7 ways to shortlist the right stocks

Equity as an asset class outperforms all other asset classes in the long run. True. But, how
do you pick the right company?
Its always important to spend time in knowing a company, its business, financial health and
prospects. But do you have the time, resources and energy to study about 1,400 companies listed
on the National Stock Exchange (NSE) and about 4,900 on the Bombay Stock Exchange (BSE)
before selecting the one to invest?
If these numbers make you uncomfortable, sample these: the market capitalisation of these
companies ranges from a few lakhs to over Rs 2 lakh crore and the prices of shares from less
than a rupee to over Rs 12,000 per share.
So, how and where do you make a start? We give you seven basic screening criteria, which will
help you shortlist companies that are worth researching in the first place.
1. Is the companys market cap more than Rs 250 crore (Rs 2.50 billion)?
Setting a minimum market cap floor really helps it eliminates very small companies, or penny
stocks. Generally, small companies have a small revenue base and they do not spend too much
on investor relations. This makes tracking them difficult. At Outlook Money, we do not look at
companies that have a market cap of less than Rs 250 crore. About 500 companies at NSE pass
this criteria.
2. Are the companys trading volumes high?
The company should have a reasonable trading volume at least a few thousand shares per day.
If you buy into a stock that has low volume, it can become difficult to get out when the markets
fall. Both rise and fall is sharp in stocks with low volume. Also, the impact cost is high.
For example, MMTC, a state-owned company, has a market cap of over Rs 62,000 crore (Rs 620
billion), but its trading volume is very thin. The 30-day average trading volume of this stock is
just about 338 shares and the stock is trading at Rs 12,400 per share. It is always advisable to
avoid these kinds of stocks.

3. Does the company make quality disclosures?
The company should have good quality disclosures. This is an easy test. All you have to do is
visit the company website and see press releases and results for the last few quarters. In the
results part, you need not get into numbers in detail as of now, but do see how the developments
of last quarter have been explained.
For example, see if cost has increased, or margins have declined, and whether there is an
explanation for it.
Large companies, especially in the information technology sector, are generally good at this.
Tata Consultancy Services [Get Quote], Indias largest IT company by revenue, has a transcript
of analyst conference call on its website, which possibly answers all the questions that investors
have.
Availability of information makes tracking easy and decision-making becomes quicker while
you are invested in the company.
4. Does the company have operating profits?
Sometimes, companies raise money from the equity markets in their initial stages and hope to
cover the costs by generating profits from operations later. Actually, they are in a stage when
they spend money for, say, setting up plants, or research and development facilities.
These businesses sound exciting, but can be risky. It is advisable to avoid such companies. New
projects involve a lot of regulatory approvals and can get delayed, which can escalate cost. Also,
stock prices of such companies are the first to fall during any broader market correction, as there
are no earnings to support the prices.
This is exactly what happened with Reliance Power, which does not have any of its plants in
operation. Its public issue got heavily oversubscribed (73 times) due to general euphoria in the
market, but sentiments changed between issue and listing. The issue went on to become one of
the biggest disasters in the markets.
Therefore, it is always safer to be in companies that generate profits from their operations.
5. Does the company generate constant cash flows?
At times, fast-growing companies may show profits without generating cash. These companies
are in their expansion stage. They have to generate cash eventually and create value for the
shareholders.
Companies with a negative cash flow may have to seek additional capital, either through debt or
equity. Debt will increase the risk while equity will dilute the earnings, which will get reflected
in the share prices also.
6. Is its return to equity (RTE) constantly above 10 per cent?
RTE is the profit a company generates with the shareholders money and is calculated by
dividing net profits with shareholders equity. It indicates how well a company has deployed
investors money.
The RTE is generally low in case of manufacturing companies and is higher for services
companies as the cost of setting infrastructure is low in services companies. Use 10 per cent as
the minimum limit for companies to qualify. There are just about 400 companies listed on NSE
with a market cap above Rs 250 crore that generated return on equity above 10 per cent in the
financial year 2007-08.
7. Is the earnings growth constant or cyclical?
Cyclical earnings implies that profits move up or down depending on the business cycle.
Businesses generally move in cycles.
This is commonly seen in commodity companies, where a shortage or sudden rise in demand
helps prices to move up, resulting in super normal profits for a while. Sugar is a classic example
of cyclical earnings.
Bajaj Hindustan , the largest sugar company in India, saw its share prices soaring from Rs 200 in
November 2005 to Rs 550 in April 2006 on the back of rising sugar prices; net sales for the
company went up Rs 394 crore (Rs 3.94 billion) in the March 2006 quarter compared to Rs 282
crore (Rs 2.82 billion) in the September 2005 quarter.
But by the end of the December quarter, net sales went down to Rs 286.64 crore (Rs 2.86 billion)
and the share price to Rs 140. The biggest risk in investing in cyclical or commodity stocks is
that you could enter at the wrong time.
Once the cycle is reversed, it becomes difficult to get out. Commodity prices are interlinked
globally, and any demand-supply mismatch in one corner of the world can disturb prices all over.
Companies in the pharma and FMCG space have stable growth in the long term as demand in
these sectors depends on the business cycle and macroeconomic movements. The services sector
also has stable earnings growth compared to commodity stocks.
If you carry out these seven checks, you will, by and large, be able to eliminate companies that
are not worth investing. However, investors must note that these conditions are not fool-proof
and there can always be exceptions.
Options: The basics of call and put
What is an option?
An option contract gives the buyer the right, but not the obligation to buy/sell an underlying asset
at a pre-determined price on or before a specified time. The option buyer acquires a right, while
the option seller takes on an obligation. It is the buyers prerogative to exercise the acquired
right. If and when the right is exercised, the seller has to honour it. The underlying asset for
option contracts may be stocks, indices, commodity futures, currency or interest rates

What are the types of options?
Broadly speaking, options can be classified as call options and put options. When you buy a
call option, on a stock, you acquire a right to buy the stock. And when you buy a put option,
you acquire a right to sell the stock. You can also sell a call option, in which, you will acquire
an obligation to deliver the stock. And when you sell a put option, you acquire an obligation to
buy the stock.
What do you understand by the term option premium?
Option premium is the consideration paid upfront by the option holder (buyer of the option) to
the option writer (seller of the option). The option holder gets the right to buy / sell the
underlying.
What is the strike price or the exercise price of the option?
The right or obligation to buy or sell the underlying asset is always at a pre-decided price known
as the strike price or exercise price, which is linked to the prevailing price of the underlying
asset in the cash market. Usually, option contracts are available on the underlying asset on
various strike prices (generally, five or more)-divided equally on either side of its spot price.
How does an American option differ from a European option?
In European options, a buyer can exercise his option only on the expiration date, that is, the last
day of the contract tenure. Whereas in American options, a buyer can exercise his option any
day on or before the expiration date.In the Indian equity market context, index options are
European style, while stock options are usually American in nature.
How do options differ from futures?
In futures, both the buyer and the seller are obligated to buy and sell, respectively, the underlying
asset-the quid pro quo relationship. In case of options, however, the buyer has the right, but is
not obliged to exercise it. Effectively, while buyers and sellers face a
: linear payoff profile in futures, its not so in the case of options. An option buyers upside
potential is unlimited,while his losses are limited to the premium paid. For the option seller, on
the other hand,his maximum profits are limited to the premium received, while his loss potential
is unlimited.
Basic Rules for Futures Traders
Following are some basic rules for Future Traders :
1.Apply money management techniques to your trading.
2.Do not overtrade.
3.Take a position only when you know where your profit goal is and where you are going to get
out if the market goes against you.
4.Trade with the trends, rather than trying to pick tops and bottoms.
5.Dont trade many markets with little capital.
6.Dont just trade the volatile contracts.
7Calculate the risk/reward ratio before putting a trade on, then guard against the risk of holding it
too long.
8.Establish your trading plans before the market opening to eliminate emotional reactions.
9.Decide on entry points, exit points, and objectives. Subject your decisions to only minor
changes during the session. Profits are for those who act, not react. Dont change during the
session unless you have a very good reason.
10.Follow your plan. Once a position is established and stops are selected, do not get out unless
the stop is reached, or the fundamental reason for taking the position changes.
11.Use technical signals (charts) to maintain discipline the vast majority of traders are not
emotionally equipped to stay disciplined without some technical tools. Use discipline to
eliminate impulse trading.
12.Have a disciplined, detailed trading plan for each trade; i.e., entry, objective, exit, with no
changes unless hard data changes. Disciplined money management means intelligent trading
allocation and risk management. The overall objective is end-of-year bottom line, not each
individual trade.
13.When you have successful a trade, fight the natural tendency to give some of it back.
14.Use a disciplined trade selection systeman organized, systematic process to eliminate
impulse or emotional trading.
15.Trade with a plan not with hope, greed, or fear. Plan where you will get in the market, plan
how much you will risk on the trade, and plan where you will take your profits.
16.Cut losses short. Most importantly, cut your losses short, let your profits run. It sounds
simple, but it isnt. Lets look at some of the reasons many traders have a hard time cuttings
losses short. First, its hard for any of us to admit weve made a mistake. Lets say a position
starts going against you, and all your good reasons for putting the position on are still there.
You say to yourself, its only a temporary set-back. After all (you reason), the more the position
goes against me, the better chance it has to come back the odds will catch up. Also, the
reasons for entering the trade are still there. By now youve lost quite a bit; you sell yourself on
giving it one more day. Its easy to convince yourself because, by this time, you probably
arent thinking very clearly about the position. Besides, youve lost so much already, whats a
little more? Panic sets in, and then comes the worst, the most devastating, the most fallacious
reasoning of all, when you figure: That contract doesnt expire for a few more months; things;
are bound to turn around in the meantime.
So it goes; so cut those losses short. In fact, many experienced traders say if a position still goes
against you the second day in, get out. Cut those losses fast, before the losing position starts to
infect you, before you fall in love with it. The easiest way is to inscribe across the front of your
brain, Cut my losses fast. Use stop loss orders, aim for a Rs. 5000 per contract loss limitor
whatever works for you, but do it.
17.Let profits run. Now to the letting profits run side of the equation. This is even harder
because who knows when those profits will stop running? Well, of course, no one does, but there
are some things to consider. First of all, be aware that there is an urge in all of us to want to
wineven if its only by a narrow margin. Most of us were raised that way. Win even if its
only by one touchdown, one point, or one run. Following that philosophy almost assures you of
losing in the futures markets because the nature of trading futures usually means that there are
more losers than winners. The winners are often big, big, big winners, not one run winners.
Here again, you have to fight human nature. Lets say youve had several losses (like most
traders), and now one of your positions is developing into a pretty good winner. The temptation
to close it out is universally overwhelming. Youre sick about all those losses, and heres a
chance to cash in on a pretty good winner. You dont want it to get away. Besides, it gives you a
nice warm feeling to close out a winning position and tell yourself (and maybe even your
friends) how smart you were (particularly if youre beginning to doubt yourself because of all
those past losers).
18.That kind of reasoning and emotionalism have no place in futures trading; therefore, the next
time you are about to close out a winning position, ask yourself why. If the cold, calculating,
sound reasons you used to put on the position are still there, you should strongly consider
staying. Of course, you can use trailing stops to protect your profits, but if you are exiting a
winning position out of feardont; out of greeddont; out of ego dont; out of
impatiencedont; out of anxietydont; out of sound fundamental and/or technical
reasoningdo.
You can avoid the emotionalism, the second guessing, the wondering, the agonizing, if you
have a sound trading plan (including price objectives, entry points, exit points, risk-reward ratios,
stops, information about historical price levels, seasonal influences, government reports, prices
of related markets, chart analysis, etc.) and follow it. Most traders dont want to bother, they like
to wing it. Perhaps they think a plan might take the fun out of it for them. If youre like that
and trade futures for the fun of it, fine. If youre trying to make money without a plan forget it.
Trading a sound, smart plan is the answer to cutting your losses short and letting your profits run.
19.Do not overstay a good market. If you do, you are bound to overstay a bad one also.
20.Take your lumps. Just be sure they are little lumps. Very successful traders generally have
more losing trades than winning trades. Its just that they dont leave any hang-ups about
admitting theyre wrong, and have the ability to close out losing positions quickly.
21.Trade all positions in futures on a performance basis. The position must give a profit by the
end of the second day after the position is taken, or else get out.
22.Program your mind to accept many small losses. Program your mind to sit still for a few
large gains.
23.Learn to trade from the short side. Most people would rather own something (go long) than
owe something (go short). Markets can (and should) also be traded frown the short side.
24.Watch for divergences in related markets is one market making a new high and another not
following?
25.Recognize that fear, greed, ignorance, generosity, stupidity, impatience, self-delusion, etc.,
can cost you a lot more money than the market(s) going against you, and that there is no
fundamental method to recognize these factors.
26.Learn the basics of futures trading. Its amazing how many people simply dont know what
theyre doing. Theyre bound to lose, unless they have a strong broker to guide them and keep
them out of trouble.
27.Standing aside is a position. Patience is important.
28.Client and broker must have rapport. Chemistry between account executive and client is very
important; the odds of picking the right Account Executive (AE) the first time are remote. Pick a
broker who will protect you from yourselfgreed, ego, fear, subconscious desire to lose
(actually true with some traders). Ask someone who trades if they know a good futures broker. If
you find one who has room for you, give him your account.
29.Sometimes, when things arent going well and youre thinking about changing brokerage
firms, think about just changing AEs instead. Phone the manager of the local office, let him
describe some of the other AEs in the office, and see if any of them seem right enough to have a
first meeting with. Dont worry about getting your account executive in trouble; the office
certainly would rather have you switch AEs than to lose your business altogether.
30.Broker/client psychology must be in tune, or else the broker and client should part company
early in the program. Client and broker should be in touch repeatedly, so when the time comes,
both parties are mentally programmed to take the necessary action without delay.
31.Most people do not have the time or the experience to trade futures profitably, so choosing a
broker is the most important step to profitable futures trading.
32.When you go stale, get out of the markets for a while. Trading futures is demanding, and can
be draining especially when youre losing. Step back; get away from it all to recharge your
batteries.
33.Thrill seekers usually lose. If youre in futures simply for the thrill of gambling, youll
probably lose because, chances are, the money does not mean as much to you as the excitement.
Just knowing this about yourself may cause you to be more prudent, which could improve your
trading record. Have a business-like approach to the markets.
34.Anyone who is inclined to speculate in futures should look at speculation as a business, and
treat it as such. Do not regard it as a pure gamble, as so many people do. If speculation is a
business, anyone in that business should learn and understand it to the best of his ability.
35.Approach the markets with a reasonable time goal. When you open an account with a broker,
dont just decide on the amount of money, decide on the length of time you should trade. This
approach helps you conserve your equity, and helps avoid the Las Vegas approach of Well, Ill
trade till my stake runs out. Experience shows that many who have been at it over a long period
of time end up making money.
36.Dont trade on rumors. If you have, ask yourself this: Over the long run, have I made money
or lost money trading on rumors? O.K. then, stop it.
37.Dont trade unless youre well financedso that market action, not financial condition,
dictates your entry and exit from the market. If you dont start with enough money, you may not
be able to hang in there if the market temporarily turns against you.
38.Be more careful if youre extra smart. Smart people very often put on a position a little too
early. They see the potential for a price movement before it becomes actual. They become worn
out or tapped out, and arent around when a big move finally gets under way. They were too
busy trading to make money.
39.Never add to a losing position. Stay out of trouble, your first loss is your smallest loss.
40.Analyze your losses. Learn from your losses. Theyre expensive lessons; you paid for them.
Most traders dont learn from their mistakes because they dont like to think about them.
41.Survive! In futures trading, the ones who stay around long enough to be there when those big
moves come along are often successful.
42.If youre just getting into the markets, be a small trader for at least a year, then analyze your
good trades and your bad ones. You can really learn more from your bad ones.
43.Carry a notebook with you, and jot down interesting market information. Write down the
market openings, price ranges, your fills, stop orders, and your own personal observations. Re-
read your notes from time to time; use them to help analyze your performance.
Rome was not built in a day, and no real movement of importance ends in one day. A
speculator should have enough excess margin in his account to provide staying power so he can
participate in big moves.
44.Take windfall profits (profits that have no sound reasons for occurring).
45.Periodically redefine the kind of capital you have in the markets. If your personal financial
situation changes and the risk capital becomes necessary capital, dont wait for just one more
day or one more price tick, get out right away. If you dont, youll most likely start trading
with your heart instead of your head, and then youll surely lose.
46.Always use stop orders, alwaysalways always
Dos And Donts For Intraday Traders

If index is in minus then one should look to short stocks which are minus and not stocks which
are in plus.
It is not necessary that a stock which is weak today during intraday trading might be weak
tomorrow also, simultaneously if a stock is strong today might not be strong tomorrow
Being a contrarians is very important while trading intraday.
If index is in positive from yesterday and the share you are holding is in minus then it should be
cut and if intraday trend of index is in buy then one should buy a stock in which is in plus.
If US Markets have gone up overnight, the markets here in all probability will open strong, so
one should be quite careful when buying stocks as the general psychology of public is to buy
when good news is there.
Stop loss is a must while trading intraday.
Always trade in very liquid stocks i.e. which have very high volume because as entry and exit
can be very fast in such stocks.
Keep your volume constant e.g.: if you trade in five lots of nifty future then trade in five lots
only. This position can be increased only when you are satisfied with your trading for a month. It
should not be that one day you buy five lots and next day you trade in ten lots and third day you
get a loss and stop trading for two days.
Do paper trading before you actually start trading so that when you start making paper profits,
then shift to actual trading.
Fear and Greed are at maximum levels while trading intraday so always have less position when
you are new to intraday trading as otherwise you will be mostly under tension.