Difficult as this economic climate appears, I want to stress that this is still a very good time to invest. The third quarter saw a correction morph into a bear market and panic. Steep stock market deterioration was concentrated in late September and October. Extreme volatility is reminiscent of typical bear market bottoming, forming the classic V-shaped market. Many stocks today are at their 52-week lows, many below listing or IPO price, valuations higher than the market price!

But there’s an important hitch - we need to be much more careful in our stock selections. As long as we remain prudent investors, you and I stand to see massive gains in the weeks and months ahead. This is one of best profit opportunities of our lifetime.

Everything today looks good for a buy but does that mean we buy anything? I have listed below four simple fundamentals that you need to look at when buying in these volatile markets.

The Best Measure: Return on Equity (ROE)

The foremost thing you need to do is zero in on a company with high ROE. This is a benchmark to find the efficiency of the company. This measure will actually tell you how much profit a company is making on the equity it has. ROE is a report card for a company’s management. We can’t always know what management is up to, but by analyzing a company’s ROE, it lets us know how prudent they’ve been with their shareholders’ money. Management should never forget exactly who it is they’re working for. An ROE number above 15% is good, and anything above 25% is outstanding.

Avoid Companies that Spend More than They Earn

Next to look for are companies with strong cash flows. Examine a company’s cash flow because it’s something that’s hard to manipulate. The simplest definition of cash flow is earnings plus depreciation. What cash flow tells us is how much cash is coming into the company from its business compared with the amount of cash going to fund its operations. The problem is that some companies generate a lot of cash, but they require even more to keep things going. Whenever we see that, we should know it’s not a good sign. By looking at cash flow, we can cut through the thorns and see how healthy a company really is.

Companies with Big Profit Margins

The third step is to find stocks with expanding operating margins. This is very important because it shows us a company that can grow its earnings faster than its sales. When a company has growing operating margins, it usually means the company has pricing power in its market. That’s crucial in this economic environment. More often than not, such a company can grow its profit margins because it has a dominant niche in its market.

Outperforming Other Stocks

The final step in spotting winning stocks is to find companies that are having their earnings estimates revised higher. Beating earnings expectations is great, but we also want to hear a company say that future earnings are going to be better than expected. Spotting earnings revisions is a great way to uncover value stocks before the crowd does.

I hope my readers would now look into these four fundamentals discussed above before buying or selling stocks.

Kirtan Shah, a Certified Financial Planner, is a partner at AmbestinQ Consultancy Services.

Inflation is a money eater that reduces your purchasing power. For instance if the average rate of inflation is 8%, you need to make sure that your investments are earning a minimum of 8% or more, post-tax. Let us assume an investment portfolio of Rs. 1, 00,000, earning returns at 10% and inflation at 8%. The returns in this case would be Rs. 10,000 gross annually, with the net after income tax Rs. 7000 (Assuming you are in the highest tax bracket of 30%). Now if you account for the 8% inflation specified (8000, or 8% of Rs. 100,000), you are left with Rs. -1000 (Return of 7000 minus inflation of 8000)! The best way to grow a retirement corpus is to have a diversified investment portfolio according to the asset allocation designed for your risk profile. An ideal one would be 40% equity (blue chip), 50% debt, 5% gold, and 5% cash. Equity would help appreciate the retirement corpus. Debt investments would provide for regular income and gold would act as a hedge to inflation and equity turmoil. The recent equity market downturn was the perfect example for gold to stand out as a surge. Selective equity investments made for the long term are more often than not investments with high returns.

Equity: Do not sell blue chip stocks when the value increases. This should not be done when you planning for retirement. These stocks provide for the regular incomes by the way of dividends. At the same time if the dividends paid by the companies increase, it will reflect positively on the stock price too. The most crucial aspect that we never consider in an investment is the dividend that companies pay. We always look at just the capital appreciation. Dividend income in India is tax-free. The dividend payouts by all good companies grow proportionate to the growth in the net profit. It means that if you stay invested, your equity dividend income will keep growing year after year, compounded. If you think that the return on your capital is tiny compared to your investments, just be patient and watch out for a few years. Lets assume that your company’s dividend payout grows 20% year on year, in 10 years your dividend income will jump by more than 6 times and in 20 years it will go up by nearly 40 times. And if you consider the occupational windfall gains like rights and bonus issues, your dividend income goes up in compounding multiples over a period of time.

Your Investments should perform better than the market: Is it easy? Yes quite possible. The Bombay Stock Exchange has approximately 3000 shares listed on it but its index, the Sensex, is a weighted average representation of just 30 stocks. So, if the Sensex falls it is an indication that the heavy weights from the 30 stocks fell; not all the 3000 stocks. If your investment portfolio is to beat the Sensex, they will need to have a Beta more than 1. The Beta is a measure of sensitivity of a scrip movement relative to the movement of the benchmark index (in this case, the Sensex). A Beta of 1 means that for every 1% change in the index, your scrip moves by 1%. The caution here is that when you have a Beta of more than 1, your investments will also fall faster than the Sensex fall. Investments in stocks can be very rewarding but with high risk.

If you lack knowledge let mutual funds take care of it: I believe most of you investors who lack knowledge should rely on mutual funds, not individual common stocks. This is not because I think your performance will not be better; rather I think it will be easier for you to operate and will allow less potential for a catastrophe. Investments in mutual funds are managed by professionals who understand and study all the critical aspects before investing your money. This will help in proper diversification, but be sure of you choosing the right scheme to invest in as per your risk profile and aspirations.

Let your debt investments comprise of Government securities and highly-rated bonds (AAA): The most important component in a diversified portfolio is investment-grade fixed income. High-grade bonds and full-faith-and-credit-pledge government securities are the most reliable fixed-income counter balancers.

The balance between debt and equities is a function of (1) your age - the younger you are, the larger your equities percentage; (2) your financial resources; and (3) your need for current income. No two investors have exactly the same risk/reward profile.

Once your debt investments are in place, you need to make adjustments and additions from time to time depending on your changing needs and available new cash for investment. But you should keep rebalancing the portfolio according to your asset allocation strategy once a year.

Biggest mistake is investing based on events: You should never make investment decisions reacting to short term economic indicators or performance. You should build long-term wealth by investing in good companies with strong balance sheets and a history of paying and increasing dividends, and then you remain patient. You don’t jump in and out of stocks based on quarterly earnings reports. Base your investment program on business cycle trends, not market noise created by events.

You should not make many changes to your portfolio in the course of an average year. You should add money to some positions and tinker with others. You should not run from one idea to the next each time the economic wind changes direction.

I would like to urge all the investors reading this to begin weeding out your portfolio’s deadwood. Simplify and organize your investing, and practice the basic rules. As you start to see the profits rolling your way, you’ll be glad that you took the time to read this article to lay a solid investment foundation.

Kirtan Shah, a Certified Financial Planner, is a partner at AmbestinQ Consultancy Services.