Is this company’s stock worth investing in? Basics of equity research

Sep 30, 2019 | 3 weeks ago | Read Time: 4 minutes | By iKnowledge Team
Basics of equity research

When you buy the shares of a company, you are taking up part ownership of that company (to the extent of the stake that your shares represent). Think of it like buying an apple. You check it for firmness, its red colour, that there is no damage and that it smells good. You may even taste it a bit to find out if it is to your liking.

In the same way, when investing money to buy shares you need to do a little bit of research on the company. Equity research is a vast area and there are specialists who do the work. For you to do full justice to equity research, you must know all about accounting policies and accounting standards, the business of accounting itself and so on.

Without all that specialised knowledge however, one can do some fundamental analysis in order to arrive at a decision as to whether to invest in a stock or where to invest money. Let us guide you through the process.

All equity research starts with the annual accounts of the company – the balance sheet and the profit and loss statement. The balance sheet gives the position of the company – its assets and liabilities as of a certain date. The profit and loss statement tells about the operations of the company, how much it has sold, what it has spent and on what, and ultimately whether it has made a profit or not.

Consistent growth in revenues

One of the first things you need to look at is the revenue growth of a company. Has this consistently increased over the years, by how much and has this growth been sustained. All this information should be available in the annual report. You also need to compare the growth of the company in which you plan to invest with the revenue growth in a similar company. So if Company A (whose shares you plan to buy) has grown consistently at 10% every year for the last 10 years, and Company B (in the same business), has grown at 15% in the same period, then you need to see why. To make a comparison, you also need to see the size of the sales of both companies. It should be comparable.

When looking at the revenues you can also see the revenue break-up. Is major portion of the revenue coming from its core operation or is it the result of other non-operating income?

Expenses

Look at the total expenses of the company over the years. Is it increasing, decreasing in relation to the sale? Check for cost as a proportion to the revenue figure. If it is rising consistently, it could be a danger sign. Look at what component of the expenses have risen. That should give you a clue. Containing costs is a sign of efficiency of a company. Rise in finance costs mean that the company has taken on too much debt, or it may be expensive debt. The company may be spending more on sales and administration. This is a more productive expenditure.

Profit and Profit margins

The profit figure is right at the bottom of the P&L statement, but it is an important number. Look at the profit trend for the last 10 years. Is it rising? Is it fluctuating or going down? Or has it stagnated for a while. The profit and sales figure can be used to arrive at the profit margin, that is the profit expressed as a percentage to sales. Do this calculation to find out if the margin is maintained, rising or falling. If it is maintained or rising, that is a good sign. You can do a similar exercise with the operating profit margin – operating profit being the profit before interest and taxes.

Debt

Details about the debt are found in the balance sheet. Look at the trend in the long-term debt of the company. How much has it borrowed over the years? You can compare the debt to equity ratio for each year and establish a trend. Roughly a debt to equity ratio of 2 is to 1 is okay. Anything more than that may not be good. Explanations about debt can be found in the notes and schedules to the accounts.

Another calculation that you can do is to calculate return on capital employed.

Here return is earnings before interest and taxes plus depreciation. Capital employed means equity capital and long-term debt. Calculate this figure for a decade or so and plot a trend. If it is rising, it is a good investment. If it is falling, then you need to be careful.

These are just some basic figures and calculations that you can easily find, and they tell you a great deal about the company.

However, if research is not your forte then there are other types of investment you can opt for, such as insurance. Aegon Life’s unit linked insurance plan provides protection while it also offers market-linked investment returns. You can choose from six plans according to your investment objective and you can withdraw 20% of your investment after 5 years.

Beats all the tediousness of equity research, doesn’t it? To know about Aegon Life’s life insurance products like term insurance and other products, visit our home page.


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