Plenty of investors check the Tata Motors share price on their phones several times a day, yet far fewer know how to dig into the business behind the number. The same is true for those who glance at the Maruti share price without understanding what drives it. Good research does not require expensive tools or complicated models. It requires a repeatable process, steady habits and a willingness to read what companies actually publish.
Start With Annual Reports and Investor Presentations
The best source of reliable information about a company is the company itself. Annual reports contain information on the company’s strategy, risks, segment performance, capital spending and management discussions in considerable detail. Quarterly investor presentations capture a summary of volumes, realisations, margins and outlook. Earnings call transcripts highlight how the management responds to tough questions posed by analysts and investors, which can be just as informative as the prepared remarks.
Read More: FUND MANAGEMENT IN FOCUS: HOW MUTUAL FUNDS TRANSLATE STRATEGY INTO SCALE
Read these documents with a notebook handy, taking note of the key growth drivers, risks and any targets set by the management. Compare them with subsequent developments later in the year. Did the company deliver on its promises on launches, margin improvement or debt reduction? A management team that is able to consistently match its guidance builds credibility with investors, while one that frequently revises its targets can act as a caution. Exchange websites and company investor pages offer these documents free of cost, so there is no need to rely on third parties or unverified summaries.
Key Ratios Worth Tracking
A few financial ratios can provide deep insights into the workings of an automobile manufacturer as well as highlight specific risks. The operating margin highlights how efficiently the company is able to convert sales into profit before interest and taxes. The return on capital employed shows whether the company’s capital structure is able to generate adequate returns. The net debt to earnings ratio is an important indicator of the company’s overall financial health, especially because the automobile industry is capital intensive with its ongoing requirement for investment in plants, platforms and technology.
Cash flow generation deserves special attention as automobile companies are often capital intensive, and the companies can record profits on the income statement even as they may have negative cash flows due to inventory build or large capital expenditures. Free cash flow generation, which reflects the cash remaining after necessary investments, is a good measure of the company’s ability to fund its dividends or buybacks and fund its reinvestment. Valuation multiples such as price to earnings and enterprise value to operating profit can help compare companies but these need to be viewed in the context of growth and cyclicality. A low multiple at the peaks can be just as misleading as a high multiple at the troughs of the cycle.
Qualitative Factors Beyond Numbers
The qualitative aspects can often be overlooked by investors. Brand equity, product quality, service offering and dealer network can be extremely important elements to identify strengths and potential risks. Visiting showrooms and service centres if possible, and talking to owners about their experiences can be valuable. How often is the company launching new cars and are they well received by the market? Is their portfolio relevant to the evolving preferences of buyers? For instance, the focus on safety, connected cars and cleaner fuels.
The governance aspects such as the quality of the board, transparency in disclosures, related party transactions and minority shareholder treatment can also indicate potential risks. The manner in which the company recalls cars and handles customer complaints can help highlight the underlying discipline of operations. Honest assessment of the competitive environment can help identify the threats posed by rivals as well as the key strengths that can sustain competitive advantage. Answers to such questions can help distinguish between noise and value creation potential of a company.
Position Sizing and Discipline
Even the best research process is subject to uncertainties and vagaries of the marketplace, which is why position sizing is critical. Decide on how much size you are willing to take in any specific stock or sector based on your individual risk tolerance. Many investors follow a systematic approach in order to ensure that no individual stock dominates the portfolio and that the losses on any one stock do not outweigh the gains on others.
Read More: HOW TO SECURE A LOAN AGAINST MUTUAL FUNDS EASILY?
Using systematic investing methods to spread out your purchases in a particular stock can help reduce risks and writing down the reasons for every investment can help provide clarity on whether volatility is a reason to sell or not. If the rationale still remains valid, continued investment or patience can be warranted. On the other hand, if the reasons no longer apply, investors should have the discipline to exit rather than wait for an opportunity to buy back later. Maintaining an emergency fund, which is separate from your investing money, is critical to avoid forced sales during market stress.
Research is a continuous process, which is why periodic reviews are critical to identifying your mistakes as well as opportunities, learn from them and continue to evolve your thinking while also staying honest about what you do not know. Seeking independent advice from a SEBI registered investment adviser can help ensure objective advice tailored to individual requirements.