Chapter: 5 Investing in Stocks

Section: 9 How to Choose Stocks?

  • Earnings
    The most important factor that influences price is earnings. Earnings are the profit a company makes from the sales after deducting all expenses and taxes. Earnings help the company to grow and thus the share price.

    Companies that are growing would see their share appreciating in value in the market. Growth would mean growth in revenue, growth in profit and thus growth in dividend and share prices.

  • Cash Flows
    In addition to accounting profits, it is crucially important to see the ability of the company to generate cash. Hence it is possible that a company is incurring losses but still its cash flows are positive. For example, a company might have a very large depreciation expense that would be affecting its earnings negatively but in reality the cash profits are much higher. Therefore, an analysis of the company's cash flows provides a better picture of its earnings potential.

  • Management
    Quality of management team translates into improved corporate performance. Therefore it is perfectly logical to monitor the appointments to key management positions such as Chief Executive Officer, Board of Directors. Professionals with proven track records in corporate world can make fortunes for the company. In developed markets the management appointments cause stock price fluctuations.

  • Undervalued stocks
    Undervalued stocks can be compared to hidden treasures; these are stocks that have considerable upward potential but are overlooked by other investors. Stock prices of undervalued stocks may have declined due to some event or factor that impacted the stock's perception negatively. However, the company's assets and future earning potential are not reflected in the price of the share and thus the fair market value may be greater than the existing market price of the company. By capturing these stocks and holding them until the market recognizes their true potential, this can be a rewarding strategy.

  • Identifying The Forerunners
    Successful investors spot stocks which can outperform the sector or the market and invest in those stocks. These stocks grow faster than the average of competitors and the market and yield attractive returns. Generally high growth oriented companies do not declare dividend, instead they finance the explosive business growth with those funds.