I’ve written an algorithm that filters the highest return stocks in the Indian stock market. It is not difficult to find stocks with high returns, so why write an algorithm for it? It is essential because relying only on past return numbers may lead to problems. How?
List of High Return Stock in India
|SL||Name||Price (Rs.)||Return (3M) %||Return (1Y) %||Return (5Y) %||Return (10Y) %||GMR Score|
|1||MK Exim India||93.45||19.81||277.07||106.31||41.17||66.48|
Let me give you an example. There is a company called Sejal Glass listed in BSE in Year-2008. For the last 10-Years, its stock price was in the single digits. It was a penny stock.
Till twelve months back its share price was Rs.3.64, today the price is at Rs.425 levels. It has a CAGR growth rate of 11,597%. Rupees one lakhs invested in this share would have become more than a Crore in 12 months.
But my algorithm gives this share a Score of Zero. Why? Opening the financial report of this company will tell the reasons.
- The company has reported only losses in the last 5-Years.
- Its net worth is negative because all of its retained earnings are exhausted.
- The company is living dangerously in high debt. Neither its equity base nor earnings nor cash flow can support its debt load.
- The current ratio of the company is dangerously low. May lead to bankruptcy.
- The company’s cash flow is falling.
- The net sales have grown at 15% per annum but it is not sufficient to justify the exorbitant rise in share price.
So the question is, shall we buy such a poor-fundamental stock just because its share price is rising? A long-term investor like Warren Buffett would never do it.
Company Fundamentals Are More Important
People who are successful in the stock market are investors, not speculators. Who are investors? They are people who buy stocks of fundamentally strong companies and hold on to them for a very long time. Extended holding time helps them to take advantage of the power of compounding. So buying stocks and holding on to them for 10-15 years is the first trick. The second trick is to invest only in fundamentally strong companies.
But how to know if a stock is of a fundamentally strong company? It can be known through fundamental analysis. If you are interested in knowing how the analysis is done, I’ll request you to read my series of articles on fundamental analysis. For now, we’ll stay on the topic of highest return stocks.
As we saw in the example of Sejal Glass, the company’s fundamentals were weak, but still, its share price went up the roof. How? The promoter’s holdings in Sejal Glass has increased from 50% to 99% between Dec’21 and Feb’22. So the demand for the share was pumped up, hence the price rise.
In the case of Sejal Glass, the price jump is caused by an increase in demand for its shares from the promoter’s side. Nevertheless, the fundamentals of the company remained weak. I’ve checked their last few quarters (till Dec’21) numbers. It was not encouraging.
The point is, it is important to further investigate shares that gave high returns in the past. Why? Because not all high-return shares have a profitable underlying business. We must avoid investing in loss-making or even less profitable companies.
How to Judge High Return Stocks?
In my stock screener, there is a list of stocks that gave the highest return in the last 10 years. But what is more interesting about this list is the consistency of returns yielded by these stocks. How to measure it? It is also the topic of discussion in this article.
Let me give you an example to highlight the utility of my stock screener and its scoring method. Suppose you were researching a stock XYZ for its past returns. You found its numbers as presented below.
XYZ had phenomenal periods in the last 1, 5, and 10-Years (in terms of share price rise). There is also a price correction of 26% in the last 3-months. Currently, its P/E ratio is also very low at 1.54 levels. What do you think, just by looking at these numbers, the stock looks ready to buy, right? But our stock screener gave it a “GMR score” of 15 out of 100. The low score points towards weak business.
What is a GMR Score? For this screener theme, it is an algorithm that rates stocks based on the past returns it has generated for its investors. The higher are the past returns, the better. Moreover, instead of focusing on absolute return numbers, we give scores based on the return trend.
Along with the past returns, the screener also looks at the host of other stock data. A few prominent ones are listed below:
#1. Return on Capital Employed (ROCE)
XYZ posted negative ROCE numbers in the last 3, 5, and 10-Years. Read more about ROCE Formula. The algorithm includes the RoCE (Return on Capital Employed) numbers to calculate the GMR score. A positive and growing RoCE is an indicator of strong underlying fundamentals.
#2. Earning Per Share Growth (EPSG)
In the last 3, 5, and 10-Year periods, XYZ’s EPS growth is negative. In fact, in the last couple of years, its revenue is negligible. The algorithm considers the historical EPS growth numbers. Why use EPS Growth? There are some stocks whose price grows irrespective of falling profits (EPS). Factoring in EPS trends will filter out such companies.
#3. Price To Earnings Ratio (P/E)
No matter how high are the past returns posted by a stock, if currently it’s overvalued, it is not useful. How to judge if a stock is overvalued or undervalued? The easiest is through the PE ratio. Our algorithm gives low scores to stocks that trade at high PE multiples. Learn more about the PEG ratio which combines EPSG and PE to value stocks.
#4. Debt To Equity Ratio (D/E)
It is safe to invest in companies with low debt. How to quantify the debt level of a company? It can be done using the D/E ratio. To score a high return stock, our algorithm gives low scores to companies that have a D/E ratio above two. Extremely debt-ridden companies are altogether not scored no matter how high are their past returns. Why do we do so? Because high debt companies can become immediately risky when their business is not doing well. Know more about debt-free companies.
#5. Current Ratio
Even the best companies can fail due to insufficient cash. How do companies generate cash? Through their current assets. What is the use of current assets? Repayment of current liability and creating a surplus to manage future expenses (working capital). A company that can do this is called a reasonably liquid company. How to measure a company’s liquidity? The easiest way to do it is through the current ratio. Our algorithm gives low scores to companies whose current ratio is low.
So, the GMR Score displayed in our stock screener for high return stocks is an amalgamation of the following parameters:
- Past returns,
- EPS growth,
- P/E ratio,
- D/E ratio, and
- Current Ratio.
As an investor, we must also realize the most basic factors that make a business profitable. A profitable business, as a result, will grow fast and will yield higher returns. The most fundamental thing about any business is its business model and its management team. Once these two factors are in place, the next-essential thing about the company is capital.
These three ingredients are the basics of any company. Together it gives quality to a business. Two fundamental indicators highlighting the quality of a company are its profitability and growth numbers.
All factors that include the business model, management’s quality, capital structure, profitability, and growth ensure future price appreciation of a stock.
So, in our endeavor to find a high return share, looking only at the price is insufficient. Why? Because business fundamentals drive a stock price high or low.
I hope you’ve liked reading this article.
Have a happy investing