10 Easy Rules Of The Secret Makes You Rich in the stock market

To become rich, you need money. To earn money, you should know how many different source of income available for you. Because all the Millionaires have at least three streams of income from below 7 streams of income. First step to become rich is understanding the streams of income available to you become rich in India.

7 Streams of Income:

Earned Income : A salary is a fixed amount of money that you can earn as an employee. It’s termed as “active” income because you have to work to earn a salary.
Profit Income : By selling a service or product for more than they cost, you use the basis of profit income. You could open a retail store and sell products, offer professional services and charge for your time, or combine the two.
Interest Income : invest it in a savings scheme and use the power of compound interest to gain a passive income. Buying government bonds is another safe investment that will generate interest.
Dividend Income : When you buy shares in a company, you become part-owner of that company and entitled to dividend payments.
Rental Income : Rental income can be generated in the form of rent or lease by a property that you own. It’s one of the go-to passive income-generating options in India but requires a large initial investment.
Capital Gains Income : Buying and selling assets can provide you with an income known as capital gains. For example, if you buy stocks and shares worth 100 rupees and then sell them on for 150 rupees , the capital gain is 50 rupees
Royalty Income : This is similar to rental income but instead of renting out a house, you rent out a product or service that you built and get a royalty paid in return. Simple examples include royalty payments for published books or music.

From above list, most of us have the first one, earned income. Along with earned income, we have to acquire another 2 streams of income using available time. Shall we look at simplest options to earn another 2 incomes.

You have to find way to earn 2 more streams of income to become rich

Investing in stock market is only option provides you 2 streams of income, dividend income and capital gains income. So investing in stock market is crucial role to make you rich.

Do not confuse between trader vs investor in the stock market.

Investor invest for long-term to become rich and create wealth from the markets. Warren Buffet, the legendary value investor that every investor looks up to created wealth for himself by investing in good stocks and holding them for a long period of time. According to him, you should invest in companies that you can hold forever. Trader looks for short-term strategies to earn money for his day-to-day life. Trader does full time job in the market by following market and tracks the returns daily, monthly, or quarterly.

You are investor and come out from trader mindset.

We are investor and invest for long term. No confusion or second thought in this. Next we require 2 incomes, dividend income and capital gain income. Market has 2 different types of stocks value stocks and growth stocks.

Stock market both streams of income
Value stocks = Dividend income
Growth Stocks = Capital gain income

Warren Buffett describe himself as as 85% Benjamin Graham and 15% Phil Fisher. Warren Buffett portfolio is 85% value stocks and 15% growth stocks.

Warren Buffett portfolio is 85% value stocks and 15% growth stocks

Benjamin Graham’s Seven Criteria for Selecting Value Stocks :

Here are at least 7 principles/criterion from Benjamin Graham’s checklist to help you identify value stocks.
These are shares that are trading below their intrinsic value and are, therefore, considered good picks. Investing experts Benjamin Graham and Warren Buffett pioneered the concept of value investing. Value investors are bargain hunters on the lookout for such stocks. However, don’t mistake value stocks to be penny stocks which trade at below par prices

Value stocks have a low PE and a low price to book value (PBV) ratio. Such stocks are also good dividend payers and have a healthy dividend yield. Value stocks could be from slow growing industries or from companies that are facing some problems which leads to a fall in their stock price.

Stability, Profitability, and Growth :

Look at the EPS and Dividend of the company. Graham focuses on companies that perform consistently. It gives a sense of stability and smooth operations. The quality of the stocks by stock group, is it part of Nifty 50 index or Nifty Next index . BSE classifies the company to different groups.

A group contains the most active and popular stocks provided they meet certain criteria set by the BSE
Z group consists of equity stocks which are blacklisted for not following Exchange rules and regulations
T group consists of stocks that form part of trade to trade segment. I.e. not for intraday trading
F group denotes the debt market segment
M/MT comprises of small and medium enterprises
G group consists of government securities available to retail investors
E group comprises exchange traded funds
B category includes stocks which don’t form part of any of the above groups.

Invests only in company in “A” Group

2. Financial Leverage :

Avoid companies that have debt much higher than their current assets. The value investing formula is: Total Debt to Current Asset ratio less than 1.10.

3. Company’s Liquidity :

In alignment with the previous point, a company’s ability to pay is denoted by the current ratio: the ratio of Current Assets to Liabilities. Value investing encourages you to select a company with current assets at least 1 ½ (or 1.50) times its current liabilities. The ratio indicates the company’s ability to pay short-term liabilities.

Current Ratio formula = Current Asset / Current Liabilities

4. EPS Growth :

Criteria four is simple: Find companies with positive earnings per share growth during the past five years with no earnings deficits. Earnings need to be higher in the most recent year than five years ago. Avoiding companies with earnings deficits during the past five years will help you stay clear of high-risk companies.

5. Price to Earnings Ratio :

Benjamin Graham advises one must select a company with a low to moderate PE ratio. Whereas, the company’s EPS must be positive. A negative EPS suggests that the company is making losses for its shareholders. The trick here is to invest in companies with a P/E Ratio of 10.0 or less. Companies that sell for low prices compared to EPS are often undervalued, meaning the value should increase.

6. Price to Book Ratio :

Find companies with a price to book value (P/BV) ratio less than 1.20. P/BV ratios are calculated by dividing the current share price by the most recent book value per share for a company. Book value provides a good indication of the underlying value of a company. Investing in stocks selling near or below their book value makes sense from a value investing perspective.

7. Dividends :

Companies that pay dividends will help you create a passive income. The main reason to invest in value stocks to get dividend income. So considering the dividend income is crucial in selecting the stocks.

Value investing is number and data based fundamental analysis

How to find Value stocks in a Click:

There are many website provides simple approach to get the value stocks. For example screener and smallcase websites provides list of value stocks.

Screener value stocks formula is,

Market Cap > Rs 500 cr
Sales and Profit growth >10%
Earnings Per Share(EPS) growth rate is increasing for the past 5 years
Debt to Equity Ratio <1 Return on Equity(RoE) >20%
Price to Book value(P/B) <= 1.5 or low compared to peer companies within the same industry Price to Earnings(P/E) < 25 or low compared to peer companies within the same industry Current Ratio > 1

The results returns more than 100 values stocks. The few from the list are

Wipro,
Tech Mahindra,
Bajaj auto,
HCL,
HGS,
Sun TV network,
Kalyani Steels,
Heritage foods,
Exide battery,
National Aluminum Company Ltd,
Manali Petrochemicals Ltd,
Ambika Cotton Mills Ltd,
Godawari Power
Andhra Petrochemicals Ltd
Castrol India Ltd
Coal India Ltd
Aditya Birla Sun Life AMC Ltd
and many more.

Growth Stocks :

Growth companies are those whose earnings (or net profits) are expected to grow at a faster pace than the market. Their shares, therefore, have the potential to rise faster than the market. Growth stocks usually have a high price to earnings (PE) ratio, indicating that they are overvalued. This is so because stock investors factor in the high growth rate that is expected of the company. Investors in such stocks believe that the fast growth in profits will make the shares more attractive in the future and fetch a higher price. These stocks are often from relatively new companies in sunrise industries. These companies usually don’t pay dividends. Since they are in an expansive phase, they prefer to reinvest their earnings to make the business grow.

Identify the Growth Stocks by Philip Fishers Style

Fisher was always on the lookout for growth stocks. In his book, Common Stocks and Uncommon Profits, he writes about few ways to identify good stocks for investing. Here are Fisher’s fifteen stock screening criteria:

1. Product & Services

For a business, it all starts with what they have to offer to their customers. Unique products and services catering to a growing demand will automatically emerge as a winner in the long term.

2. Management’s Drive To Develop Products and Services

No products or services can continue to remain useful forever. That is why the offerings of companies must continue to evolve with time. Top management must realize it and shall continue the drive the team to continuously develop and innovate new and existing products.

3. Research & Development Infrastructure

A company which wants to grow must do their own research and development. To do it, they must have a decent infrastructure to practice R&D functions.

4. Sales Force

The majority of products and services in this world will not start selling on their own. There must be a sales team with a sales strategy in place. Moreover, to continue to sell more and more offerings, there must be a master sales plan.

5. Profit Margin

A company may be selling millions of products, but if its profit margin is meager, it will report only subdued net profits. Hence, for a company, it is of most importance to build a reasonably large profit margin. The target should be to better the industry’s standard.

6. Profit-Margin-Growth Focus

Profit margins of the past will dictate today’s price. But the future price will be dictated by future profits and its margins. A company has to work tooth and nail to maintain its profit margins. More effort is required to improve the margins. Cost reduction, pricing power are two tools using which a company can control its margins.

7. Employee Focus

There can be two yardsticks to evaluate the focus of the company on its employees. A team of satisfied employees can take the company a long way. Promotions and salary revisions are two immediate things that come to mind that can render employee’s satisfaction.

8. Talent Development

A company that identifies talents and then grooms them for future leadership positions is always future-ready. Hesitancy to delegate responsibility to younger managers is a sure sort recipe of self-enforced stagnation.

9. How Company Is Tracking It’s Costs?

As we have seen in #5 and #6 above, profit margin and margin growth are critical. One way to achieve higher margins is through cost control. The company can keep its costs under control by tracking all pay-outs. Generally, an ERP system will do this task. Diligently booking all expenses into the ERP system will give a visualization. Top managers will know the where are the major cash flows happening, and hence can keep a check. A company with a robust ERP system will flourish.

10. What Is The Company’s Success Factor?

All new companies operate in their own core sectors/industries. To triumph in a Sector, a company must follow a success path (a winning strategy). The key is to identify and formulate this success path. Companies that have found their ‘winning strategy’ will have more chances to grow faster in times to come.

11. Focus on Long Term Profits

Some companies focus too must on their quarterly numbers. They are too concerned about how the market will respond to their numbers. This hesitancy makes them defensive, and such companies often grow at a slow speed. Why? Because they focus too much on current operations avoiding future growth plans (CAPEX). On the contrary, companies that handle both current operations and CAPEX plans at the same time will always remain profitable.

12. The Company Has Cash or Borrowing Capacity?

For listed companies, raising funds through the equity route is easy. The gap between ‘issued capital’ and ‘authorized capital triggers equity financing. The company sells its shares to raise funds. Such companies may increase their profits over time, but such profits get liquidated by the increasing shares outstanding. Companies that remain creditworthy will not have to raise money through the equity route. They can borrow money from banks. Shareholders of such companies will see growth in terms of increasing EPS.

13. How does The Company Report During Troubled Times?

It is a natural first instinct to hide our mistakes and bad performance. But for a listed company, hiding facts from its shareholders is not legal. Good companies remain transparent at all times. Reading annual reports of companies can give this idea. An annual report, which is only boasting about its achievements, is like a red flag.

14. Quality of Management

A company run by excellent managers can become exceptional. No matter how good are the numbers, sales and profits, but if it does not have quality managers, investors will eventually start avoiding its stocks.

15. Addressing Labor Grievances

There will be times when the issues of the employees will escalate. Reasons can be accidents, loss of job, penal actions, etc. How a company will address these issues can make a big difference. Asap resolution of labor grievances is the key. A company cannot afford to fight these cases in courts all the time.