RAINBOW investing is based on fundamental analysis of a business using a spectrum of parameters. These parameters help to differentiate stocks fundamentally. In actuality, RAINBOW is the acronym for parameters used to pick stocks to make investments. You can select the right stocks to meet your financial objectives after complete screening of stocks.
The acronym RAINBOW stands for –
R – Return on Capital and Equity (ROCE)
ROCE is a significant profitability ratio to consider a company for investing. ROCE is the primary measure to analyze how efficiently a corporation can utilize available capital to generate profits. A higher ROCE in a corporation indicates its high cost-effectiveness to use the capital employed. Ideally, it should be above 15%. ROCE is also known as Return on Total Capital (ROTC).
ROCE is calculated as:
ROCE = Earnings Before Interest & Taxes (EBIT) ÷ Total Capital Employed
Where,
EBIT – Operating Profit
Total capital Employed is the Total Equity and Total Debt of a corporation.
You can trade in the stocks of a company with a higher ROCE using an online trading account.
A – Accountability of Management
Stable management and a team of talent bring significant growth to a company. They don’t let it disrupt its operations or strategy. Therefore, the quality of a corporation’s management is considered before investing.
Investors can look at its truthfulness in accepting accountability. Watch out whether senior officials are taking full responsibility for their unsuccessful decisions instead of making excuses. If so, you can reconsider your investment decision. You can bet on margin trade for a company with higher quality management.
I – Information Transparency
Greater financial transparency is vital for investors. An investor needs adequate financial reporting/disclosures promptly to make an investment decision. To maintain financial transparency, corporations provide the necessary information to investors that help in monitoring their governance behavior. Corporate governance fuels up financial transparency and helps decrease conflicts between stakeholders in a corporation. There should be complete transparency incorporating details, facts, and interests of minority shareholders.
N – Net Profits
Net profit-based sorting of stocks for investing improves stock selection. Investors select corporations with enormous profits. In actuality, profit is the one way for investors to measure the effectiveness of the management team of a corporation. A business with higher profits improves its ability to fund working capital requirements. Its future growth outlook can be gauged by its profits and the potential of its earnings growth.
B – Battle Readiness (Competitiveness)
Competitiveness is a key to business viability as it is primarily based on a more successful business strategy choice. It is the ability to outperform its competitors. Corporations focus on core competencies like cost-efficiencies to add greater value than their competitors. Competitive corporations enjoy a large number of regular customers that results in increased sales and greater profits. Therefore, investors consider a corporation’s competitive landscape as well.
O – Obligation Analysis (Liabilities: Debt to Equity Ratio)
The debt to equity ratio is evaluated to determine the long-term financial stability of a corporation. A corporation is financially solvent until it can meet its obligations, i.e., interest payments, working capital requirements, salaries, taxes, etc.
Debt to Equity Ratio = Total Liabilities / Shareholder’s Equity
D/E ratio tends to vary widely by industry. Ideally, it should not go above 2.
W – Winning ability of Business Model
The main elements of a successful business model are
- a profit formula,
- a customer value proposition
- key processes
- key resources
If a corporation has established a solid business model and attained a majority market share, it is a sign of long-term sustainability.
Investors can look at a company’s plans to acquire a new market share and protect its existing market share to make an informed decision.
The Bottom Line
RAINBOW investing is the combination of several parameters to choose profitable stocks. To take advantage of this technique, you can open online demat and trading accounts. Traders tend to focus on margin trading for quick and high gains but, the RAINBOW, if done carefully, can earn slow and steady returns for you without the risk of amplified losses.
If you are looking for better brokerage services, you can use the facility of demat account transfer.