Simple steps to Select the best Stocks

Master the Art of Stock Picking: A Simple Yet Powerful Guide

Choosing the right stock can feel overwhelming, but it doesn’t have to be! While companies can sometimes tweak profit and sales figures to look good on paper, savvy investors know where to focus. The real key is diving deeper into the numbers that matter most.

Start with Return on Equity (ROE) – one of the most reliable metrics for evaluating a stock. A higher ROE is almost always better, especially if it’s been steadily increasing over the last 5–10 years. Pair this with improved operating margins and strong cash flow, and you’ve likely found a company with an economic moat.

But there are some red flags to watch out for:

  • Avoid stocks with a debt-to-equity (D/E) ratio greater than 1, especially if this is rising.
  • Stay away from companies with an ROE below 12% that has been decreasing over the years.
  • Companies with pledging above 30% are also risky bets.

For the best results, look at the average ROE over the past 5 years. An average above 20% suggests the company has likely been transparent in its reporting and is not manipulating its accounts.

A higher dividend payout ratio with an increasing dividend rate is another sign of management that values its shareholders.

When it comes to valuations, keep these tips in mind:

  • Compare the P/E ratio with its historical averages, industry peers, and even the broader market like the Sensex.
  • Use the PEG ratio as a quick check for undervaluation:
    • Below 0.5: Highly undervalued and worth considering.
    • 0.5–1: Undervalued or reasonably valued.
    • 1–2: Reasonably valued; further analysis needed.
    • Above 2: Likely overvalued.
  • Check if the P/B ratio aligns with ROE. Companies with high ROE usually justify a higher P/B ratio, but mismatches warrant a closer look.

Finally, don’t ignore quantitative factors like:

  • Earnings Per Share (EPS): Consistent growth in EPS is a positive sign.
  • Debt-to-Equity Ratio: A lower ratio means less financial risk.

By focusing on these metrics and avoiding companies with weak fundamentals, you’ll be better equipped to identify stocks that are not just good but great investments. Let’s dive deeper into the details and build your path to smarter investing!

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    Evaluate Management

    Stay away from companies where pledging is more than 30%.

    Always consider the last 5 year’s average ROE. Last 5 year’s average ROE of more than 20% indicates that the company is unlikely to be manipulating their accounts.

    Higher dividend pay-out ratio with increasing dividend rate confirms shareholder’s friendliness of management.

    Considering all other parameters remain same, higher the ROE, the better the investment option.

    Increasing ROE over the last 5–10 years with improved operating margin and cash flow is a prominent signal of an economic moat.

    It is highly recommended to avoid high-debt companies.

    Avoid stocks with a debt-to-equity ratio greater than 1 (increasing) and ROE less than

    12% (decreasing over the last few years).

    Valuation

    PE Ratio

    You can compare a stock’s P.E with its last three years or five years historical P.E. If you find that a fundamentally strong stock is trading much below at its historical average, then it might be a worthy investment.

     Compare with its industry peers- You can compare a stock’s P.E with other stocks those are in the similar business. Normally, a stock that trades at a P.E below than their industry peers is valuation wise more attractive.

     Compare with the broader market- You can also compare a stock’s P.E with the P.E of Sensex to get a rough idea of the valuation.

    1. PEG ratio less than 0.5 indicates that the stock is undervalued and can be a great investment bet.
    2. PEG ratio greater than 0.5 but less than 1 indicates that the stock is either undervalued or reasonably valued, based on other parameters it can be a good investment bet.
    3. PEG ratio greater than 1 but less than 2 indicates that the stock is reasonably valued. To take any investment decision, make sure to check other parameters.
    4. PEG ratio greater than 2 indicates that the stock is overvalued.

    Combining P.B ratio with ROE

    Given the two companies that are equal elsewhere, the one with higher ROE will have higher P.B ratio. The reason is simple. The company that can return higher value on its equity should quickly compound its book value at a faster rate.

    Companies whose ROE and P.B ratio doesn’t go hand in hand should be analysed with extra care.

    Conclusion –

    Like every ratio, the P.B ratio also has several advantages and disadvantages.

    This ratio is useful for analysing Banking/NBFC stocks and other capital intensive business but doesn’t have much significance in the service sector or software firms. Lower the ratio better is the investment.

    Qualitative and Quantitative

    Quantitative Factors

    Earnings Per Share (EPS):

    This metric shows how much profit a company generates per share of outstanding stock. A rising EPS is generally a positive sign.

    Price-to-Earnings Ratio (P/E Ratio):

    As discussed earlier, this compares the stock price to EPS, indicating how much investors are paying for each rupee of earnings.

    Price-to-Book Ratio (P/B Ratio):

    This compares the stock price to the company’s book value (net assets). A low P/B ratio might suggest the stock is undervalued.

    Debt-to-Equity Ratio:

    This measures a company’s financial leverage, indicating how much debt it has compared to shareholder equity. A high ratio suggests a higher risk of default.

    Return on Equity (ROE):

    This profitability metric shows how much profit a company generates for each rupee of shareholder equity.

     

    Qualitative Factors

     

    Business Model: How does the company generate revenue and profit? Is it sustainable and innovative?

    Management Team: Does the company have a strong and experienced management team with a proven track record?

    Competitive Advantage: Does the company have a competitive edge in its industry? What are the threats from competitors and potential disruptions?

    Industry Trends: What are the overall trends in the industry that the company operates in? Are there any tailwinds or headwinds that could impact its future growth?

    Future Growth Potential: Does the company have a clear path for future growth? Are there new markets or products on the horizon?

    Definitions

    ROE – ROE stands for Return on Equity. It’s a way to measure how good a company is at turning the money shareholders invested (equity) into profit. Imagine you give a company ₹100, and a year later they make ₹10 in profit from it. That would be a 10% ROE.

    EPS (Earnings Per Share):

    Imagine you run a lemonade stand and sell $100 worth of lemonade in a day. You have 10 shares you sold to your friends (think of them as mini-investors). Your EPS would be:

    EPS = Profit / Number of Shares = $100 / 10 shares = $10 per share

    This means for every share your friends bought, the stand made $10 in profit that day.

    P/E Ratio (Price-to-Earnings Ratio):

    Let’s say your friends are so impressed with your lemonade, they’re willing to pay $20 each for a share in your stand (the stock price). Now, the P/E ratio tells you how much they’re paying for each dollar of profit:

    P/E Ratio = Stock Price / EPS = $20 / $10 = 2

    This means your friends are paying $2 for every $1 of profit your stand makes. A high P/E like this might suggest your stand is a bit expensive compared to its current earnings.

    P/B Ratio (Price-to-Book Ratio):

    Imagine you bought all the supplies for your stand (cups, lemons, sugar) for $30. This is your stand’s book value (assets minus debts). If your friends are still willing to pay $20 per share, the P/B ratio is:

    P/B Ratio = Stock Price / Book Value per Share = $20 / ($30 / 10 shares) = $20 / $3 = 6.67

    This P/B is high. It means your friends value your stand (the stock) much more than the actual cost of your supplies (the book value).

    Debt to Equity Ratio:

    Let’s say you decide to expand your lemonade business and borrow $10 from your neighbor to buy more lemons. This $10 is your debt. Since you still have $30 in your own money invested, your Debt to Equity Ratio is:

    Debt to Equity Ratio = Debt / Equity = $10 / $30 = 1/3

    This is a low debt ratio, meaning most of your business is financed by your own money (equity) and not borrowed money (debt). This can be good because you owe less money, but it might also limit your growth.

    Remember: These are just examples. In the real world, companies use these ratios to compare themselves to competitors and see how healthy their finances are.

    Conclusion

    Picking the right stock isn’t just about crunching numbers – it’s about understanding the bigger picture. While metrics like ROE, P/E, PEG, and D/E ratios give a snapshot of a company’s financial health, they’re just one piece of the puzzle. A great stock often shows a pattern: steady growth in ROE, low debt, improving margins, and strong cash flow.

    At the same time, don’t get trapped by companies with too much debt, high pledging, or falling profits. Look for businesses that are honest in their numbers, reward shareholders with good dividends, and have a solid track record of growth.

    Finally, keep valuations in mind. A stock might have strong fundamentals, but if it’s overpriced, it might not be the best time to invest. Focus on stocks that tick most of the boxes and feel like a good fit for your goals. With the right mix of numbers and intuition, you can build a portfolio that grows steadily over time.

    For more you can refer to

    Top 10 High Paying Dividend Stocks to Watch In 2025

    Which is Better for You: Dividend Investing or Value Investing?