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.

On vacation earlier this month my wife and I visited a casino during an evening with friends. We were clearly the poorest of our group. We started setting a limit to the amount we would lose that evening. Like all our friends, we lost. The difference in amounts lost was just a matter of decimals.

The losses showed us who paid for plush setting of the casino, good liquor and food, served “free.”

The capital markets are in some ways akin to a casino. Large advertisements by merchant bankers, stockbrokers and mutual funds are paid for - by the person in your mirror.

I have written earlier about methods of analysis. At the risk of repeating them, then: they are fundamental, technical, and logical. Call them the three guides to making money.

Three ways of losing money would be:

1. Gambling on horses, cards or at the casino - the fastest

2. Women - the most pleasant

3. Speculating on the stock market - the most certain and definitely the most boring

Add to these, a fourth - watching too much TV or reading too many expert opinions, mine included. Rewind to the beginning of the last boom and early April 2003 when the jokers on TV suggested a drop to 2,200 for the Sensex from 2,800. Less than a fortnight later, this same bunch was speaking of the Sensex going up to 6,000. There had been no fundamental change during those two weeks.

Fast forward to January 2008: 25,000 was almost the overnight target, 40,000 in the rather near future, for the Sensex (which was then at 21,000). During a meeting with a brilliant fund manager recently, he showed me a clip from a TV channel. It had a number of the most respected names in the capital markets providing sound bites on the Sensex crossing 20,000. Everyone was advocating a buying spree. There was to be no end to the boom.

Now the same purveyors of garbage suggest 6,000 and lower. The difference is that we have a fundamental change in lower earning forecasts, which was obvious even before Diwali 2007 when the index was around 20,000. Will the experts be correct in their bearish forecast? Unlikely for an extended period, would be my guess.

Yes, they will be for a few days, or weeks. Fear and the memory of recent losses will ensure the investor will refrain from committing fresh money to the markets. But the smart money that exited the markets in January, close to their peak PE of 30 on the Sensex will nibble at choice stocks on offer, now at a market PE of about 10. Along the way will be opportunities to grab at the feast table - opportunities such as a payment crisis, the failure of a large institution, announcement of elections or formation of a Government, when shrill loudmouths, only distinguishable by their shrillness, from Mayavathi, Jayalalitha, Mamta Banerjee, Yechury, and the Karats confirm their idiocy on TV. Each occasion such as the ones mentioned above that causes a temporarily sinking Sensex, the smart money will refill its pockets with the crème de la crème of the equity markets.

Start loosening your purse strings in bits and build a quality portfolio. Take a couple of years doing that, for the opportunity cost of money in a stagnant market would mean an erosion of 50% of your money’s risk-adjusted value in 3 or 4 years. At 10%, the current bank FD rates, your money doubles in about 7 years. Expecting double that rate of return on equity investments is fair considering the market risk, thus leading to my above assumption. However, the markets might just surprise and double next year or stay flat till 2015. I am not gambling on the time frame!

Getting into an SIP in mutual funds, or directly in a personal portfolio is a good idea now. This will likely be a good sum in 10 years, if not sooner.

Meanwhile, if you decide to visit that casino carry just as much cash as you believe you’d pay for a nice evening. You will also find that it’s a lot more fun losing it yourself, than on the advise of an expert.

Naveen Fernandes is Vice President - Sales at Orbis Financial Corporation Ltd., a SEBI approved custodian. He is a Certified Financial Planner. On good days, he fancies himself an investment expert.

I had just started college in 1981. Some saved pocket money and small prizes added up to Rs. 125, which became my first investment in shares. 3 years later I got out of college with some education, a portfolio of about Rs. 10,000 and a lesson in keeping my mouth shut…Knowing my dad also had some investments in shares (from the addresses on the mail) I mentioned a particular stock at home. Dad promptly took me out and warned me never to speak of shares in my grandmother’s hearing. The belief was that investing in shares was as big a sin as gambling – anathema for a small town middle class family.

Stories of legendary wealth created from investments (Warren Buffet, according to an email doing its regular rounds, started at age 11 and used profits to buy a farm at 14, to turning into one of the richest men in the world), to tales of suicides by big losers would suggest that investments in shares is gambling and that the stock market is a huge gambling den. Is it?

Starting at the beginning, what is a share? If I may use examples, a person starting a small business could use his/her money, if a little more money were needed. He/she could rope in friends as partners, or borrow from banks, but would be hard-pressed if the capital required were substantially larger. Such a businessman could split the entire owners’ capital into small units, of normally Rs. 10 and sell it to a large number of ‘investors’, each being a partner in the business to the extent of the money invested (’shares’ bought). The business would be in the form of a ‘Joint Stock Company’ (Company).

The share market? If the investor, from my previous paragraph, had invested in a share of a profitable company, others interested in being a part of the venture would try to buy shares in that company. This would take the prices up. Conversely, if the company were not profitable the holders would try to sell it bringing down the price of the shares. The share market is a forum that facilitates and controls the transactions, to ensure the investors’ transactions are safeguarded.

This does not mean that the stock exchange guarantees profits to all investors. Every transaction of a share bought involves another where a share is sold (shares are not created at will). While the buyer would purchase a share expecting the price to go up, the seller would expect it to drop. One would be right. The Stock Exchange is a place where a seller can find a buyer. The Exchange also ensures that the buyer receives his shares and seller his payment.

Returning to the beginning and my grandmother? How is investing different from gambling? While gambling involves chance (I do not know anything more about gambling in any form), investing involves the science of numbers. All stocks traded (stocks are bundles of shares) are at a price. This price is normally based on measurable factors, including but not limited to the profit of the company (from which is derived the profit per share, also called Earnings per Share or EPS), Book Value (which indicates the amount of profit plowed back in the business), ROE (Return on Equity) and ROCE (Return on Capital Employed, showing how well money has been used to make profits by the Company). Out of these come other ratios relevant to the price, like PE (Price/ Earnings, a fundamental value), PEG (PE/ Growth), P/BV (Price/ Book Value) and others. The market becomes a casino when these values are ignored and shares are bought because it is fashionable to have some!

The guru of investors, Warren Buffet, has said that he considers ROE, followed by PE, the most important values.

Returns are the most important simply because that is the reason for any investment. With a number of options available, the investor would be unwise to use the less profitable. Therefore, knowing that your company earns reasonable returns on the money invested in its business (Return on Equity and Return on Capital Employed) is the basic parameter to value a company and its share.

PE tells us the price we pay for the returns. Simply PE is the number of years it takes to get your investment back as profits, at the present rate of profit. Obviously the investor would like to recover his investment early, so a small PE would normally be better. An example, most small businesses are started with loans from parents or uncles, autorickshaws, fruit juice stalls, vegetable vending and the like, which are numerous successful businesses in India. The loans are taken with a promise to repay (mostly honored) the loan after deducting daily personal expenses. The loans are to be repaid in 2 or 3 years, indicating a PE of 2 or 3. Would the lending ‘uncle’ be as generous if the loan were to be repaid in 30 years? I doubt it. But in shares investors often disregard their ‘pay-back’ period (the BSE Sensex was at a PE of 30 a few months ago), clearly indicating gambling was getting the better of investing. The market fall to a current level of about 18 PE was a natural phenomenon of valuations and better sense descending!

There are several methods to investing and they will be covered in time. The most important is to invest with some knowledge. Data is available today, as easily to the rookie, as a professional. If the money invested is hard earned, the investor has a duty to himself, to see that the money is not lost to stupidity. Three basic types of research are Fundamental, Technical and Logical.

Fundamental research is a study of the Profit & Loss account, as well as the balance sheet of a company to check the financial health and profitability of the business. The ratios mentioned earlier all stem from this.

Technical research is a study of graphs and patterns, best left to experts. This is used to identify the best time to buy, or sell, a stock.

Logical research is simply keeping ones eyes open. The daily news often provides information on opportunities. For example, increases in interest rates hurts companies that borrow, and banks that would see erosion in the value of their bond portfolios. Increased customs duty on steel would benefit the local steel manufacturers.

Till we meet again, a word of advise. Gather some knowledge, or go to experts (through Mutual Funds). Invest so that you keep your losses low (therefore invest cheap – not at low prices, but at cheap valuations). Prefer to lose opportunities, not money (Buffet’s 2 rules to his managers are:

1) Never lose your investors’ money

2) Never forget Rule 1

May your investments be profitable and your days peaceful.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.