Here’s how to pick fundamentally strong stocks

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Here’s how to pick fundamentally strong stocks

 Here’s how to pick fundamentally strong stocks
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Highlights

  • Having a portfolio of fundamentally strong companies is very essential for long-term investing.
  • Periods of broader market sell-off show the importance of these strong businesses in the portfolio.
  • An investor should always try to invest in companies with a proven track record.

When it comes to long-term investing, creating a fundamentally strong portfolio is very important. Strong companies are not only able to generate more or less consistent returns but also display much less volatility. Another big advantage of selecting robust companies is witnessed during rough periods when the broader markets are in a sell-off phase.

How to choose fundamentally strong companies

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Many a time investors encounter geopolitical events, economic turbulence, natural calamities or one-of-a kind events (such as the financial crisis of 2008 or the recent COVID-19 pandemic) that shake the entire financial market. In such scenarios, investors generally flock towards strong companies, which they believe would be able to withstand these turbulent times and sail through them.

These periods of market-wide selling may easily dent a portfolio to a great extent if it is composed of fundamentally weak companies, the share prices of which in some cases might even take several years to recoup the losses. If you are new to the investing game and looking for simple yet powerful ways to select fundamentally strong companies, then we’ve got you covered. Find below a list of three factors that make for essential traits of a robust company.

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  1. Good historical performance

While buying shares of a company, an investor is essentially trying to bet on its future share price, or in other words, the future of the company. A good track performance is one of the key metrices used to gauge the future potential of a company.

A company with poor track record might do well in the future, but it is always better to stick to a proven result. To measure historical performance, an investor can look at historical revenue growth, profit margins, the trend of its market share, etc.

  1. Quality of the management

The management is to a company, what a captain is to a ship. Without a captain, a ship is almost directionless and may never be able to reach its destination.

Similarly, without a capable, experienced and ethical management team, even a good company might soon go to the dogs. Although it is a bit difficult to judge the quality of the management as it is all subjective, an investor should at least make sure that there are no red flags in the current management’s history.

  1. High promotor holdings

High promotor holdings in the business reflects the confidence of some of the biggest stakeholders of the company in the potential of the business. No other stakeholder – be it an outside investor, an analyst, a research company or any other market participant can know a business better than the promotors themselves.

Therefore, if promotors increase their stake, it is viewed as a positive sign for the company and if they offload their stake, it is considered as a negative one. Promotors’ stake might not affect the performance of the business, but promotors with skin in the game are generally a better choice over the others.

Bottom Line

Finding and picking up the best companies to invest in is not a cakewalk. An investor would require at least some level of understanding as to how to read the financial statements to compare historical performance of a company. Also, being able to judge the quality of the management is a skill in itself, which requires a good amount of experience.

However, an investor can start with selecting the companies with big market capitalisation, a generally increasing trend in the revenues, etc. and gradually work their way up to understand further complexities of investing.    

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