How to choose good quality stocks for investment

How to choose good quality stocks for investment


Every one says choose good investments. Everybody says choose good stocks when you want to invest. But how to choose good stocks? What are the different ways in which one can get to know about the future of a stock or a company? Can we predict how a company will perform in the future? We will try to answer these questions in this post. 

Which stocks will do well? 

Simply saying, if you buy a stock, you are essentially buying in 'share' in the company, ie ownership in the company. So what is supposed to work? Well, that would be the company. If the company is doing well, so will the stock. 


How do I know if a company is doing well?

You know that by looking at the annual and quarterly statements of the company under question. Nowadays you can easily get the company's results on the internet- either on the company's website or on numerous other websites displaying the same including stock exchange website eg NSE, BSE, SEBI etc. If you want to follow a particular company, you can set up an alert on websites such as screener and get regular updates about the company's announcements including results. 

So look at the results of the company and see whether it has been performing consistently over the past few years and past few quarters. If it has been performing well, ie making profits quarter after quarter, year after year, you have got a winner. 


How do I find such companies? 

Use screeners to screen from large number of companies and identify those companies that are doing well and are worth your money. There are many websites which give useful screeners with a wide variety of options to screen out stocks based on various parameters. Every one of them has there own set of advantages and user-friendly interface. See what suits you the most and what is your criteria for screening. Some of such sites are screener.in, investing.com, economictimes.indiatimes.com. Screener is very fast and useful at finding out information about individual companies. I used investing.com to screen stocks on various parameters and then to select the ones I liked. Then I used screener for detailed information about the stocks. You could do it the other way. 

Below is the screenshot of screener.in
how to choose good quality stocks
Screener.in stock screener sample view

Below is the screenshot of investing.com screener
how to choose good quality stocks
Screenshot of investing.com screener

This is how the results of the screen look like
how to choose good quality stocks
Investing.com screener - this is how the results show up

What are the parameters I should apply to screen for good quality stocks? 

ROCE, ROE, 5year profit growth, 5 yrs sales growth, revenue growth, debt-equity ratio, current ratio, book to price ratio, equity returns over past 3yrs/ 5yrs etc. You can apply one filter or many of these filters to screen for stocks. More the criteria less will be the number of stocks and easier will it be to select. 
Following screenshots from screener.in illustrate how does all this look like.

Sample view of stock profile on screener.in. Here profile of HDFC bank is shown

how to choose good quality stocks
Quarterly results of HDFC bank shown in the screenshot. Observe the consistency of increasing sales and profits through quarters which has dipped a bit in June 19 quarter. 

What do I do after screening stocks? 

All the stocks that fulfil your screening criteria do not become eligible for your investments. You have to further find out what is the company doing and how is it doing. Following are some of the questions that you need to ask - 
Is the company in a good business? 
Is the business going to survive in the next 20 yrs?
Is it a cyclical business?
How much is the business going to get impacted by government policy decisions?
Does the company have stable earnings over the years?
How much is the debt in the company? (debt to equity ratio of 1 is acceptable)
Is the company growing its profits over the years?
Has it suffered losses in any quarter? (if yes then reject the company)
How is the public image of the company?
How is the management of the company?
Is it a large-cap (more than 20K crores), or a mid-cap (5-20K crores) or a small-cap (less than 5000 crores)?

I have selected the company. Can I put my money in? 

NO. You have to be patient and understand more about the company before you are sure about it and start investing. Keep it in your watchlist and follow it up for some time, understand its price movements and follow its news. Be sure about the public image, media image and price movement of the stock before investing in it. 

When should I get in?

This is one of the crucial questions. If you select a very good company and decide to get in at the wrong time, it may take a lot of time for you to go into profits. Your money may get trapped. Every stock goes through a particular price movement cycle. If you understand the cycle by following it up for a few months, you will be able to get in at the right time. Although it is impossible to time the markets perfectly, still with some practice you will realise that there is a pattern and it can be used in our benefit. 

How long should I wait? 

If you have selected the stock with due diligence, using the fundamental analysis techniques, it will give you phenomenal returns. You have to give it time to grow, the more time you give it, the more returns you will get. You should aim for at least 10-15 yrs horizon. Although they say it is important to get out at the right time to reap maximum profits. It doesn't matter much for a retail investor because if you take out the money when the stock is going down, chances are that you may not be able to time the market to get in again. For a retail investor, it is not always easy to be abreast with the developments of the market on a day to day basis. So it's better to remain invested for long periods and reap the benefits of long term appreciation rather than keep getting in and out of the stock. 

Should I forget about it? 

After investing in a good quality stock, many people say one should forget about it for 10 to 15 yrs. Well there is a bit of a caution there. At times even large companies fail and the stock eats away your money as it reduces to become a penny stock eroding all gains. So it is important to keep reviewing the portfolio once in a while to see if there is some bad news in a company that you own. If so, plan an exit to invest in a better company. 

Take home message 

What do you learn from all of the above? 
Learning that you should take home is that you can apply various stock screeners to kickstart your work. After that, you have to do a lot to find out if these are the stocks worth investing. Then you give some time to observe the movements of these selected stocks and after you are convinced about the stability and future of the stock, you plan to invest. 
It's a long process but it's all worth your money. 

Good luck and Happy investing. 

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