There are thousands of small, medium and big size companies listed on the Indian stock markets but shares of only few stocks can be considered as good shares to buy.
Let’s look at the parameters which can help an investor to find good shares to buy.
P/E ratio of the company
The price/earnings ratio (P/E) ratio can help an investor to determine whether a stock is overpriced or undervalued. P/E ratio is calculated by dividing the current price of the stock by the company's earnings per share. A high P/E ratio means investors are willing to pay a higher price for the stock. But it also means that the stock is overpriced and could correct. A lower P/E ratio could indicate that the stock is undervalued and priced relatively low. Such stocks could be a good investment bet. However before investing in stocks with low P/E ratio, one should also look at factors causing this, as it could also mean a fall in future earnings.
Consistency in dividend payouts
A company's ability to consistently pay and increase its dividend reveals that it has predictability in its earnings. It also means that the company is financially stable enough to pay dividends to shareholders. While looking for dividend consistency, one should consider dividend payout for atleast five years or more.
Earnings of the company
One way to evaluate companies to find good shares to buy is to look at its past earnings and future earnings projections. Companies with a consistent history of rising earnings over several years, can be considered as good shares to buy.
However an investor should also look at the company’s projected forward earnings because if there is reduction in company’s future earnings guidance, it could be a sign of earnings weakness.
Debt levels of the company
Companies with huge debt levels cannot be considered as good shares to buy. This is because, such companies will have to use a significant portion of its earnings to pay off the interest on the debt. As a result the company will neither be able to reward its shareholders with dividends, nor be able to use surplus funds for expansion of business.
Adaptability of the company
Any company which is not receptive to change and adaptable to changing technologies is like to be wiped out in the face of intense competition. The best examples of this are Nokia and Blackberry, who were once market leaders in the mobile phone and smart phone market respectively. Their inability to change with change in technology, helped their competition to capture the market. Stocks of companies which adopt new technologies with changing times, sometimes even before its competitors can be considered as good shares to buy for long term investment.
Quality of the management
A visionary management can take a business to new heights of success. Before investing in shares of a company, an investor should definitely look at the past history of the management as well as their past performance.
The bottom line while looking for good shares to buy for long term
By using the above mentioned fundamental parameters to evaluate stocks, one can definitely find good shares to buy and avoid the potential valuation traps. But it is equally important to remember that long term investing requires patience and discipline.