1. Consistent Earnings and Revenue Growth
A company’s stock price eventually follows its earnings. If a company is not making money, its stock price cannot rise indefinitely.
* Revenue Growth: Look for companies that are growing their sales (top-line) by at least 10% to 15% annually over the last 5 years.
* Net Profit Growth: Ensure that the net profit (bottom-line) is growing in line with or faster than revenues. This shows the company is operating efficiently.
* Earnings Per Share (EPS): Track the EPS growth. Consistent EPS growth indicates increasing profitability per share.
2. Low Debt Levels
Debt is a double-edged sword. While it can fund growth, high debt can crush a company during economic downturns.
* Debt-to-Equity (D/E) Ratio: This ratio measures the company’s total debt relative to shareholder equity. As a rule of thumb, look for companies with a D/E ratio of less than 1. Ideally, look for debt-free companies (D/E close to 0).
* Interest Coverage Ratio: This shows how easily a company can pay interest on its outstanding debt. A ratio above 3 is healthy.
3. High Return on Equity (ROE) and Return on Capital Employed (ROCE)
These metrics show how efficiently the company’s management is using capital to generate returns.
* Return on Equity (ROE): Look for an ROE of 15% or higher. This indicates that management is generating good returns on the money shareholders have invested.
* Return on Capital Employed (ROCE): Look for a ROCE of 15% or higher. This is particularly important for capital-intensive industries as it includes both debt and equity in the calculation.
4. Strong Competitive Advantage (Economic Moat)
An economic moat is a company’s ability to maintain a competitive advantage over its competitors to protect its long-term profits. Types of moats include:
* Brand Value: Companies like Asian Paints or Maggi (Nestle) have powerful brands that allow them to charge premium prices.
* Cost Advantage: Companies that can produce goods at a lower cost than anyone else (e.g., DMart).
* High Switching Costs: When it is too expensive or difficult for customers to switch to a competitor.
5. Trustworthy and Competent Management
A great business can be ruined by bad management. Since you are trusting management with your money, you must evaluate their capability and integrity.
* Promoter Shareholding: Look for companies where promoters hold a significant stake (ideally above 50%). High promoter holding shows they have “skin in the game.”
* Management Integrity: Check if the company has any history of accounting fraud, legal battles, or unethical practices.
* Promoter Pledging: Ensure that promoters have not pledged their shares to secure loans. Pledged shares below 10% is acceptable, but 0% is ideal.
Getting Started
To master these metrics, we highly recommend reading the acclaimed Kaliyiri Share Market Hattiri Hanada Rocket Book which breaks down complex stock criteria into simple, practical guidelines.
Once you have this fundamental checklist ready, you must learn the specific knowledge required to learn stock market balance sheets. In our next draft post, we will dive deep into how to read a balance sheet to inspect these numbers yourself.
Advanced Technical Analysis Guides:
- Learn how to identify major trend reversals in our guide on mastering chart patterns in stock trading (Double Tops, Double Bottoms, and Head & Shoulders).
- Discover trend confirmation strategies using moving averages for trend confirmation.
- Master momentum indicators and overbought/oversold levels with our complete guide on understanding the RSI indicator.
