When we invest in a stock/company, if the share price goes up, then we are elated and feel that whatever we had assumed about the company is correct.
But the problem starts if the share price starts falling. We either become long term investor or just dump the stock.
Here comes the importance of stock research i.e. knowing enough about a stock to be able to take the right decision.
I will explain that in the blog “How to analyze a stock for investment?”
Fundamental Vs Technical Analysis in How to Analyze a Stock for Investment
There are 2 ways to invest/trade in a company: Technical Analysis & fundamental analysis. Technical analysis takes into account price & volume & is used for short term(few days) trading.
Whereas fundamental analysis talks about the business. And it is used for investing for months or years.
In this blog, I will be talking about fundamental analysis.
Let’s break-up our post – How to Analyze a Stock for Investment – into multiple sections and try to figure out the different steps.
Step-1: Identifying the Stock
Guess what is the first step of analyzing the stock: It’s identifying the stock for which you want to do the research.
There are 2 ways to select your stock:
- Top-down approach: You select a “Sector” and then chose the best company from that.
- Bottom-Up approach: You select a “Company” and then understand more about the sector.
Step-2: What Does the Company Do?
This is the first step to understanding the company. If we know what the company does, what sector it is in, we would at least be aware of things/newsflow going in and around the sector.
Let us visit the company’s website to check that: Polycab. It says:
Polycab is one of India’s leading manufacturers of cables and wires and allied products.
So, now we are aware that the company is into wires & cables business.
Another way to check is to go to www.moneycontrol.com –> Search Polycab –> Under the name ‘Polycab India Ltd’, you would see the ‘Sector- Cables- Power & Others’
Step-3: Is the Market Size Big Enough?
The second step would be to know the market size & growth rate of the market: Seems difficult but it isn’t.
Just search in Google ” Cables and Wires market size in India” and voila.
You have the market size and growth. At ₹50,000cr, the market size is quite big and the growth of about 15% is quite impressive. Also, to cross verify the above data, you can match the figure with data from other search results.
Why market size matters: Companies catering to smaller market size will see their growth stagnant quite soon
Step-4: Check Profit & Loss Statement
In the next step, let’s get started with the financials.
Goto www.screener.in –> Search Polycab India Ltd –> Goto ‘Profit & Loss’
Profit & loss statement gives details on the sales/revenue of the company and the cost associated with doing those sales.
Here comes the next question, Whether to look at Standalone or Consolidated numbers. We must look at Consolidated numbers as it takes into account the result of its subsidiaries, joint ventures, etc.
Sometimes the subsidiaries are bigger than the parent company, or the subsidiaries may be loss-making. That’s why Consolidated number gives a better or broader picture of the company.
Coming back to the financial analysis: You can see the ‘+’ sign in front of various line item numbers in Screener.
Once we expand that, we will have further details.
Once we have the expanded, Profit & Loss statement, we focus on the line item numbers one by one:
1. Sales Growth
This is to check if there is a good demand for the company’s product & services in the market. Looking at the Sales growth number for Polycab, the company has been growing its sales since Fy15 and that too at a very healthy pace.
Not all companies will have a similar trend, we need to make a judgment accordingly.
Here I am considering the Material Cost & Manufacturing cost. If we look closely, in the year 2018 the material cost dropped from 75% to 5% whereas Manufacturing cost increased from 6% to 75%.
At first glance, it might look puzzling. But there is an answer to it. This usually happens if the company changes the categorization of certain items or due to accounting standard changes.
So, here, in this case, we look at the combined figure of “Material Cost + Manufacturing Cost”, and try to figure out the trend.
You can clearly see that the cost as a percentage of sales is declining, which would either mean: Better pricing of products by Polycab or an increase in operational efficiency.
You would think, it is only the interest being paid on the debt taken by the company.
But Interest also includes various charges by banks such as charges for Channel financing, various kinds of other facilities taken by companies.
We will discuss that later in the “Balance Sheet Section”
4. Operating Profit Margin(OPM) & Net Profit
The higher the better and the increasing margin trend also is equally good.
Both the OPM & Net profit are on an upward trend. Here, the net profit margin is not provided. We can calculate that by downloading the data from Screener.
Step-5: Check the Balance Sheet of the Company
The balance sheet gives details of the company’s assets and liabilities.
As you can see that Equity Capital(part of the company’s liability) has been increasing since 2014. Although it is not considered ideal. But we can take a call later looking at other aspects of the business.
If you look at the borrowings, it has reduced substantially from ₹800cr in FY18 to ₹272cr in FY19. If such is the drop, there should be a corresponding drop in Interest cost.
Let’s check that out in the P&L statement above. But interest expense increased from ₹94 to ₹117 cr. It should not have happened. What to do next?
When in doubt check the Annual report. Goto www.bseindia.com –> Search for Polycab –> On the left side of the page you will find a drop-down menu with ‘Annual Reports’ —> You will find the list of annual reports published by the company.
Now, you can search for keywords such as Interest, debt, borrowing to find out the particular reason. Actually, the Interest amount had declined but there was an others item which increased from 19 to 58 cr.
You can also read: How to efficiently read a company’s Annual reports?
Step-6: Check the Cash Flow Statement
Cash flow statement of any company is derived from the Balance sheet and Profit & Loss Statement. It gives an idea of how the company manages its cash flow.
There are 3 types of Cash flow statements and the most important is Cash flow from Operating activity(OCF). Ideally, OCF should be positive, and if it’s greater than Net profit, the merrier. In the case of Polycab, for some years the OCF exceeds Net Profit, and for some years it doesn’t.
Step-7: Getting Data in Excel
You might be thinking about how to get hands-on with this data. There is a very simple way: you can download the financials from Screener for easy analysis of numbers.
Register & Login –> Goto Company name –> On the top right you will have the “Export to Excel” feature
Step-8: Management Quality
Management quality should be judged by tracking it over time. One way to understand is if the management has been able to improve the company’s efficiency which is quite visible in the ratios below.
From 2015 onwards the company has consistently improved ROCE and even during the slowdown period of 2019-2020.
Not only the profitability, but the company also showed impressive growth during a difficult period.
Shareholding Pattern: In the last 5 quarters, the promoter shareholding has remained almost at similar levels.
You can also read:
Step-9: The Valuation Part
In the image above, you can see the word Market Cap (Market Capitalization). It is basically the valuation of the company.
There are 2 primary ways you can value a company:
- Price to Earnings Ratio (PE Ratio): Anything below 20 is reasonable and below 15 it is quite cheap. Polycab’s PE is around 20.
- Price to sales ratio: Market Cap of the company divided by sales. Anything below 2 is reasonable and below 1 is very cheap. For Polycab it comes out to be (₹15,572cr / ₹8829)= 1.76.
Step-10: Research Reports
The research reports by brokerage houses are really wonderful tools to get a better sense of the company and on top of that, they are absolutely free.
You can search by: ‘ Polycab research report pdf’; ‘Polycab Initiating coverage’; Polycab Ltd analysis etc.
Step-11: Further analysis
If you want to dig further, you can listen to management calls and interviews. Almost all company organizes a quarterly investor concall which gets recorded and uploaded on several forum.
You can goto Youtube and search ‘Polycab India Concall’ / ‘Polycab India Management interview’
Now comes the question of how to decide whether to invest in the company or not. And it is almost impossible to get such a perfect company. We should analyze if the positives outweigh the negatives.
Creating a checklist will smoothen the process of analyzing any company. I have created a checklist specific to this blog to explain how to use the checklist.
As you can see, positives outweigh negatives.
This creates a case for buying.