How to Buy a Stock

Buying a stock is not that easy to buy a cloth or food stuff it do require some serious analysis.

Step 1:- Have a good track on market and know what local and global policy or events can impact the market. This blog will help you with that because we almost every day used to give our market updates based on the global and local policy , events and their impact on stock market.

Step 2:- Keep a track of analysis reports published by the different credit rating firms in this case this blog will also help you to have a eye on them.

Step 3:- Know what the market Big Bulls are buying. We used to give regular updates on that as well.

Step 4:- Analyze the company or the business you are buying. In this regard we are already covering multiple company as per our value investing framework.

Step 5:- Check if it is a High Margin and High Growth stock or not. In this regard we will be marking the company in our analysis so you can get a help from here.

Step 5:- Find out it's intrinsic value for yearly and quarterly terms. We will try to help in this regards but we also encourage your active participation in this case.

Step 6:- Set your time line and expected return based on this intrinsic value.

Step 7:- Try to buy on dips. For this many technical indicators like MACD, Stochastic, RSI will help.

Calculating Fair Value

Before we explain anything about the fair value of a stock and how to calculate it we need to have below assumption in place.

PAT growth rate :- We need to determine which will be a moderate PAT growth rate for next 10 years based on few factors like ->
i) It's past PAT growth rate.
ii) It's expansion plan for next 10 years
iii) It's distribution network
iv) It's ability to sustain at that level
v) Macro economic impact

Discounting Rate :- This is also a vital rate of which one part is very simple i.e. the 10 year long govt bond rate but the other part i.e. the risk factor we need to calculate based on various factor like ->
i) Risk involve in it's growth plan
ii) Economic Moat
iii) Any Macro Economic effect
iv) Financial Leverage
v) Operating Leverage
vi) Debt/Equity ratio

Apart from that it is easy to get PAT,Total Outstanding Shares,Perpetuity Growth Rate,Current Share price value & Current EPS. Which will be the other inputs of this tool.

There is also one more input which we call MOS(Margin of Safety) which generally depends on a company's wider or narrower economic moat here for DCB we have taken the moderate MOS of 2%.

Consider the below example of DCB bank whose PAT stands at 151cr, Total Share Outstanding 27.4 cr, EPS 5.93,PE 18.54. Now consider 13% PAT growth and a risk premium of 8% we have calculated our intrinsic value of EPS which stands at 7.86. Hence we have the fair value of the stock at 145.97 on premium and Forward P/E at 13.97 and having an upside of 32.7%. Also have Warren Buffet Calculator here.

Know When to Sell

Most often we face a challenge of when to sell a stock. Well this might be the most difficult question of the all in a stock market and it is also very true that it can not have a straight forward answer. So here I would like to describe this in my own way of explaining few questions that comes various times to various people's mind. But before going into that let me tell you selling point is more of strategical point rather than an emotional point hence we have to plan our selling strategy even before we buy a stock. Now let me explain how..

1. Set your timeline first :- While buying a stock you must need to set a timeline for that stock i.e. how long you are going to hold it?
2. Set an expected return from this stock for this time period :- Now set a %return attached to your investment and have an alert when it reaches that price level. ET Portfolio Alert feature can really be helpful in this regards.
3. What to do when it reaches that level  ? :- Well this might be a million dollar question comes to your mind that when this alert level reach what will you do? To explain this first you need to understand how to set this alert ? Well it's not an any arbitrary % return that you set on your portfolio rather it should be determined by an particular method you follow for your investment. Let's take an example of my own method which I call retrospective periodic analysis :-
 3.1. First you need to calculate the intrinsic value of the stock :- [How I calculate it, has been explained in Calculating Intrinsic Value section]  Now for that I have to consider few things like it's revenue, revenue growth rate, current PE,Forward PE and discounting rate based on the risk and opportunity in it's business model. Generally this model has been created on yearly purpose but for periodic analysis I create it for Quarterly purpose as well having 12 quarter i.e. 3 years in the perspective and  for yearly analysis I create it for 10 year.
 3.2. Periodic analysis of this value :- Now we have to compare whether the revenue growth rate is better than our estimation of less than it?
  3.2.1. In case it is better than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
  3.2.2. In case it is lower than our estimate then we have to adjust our expected growth rate and re calculate the value and need to also change current PE and Forward PE value as well. Now if we find that it has already reached the Forward PE estimated value for the 3 year then we should sale it of otherwise we must hold on to it for more return.
  3.2.3. Though this decision is not that straight forward. You also need to check if the company is able to maintain it's PAT and EPS growth rate as well or not. In case if PAT decline and it's due to a temporary cause [e.g. Capex expansion, Investment , Short term inventory loss, Tax rate etc ] then you still can hold it but if it is due to less demand and sales growth suffer or some law suit or some approval goes against it then you must sell it off.
4. What if my target price does not reach and ? Well in case your target price does not reach you also need to follow the above mentioned process [3.2.2] and take the decision accordingly.
5. What if I am loosing ? Well that is a very critical question that every investors perhaps faced even novice to Mr. Warren Buffett [who is still making loss on his big investment of IBM for 3 consecutive year which he has bought on Nov 2011 till today which is Jan 2015] . So I guess you can understand if Mr. Buffett failed to analyze it then quite obviously with our very less knowledge we too fail. Now the question arises
  5.1. Should we hold on to it or not ?  To explain this let me tell you the cost attached to it.
       5.1.1. It might have a downward risk or trend in near term so that you might loose more money than what you are loosing now. To analyze this you have to identify few things :-
                 a. Why it's profit or revenue is down ?
                 b. Whether the company is taking some serious steps to overcome this or not like change in business model shift from concentration to diversification or targeting other profitable segment and whether the company has enough ability to overcome this or not?
                 c. If demand for the product is sustainable and growing or not?
      5.1.2. It might have a high opportunity cost. Now that is a very critical aspect of this investment like if we hold onto a loss making business for long we might miss various opportunity the current market is offering. So in my opinion it is wise to sell of a loss making  investment if you have find out a new one which has a strong potential to grow. But taking this decision is not so easy as it sound because as per human psychology it's hurt us much more if we loose 1-2% of our money rather than missing a 15-20% profit making opportunity. But to be honest this is a very wrong emotion we play with and to avoid this trap we must not invest bulk of our money in one company so that it hurt us more when comes to getting out of it. Because turning around  a loss making business to a profit making one is not an easy or one day job it takes time doesn't matter how good the management are and also it always have risk involved in it of not return to it's previous status at all. So with due respect to Mr. Buffett I am a strong believer of selling of loos making unit and buy a profitable one.
  5.2. At what price we should sell it ? Well this follow the same format of my previously explained section 3.2.2 and 3.2.3. It we find price is higher than this then we always should sell it also as risk involved in this you should raise the discounting rate and margin of safety to stretched level while calculating the value.

How to Analyze a Bank or Financial Service

Bank  or Financial Service posses an enviable position in the global economy . Because the service that a bank provide is so vital to long term economic growth, the banking industry is almost certain to grow inline with world total output , no matter which sector generates grater need for capital.

Business Model :- The banking business model is simple it receive money from depositors and capital market and lend to borrower, profiting from the difference. The revenue of a bank comes from mainly two operations interest income and non interest income.

•  Interest Income (NIM):- The difference between the money earn as interest from the borrower and money spend as interest to the depositor or capital market.
•  Non Interest Income :- Some basic fees that the bank charge to it's customer for providing different services.

This summaries the bank or financial service business model.

Relation with Federal Reserve (RBI)  :- Federal govt has all but given the keys to the liquidity kingdom to banks by essentially subsidizing banking industry. Bank can effectively borrow at below market rate from Federal Reserve if it face any short term liquidity crunch. That also make this industry low cost safest producer of liquidity of the world. Few parameters you need to know to understand this relationship.

• Repo Rate :- 

Definition: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

Description: In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.

The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.

• Reverse Repo Rate :- 

Definition: Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest.

Description: An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system.

• Cash reserve Ratio (CRR) :- 

Definition: Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system.

Description: Scheduled banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 4% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly

• Statutory Liquidity Ratio(SLR) :-

Definition: SLR or statutory liquidity ratio is the minimum percentage of deposits that a bank has to maintain in form of gold, cash or other approved securities. It is the ratio of liquid assets (cash and approved securities) to the demand and term liabilities / deposits.

Description: RBI is empowered to increase this ratio up to 40%. An increase in SLR restricts the bank's leverage position to pump more money into the economy, thereby regulating credit growth.

Risk :- The heart and soul of banking is centered on one thing : risk management. Bank accept three type of risks.(1) Credit, (2) Liquidity & (3) Interest Rate & they get paid to take on this risk. But this ability to earn a premium for managing credit and interest rate risk - can quickly become their greatest weakness if, for example, loan losses grow faster than expected.

• Managing Credit Risk :-To examine this risk we first have to had some idea of few parameter which is readily available in the balance sheet & they are :-
• NPA(Non Performing Loan) :- These are the loans on which borrowers are not paying.
• Charge Off Rate :- It measures the percentage of loans which the banks thought will never be repaid. 
• Delinquent Loan :- Loan made against an individual which can not be diversified. i.e. either you earn the entire interest rate or loose everything.
• Portfolio Diversity :- Bank can either originate a wide variety of loan to the large borrower or buy and sell loan portfolio to manage the credit risk.
• Conservative underwriting and account management :- It is the way of writing off any bad loan and aggressive collection mechanism is in place also a proper credit rating check and background check for the borrower.
• Analyzing the credit quality :- To understand the credit quality of a bank one must analyze the charge off rate and delinquency rate , which are seen as an future charge off . Look for the trend not just the absolute level. In an economic downturn the charge off rate may rise quickly but they must remain fairly low in terms of loan[less than 1%].
• Credit culture :- Types of loan bank used to give and it's collection process.
• Managing Liquidity :- To examine this we have below factors as discussed ..
• Low cost core deposit :- Check weather low cost core deposit like Savings and Current accounts are growing or not? If deposit is declining over the years it means management is not performing well.
• Entry to a new segment of loan portfolio :- Check if the bank has entered into a new riskier loan portfolio or not on which they have not had good experience. Like a traditional home loan or gold loan bank have turned into a much riskier auto loan portfolio or not?
• Factoring :- Selling of receivables to some financial services at a discount which also can worked as an Economic moat.
• Managing Interest Rate :-  
• Selling the Loan :- Check if the bank have the capability to access the capital market to pass the buck by letting investor purchase the loan(much like a bond) and assume the interest risk.
• Repositioning Balance Sheet :- Repositioning balance sheet from one sector to another depending on operating environment is also a good idea to balance the Interest Risk.
• 4 factors that control interest rate :- Banks are supported by 4 elements (1) Interest income, (2) Interest Expense, (3) Non Interest Income, (4) Provision for loans. Say if rate cut happen [in an under performing economy]then interest expense might go down but the provision fro loan loss will increase hence it virtually balance the interest rate. So we have to look at the balance sheet transformation of Liability sensitive from Asset sensitive one.
• Conservative accounting :- As discussed earlier we must look into the bank accounting policy and it should be liability sensitive than to asset sensitive i.e. interest rate on liability grow much faster than interest rate on asset.

Economic Moats :-

• Asset growth :- Balance Sheet must have quality number of asset by value compare to it's peers and it's growth rate should be high.
• Economic Scale :- Big banks and financial service with much higher asset is able to generate better revenue [based on ROA comparable]. It has been observed that larger player will able to generate better revenue per employee than the smaller player. They are also better in squeezing their customer asset for more revenue (primarily through fees).
• Market Oligopolies :- Larger market capitalization with diversified presence in all geography makes a strong economic moat for the banks.
• Customer Switching :-   Nominal customer attrition rate is mandatory for a Bank and more often than not it has seen that people are not keen to switch their bank account much due to lots of process and troubled involved with the service they are getting from the bank and quite acquainted with it just because of some higher interest rate.

 Hallmarks of Success for Banks :- The entire business it's strength,opportunity is built on risk it's a good idea to focus on conservatively managed institution that consistently deliver solid but not knockout profits.

• Strong Capital Base :- One must look at the higher equity to asset ratio and also look for a high level loan loss reserve relative to NPA.
• ROE & ROA :- High level ROA (upper than 1.2) coupled with high ROE is a good parameter to judge the bank but witl low ROA even if ROE is high you must reject it.
• Efficiency Ratio :- It measures non interest expenses or operating cost as a percentage of net revenue. Lower is better(generally lower than 50% is good).
• Net Interest Margin :- The difference between the money earn as interest from the borrower and money spend as interest to the depositor or capital market. Generally a high NIM is good but it also depend on type of loan the bank used to provide i.e Credit card interest is higher than general mortgage but it is very riskier as well.
• Strong Revenue :-  As NIM varies widely on the economic factor hence it is important to see fee income as a percentage of revenue and fee income growth. Higher is always better.
• Price to Book Value :- Considering all other factor any bank trading at less than 2 times of it's book value is a good buy. The reason behind considering the P/B ratio is to judge the asset quality of the bank compare to it's current value and this ratio coupled with ROA & ROE is very important.

Key Ratios :-

• yield on advance
• cost income ratio
• fee income/asset
• NPA
• Leverage
• ROA
• ROE

SWOT Analysis Framework :-

• Strength :-

1. Easy & Fast appraisal &  disbursement ?
2. Product innovation & superior delivery ?
3. Strong market penetration & increased in operating efficiency ?
4. Collection efficiency ?

• Weakness :-

1. Too much diversification from the core business ?
2. Increased regulatory coverage ?
3. No access to SATFAESI or DRT for recovering from bad loan and no asset to refinance ?
4. Volatile business environment ?

• Opportunity :-

1. Large unprotected market both rural, urban & also geographically ?
2. Tie up with global financial giants ?
3. New opportunity in credit card, personal finance, home equity etc. ? 

• Threat :-

1. High cost of funds ?
2. Restriction on deposit taking NBFCs ?
3. Growing retail thrust within the banks and competition from unrecognized money lender ?
4. Significant slowdown in economy affecting various segments of NBFC ?
5. Deterioration of asset quality & rising levels of NPA ?

Few more things :-

• What is loan disbursement ? 

Loan disbursement is the process of giving money to the lender. The growth in this parameter means loan growth and provision of income growth.

• What is cost of fund ?

The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one of the most important input costs for a financial institution, since a lower cost will generate better returns when the funds are deployed in the form of short-term and long-term loans to borrowers. The spread between the cost of funds and the interest rate charged to borrowers represents one of the main sources of profit for most financial institutions.


Now all these things might looks very confusing but checking some banking stocks might be very easy and you can get conviction on it. e.g. When Rakesh Jhunjunwala buy DHFL it had Rs 230 book value, 6 percent dividend yield, 4 times earnings, growing at 20 percent for the last ten years, available at Rs 105.
Consider this example the price of the stock was 105 and it's book value is at 230 with 20% growth rate for last 10 years so it is a no brainer stock. More over it was having 6% div yield which is just exceptional and was available at 4 PE. If you still can not make you conviction right simply look at the economic moat like financial leverage and all and calculate the DCB & risk value. That will do enough for you.

Along with it if you are willing to compare with other housing finance stock then check three parameter apart from PEG 1. (Sales Turnover/Market Cap) * 100 and 2. (Net Profit/Marke t Cap)*100 3. (Total Asset/Market Cap)*100