How to compare various investments opportunities?
Investors are in the business of comparisons. Investors compare different companies from various industries in order to find the best opportunity for investments. The companies which are operating in the same industries may have different business models. Investors job is to compare these business models and check the sustainability of their business models. Companies may produce the same products but their mode of manufacturing may be completely different. Investors have to keep all this thing in mind while comparing the future prospect of the company. It is important for investors to have certain tools and techniques(models) such that one can effectively compare among various things.
It is very necessary to understand how to compare different things for investors. investors are always in a comparison mode. They compare various investments opportunities and select the best possible investments. So, the necessity for understanding the essence of comparison for investors is immense.
How to compare
Comparison is relative
Investors have to think of comparison in the dimension of relativity. We cannot compare companies in absolute terms. For example, we cannot compare only one company by itself. We need at least 5-7 companies to compare with each other. If the growth rate of one company is 15%, then this growth rate should be compared with other alternative companies. And at last, the company with the highest growth rate should be selected as the candidate for our investments. These are simple things but most investors forget the basis of comparison when they compare.
For example, if the share price of some good company falls by 20-25% due to some temporary problems in the industry, most of the investors say that the company’s share price has become cheap due to a share price drop of 20-25%. But this comparison is not correct because we cannot compare one company to itself. Comparisons are always relative and not absolute. We have to compare the price drop in various companies in order to find which one has got cheap valuation relatively.
Size is important while comparing companies
We know that comparisons are always relative in nature. The size of the company should be considered while comparing various investments because, in stock markets, there are many companies raging in different sizes. We cannot take a big company and compare it with a relatively small company. For example, we cannot compare TCS with Sonata Software, even though both are operating in the same IT industry. But we can compare TCS with Infosys Ltd, HCL and Wipro Ltd because they are more or less of the same size.
The bottom line is that we should compare the companies of more or less of similar size and not of different sizes altogether. For example, we cannot compare the growth rate of small 2-wheeler automobile company with the growth rate of Eicher Motors.
Compare the numbers in long term perspective
While comparing the past growth rate or revenue growth of the company we should analyze, what the company has achieved in the last 5-10-15 years and not what it has achieved in last 3 quarter or last year. We have to dig back for at least the last 10 years to see what kind of growth the company have achieved over one full decade.
Comparing last quarter profit growth rate with current quarter profit growth rate makes no sense. Most investors calculate the profit growth rate for the last 3 quarter or last 6 quarter and compare it with other companies but this is a completely incorrect way of comparing growth rate or any other financial metrics. While comparing different investments opportunities we must think in long term perspective in backward directions. We must see how well the company have performed for the last 10 years and not in the last 1-2 years.
The bottom line is, comparing things becomes effective only when we consider long term track record and not the short-term track record of various investments opportunities.