It is not difficult to identify a successful business for investment. If one knows the basics of fundamental analysis. It is a tool for determining the company’s valuation. Fundamental analysis is a complex term to grasp, but by understanding the basics of the process, one can find good companies for investment. Fundamental analysis allows us to understand the financial health of the company.
List of 5 main criteria to consider when looking for a successful business to invest in;
- Basic understanding of companies business
- Looking at broad future outlook and try to find scalability of the business.
- Management overview
- Financial Statement analysis
- Patten of shareholding
1.Basic understanding of the company
Before investing in a company, you should have a clear understanding of how it works. What exactly does the enterprise do? What services and products does the business provide? Since it would benefit in predicting future product demand. where you can determine whether or not to invest in the business. because you have to invest in a company whose products and services will be in demand. So that the company can expand its business because if the company’s business grows in the future, the value of your investment will also increase You will find this basic information on the company’s website, where you can also find information about the company’s products and services, mission and vision, and so on.
2. Looking at the big picture and trying to find the business’s scalability.
Once you have a clear understanding of the company’s products and services. Begin by looking at the big picture. What is the potential of the industry to expand in the future? Does the business have the capacity to grow at a higher rate? Is it easy to scale the company’s business? You can get all of these ideas by merely reading the sector outline for the future. Learn more about the industry in which the firm works. If the business has the ability to expand, the organization should do well as well. Choose the demanding sector because it has more opportunities for market growth than the conventional one.
Key points to look while analyzing the sector;
- Who are the primary customers of the business.
- Competition available in the sector.
- Entry barrier in the sector.
- Economic dependence on the sector.
- Future requirement of the sector.
Looking at these metrics will give you a good understanding of the sector’s success and future requirements. This will assist you in predicting the company’s potential results.
3. Overview of the Management
The most critical factor in a company’s success is Management. Management is accountable for the quality and profitability of company processes. Management with a strong vision and good leadership accelerates the company’s success. The most critical aspect of fundamental research is studying management. Since many of the cases mentioned previously where management’s fake and deceptive loyalty ruined shareholder capital, such as YesBank.
Because of the inability to communicate with executives, retail investors are unable to comprehend management psychology. However, by relying on specific points, we will broaden our definition of management.
- Customer service – Good management always focuses on customer services, the more customer-friendly product is the indication of good management.
- Employee turnover – Good management always tries to retain their employees and employees too don’t leave the company easily, In a good companies employee turnover is low.
- Pervious Performance – You can also check the performance of the management by looking at its previous company, and change the current company seen after the new management. It will give you some idea about the working style of the management.
4. Financial Statement analysis
A good company will always reflect its performance on the financial statements. Looking at the financial statement you will get a broad idea how the company’s business currently.
Six Basic Elements to Look for in a Financial Statement Before Making an Investment Decision;
Sales growth Analysis
Looking at the sales will not be beneficial for you. Constant sales-generating businesses are not worth investing in. An investor should always aim for revenue increases because it is growth that will help the business continue to do better, and the investment value will only rise if the current business is consistently growing. Look for sales growth good company always results in sales growth if the company is posting sales growth it is the indication that the demand for the company’s product is increasing YOY. Which will help the company to grow.
Operating profit margin( OPM)
How much the company is earning by carrying out the business activities is known Operating profit margin. Compare the company’s OPM to that of other companies in the same industry; if the company has a higher OPM profit than its rivals, it indicates that the company is making more money. It is a symbol of both a good business and good management.
Net profit Growth of the Company
If the firm is reporting positive revenue growth but it is not reflected in net profit earnings growth, this is not a good indication. The company’s costs are still growing with the growth, implying that the company is unable to generate a competitive advantage in the market. Good companies have good revenue growth as well as net profit growth. Profit growth is important because it reflects the profit-making ability of the firm, which is important for a firm to grow its operations and business.
Liability status
Many businesses required borrowed funds to run their operations like banking, But not all. If a company is carrying an excess debt and not able to match it with the financial growth then it is a risky investment. Compare the debt-equity of the company with the industry peers, If the company is utilizing the debt optimally then there is no need to worry because the company is capable to pay its debt and will pay once the company fully expands its business operations. Peer comparison will help you to understand the debt requirement of the industry.
Cash Availability
Companies should have some cash in their books to meet the uncertain cash requirements of the business. Companies who keep a strong cash flow show that they are well-prepared for the future, and it can also be seen as an indication that the management is well-planned.
Important Financial Ratios
ROCE – Return on capital employed Ratio helps you to understand how much the company is making out of every single $ they are putting in the business. A good ROCE ratio is considered above 15%. Look for the companies whose ROCE is +15% as these companies generate a good return on investment. The higher the ROCE the better the company’s efficiency.
ROE – Return on equity this helps you to understand what is the amount of return the company is generating for each equity share they issued. +15% ROE is considered a good number. When looking for a business to invest in, aim for something with a return on equity (ROE) of more than 15%.
PE Ratio – Price Earning Ratio, PE ratio shows the relationship between a company’s share price and Earning per share. PER is the ratio of a share price to the companies EPS. PER is considered as a valuation ratio, IT is used to find whether the company is undervalued or overvalued. THE ideal PE ratio is below 10. Search for companies that have below 10 PE ratio, Good Companies generally trade on higher PE, This Factor can be neglected if all other factors are taken into account while making an investment decision.
5. Pattern of shareholding
The analysis of the shareholding trend is significant because it reveals the management’s interest in the firm. If the management is interested in the firm, they will want to own as many shares as possible because they see the company’s potential. Increasing shareholding indicates the increasing interest of the investor in the company. Well in the most case shareholding of promoters are usually low like IT company’s, But the investor should look at the pattern of increasing shareholding by promoters to identify the good company for investment.
Conclusion
By taking into account all the above-mentioned parameters of investing you can identify a good company for investment, by just looking at the basics of fundamental analysis. All the above-mentioned information is easily available to every retail investor. By following this basic checklist you can earn good returns from the markets without putting your money at high risk. This type of investment is capable to deliver more than 20% compounded returns. Only Faith, Patience, and Long term view are required by the investor’s end.