There is a saying: not everything that glitters is gold. The virtue of patience for long term returns remains thin for Indian investors, most of whom get carried away by the false hope of quick returns.
If you are ready to stop treating stocks as lottery tickets but as a money plant that requires consistent care and patience to bear fruit, the stock market can help you here. To invest money in the long term, say more than five years at least, in a stock that has the potential to offer compounding returns, you have to check these aspects of the business before you punch in your OTP to send the money across.
Economic Moats and Competitive Barriers
Some stocks remain under the radar, underrated and undervalued for years despite having a structural advantage that allows them to stand out from the crowd. This could mean locked in revenues from long-term contracts as customers aren’t willing to switch to competitors, as the company may offer a solution that doesn’t match anything in the market.
Besides this, intangible assets held, such as intellectual property, patent portfolios, regulatory licenses (such as US FDA approvals or aerospace AS9100 manufacturing certifications) create defensible barriers to entry.
Additional low-cost production advantages achieved from self-developed manufacturing processes and geographic proximity to essential raw materials offer cost advantages that competitors cannot easily match.
Operating Fundamentals
The capital markets have a tendency to react to negative news- it could be underwhelming earnings during a quarter, operational challenges or rumours. Though a reaction on the stock’s price is usually temporary, the underlying fundamentals of the business should remain strong.
For example, a precision engineering firm may see a decline in quarterly profits due to a temporary increase in global raw material prices or supply chain disruptions. If the company maintains its position in the market, retains its key enterprise accounts, and operates with zero net debt, its gross profit margins will normalize once the raw material markets stabilize, supporting operational recovery and further growth.
If the business continues to be structurally weaker but its share price remains artificially high from business speculations, the business may not be able to sustain profits for itself in the future.
Sunrise Industries
Companies working in ‘sunrise sectors’-emerging sectors that are expected to see exponential growth, offer strong, multi year growth potential. These include renewable energy components, advanced electronics manufacturing services (EMS), industrial automation, agrochemical crop protection and expanding digital infrastructure can offer the potential for strong demand and expansion.
If the business operates in a niche with limited competition, this gives it strong revenue potential that helps it strengthen its position in the market, even for the global supply chain.
Relative Valuation Metrics in Sectoral Context
Understanding the true financial health of a company rests on understanding its relevant financial metrics. Share prices often don’t reveal the truth, as the company’s performance is tied to the orders it wins, the long-term contracts it has, or the revenues it has realized within a time period.
A better method is to check the company’s valuation metrics, that involve operational efficiencies and ease of doing business
- The Price to Earnings(P/E) Ratio: The P/E ratio compares the stock price to its earnings per share. The ratio varies across industries and sectors, and the best way to judge a company’s share valuation is by comparing it with its competitors. If the P/E ratio is higher than its peers, the company may have high growth potential or may be overvalued. A lower P/E ratio could mean the opposite, but, again, this depends on how it is performing as against its competitors within the same industry.
- The Price/Earnings to Growth (PEG) Ratio: This one works on the P/E ratio by measuring it against the annual earnings per share of the company. If the PEG ratio is under 1.0 this could mean the stock is undervalued, with high potential for growth, while the anything above 1.0 means the stock could be overvalued, with investors paying a premium for it though the stock may not offer a higher growth potential.
- Debt to Equity (D/E) Ratio: There could be meaningful returns, but the growth may not be sustainable in the long run if it is dependent on borrowed money. The Debt to Equity (D/E) Ratio measures the total liabilities the company owes (including long term and short term debt) to the net worth of the company. If it is on the higher side (above 1.0 or 1.5), the company may be using more debt than its own money to grow, which could include a higher risk of default. Anything lower than 1.0 often means long term financial stability, though the ideal numbers are dependent on industry standards.
- Return on Equity (ROE): This measures the company’s net income against its average shareholders equity, after paying all expenses, interests and taxes. It showcases the company’s profitability for every Rupee of shareholder’s money. Usually, an ROE of 15% or more is considered ideal for a healthy, investment-grade company, though the number varies across industries.
- Return on Capital Employed (ROCE): This ratio measures how well the company is using its money to generate profits. This remains crucial as the way the company uses its money shows how it can turn investments into profits, including managing its debt. The ROCE ratio is measured by taking the Earnings Before Interest and Taxes (EBIT) to the capital it employs. Usually, a ROCE of 20% or more is a positive sign, though it varies across industries.
The path to research quickly, with riders
An experienced investor will make a highly detailed study on the stock, its market position, future revenue guidance and its metrics before making an investment decision. Today, using a prompt can get this done within a day, though you may have to fact check all the decisions. You can refer to the video below to help you, but do not make any decision in haste, after all, its your hard earned money that you hope will get you good returns.
