Stock Shastra #2 – Buy a wonderful business and not just a stock!

We said in Stock Shastra #1 that Investing in stocks is not rocket science, not as difficult as it has been made out to be. You don’t need to be an expert to do it. You just need to buy a great business with the mindset of an owner. Let’s see why this is important and how you can find this kind of business.

Why do you need to buy a great business?

If you are currently investing in stocks, what is the method you use to select stocks? Is it low P/E, low Price/Book Value, High Dividend yield? Or is it based on charts showing peculiar patterns? These methods are completely inadequate because they over-simplify your investing method. They don’t tell you about the earning capacity of a company – the key driver of its stock price in the long term. They may lead you to take a wrong decision. It’s much like the story of three blind men who encounter an elephant for the first time and attempt to learn about it by touch alone. The first touches the trunk and thinks the elephant is like a snake; the second touches the ear and thinks the animal is like a fan while the third touches the leg and thinks it is like a tree.

So, what is the best way to avoid making this mistake of over-simplification and at the same time, have a simple but robust way of investing in stocks? The answer is Stock Shastra #2: Buy a wonderful business and not just a stock. The fact is that, in the short run, market sentiments drive the stock prices due to which any stock can go up or down, no matter whether it is wonderful or not. But in the long run the price of any stock is driven by the company’s ability to earn profits consistently.  As Benjamin Graham says,

And a company can earn profits consistently only if it has a wonderful business!

How do you find a wonderful business?

A wonderful business is one which has done well and will continue to grow in the future. It mainly has three characteristics:

  1. An Excellent Financial Track Record
  2. A Sustainable Moat, and
  3. Respectable Management

An excellent track record is proof of its successful past whereas a sustainable moat and respectable management will drive the growth in the future. Hence, to find such a wonderful business you need to look for these things.

To find whether a company has an excellent financial track record, you need to see whether it has performed very well over atleast the past 10 years. Why 10 years? Because, over a 10-year period, the company is likely to have experienced one full economic cycle: good & bad times; growth and recession. A business does not do well over a 10—year period just by accident! A question may arise in your mind: Are we saying past performance is a guarantee of future performance? No. But past performance and past behaviour of management give enough clues for the future.

A company which has performed well over a 10-year period will most likely have a moat. A moat is a strong competitive advantage that helps the company survive in tough times and helps earn consistent profits. Consider the example of Colgate. Its moat is its brand, which is known all over the country.

What if a company has an excellent track record, a strong moat but has management who was arrested for a FERA/Excise Duty violation? Would you invest in such a company? The business must have a good, credible leader and management who drive the growth of the company.

Having shortlisted a company that has good financial track record, a strong, sustainable moat and good management, you are on course to find a company that has a high probability of performing well in the future.


The next Stock Shastra will talk about a simple and powerful lens through which we can identify if a business has an excellent financial track record.

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23 Responses to “Stock Shastra #2 – Buy a wonderful business and not just a stock!”

  1. HOW WE CAN WE FIND STOCK BROKERS ARE MANIPULATING A PERTICULAR
    STOCK FOR A SHORT TIME RISE&FALL

  2. A superb guide even to a “seasoned” investor. Helps take care of critical aspects in a very simple manner while taking investment decision.

  3. Team_MoneyWorks4me 17. May, 2010 at 4:18 am

    Thank you, Ramkumar. We appreciate your feedback.

  4. Team_MoneyWorks4me 17. May, 2010 at 4:21 am

    One way could be to see if the prices have risen or fallen considerably without any change in underlying fundamentals (financial results, some problem with the company or some positive etc.)

  5. really useful i have wasted a good fortune off my carrer by trading and investing in worthles stocks in my portfolio

    tku
    radha

  6. Team_MoneyWorks4me 05. Aug, 2010 at 5:11 am

    Thanks so much for your appreciation. From Stock Shastra #3 onwards, we have explained how you can access a company on the above given parameters and also explained the right prices to buy and sell stocks. Please do read all our 13 Stock Shastras http://bit.ly/aHBGTC , where we have explained a complete methodology to invest in stocks, the right way. In fact, Stock Shastra is an educational initiative by MoneyWorks4me.com – a website that enables investors to take confident stock investing decisions.
    Please let us know your feedback.
    Thank You.

  7. Balasubrahmanyan 07. Sep, 2010 at 5:02 am

    A very good guide! Previously I had invested with out knowing all this rules.

  8. very informative and eye opener .I am sure it will help all of us to make informed decisions.wish it is available on pdf also.????/

  9. How can one find about the credibility of the management/promoter?  I doubt if enough information is available on the ‘not so popular’ names and even if there is any, there is no surety that it will be right!!!

  10. very logical, analytical, useful educative guide to investors. Thanks to Money works 4 me Team for the nice initiative.

  11. Awesome…

  12. I should have seen this site 3 yrs ago.. After lot of futile efforts to identify a valuable stock teacher on the internet, this site gives exactly what a novice stock investor likes me aspires for. I hope I can a build a steadily growing investment in stock market with your help.. Keep up the good work team

  13. thanks to your team. its great for stock inestment business

  14. sir,
    the pictures in this article are not opening. it shows nothing but error

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  3. Stock Shastra - 20. May, 2010

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  4. MoneyWorks4me - 20. May, 2010

    Stock Shastra #2 Buy a wonderful business and not just a stock! http://ow.ly/1NvMw

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    Stock Shastra Update : Stock Shastra #2 Buy a wonderful business and
    not just a stock! http://ow.ly/1NvNw http://fb.me/DVkgVXCJ

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