Chapter 6 : Spot Undervalued Stocks

So far in all the previous chapters I haven’t used any financial terms or fundamental analysis. I strongly believe technical analysis doesn’t not add much value to your investment strategy or investment style. You can create wealth out of share market with discipline and patience.

In this Chapter you will learn everything about Fundamental Analysis of a Company for finding Undervalued Stocks to Invest.

Flipkart Vs FoodPanda

Lets compare the story of Flipkart and FoodPanda.

You might be wondering why should we analyse an unlisted company to understand the markets. I want you understand the real business and how you should choose a stock just like a business person selects.

Flipkart established in 2007 and so far it has not made a single rupee out of business. There is no profits in flipkart business and no value to investors right…but if you see the cost of operation of flipkart, it is increasing manifold year on year. Even Flipkart If you see the valuation it is increasing more aggressively.Now we can see the case of foodpanda..The story of foodpanda is similar to flipkart but valuation is coming down.

Why…?

Foodpanda is unable to maintain sales..due to the recent entry of swiggy and zomato who are offering cashbacks and discounts relentlessly…
Though a company is not making profits Investors are happy if the revenues are improved.

But in case of foodpanda revenues are a burden.

Flipkart has invested good amount of money in it’s subsidiaries like phonepe, Myntra, Jabong, eKart etc. Which may yield good business in the near future and helps to grow Flipkarts revenues in the future.

Flipkart’s Moat

In investor words we can say that Flipkart is increasing it’s Moat. Investors are interested in companies having Big Moat. That is the reason for Wallmart’s acquisition of Flipkart.

The case of listed companies is also the same. Net revenues of a company and how it acquires those revenues and Future sustainability of business are to be considered.

1st Filter : Market Capitalization < Net Revenues or Net Sales

The ratio of market cap to net sales is a powerful tool to identify an undervalued stock. I suggest you to find businesses whose market cap is less than net sales or net revenues. At the same time consider how its peer companies are performing. And also the sector average or industry average market cap to sales ratio.

  • Market Cap to Sales < 1

2nd Filter : Book Value of a Stock

Book Value denotes the quality of Assets & Reserves of a Company and gives idea about Financial Soundness of a Company. Companies with good Reserves can sustain in bad times over the companies without Reserves. I recommend companies with book value of at least 50 % of share value.

  • Book Value/ current market price > 0.5

3rd Filter : Debt of a Company

Book value itself considers the debt of a company. If Debt of a company is more book value will come down. But I want you to look at revenues growth to debt growth in the past 10 year or 5 years.

If a company has good revenue growth and reduced debt you found a multibagger.

Where as the debt increased and revenues decreased just stay away from it.

Be optimistic. You see the analysis of Flipkart and Foodpanda. It is not always possible for companies to increase revenues and reduce debt. So it is Ok if the debt of a company increases less than 10% per anum over the period, provided it maintains a steady growth in sales.

4th Filter : Un-pledged Promoter Holding

Promoters are the only people who knows everything about the company. Companies with high Promoter Holdings denotes that the Promoters are having trust in their venture and it will grow over time. To invest in any company first thing to check is Promoter Holding. I suggest a Promoter Holding of 40% and more.

It doesn’t mean that you should avoid companies with less than 40% Promoter Holding.

For example, ITC, 4th Biggest company by Market Capitalization is having 0% Promoter Holding.

Once you are done with Promoter Holding you should check Pledged Percentage of Promoter Holding. To meet financial needs of the company, Promoters borrow money from Corporate Lenders, for that they need to pledge the shares held on their name. Pledging shares is a risky Job. If the pledged ratio is high the company may go bankrupt at any time.

I never recommend a company with pledged percentage of promoter holding > 25%

Filter for Un-pledged Promoter Holding is

  • Promoter Holding > 40% AND Pledged Percentage < 25%

5th Filter : Revenue Growth & Other Financial Data

From Screener.in, you can get Profit & Loss statement for the past TEN Years of any company listed in Stock Exchange.

HDFC Bank Profit & Loss

Three things to be considered from Profit & Loss statement, Revenue Growth, Expenses of the Company and Net Profit.

Companies with steady Revenue & Profit Growth with diminishing expenses is a sign of Capable Management. So it is always preferred to invest in those stocks.

6th Filter : Peer Comparison

Stock Value is a relative value. Once again I remind you that there is no intrinsic value in stock. Stock Value is purely depend on demand & Supply.

Stock Price does not depend on the performance of a company but on the relative performance of a company.

Thanks Screener, we no need to refer to all company balance sheets to check the performance of all companies in the same sector or industry. Screener gives us a detailed comparison in all the parameters.

HDFC BANK Peer Comparison

You can add the parameters (as columns) to the screen to check the performance in a specific category. Or you can also compare companies Head to Head by adding the company name as shown in the image.

Additional Filter : Moat of a Company

As explained above, Flipkart is having various subsidiaries from different fields which generate revenues for the company. So try to find companies with Big Moat.

Never limit yourself to these filters, explore Screener you will find more ideas and share your with others @ IndShare Forums

Read On… Chapter 7 : Investing in Small Cap Stocks

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