Step 1: Begin by opening a demat and trading account
To kickstart your journey into the share market, the first crucial step is to open a demat account. Opt for a brokerage service with low fees and excellent services. Zerodha stands out as a top choice for a demat and trading account broker in India. Your account typically gets activated within 48 hours upon completing the necessary documentation, sometimes even on the same day.
Step 2: Fund your demat account
Once your demat account is set up, it gets linked to your bank account. You can transfer funds exclusively from your linked account using methods like net banking, UPI, or NEFT. After the transaction is completed, your funds become immediately available for trading.
Step 3: Choose a stock for purchase
Selecting a fundamentally strong stock is crucial. Conduct your research to identify stocks that align with your preferences. Later in this article, I’ll delve into 7 effective ways to filter and shortlist robust stocks. Alternatively, you can explore a list of high dividend-paying stocks.
Step 4: Place a buy order in your trading account
Once you’ve chosen a stock, navigate to the buy option. You can purchase stocks at the current market price or set a limit price according to your preferences. It’s essential to ensure you have sufficient funds to cover the stock’s cost; otherwise, your order will be canceled by the stock exchange.
Step 5: Monitor your portfolio’s status
After placing your order, check your order book and transaction history. Once your order is successfully executed, you can view your stocks in the portfolio section of your demat account. From there, you can decide to exit the position on the same day or simply hold onto the stocks in your demat account.
Trading and investing are two distinct approaches to profit in financial markets. Trading involves making daily profits, regardless of market direction. Long positions involve buying at a lower price and selling at a higher price during market upswings, while shorting entails selling at a higher price and buying at a lower price when the market is declining. To navigate this, traders often employ technical analysis, interpreting indicators like candlestick chart patterns, moving averages, and stochastic oscillators to predict stock price movements. Due to the inherent volatility in stock prices, trading can yield significant rewards or losses, necessitating a clear strategy, especially in intraday trading.
On the other hand, value investing, as advocated by Warren Buffett, focuses on holding stocks for extended periods, typically a decade or more. Buffett’s philosophy emphasizes the importance of considering long-term ownership, steering clear of stocks not intended for a decade-long commitment. The major advantages of this approach include dividends and stock splits, contributing to the creation of wealth. Warren Buffett’s success is attributed to investing in sound stocks and patiently holding onto them, harnessing the power of compounding for exponential growth over time. This strategy, rooted in value investing, aligns with the principle of generating substantial wealth through patient and strategic long-term stock ownership.
To learn about the basics of the stock market in India in 2023, follow these seven steps. Start by gaining a fundamental understanding of financials, then focus on businesses within your comprehension. Identify companies with a competitive advantage or “moat” that sets them apart. Opt for companies with low debt levels and calculate important financial ratios such as Return on Equity (RoE) and Return on Capital Employed (RoCE). Assess the integrity of the management to ensure trustworthiness.
With as little as a Rs. 10,000 investment, you can begin applying these principles, even without prior financial knowledge. Consider the potential for making a Rs. 5,000 profit in the first year with a Rs. 10,000 investment. This same approach can be scaled up with a Rs. 10 Lakh investment to aim for Rs. 5 Lakh in future profits. The key lies in finding promising stocks through strategic thinking and a basic understanding of the business. Trust that with a bit of smartness and fundamental knowledge, you can uncover excellent investment opportunities in the stock market.
Step 1. Understand the basics of financials
There are thousands of stocks listed on BSE and NSE and it’s almost impossible to investigate each and every one of them by going through their entire financial information.
Therefore, for your initial consideration, you can use the below easy to implement screening criteria to filter out those stocks whose fundamentals look strong.
Screening criteria
Market Cap > Rs 500 cr
Sales and Profit growth >10%
Earnings Per Share(EPS) growth rate is increasing for the past 5 years
Debt to Equity Ratio <1
Return on Equity(RoE) >20%
Price to Book value(P/B) <= 1.5 or low compared to peer companies within the same industry
Price to Earnings(P/E) < 25 or low compared to peer companies within the same industry
Current Ratio > 1
You can then check the other financial ratios as part of the screening criteria by clicking on the company factsheet
Step 2. Find businesses that you understand
You can do this by visiting the website of the company, tracking updates on media platforms, searching for the company on Google, and getting peer feedback from fellow investors.
Learning more about the company will help you to understand the company’s business and will provide answers to three key questions
Is the company’s business simple?
Do I understand the product/service?
Do I understand how the business works and makes money?
It is important that you invest in companies that you understand, at least in the initial stage when you are learning to invest in stocks. That way you will be ensuring that you don’t lose money
Consider this: among the stocks you’ve filtered, there might be a two-wheeler manufacturing company. It’s not necessary to have an industry background to recognize that the two-wheeler sector consistently experiences growth in India, driven by increasing demand and improved road connectivity.
In a similar vein, during the boom of the real estate sector in India, companies involved in supporting industries like tile manufacturing (Kajaria), sanitary products (Cera), and others showed promise.
When evaluating potential investments, aim for simplicity in the business model. Look for companies that genuinely excite you. For instance, understanding the growth trajectory of the two-wheeler industry or recognizing the demand for supporting products during a real estate boom can guide your choices.
If you encounter companies where the business isn’t immediately clear, invest time in studying both the company and its sector. This diligence can enhance your understanding and confidence in making informed investment decisions.
Step 3. Look for companies with moat (competitive advantage)
It’s not sufficient to merely identify companies based on financial metrics and comprehensible business models. Equally crucial is a qualitative analysis focusing on the concept of a “moat.”
In business terms, a moat represents the competitive advantage a company holds over others in the same industry. The wider the moat, the more substantial and sustainable the company’s competitive advantage becomes. A robust moat makes it challenging for competitors to displace the company and seize its market share.
Therefore, selecting and investing in a company with a significant moat is a prudent choice. Examples of moats include brand power, intellectual property rights, patents, network effects, government regulations acting as barriers to entry, and more.
Take Apple, for instance, with its strong brand name, pricing power, patents, and high market demand, creating a wide moat that shields it from competitors. This has contributed to Apple’s impressive financial performance, nearing the trillion-dollar mark and consistently delivering substantial returns to investors.
Similarly, brands like Maruti, Colgate, and Fevicol enjoy strong moats with significant recall value in public memory. Factors like a vast distribution network and government-driven digitization initiatives make it challenging for new competitors to displace these brands from the market. This is reflected in the soaring stock prices, such as Maruti’s journey from Rs 16 in 2010 to Rs 500+ in 2017 (Note: Current prices may fluctuate based on short-term market conditions).
Identifying companies with robust moats in the early stages can contribute to successful and sustainable investments.
Step 4. Find Low Debt Companies
High levels of debt can pose a significant risk to a company’s stability. We employed two screening criteria, namely Debt to Equity Ratio and Current Ratio, to filter stocks based on their debt levels. These ratios provide insights into how reliant a company is on borrowed capital (debt) for its growth and its ability to meet short-term capital obligations.
When selecting stocks, it’s crucial to not only consider these ratios but also assess how a company has managed its debt over several years. A company actively reducing its debt is a positive indicator of its financial health and potential for increased profits.
Tips for Checking Financial Health:
To evaluate this, examine the company’s balance sheet, where both current liabilities and long-term debt are detailed. Long-term debt refers to obligations due after 12 months, while current liabilities encompass debts payable within the year.
Companies burdened with excessive long-term debt may struggle to meet these obligations, as a significant portion of their capital goes towards interest payments, limiting funds for other purposes. This situation increases the risk of insolvency and potential bankruptcy.
The long-term debt ratio is a valuable metric in this context, calculated as:
Long-term Debt Ratio = Long-term Debt / Total Assets
Step 5. Calculate financial ratios RoE and RoCE
Warren Buffett relies on two key financial ratios, RoE (Return on Equity) and RoCE (Return on Capital Employed), as part of his stock selection strategy.
RoE is expressed as a percentage and represents a company’s net income returned to shareholders. This ratio offers investors an alternative measure of a company’s profitability, showcasing how efficiently it generates profit using shareholder investments.
RoCE serves as a primary metric for assessing how effectively a company utilizes all available capital to generate additional profits.
When combined, these two financial ratios provide insights into:
- The profitability of a company in terms of investments.
- How efficiently it utilizes its resources.
A company boasting high RoE and RoCE signifies considerable potential for future growth in its value.
Consider the case of Avanti Feeds, one of the stocks identified through screening criteria. Examining its balance sheet data reveals that RoE and RoCE have consistently exceeded 20% over the past five years and have generally been on an upward trajectory.
Companies performing well on these two ratios, maintaining levels above 20% and showing a positive trend over the past five years, often command premium valuations in the market.
Step 6. Honest, Transparent, and Competent Management
Concerns about fraudulent activities by management have led many to hesitate in trusting the stock market with their savings. Instances of shady deals, accounting frauds, and misleading actions by management in listed companies have resulted in significant financial losses for investors. The infamous case of Ramalinga Raju of Satyam stands as a stark example.
Ensuring that the stock and, by extension, the company you plan to invest in is governed by honest, transparent, and competent management is crucial. The management team includes key figures like Promoters, CEO/MD, CFO, among others.
One notable example of a company thriving under competent and honest management, as discussed earlier, is Avanti Feeds.
As an investor, there are several ways to assess whether a company’s management is trustworthy:
- Search for fraud and track record
Utilize Google to search for the names of the management and investigate any reported fraud against company executives. Check their professional qualifications and track record to gauge their credibility.
- Read Annual Reports
Annual reports serve as a valuable resource for gaining a comprehensive understanding of the company and its management. Studying these reports enables investors to grasp the management’s analysis, strategy, notices, and future vision for the company. While the CEO aims to present a positive outlook, experience will help you discern between genuine intentions and bluffing.
Tip: Obtain the annual report from the company’s website as a free download or email the designated investment relations contact for a copy.
- Look out for Promoters’ shareholding
A higher level of promoters’ shareholding in the company is generally perceived as a positive signal. Although promoters’ shareholding may vary over the years, an increasing stake indicates their confidence in the company, making it a favorable investment opportunity.
Step 7: Right Price to Buy the Stock
Congratulations on reaching this step, indicating that you have narrowed down your options to a few potential stocks for investment. The critical question now is: What is the right price to buy these stocks?
It’s worth noting what Warren Buffett emphasized about pricing: “Price is what you pay, the value is what you get.”
The goal is to identify companies with maximum value while paying a minimum price. Even if a company is fundamentally strong, buying its stock at a high value might lead to losses if the stock’s future doesn’t align with expectations.
Buying at the right price establishes a margin of safety, shielding your investment from potential downside risks. Often, this optimal price is significantly below the intrinsic value of the stock, indicating a deep discount from its actual worth.
When a stock is available in the market at such a substantial discount, it’s akin to a bargain. Seizing this opportunity means acquiring the stock at a very reasonable price, thereby increasing the likelihood of generating substantial returns in the future.
Portfolio Allocation
On the allocation front, limit the holding of one stock to no more than 20% of the entire portfolio.
For instance, if your investable amount (size of your original portfolio in the beginning) is Rs 10,000, and you plan to invest in 5 stocks to make up your entire portfolio, then you shouldn’t invest more than Rs 2000 in a single stock. Of course, you can choose to allocate only 5 or 10% in a stock in which you feel the risk is higher.
Also, once you start investing and your portfolio starts appreciating, you need to allocate accordingly, keeping in view the present value of your portfolio.
For example, if your original portfolio is Rs 10,000, and you allocate 20% i.e., Rs 2000 in one stock. Now you have a holding of Rs 2000 in the stock + Rs 8000 in cash.
After some months, your stock rises by 25%, giving you a return of Rs 500, then your present value of your portfolio is Rs 8000 (cash) + Rs 2000 + Rs 500 = Rs 10,500.
Now, next time when you allocate 20%, the allocation value has to be calculated on this Rs 10,500. So, 20% allocation would now be Rs 2100.
Final thoughts
You don’t need an elite MBA or a Finance degree to know how to invest in stocks. Some of the best investors in India and around the world come from very humble and normal academic backgrounds.
If you don’t have a Demat account, then read – Zerodha review and Upstox review.
For starters, take the help of this article to kick-start your journey of investing in stocks. In fact, Peter Lynch, in his book, says that “You need about a 3rd-grade math education to be a good investor.”
And, ultimately, your investing success will boil down to this simple formula:
Investing Success = Identifying a Good Company + Buying at Right Price + Holding with Patience.
