First, look at the Market Cap of the company.
Market cap stands for Market capitalization; it is the company's value in the stocks traded on the market. It is the total shares multiplied by the share value of each claim. It is a way to value the company in the nation's currency.
Market cap divides the companies into small-cap, mid-cap and large-cap. With increasing orders of capitalization, the company has more presence in its market segment. A market segment means a portion of the total market of the economy the industry is in.
More the size of the cap means the company is in a good strong position, which means that in case of a recession or any other driving force that would bring the market down, the company has the strength and capacity to bear the stresses imposed by it. Simply put, it is less risky to invest in a Large cap than in a small cap company because they have the funds to sustain and compete in a downtrend.
But another concept says that a company that is already so huge can not show phenomenal growth in a period. There are exceptions to it, and many companies that were penny stocks made 5 to 10 times growth in 3 years too. Nothing is permanent in the market, and it should not be so because, ultimately, it's a market that should keep on changing and not remain static.
Balance Sheet
A balance sheet is a financial document that exactly states a company's financial position at a particular point in time. A balance sheet is made using the basic formula that assets always equal liabilities and capital.
To invest in a company, a balance sheet is the first document you would see, but nowadays, apps and websites provide the crucial ratios and values required in the form of interactive graphs and charts.
You must see the asset holding in the form of fixed assets and the company's debt. Still, wait, don't just negate a company because the debt to equity is high; a company that can repay loans would eventually pay them. Still, you need to check if it has this capacity.
If a company involves debt expansion, it's good because it gets financial leverage, but you need to be careful of the amount of debt too. There is a sweet spot that you will get after gaining experience in this skill according to the industry you are investing in.
Ratio Analysis
Various ratios are stated in apps; some of these are:
1.D/E or Debt to Equity Ratio:
The debt to equity is simply the amount of loan taken by the company to the company's equity or the company's capital. A higher DE ratio signifies that the company has taken more loans; the higher it means a debt burden on the company. In the eventuality of liquidation or closure of the firm, the liabilities are first paid off. Then, at last, it pays its shareholders whatever money is left with the company. So be careful of this ratio while investing for long terms, especially in small caps.
2. PE ratio:
It tells us whether the stock is overvalued or undervalued. A higher PE says that the firm is overvalued and a lower PE means it is undervalued. An undervalued firm has a huge scope of growth but the overvalued firm can mean it can go for a short term correction in the stock(high probability). Hence if you keep long term investing as your vision then it is better to invest in smaller PE companies as they have better growth potential(all other factors remaining same).
3. PB ratio:
Price to book ratio tells us whether the company has a share value higher or lower than what is recorded in the books of the company(aka book value). A higher ratio tells an overpriced company, and a lower value states that the company is underpriced and has a margin to expand more than the overpriced company(most of the time). A price-to-book ratio of less than 1 is favoured by value investors for high gains. Hence the lower the PB ratio, the better it is for investment and growth.
Income Statement
From the income statements, you can check whether the company is making regular profits and is growing in sales. A company that has shown good returns in the past is likely to do so in the future ( all other factors remaining the same, e.g. Corona was an exception). Hence put your money into something that is already profitable instead of expecting gains from someone unable to sustain profits in a typical case.
Check for other Red Flags
Government regulations and other policy changes can significantly impact any sector and industry, so be careful on this point while investing.
One tip- Try doing a PESTLE Analysis before investing in that company.
A pestle analysis stands for the external environment analysis of the company; if it is difficult, you can do a SWOT analysis too. This analysis will help you drill down the company's problems, and you can visualize the management's position by reading the Annual Report; it clearly shows the vision and goal of the company, which should align with your analysis to make an investment decision.
Do not invest in something you do not believe and do not understand fully.
If you cannot analyze and think for yourself, it is better to take the help of a SEBI-registered expert or invest in diversified funds and mutual funds; investing this way would lead to paying fees to the fund manager as an expense. But it is justified to invest in mutual funds if you need help with the analysis or find this information above your head.
Always remember this:
Do not invest in something you do not believe and do not understand fully.
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