Buying a stock : Step 2

This step is the most important and the most difficult step a long term investor faces, especially when he is new to stock market. Problem is that most of us are attracted to market when it is going up and hates the market when it goes down. It should be exactly opposite. The best time to have a ride on a bus is when everybody is getting down. Believe me you will get the window seat :)

When we like a company and decides to invest in it, it is almost difficult to resist that temptation to go and buy. When you are attracted by fundamental analysis (I will refer step 1 in previous post as “Fundamental Analysis”) of a company, you immediately want to invest in it after reading all those good things. But a share price doesn't reflect just the fundamentals. Daily share price movement reflects lot of sentiments which keeps going up and down. Take the benefit of this price movement to enter only when it's available at some cheap valuations.

What we can do is to minimize the risk. In this step, we need to see valuations part. When you go to shopping of a shirt, How do you decide a shirt is costly ? You compare the price with other brands. Same strategy is to be used here.

I have finalized following strategy for buying a stock :

1. Valuation information : Nowadays, this information is available at a click on net. You can get information on moneycontrol, Indiaearnings, ICICIDirect and many other finance sites.

2. Once I like some stock, I add it to my watch list on any of above site. Then I first check the “Financial” section. This will give last year's EPS, last quarter's EPS and current P/E. (Current price/EPS).

3. Next step should be checking “News” section. This will give all news releases happened for this stock in past. I generally check “analysis of last quarterly result” and “management interview”. Management interview will give you how company management perceives the results and what are their plans for next quarter or year.

4. Brokerage Reports : on CNBC/NDTV profit channel, you might have seen in ticker something like this : “CLSA keeps buy on Infosys : Target 2500 Rs”. This is actually full brokerage report. This one is a must read, as it gives expert's analysis about valuations for a particular stock. Check some example reports here. You can go to that stock's page and find brokerage reports available for the stock.
It's not necessary that you agree with that report or expert but you get some useful information here. i.e. Current EPS, Next year's estimated EPS and possible P/E ratio. If you think, what report is saying is totally absurd, just neglect it. Common sense will help here a lot. But finding and analysing brokerage reports for your stock is a must.

5. You can compare it's P/E with its peer group companies also. P/E for different Sector is generally different, i.e. For commodities (cement, steel) , P/E is generally low 6-10. For IT sector, P/E is in 15-25 range.

6. Now you should have idea that stock price is expensive or cheap. Is it near to it's lifetime high price or available at good price ? Is it expensive compare to it's peer stocks ?

7. Now keep the track of that stock price for 2-3 months. Yes, that long. Many people are not ready to wait this much. Since we are investing for time frame more than one year, it's always better to wait for a good time to enter. There are lot of reasons like liquidity, govt policy changes, international market trends, F&O Expiry etc. for which market keeps going up and down. So take benefit of this and whenever market or the particular sector or your favorite stock is going through correction phase or available at very cheap valuations , buy your stock at minimum 15-20 % lower price than price which you have seen at first.

8. Suppose even after waiting for 2-3 months, you didn't get that stock at low price and still it looks very attractive, then you can buy it in small chunk. i.e. If you want to invest 15k Rs in that stock, at first transaction, generally buy only stocks worth only 4-5 k Rs. Every time stock falls by 10-20 %, invest 5k Rs more.

9. Resist the temptation : Even after waiting for some months, if you don't get chance to enter at low price and price keeps going up without any fundamental change (P/E keeps increasing without any good news or EPS growth), then forget that stock. It's not only company available in market and you are not in gambling.

Buying a stock is a longer step and requires some analysis. All companies are growing at certain pace, so their stock prices can not go high without any limit. Better to have patience and enter at good price. Last few steps (7 to 9) will add to your “Margin of Safety”. Check this definition for more help.

These steps had helped me a lot in maximizing my returns. Hope this helps you also !!!

Read more on :
The IPO Checklist
First Year Portfolio Strategy