Thumb rule for Investing!

Do you stay glued to the daily ups and downs of stock prices? Do you wonder what to conclude from the prices, fluctuating every now and then? Do you hope to make a windfall on the hot new stock you bought?

And yet, things don’t go as you want. Trust me; this can be simply termed as human misjudgement of the underlying value.

What is a stock? It’s a small piece of business. What does that mean? Simply, that you own the earnings and the cash flows that the business generates from time to time.

To give you an evident analogy, the dividend on the stock is similar to rent you receive on your property and capital gain from the stock is similar to gains you earn after selling the property. Does the rent or property price change every day? It changes only over a period of time, may be a year or after three years. What does it depend upon? It depends upon the area of the property (the Market in case of business), location (position of the company) and the built or construction (quality of the earnings).

Do you buy in or out of the property just because the street lights are temporarily out of work or streets are momentarily worn out due to excessive rains? Of course not! What do you actually look at? You look at the infrastructure, like electricity or water supply, commercial presence, road leading to the property and access to malls and public places.

Why are businesses not sought in a similar fashion? The developments in the business do not happen every day but over several days, months and even years. It largely depends on the market it operates in, the strategy the company adopts to tackle competition and the tactics the company deploys to increase earnings year after year.

You have to understand that the company’s value is dependent only and only on fundamentals of the underlying business. The company’s brands, business model, product innovation and management abilities together decide the value of the company. There is no other factor which influences the value of the business, not the temporary swings of currency, crude oil and equity markets. As the legendary investor Peter Lynch once put it: “If you spend more than 15 minutes a year worrying about where the stock markets are going, you’ve wasted 12 minutes.”

Never get influenced by the daily buy-and-sell calls given by the brokerages. Brokerages earn revenues from your trading. Do you think they send out these calls solely for our benefit? Definitely not!

“We’re emphasizing the knowable by predicting how certain people and companies will swim against the current. We’re not predicting the fluctuation in the current.” -Charlie Munger

What should you do?

Invest in financially sound companies with good track record, excellent management and presence in a growing industry. These companies will generate free cash flows which will be distributed amongst shareholders at a later date. Do not track the daily price movements of these stocks. Only be updated with the companies’ quarterly, annual and related fillings. Do not judge the companies based on the earnings of single quarter or single financial year. It might be due to some restructuring in accounting policies, cost structure or some cyclical fluctuation.

“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever” – Warren Buffett

You have to trust your own research of the company and not become judgemental based on what others are saying. You have to review what the management communicates to you about the business. The companies sometimes see things differently. (Like Exide Industries cited poor market growth rate for their average performance, while Amara Raja feels that they achieved growth because the market is growing). Understand if the management is rational behind the deployments of capital. One may analyse whether M&M’s strategy to venture into two wheeler segment will earn incremental returns on capital in future. So effectively you should monitor the developments in the industry and strategies of the companies to win over their peers.

You should consider learning more about upcoming industries, new business models and emerging marketplaces. For example, will the ecommerce sites like Flipkart and Amazon change the course of doing business by diverting people to buy online, turning brick-and-mortar business obsolete? Or say businesses like Fractal Analytics going to change how the knowledge processing industry works. Ultimately these things are going to help you generate new ideas which will add to your corpus someday.

The key to making money in the markets is simple. Be patient and stay invested for long till the full potential of the company is realized. Or else you stand to miss out opportunities of becoming wealthy by moving in and out of the stocks.

“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”- Warren Buffett

Happy Investing!!

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One Response to “Thumb rule for Investing!”

  1. great article. You said what i want to hear from you.