPS growth, revenue must also grow at the required rate.
Let’s see how an example company displays revenue and EPS growth over time:
Revenue and EPS growth is evident. But the trend line is showing a steeper growth rate for revenue than for the EPS. This can happen in two cases, either the profit margins are falling, or the company has issued more shares to the public. When shares outstanding numbers increase, it dilutes the EPS.
Nevertheless, the Revenue and EPS trend as seen in the above chart is acceptable.
#4. Quality Management
Judging the quality of management of a company using ratios is not so straightforward. Hence it is essential to select a suitable ratio that closely relates to the actions of the top management.
Revenue growth and profitability enhancement are two factors that rely on management’s actions to see improvement. Out of the two, I find profitability enhancement represents management’s quality more deeply.
To judge a company’s top management, establishing the ROIC trend will prove helpful. ROIC is a ratio that highlights how much profit (NOPAT) the company is generated for every Rupee of invested capital. This is the ROIC formula:
ROIC is a unique return ratio for two reasons. In the numerator, it uses NOPAT instead of net profit. NOPAT is unique because it is a tax-adjusted operating profit. It is a good representation of cash available in the hands of the company for the creditors and the owners (shareholders).
In the denominator, it uses invested capital instead of total capital (total assets). Invested capital is the net of cash available in the bank and the account payables. The cash parked in the bank account is doing no work, hence it cannot be treated as invested capital. Good companies make provisions for the upcoming account payable obligations. Even if there are no provisions, this quantum money needs to be paid within the next 12 months. Hence it cannot be included as invested capital.
I hope this explanation gives an idea about why ROIC is a better metric to judge the quality of management. But a year’s ROIC will not speak enough. Establishing a 10-year trend will be better.
What is shown above is the ROIC trend of an example company. Though it is showing a growing trend, the intermittent dips tell that it is a cyclical stock. In some years the demand is more than others. I personally take caution in picking such stocks on my watchlist. On the positive side, the ROIC of the company is displaying an uptrend, which is good.
#5. Wide Moat Company – Competitive Advantage
We all know the term monopoly. There are companies that have a monopoly in their industry. One such company is Google. Its monopoly in an internet search is known. Such a company is said to enjoy a competitive advantage. Warren Buffett refers to such a company as one having a wide moat.
There is a detail article on Economic Moat. I’ll suggest that you kindly read that piece. It details how monopoly benefits a company and hence its stocks.
A company that has a wide moat enjoys pricing power. They are free to increase the prices of their products & services as desired.
As an investor, we must keep our radars sensitive towards such companies. Why? Because when held for a long term, moat stocks can give phenomenal returns.
Talking about Moat Stocks is easy, but identifying them is another thing. If a moat company is as visible as Google, it helps. But not all companies are so evident. How to identify them?
Out of all financial ratios, ROA and Free Cash Flow Yield highlights a moat company more clearly. Why?
Before we can answer that, it is essential to understand that high ROA or high FCF Yield (FCFY) companies need not necessarily have a wide moat. Maybe the ROA and FCFY are low, but if it is high in comparison to their peers, it will work.
What does it mean? Suppose there is a company in the steel sector. It is a very capital-intensive sector. Moreover, their CAPEX cycle is longer and frequent. Due to these reasons, the ROA and FCFY of these companies are low.
It will be unfair to compare the ROA and FCFY of a steel company with that of an IT sector. They are incomparable. Hence, to find moat stock, we must look within a sector/industry.
Allow me to show you a comparison of ROA of a few companies operating in the same sector/Industry.
As you can see, though companies in this sector have a low ROA, company-1 looks different. Right? It seems to enjoy a very high ROA over its peers. It is a clear sign of competitive advantage (wide moat).
The concept of valuation says that one must buy even the best shares at the right price (intrinsic value). Paying a higher price will either result in a loss or subdued profits. How to know the right price?
There are two ways of doing it. First, we can calculate the intrinsic value using the mathematical models proposed by experts. Second, we can calculate the financial ratios and compare them to judge the valuation of a company’s stock price.
The first method of intrinsic value calculation is not easy. One must practice it before the correct numbers start to prop up. If you want to know more about intrinsic value calculation, I’ll suggest you start with these two lessons: Stock Basics and Fundamental Analysis.
The second method of price valuation by ratios is what we will see in this section. We all know about a ratio called Price to Earning (P/E). In my earlier days when the concept of intrinsic value was unknown to me, I also used a combination of ratios like PE, PB, Dividend Yield, and PEG to value stocks.
Here we will talk about the PEG ratio. There is a separate article on the concept of the PEG ratio. If you like to get a feel of how this ratio works, please read the piece. It will surely lead you to new insights about stock valuation.
In our endeavor to find the best shares to buy today, price analysis is a very critical step. An investor cannot make money even from stocks like Google, Amazon, or Netflix if it is not bought at the right price. PEG ratio plays a decent role in unearthing the true value of a stock.
What makes PEG ratio unique for valuation purposes is its ability to factor in the company’s future growth. The concept of PEG says that for a fast-growing company even a higher PE ratio is acceptable. Conversely, for a slow-growing company, even a low PE may not be suitable.
We will see an example of a fast-growing and a slow-growing company for a better understanding of the use of PEG.
For sure PEG ratio is more effective than the PE ratio. Why? Because of its two-layered valuation parameters. Hence, the conclusion derived from the PEG ratio is more reliable than a standalone ratio like PE, PB, Dividend Yield, etc.
As shown in the above infographics, two layers of filter will give us a group of stocks with a PEG ratio of one or less. These are undervalued stocks.
In terms of formula, the PEG ratio looks simple. But we must not forget that the EPS CAGR we are talking about is of the future. How to predict future EPS growth rates? Frankly speaking, it is not easy. But looking at the past EPS number will establish a trend. It helps in guessing how the EPS might behave in times to come (1-Yr, 3-Yr, 5-Yr, etc).
The below infographics shows an example of a fast-growing company (high EPS CAGR) but its valuation is coming out as overvalued.
This is another example of a low PE, slow-growing company. From Yr-2013 to 2019, its EPS was only falling. Hence it was showing a negative PEG. But since the last 3 years, the EPS trend is reversing. Considering that it was a low PE stock, its PEG is now below one. It is a case of an undervalued stock.
#7. Positive Net Cash From Operations (CFO)
Profitability, growth, valuations, moat everything will prove meaningless till they are converted into cash for the company. Cash flow is like blood for an organization. It must continue to flow to keep it alive.
Net Cash from operations (CFO) is the number I’m talking about. This metric is easily available in the cash flow report of any company. Before one can go ahead add a company in their best shares to buy list, analysis of CFO is a must.
No matter how much revenue & PAT the company is reporting in its P&L account, it is not enough. All those reported profits must flow in as cash into the company’s bank account. In short, the customers must pay, and suppliers must get paid. The net of payment received and paid must stand out as a positive number, year after year.
Good management will do its best to convert all net profits into net cash flows. How to know about this fact? A comparison between the company’s revenue, PAT, and CFO will give a clear picture. Here is an example of a fundamentally strong company displaying a falling CFO trend. A good company must increase its net cash flow at the rate of revenue and PAT growth.
Here are the seven parameters based on which a layman can shortlist good stocks. Pick your favorite stock and scrutinize them based on these seven parameters. See how they fair each step.
Give one point for each step. A stock that earns all the seven points will qualify to be the best share to buy today. I keep at least 10 such shares on my watch list.
Most of the time, they do not qualify on the valuation front. So I keep watching them regularly. When their price falls, I do its analysis using my worksheet. If you do not want to go into those details, do a PE and PEG check. If it qualifies, it must be good.
I hope you liked the article.
Enjoy your investments.
Best Shares To Buy Today in India (20-Nov-2021)
|SL||Name||Price (Rs.)||M.Cap (Rs.Cr.)||RoCE-3Y (%)||P/E||GMR Score|
|7||Indian Energy E||785.75||23,549.64||64.34||90.5||91.16|
|8||Sadhana Nitro C||42.35||828.44||72.98||44.11||90.85|
|9||West Coast Pape||269.6||1,780.35||16.69||10.09||90.55|