The first thing I do is run a potential stock I may be interested in through a screener. My list of potential stocks are only stocks from sectors that I understand and am interested in. Circle of competence is the most important thing in investing. For me this is tech, consumer and parts of pharma. If it is anything outside this, it is out before I even begin. I already have a broad overview/knowledge of the business before I start studying it. Also these sectors historically have had very high ROCEs.
It is OK if a company does not pass many/any of these, but it is important to know why it did not. Eg. A recently listed high growth startup will likely not pass many of these parameters. It is fine to override these. These basic investing hygiene checks can help in ensuring that there aren't any big blowups. High quality companies with long term business advantages will have good balance sheets and cash flows.
Average return on capital employed 10Years > 15 AND
Sales growth 10Years > 10 AND
Market Capitalization > 500 AND
Sales growth 5Years > 10 AND
Free cash flow 5years > 0 AND
Free cash flow 10years > 0 AND
Altman Z Score > 5 AND
Debt to equity < 0.5 AND
Price to Earning > 10
Glancing over receivables/payables/other liabilities, asset split up may also help. Also if it is a cyclical, capital heavy(requires a lot of cash to be invested back into the company) or commodity, it is out. Then I Google around trying to find any dirt on the promoters or the company:
- Google search promoter/company name+fraud/murder/IT raid/chor etc.
- Twitter search for the same, go through Twitter/LinkedIn for key management personnel/directors.
- If there are any family members in management, board it is most likely out.
- Search Glassdoor for insights on company. Note: Reviews are mostly gamed, look for insightful comments.
- Valuepickr. Again try to look to see if there are any insightful negative comments.
Unless I am 150% sure the promoter is honest, I do not invest. Then I check cashflows for the last few years.
Most important things to check is cash flows from operations and how much is being re-invested over the years. Growth of operating cash flow/free cash flow IMO is more important than EPS growth.
Then I will start reading the annual reports, conference call transcripts, interviews to try to understand the business in depth. The main question to ask is: What is the competitive advantage that allows the business to generate high shareholder returns? This can be a brand that allows the company to sell cheap product for a higher cost, it can also be because the company is the lowest cost provider in the market, it can be because it is a monopoly in a hard to get into(consolidated) business etc.
I also look at ROCE over the years and try to understand why it was at that level and ups and downs the business the business may have and what the runway for growth looks like.
Then if I like the business on all of these parameters, I try to look at the valuations. I use OCF/EV and FCF/EV valuation parameter. I also look at growth of cash flows, where the extra cash is being invested in and how much returns it will generate for shareholders. If it is just to maintain the business, it isn't very useful for the shareholders. I compare these parameters with peers, historical averages, other global peers etc.
NOTE: Nothing is investment advise. DYOR. Not an investment advisor.