Success in investing depends on many factors such as macroeconomic factors and market conditions but the most important factor is the choice of stocks.
Picking quality stock is important to get good returns in a bull, bear and normal market. When the market is in a bullish phase, most stocks rally including those that are not strong fundamentally. And in a bear market, many stocks are available at cheap valuations which may lure investors to buy them. However, in a bear market like now, one must pick stocks prudently.
In a bear market, stocks trade at a discount, so it can be an opportunity to put money to work for the long term.
While the recent correction in the market provides a good opportunity to accumulate quality stocks, avoid getting carried away.
Here are 6 key parameters that one should keep in mind before picking stocks in a bear market.
1. Business model: Of late, there has been a lot of debate around the new-age internet companies such as Paytm, Zomato, etc. The stock of Paytm is down 68 percent while that of Zomato is down 60 percent from their respective all-time highs. Their business model is such that they incur losses in the initial years to gain market share.
While these stocks may hot a lot of potential to grow manifold in the future, in the recent bearish market, they may suffer more since investors tend to prefer companies that have solid earnings and a healthy balance sheet.
This is the reason analysts advise focusing on the business model of the company before investing in them. "It is important to see whether the company assures steady growth prospects for the near future or not," G. Chokkalingam, Founder & Head of Research, Equinomics Research & Advisory underscored.
2. Balance sheet strength: How capable is the firm to sustain its business. Is it under heavy debt? Can it sustain a period of crisis? As Chokkalingam pointed out, the firm should have the least leverage and least working capital crisis and the sum of inventories plus receivables as the percentage of annual revenues should not be significantly above the industry average.
Also, look at the debt-equity ratio to see how much debt a company has against the number of total shares. The lower the debt-to-equity ratio compared with the industry average, the better it is.
3. Growth trajectory: Not only in times of uncertainty, but even in a bull market, one must prefer stocks of the companies that have a good long-term growth trajectory. Why should one invest in a stock which is not going to grow significantly? This is as simple as it.
But how do you get clarity about a company's growth prospects? Study the fine prints of annual reports, keenly observe investors and annual meets, and listen to what the management is saying about the growth, demand and the road ahead. And invest only if you have faith in the company's growth story.
4. Management: Analysts emphasise understanding the quality of management. Many investors ignore this aspect even as it impacts a company's performance significantly. The importance of good management can't be overemphasised as it can lead to the enhancement, or erosion of an economic moat of a company.
5. Earnings: Quarterly earnings of the companies show where the company is going and what is working and not working for them. Earnings also give us a picture of how the company has been growing in the last few quarters and years. If a company exhibits good earnings momentum, it can be a good bet, say analysts.
6. Valuation comfort: Valuation is the price one agrees to pay for a company's fundamentals and growth story. Even if a stock has a good growth trajectory and strong balance sheet, it may not meet your expectations in terms of returns if it is available at rich valuations.
One must see at what level the stock is trading and how high it can go based on its fundamentals and the market situation. This is where the concept of compounding fails. If you invest in a stock at a reasonable valuation, you will get good returns in the long term while if you invest in stocks with rich valuations, you will get tepid returns in the long term.
Apart from these, there are many other factors that one can look at before picking a stock for investment in a bear market.
As Punit Patni, Equity Research Analyst, Swastika Investmart says, companies having competitive advantages, pricing power, good cash flow generating ability, reasonable debt to equity ratios, and high return ratios are good bets during these turbulent times.
Akhilesh Jat, Category Manager - Equity Research, CapitalVia Global Research says, "Do not make decisions based on randomness and short term. Focus on quality and invest for the long term. Diversify your portfolio, build positions over time and don't try to catch the bottom."
Disclaimer: The views and recommendations made above are those of individual analysts and not of MintGenie.