Before you start investing in stocks, make note of 4 key considerations | Mint

You can make money by investing in the share market, but you need to be careful and keep in mind a list of financial points. Warren Buffett once said, “Price is what you pay. Value is what you get.” You need to keep the following points in mind as you invest your hard-earned money in stocks.

Understanding financial goals, risk taking capacity and tolerance

It is important for you to first determine your financial goals, life aspirations and your risk tolerance. Your financial goals can be as simple as saving for a car in the short term or retirement savings in the long term. Your risk tolerance will decide how much risk you are willing to take and put your funds i.e., your money out on growth instead of putting everything in safe debt like bank fixed deposits or savings.

For example: If you have a low-risk tendency, then dividend-paying stocks would be better for you compared to risky but high-growth IT sector stocks. Now for such decisions it is important to build knowledge and speak to professionals before investing.

Crucial financial metrics and factors to look at

There are a few financial metrics that can be utilised by investors in order to decide the health and future of a company. 

• Debt-to-equity ratio is one much metric, it informs a company about the level of debt on it, therefore, the lesser the debt-to-equity ratio, the stronger the financial position of a company.
• Further, net profit margin, i.e., net profit over total revenue, is another crucial metric, it informs us about how large a profit, in terms of percentage of its own revenue, the company makes. The larger the net profit margin the better it is.
• Return on Equity (ROE), is yet another important metric, it is a ratio calculated as a proportion representing the degree of the firm’s net income compared to the shareholder equity, and depicts the company’s performance in converting shareholder equity investments into profit.
• Then we have another important metric which is liquidity of stocks traded on benchmark indices. Liquidity is also extremely essential. Investors must check and follow market liquidity (sale-ability of the stock of a company) and accounting liquidity (settlement of short-term obligations). This is important because this teaches investors to avoid investing in lucrative penny stocks. As most of the penny stocks have limited liquidity and generally act as pump and dump tools for trapping less informed retail investors. 
• Further, the price-to-book value (P/BV) ratio, which is of particular concern to companies with physical assets like banks, sets the market value of a company relative to its book value. A P/BV ratio of less than 1, adjusted, may suggest the stock is undervalued. Hence these are some important factors to always keep in mind before considering investments in equity markets.

Diversification, promoters holdings, and regulatory compliance

Portfolio diversification is necessary to limit the risks in the share market. Investment diversification across various industries and asset classes provides stability. It hedges investors against extended underperformance in any one single asset class.

The investor will also need to verify the promoter holding of the company. A five-year promoter holding track would provide an indication of the management’s confidence level in the firm and the stability of a company.

Investors should also be aware of the regulatory rules, regulations and setup. The Securities and Exchange Board of India (SEBI) is one of the significant pillars of protection of investors and market transparency. Familiarising oneself with the role of SEBI and the following of rules from SEBI can enable the investors to keep themselves protected and safe from making mistakes in the market.

Role of an emergency fund

Over and above everything else in investing and markets, having an emergency fund can serve as a buffer in a falling market and enable investors to refrain from selling shares at a loss. That is why it is always important to plan and take into consideration all the associated aspects of one’s financial situation so that panic free investing can be practised in a professional manner.

Briefly put, successful investment in Indian stocks is made easier by a synthesis of clearly chalked-out financial goals, evaluation of risk, diversified portfolios, along with sharp observation of the market with analysis of significant financial metrics and responsiveness to market forces.

Keeping these simple points in mind and always reading and remaining updated at all times, can help investors make objective decisions based on their long term financial goals and aspirations.

Disclaimer: This article is for informational purposes only and should not be considered financial advice; investors should conduct their own research and consult a finance professional before making investment decisions.