Good Stock

Stock is actually a share in the business. These may be equity shares, or preference shares. For investing in stock markets, it is necessary to identify which stock is a good stock. Factors that can make a stock a good stock include consistent or increased growth, dividend, earnings, assets, good management, and good prospects. There may be many such stocks belonging to different types of industries, such as textiles, information and technology, foodstuff, alcoholic beverages, etc. Traders classify a stock to be good in relation to overall performance of the market as well as performance within the industry. Therefore, it is not essential that a stock with good dividends is essentially a good stock.

If the average number stocks forming the sensitive index (select stocks that mirror the performance of the stock market) increase in value by 24 percent in the year, then if the stock under consideration increases in price only by 10 percent in the same period, then it is under performer, even if it is a profit making company. Likewise, if the stock performs better than this index, then it is called out performer. Note that here a good stock is identified based on its price in stock markets, and not as per earnings of the company.

Earnings do not essentially indicate the future prospects of the business, though there are some ratios that can be used to assess the profitability of the business. At times, there could be very valid reasons for drop in profits. For example, the company takes up a major expansion, and therefore it incurs heavily on interests, which bring down the profits. This expansion would start fetching the business returns in about 2 years time. Therefore, in the interim, the earnings per share may seem to be on lower end, but future prospects are considerably improved. The markets generally discount such factors at appropriate rates, and add it to the book value of the stock, to arrive at a realistic valuation of the stock. This is the reason, some stocks seem to be trading at a very high price by earnings multiple, whereas other stocks in the same industry languish much lower. They will in due course do the catch up act, of course, but not to the spectacular extent that the forerunners did.

In stock markets, everything is thought of in ratios. Good quality stocks show some consistencies in these ratios. Ratios from both profit and loss account, and the balance sheet of any business enterprises indicate about the health of the business. There are several such ratios, each giving some indication. There are also some accepted norms, and if these ratios do not come close to these norms then chances of the business failing increase substantially. Interpretation of ratios is therefore, very important. For example, net profit divided by gross profit gives an idea about the percentage of profit margin at which the business is operating. These are compared with the numbers of the previous year, and with the numbers of other companies in the same industry. If net profit to gross profit comes down, then the reason why this happened needs to be investigated. Likewise, ratio of net profit to profits gives investors a confident that their investment may be fetching them handsome profits. Net profit to assets gives an indication whether the assets are optimally being utilized, and so on. There are many such ratios and each one indicates some aspects of the business.

As far as prospects of the business are concerned, they are deduced from the information periodically furnished by the company in accordance with the terms under listing agreement, and Securities Exchange regulations. Companies are required to advise stock exchanges about any material contracts, any scheme of mergers, and amalgamations, and several other things, as per listing agreement.

There are personal perceptions also working in the market. Some people are aggressive in investment, and appreciate a company when it is highly leveraged (has more loans on its balance sheet). Others would prefer to see a company without any loans what so ever. Newcomers tend to think that the stock's price will increase after the announcement of bonus, while experienced traders are aware that such news is already factored in when it formed part of the board meeting's agenda. Therefore, when the stock's price slips, the newcomer is left wondering why it happened. The ultimate object of any business is to increase the wealth of the owners. Therefore the stocks that increase in value are said to be good stocks. This increase in value of stocks is achieved by improving prospects and performance of the business. Good stock investing involves picking these stocks when they are down. Markets tend to over react when they receive some bad news. This is when stocks of even good company slip. The smart investor steps in at such times and invests in the good stock.