Do you want find to invest in stocks that can make really good money in good times? This guide will explain the step-by-step process.
We explain the concept and then will explain what do we think might happen in 2023.
Generally the process looks like this:
Step 1: Understand the story in stock – then believe in it!
Step 2: Look at historical sales growth
Step 3: Look for consistency in Profitability
Step 4: Valuations / PE Multiples
Step 5: Some additional considerations!
Result: Final Screened Growth Stocks
Step 1: Understand the story in stock – then believe in it!
What does a company do? This is where we will start! By knowing the industry you will know when do they grow or make more money.
Like a cement company would grow when Pakistan’s economy will do good and hence more construction will happen.
Or tractors will be sold more if crop prices are higher because farmers will then invest more in buying tractors and fertilizers.
Once you know about these basics, making a story becomes very easy.
Now look at our story for 2023!
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Our story expectations for 2023:
Pakistan has to repay USD25bn each year from 2023 to 2025. For this we need to earn more dollars than we spend.
This mean less imports and more exports and remittances.
But Pakistan’s growth has always come through consumption that means to grow me need more imports which isn't possible.
So in 2023 and may be in the next two years also, GDP growth will be very low.
So all those companies that make or grow their income those selling their products to local awam, might not see good increase in their profits.
Now, which companies may see the growth? All those that export goods.
The two sectors that will stand out the most incase our exports grow i.e. textiles and software companies, as they are already in the business and have all the channels set up already.
InvestKaar’s Comments:
See, this is our story! You may agree or disagree with it, it’s your choice. But the reason to write all this is to tell you that you have to have a story behind the stock or the company you are looking to invest in. If you are new or don’t have a story yet, you can borrow the story from research reports or your brokers. But have a story!
Step 2: Look at historical sales growth
With that story in mind, we will not go and blindly buy any company that exports textiles or software services.
Proof of concept i.e. what have they done in the past, is best to start with. So we will look at historical sales growth.
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InvestKaar’s Comments: Let’s start off by looking at sales growth for the last five years by different textile composites and software companies. See the chart below.
Out of a total of 26 companies listed in the textile composite space, 14 had been showing strong sales growth. So, the probability of increasing sales is higher for such companies – a high chance that they will thrive when incentivized.
To come to a reasonable sales estimate for the next year, we will suggest growing the sales for the next year at their average growth numbers.
For instance, they grew by 20% over the last 5 years, we will increase their last year sales by 20% to reach to next year’s sales number.
This is a simplified example to show how to forecast sales for a company
Step 3: Look for consistency in Profitability
What good a strong sales growth is if the company isn’t showing profits? Pakistani investors don’t have the patience to let a company grow without profits, gain the market share, slowly increase prices and then start to show massive profits. This is not Nasdaq!
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InvestKaar’s Comments: Again, we will be needing proof of concept to know that they were profitable even when things were not that good. This way we will be comfortable to sit on our investments comfortably and let them grow! Also, profit means potential dividends and they can be very handy when the market isn’t performing like today!
The best way to go about it is by taking a look at the net margins – the higher, the better. We don’t need long excel sheets to figure out every bit and piece about the company. We want to know how much they make as a percentage of sales they do. Historical numbers give you enough idea to make a reasonable estimate for that.
See the chart below.
Out of 14 shortlisted companies, the net margins for 8 companies are rising while 4 have been consistent. So we will move forward with these 12 companies. We will go ahead with these companies only to finalize ‘our example’ best picks from the sector.
Step 4: Valuations / PE Multiples
The company should be worth our money. This means that it should be trading a such a multiple that we can put in money and expect it to give us returns. If it’s trading high vs other companies in the sector, it can mean either of two things:
the stock has already performed and hence the seller you are buying from will keep most of the returns, leaving fewer capital gains for you or
the company is unique and has something like good management which other companies in the sector don’t have
the stock is relatively more liquid – take the textile sector for example; most of the companies are illiquid (read the concept checker below) so any company which is freely traded will have a higher multiple.
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InvestKaar’s Comments: We will accept that valuation is a subjective thing. Someone will tell you a stock is cheaper on DCF while others will use pricing multiples like price-to-earnings ratio or price-to-sales to arrive at a conclusion. These are all fancy ways of saying how cheap or expensive the stock is.
The most basic, easiest and useful is to look at the PE ratio. It’s easily the most used and every investor/trader follows it. Use it as general valuation guidance on the stocks you like.
Concept checker
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What is illiquidity?
Simply put, investing in an illiquid stock means that you will have a hard time finding a seller when you want to buy and finding buyers when you want to sell.
Step 5: Some additional considerations!
All the sectors will have different considerations. In textiles, the foremost is illiquidity. When you go in-depth you also need to consider factors like new orders (if any), cotton prices etc
Other sectors might have different considerations. For cement, you need to follow international coal prices and local cement prices
A true analysis requires, reading financial statements. Just open the latest and read their director’s report. You want to focus on the company’s future prospects and the debt levels.
Management quality. Better the management quality, the higher the value of the company! If you are new, ask your broker about the management and he will spill out everything
Taking different perspectives! Once you have finalized the stock you want to buy, talk to people in your trading circle (broker/friends). You might find out a different story or a new angle worth considering to look at.
Result: Final Screened Growth Stocks
We started off with 26 textile composite stocks and have reached a final 4.
If we further have to choose two from the final four, they would be Interloop and Kohinoor Textile Mills. They have all the ingredients to qualify as growth stocks and are liquid enough.
How will this growth stock framework help you?
It’s simple but effective. We don’t need to do a ton of financial analysis to take a decision – some key numbers help you keep on top. Follow these guidelines with whatever you want to buy or already own.
Knowing the story with all your beliefs will let you hold on to the investment even when it’s not working. This is so much better than blindly following a tip and having no idea of what you are getting into.
You don’t have to follow the steps on your own all the time. Listen to your broker with intent and see if he has a credible story to tell and that his numbers make sense. That works well too!
Disclaimer:
The stocks that we shortlisted should only be used as examples to explain the stock-picking framework clearly. They in no way should be considered investment calls by InvestKaar.
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Founder at InvestKaar.com. 15 years of investing and wealth management experience. Worked at most renowned brokerage houses in Pakistan. Won the best sales trader award for 2021 by CFA Society of Pakistan.
