Choosing a stock should never begin with a tip from a friend or a trending video. It should begin with a structured evaluation. People who monitor the NSDL Share Price after a major listing event often ask whether the valuation is reasonable. Similarly, those keeping an eye on the CDSL Share Price wonder how a premium multiple can be justified. A methodical checklist helps answer such questions calmly and objectively.

Begin With the Quality of the Business

Ask yourself if the company has a durable advantage. For this industry, licences, regulatory trust, technology infrastructure and the lack of willingness of intermediaries to switch providers constitute a protective moat. Think through if these advantages are enduring in nature.

Next, think through the dependence on the business cycle. Recurring fees from issuers give stability while transaction income can vary. A mix is a good position to be in.

Study Growth Consistency

Review the revenue and profits over a period of five to ten years and look for consistency in growth. Examine how the business performed in a down market since that presents the true test.

Look at the growth in income versus the growth in costs. If costs are rising faster than revenues for a prolonged period, it is a cause for concern. Good operating leverage (profits rising faster than sales) is an important attribute.

Return Ratios and Balance Sheet

Return on equity and return on capital employed are good indicators of the ability of the management to utilise the shareholders’ money. The higher and more consistent these ratios are, the better it is for the franchise. Since these are depositories, the need to borrow is limited; however, check out the balance sheet to confirm.

Review the quality of the investments that the company holds, as these can impact the income statement. A large chunk of cash in the form of a treasury portfolio can aid in boosting the income, albeit with the risk of wide swings in profits.

Valuation

A high price-to-earnings multiple is not necessarily a bad sign as long as the growth is commensurate with the multiple. Ask yourself, given the current valuation, what growth do I expect from the company? If the company needs to deliver exceptionally high growth for an extended period for you to justify the multiple, think again. Look at other valuation metrics such as price-to-book, dividend yield and enterprise value to operating profit and compare it to its own history as well as other similar market infrastructure players in India.

Governance, Ownership and Regulation

Review the shareholding pattern and see who the major players are. Look at the changes in the institutional shareholding. See the degree of independence that the board enjoys and the track record of the management in terms of transparency.

Regulatory risk is another important factor that can impact the earnings potential. Any capping of fees or fresh regulations or changes in ownership rules can impact the business. Make sure to read the risk factors section in any document about the company and not ignore it.

Beholden to Behaviour

Even the best analysis can be undone by our behaviour. Don’t park all your eggs in this basket. Diversify. Moreover, do so over a period of time, rather than all at once. Have a written mandate on why you have bought the stock and under what circumstances you will sell it. The latter should include a deterioration in fundamentals or a rise in valuation without an increase in earnings. Review your portfolio every six months and not every day. After all, too much vigilance can turn into obsession.

Summing Up

A good analysis should take into account a host of factors including business moats, growth consistency, financials, valuation, governance and individual behaviour. None of them are mutually exclusive. It is only when we look at all these factors that we can make a reasoned and well-rounded decision. Remember, even the best companies can turn out to be Dud-like merely because we thought they were great and we bought too much of them at too high a price. And remember diversification is the best hedge against our own misjudgments.