The Art of Quick Diagnosis of a Stock

Often friends tell me, “Buy stock X at the current price. It will double in two years.”

Often friends tell me, “Buy stock X at the current price. It will double in two years.” They know I am a long-term investor. Others may have WhatsApp advisers who say, “Buy Y for a 40 per cent upside in a month. It’s going one way up.”

We should ask them why, and they would tell us a juicy story, e.g. that a star investor had been accumulating it, or simply that their highly-rated technical analyst has predicted this. Markets always vibrate with gossip and communication networks! We are not talking about those who breach the law and pass on insider information – one should never indulge in that.

There can be two options to deal with this sort of information. One: throw it in the bin. And, two: have a quick look at the company to decide if indeed it looks good without the gossip.

So how do we have a quick look at the company? In my world, a quick look means spending 30 to 60 minutes on the screen! Well, the time spent is worth it if one were to take risk with one’s hard-earned money. 

When you buy a Rs 25,000 mobile or a refrigerator, you would spend quite some time researching for the machine with the best package of features, reliability, prestige value, and cost. That would often take hours on the internet and a couple of visits to the store; so why not spend less than an hour on the stock you have been tipped to buy?

Here is a quick diagnosis methodology I use. You can always customize it for your own purpose:

1. Financials: Check three-year financials, plus the last 2-3 quarters. Just the top line numbers such as sales, EBITDA, net profit, total assets, and shareholders’ funds. Check if the business has been growing and profits growing, too? Or are these stagnating or declining? That should give you a first impression of how desirable the business is.
2. Corporate News: Perform a search for the top 3-5 news items for that company. Is the company planning an expansion or merger or is it getting a new CEO or are its debts being restructured? Now you know a bit more about the company.
3. Price Chart: Have a look at the chart. What has been happening in the past 3-6 months and the past 1-5 years? Is the CMP 5x over 5 years or is it rising a bit after a 75% correction last year? You don’t have to be a technical analyst and you are not trying to make a prediction. You are only trying to see what is the downside risk if the stock has run up too much too fast or if it has simply been on a downward trajectory with unimpressive financial results.
4. Sector: Any reliable source such as DSIJ will provide you a list of peer group companies, i.e. companies in the same industry. Take 3 large companies in the sector and see if their price charts and financial results look good. This data should give you general comfort or discomfort!
5. Company Website and Profile: General information on the business of the company, names of CEO and CFO as well as members of the board of directors, one or two analyst presentations, promoter shareholding, and their pledged share numbers, etc. are the last bits of details to look for.

By the time this exercise is over, you should get comfortable about the idea of investing in the stock and how much upside to expect as well as the potential holding period; or else you should get a sense of not investing in the stock.

Of course, this is not a foolproof method, but it does cover you on many fronts.

Do have your own diagnostic method to quickly evaluate a stock? Do you think this approach helps you to improve your method? Do let us know.