9 ways to find out quality stocks when markets are at highs

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The Indian equity market is in a strong bull market which was started in March 2020 and I believe this bull market is likely to continue for at least the next 2-3 years however many stocks have rallied a lot and it is difficult to identify quality stocks at comfortable valuations. The bull run is likely to continue for the next 2-3 years but things won’t be easy from here in terms of stock picking therefore I want to discuss with you 9 ways to identify quality stocks after a big rally in the market and following are 9 important points investors can consider while investing in the current market scenario:

Quality and experienced management: One of the most important thumb rules of investing is to invest in a company that has well-experienced management with no issue of integrity.

Clean accounting: Most of the promotors want to cash out this bull market, therefore, they try to inflate their profitability through manipulative accounting policies. Investors should do due diligence about the accounting policies of the company before investing in it.

Prudent asset allocation: Sometimes well-running businesses do mistakes by allocating their money to unrelated businesses or unnecessary assets that may derail their profitability therefore investors should focus on those companies which have prudent asset allocation policies.

Monopoly/High entry barrier business: It is always wise to invest in the companies that enjoy monopoly or serve in the industry which has high entry barriers because such kinds of businesses always have pricing power and have high margins.

Leader in the sector: If you are looking company from an industry with many players then should focus on the leader or top 2 players of the industry because leaders always manage to survive in a tough time and bounce back sharply by taking market share from the weak players.

Strong earning growth should be visible: Ultimately earnings matter in the long run therefore investors should focus on those companies which have visibility of strong earnings growth in the next 5 years.

The margin of safety in terms of valuations: The market has already rallied where many stocks look expensive but some stocks may continue to do well despite expensive valuations because strong earnings will justify their valuations however there will be some companies where valuations are stretched and there is no scope for any error, therefore, investors look for the companies with a margin of safety in terms of valuations.

Return on Capital Employed > Cost of Capital: One of the important parameters to judge a company with strong earnings growth, high margin, and prudent asset allocation are that Return on capital employed should be greater than its cost of capital.

Special situation ideas: As we know the market has rallied significantly from the March 2020 low and most of the companies either look expensive or fairly valued therefore it is difficult to pick a stock into a portfolio with ease. Special situation investing is one way to generate alpha into your portfolio where investors should identify companies with special situations like bonus issues, mergers, reverse mergers, buyback, M&A, etc.

(The author is the Founder of Tradingo; views expressed are personal)