Let us start with a scenario where you have stumbled upon a potentially brilliant stock idea. It is a potential multi-bagger story.
Some of your friends have bought it and told you about it or you have read about it somewhere or you have information from sources that a big investor has recently bought into the company.
You need to build the conviction that this is indeed a very good stock/company that can be held for the long-term to create wealth.
Now the question is where do you start researching the stock idea and how do you decide in the lease possible time whether this is a potentially good company to invest in.
To effectively solve the above problem, let us turn this problem upside down.
How do I decide quickly whether the particular stock I have heard of is not worth my time? – The answer to this challenge lies in creating a set of questions -(a checklist) which can be quickly answered to determine whether to spend more time with the idea or not
In this article, I will enlist the set of questions (checklist) I use to filter the ideas that I work on. The beauty of the checklist approach is that it is a comprehensive tool to quickly address the question – “Should I spend more time researching this idea?”; “Am I better off researching some other idea rather than this one?”
The place to start is basic Financial Analysis
| Sr No | Parameter | Criteria | Value | Remarks / Judgment |
| 1 | Sales Growth | CAGR (10 yrs)> 15% | ||
| 2 | Profitability (NPM) | NPM > 8% | ||
| 3 | Tax Payout | > 30% | ||
| 4 | Interest Coverage | > 3 | ||
| 5 | Debt to Equity | < 0.5 | ||
| 6 | Current Ratio | > 1.25 | ||
| 7 | Cash Flow | CFO > 0 (all years) | ||
| 8 | Cum PAT Vs Cum CFO | cCFO ~ cPAT | ||
| 9 | Self Sustainable Growth Rate (SSGR) | SSGR > Sales Growth | ||
| 10 | FCF generation over 10 years | FCF (10 yrs) > 0 |
The next step is to do some basic business analysis – return ratios and some Industry and Peer Analysis
| Sr No | Parameter | Criteria | Value | Remarks |
| 1 | ROCE (10 yr avg) | ROCE > 20% | ||
| 2 | ROE (10 yr avg) | ROE > 15% | ||
| 3 | Comparison with Industry Peers | Sales Growth > Peers | ||
| 4 | Increase in Production Capacity & Sales Volume | Capacity/Volume CAGR ~ Sales CAGR | ||
| 5 | Profitable Growth | Profit Growth >= Sales CAGR | ||
| 6 | Creation of value for shareholders from retained earnings over 10 years | Increase in Mcap in 10 yrs / Retained Profits in 10 yrs > 1 |
It is not necessary that a company qualifies excellent on all the above 16 parameters.
However, a potential multi-bagger company will in all probability will in all likelihood qualify on most. The most critical of the parameters are
- cCFO ~ cPAT (10 yrs) – This is most important barometer of the ability of the company to convert accounting profits to cash and a lead indicator of presence/absence of accounting fraud
- SSGR (Self Sustainable Grwoth Rate) – SSGR must be greater than Sales Growth. This indicates whether the company can keep growing for a long time in the future with internal accruals without taking external debt.
Dr Vijay Malik beautifically describes this concept over here. - Free Cash Flow over 10 years – This parameter tells us whether this business is a cash guzzler or a cash generator
- ROCE (10 years) – Return on Capital Employed over a period of 10 years over a upward and a downward business cycle
Once the stock ideas passes this basic analysis, next we do some analysis for accounting fraud and management integrity
PS – www.screener.in is the best available free online tool to check financials of any company listed on the Indian stock exchanges
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