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Prefer companies that make profits
Yesterday we had a quick revision of all the topics.
Earlier, on Saturday, we discussed about why and how it is important to pick companies that have more positive factors than negative (i.e more Pros than Cons).
I asked you to identify a good stock and a bad stock based on screener.in Pros and Cons.
If you have done that, it is should be a good effort!
Let us see the rule once again:
Rule #5: Prefer companies that have more pros and preferably no cons
Now, in today's class, we will add a new rule in our journey of finding fundamentally good companies to invest in.
Rule #6: Prefer consistently profit making companies. Look for companies that make profits (in particular operating profit, profit before tax and net profit)
Do not get scared reading the Rule.
We will decode it for easy understanding in todays class.
And hey, you need not be a financial expert or a person with commerce background to understand this (though being so will help).
Profit is an important element for a company.
Companies are formed to do business and profit is an essential part of it.
A company making profit means
.. it enjoy some comfort in terms of financials and
.. can use the money for several good reasons.
For instance, the company can use the profits to expand its business.
Or in some cases, some companies might not have identified any good use of its profits (and idle cash) and hence feels it is better to distribute the money to its investors in the form of dividends.
we are not looking just for profit making companies
but *consistently* profit making.
i.e quarter after quarter and year after year.
There are two profits we are interested to look at:
1. Quarterly profit (profits made every quarter i.e every three months)
2. Annual profit (total profit made during the entire year of its business)
Question to think:
- How to know if the company is making profits?*
The best source to check as to company is making proit or now is the Profit and Loss Statement.
The next best source is the quarterly and annual results report that the company shares with its shareholders.
Almost all financial websites provide this information.
But, we will use screener.in to find this. Because it is easy way out.
Let us take REC Ltd as our example company.
Go to this webpage: http://www.screener.in/company/RECLTD/
If you scroll in the page, you will find a section called *Quarterly Results*
Observe the *Operating Profit* part
You will notice that, for every quarter, the company is making profits.
And over a period of time, the profit amount is increasing.
So, here are two observations we are making:
1. Consistently profit making
2. Increase in profit QoQ
What is Operating Profit?
Operating Profit = Profit generated from its business operations (and not from other modes such as investing, gains from sale of assets such as real estate etc.)
It is this type of companies that we need to prefer for long term investing.
We will discuss about this in our later lessons. Cannot wait till then? Jump to Operating Profit Margin
On the same screener page, please scroll a bit lower.
Look for *Annual Results* section
You will observe that year after year,
the company is making profits
and they are increasing consistently.
From profits perspective, we can say REC is a good company to invest in.
Question: Every quarter profit has to higher than previous or consistent is also good ?
Regular profits are sufficient. They need not be always growing.
Most businesses follow cycles, seasons etc.
So we cannot say that just because less profits came during a quarter, it is a bad company.
This is why, we are checking for Annual profits as well.
Irregular profit moment is not a good sign but not a worst ones either.
But, profits in one year, loss in another, profit is the third year etc. is a concern. It does not allow us to be predictable.
If a company makes profits, it could pay dividends for its investors.