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Stockmarkets: Discipline is the key - Views on News from Equitymaster
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  • Mar 13, 2007

    Stockmarkets: Discipline is the key

    The past few months have been volatile as far as the Indian stock markets are concerned, with the indices struggling to grope for direction. Both domestic factors (the Union Budget and interest rate hikes) and international factors (meltdown in the Asian markets) have contributed to the volatility. Nevertheless, we believe that such 'corrections' provide opportunities. In this article, we enumerate some of the factors that investors need to consider while choosing the stocks that they want to invest in.

    Business model: The 'business model' is the first important parameter to look at while investing in a particular stock. This implies how sustainable is the business in facing the increasing competition. A company's business has to be studied in context of the sector in which it operates. For instance, domestic pharma companies such as Ranbaxy, Dr. Reddy's and Sun Pharma among others are adopting a more global business model given the highly competitive nature of the pharma industry. These companies, besides focusing on the domestic market, are increasingly looking to strengthen their international operations by focusing on the semi-regulated markets and the regulated markets of US and Europe. This has ensured that the business model is de-risked and the companies do not heavily depend upon any one market to drive growth in the future.

    Ability to innovate: The ability of the company to innovate and stay ahead of the competition on a sustained basis is an important criterion that needs to be considered. The pharmaceutical industry that lays heavy emphasis on innovation is a case in point. To put things into perspective, while success in launching a new drug molecule in the markets highlights a pharma company's discovery led capabilities, even in the generics market, the ability to introduce products, which are niche with high barriers of entry and lesser competition will provide some sort of sustainability in revenues in the long-term. New product introduction and R&D capabilities also assume significant importance in case of auto and FMCG companies.

    Management vision and depth: This is determined by various factors such as the management's foresight in terms of anticipating changes in a particular sector, track record in terms of financials, ethics and sound corporate governance practices and ability to effectively utilise capital. Also, the key for the management is to ensure that it does not compromise on its long-term objectives to achieve short-term goals. One strong example would be that of Dr. Reddy's. The company's performance in FY05 was well below par largely due to drop in sales and increased investments in R&D. The company countered this by entering into alliances with venture capital funds, which while on the one hand achieved the medium term goal of reducing R&D costs and improving margins, on the other hand did not dent the company's focus on R&D in its long-term vision of being a discovery led global pharma company.

    Financial track record: The financials of a company are a critical factor to watch out for. Whether the company has been consistently delivering good performances year over year can be gauged by its revenue growth and profitability and more importantly its return ratios. Other important criteria would be the extent to which the company is leveraged (a highly leveraged company will see its profitability getting hurt in a rising interest rate scenario) and its history of dividend payouts.

    Valuations: At the end of the day, the price at which a stock is bought is important. A company's growth prospects may be highly visible, but after factoring these prospects, if the valuations appear rich then it does not make sense to buy into a particular stock.

    To sum up...
    Thus, it becomes important for investors to research the companies well and understand the businesses and not base their investment decisions on any 'news item' or 'tips'. At the end of the day, it is important to understand one's risk appetite and invest in companies with strong fundamentals from a long-term perspective.



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