Timeless Principles of Stock Investing
Investing in stocks is the best way to create wealth. Many of us would have taken chances based on tips, recommendations, advisors, business channels etc. And, would have had hits and misses.
Like everything else in life, stock investing too is governed by certain fundamental principles. And it is not rocket science. Every investor can easily learn and apply these principles and create personal wealth, by following these fundamental principles of Investing.
Stock Shastra is an educative newsletter launched by us, at MoneyWorks4me.com, to achieve this mission – to help investors master the art and science of stock investing.
Here are the timeless, fundamental principles of investing which will help beginners as well savvy investors learn the safest way of investing in stocks:
Investing in stocks is essential to make your money work for you! But most of us have come to regard stock investing as something best left to the “experts” to handle. We invest in mutual funds, letting fund managers make our stock investing decisions. We wholly trust the advice of our brokers and act on it. We are afraid of venturing in it on our own.
Is stock investing really as difficult as it has been made out to be?
Investing in stocks is not as difficult as it has been made out to be. We can definitely do it on our own. But what do we do when we invest in stocks? We tend to pick stocks based on its P/E, Price/Book Value, Charts and other such criteria. These methods are completely inadequate because they over-simplify and lead you to take wrong decisions.
So, how can we avoid these mistakes and at the same time have a simple but robust way of investing in stocks?
Investing in stocks is all about buying a wonderful business and not just a stock. To find such a wonderful business it is essential to look at 3 important characteristics: An excellent financial track record, A Sustainable Moat and Respectable management. But, the way the financials of a company are made available, it becomes impossible to even make sense out of them, let alone analyse them.
So, how do we shortlist a company with excellent financial track record?
To shortlist a wonderful company with an excellent financial track record, you just need to look at 5 financial parameters over a period of 10 years. However, not all companies with a wonderful past can survive and grow in the future. It thus becomes critical to determine whether the company will continue to grow in the future.
So, how do you find out whether a company has what it takes to remain a winner in the future?
To invest in a wonderful company you need to look for a business with unbreachable moats. We said that these moats are Brand, Secret, Switching, Toll and Price. A company with these moats can become a winner in the long term. The first moat is brand.
So, why are brands a moat? And does it always translate into an excellent financial track record?
Some of the moats that we look for, to identify a wonderful business are Brand, Secret, Switching, Toll and Price. These moats can help a company remain a winner in the long term. A brand helps a business create loyal customers thus ensuring higher sales and profits. The second moat – Patents/Trade Secrets is another competitive advantage that a company can have.
So, how exactly does this moat work? And which companies in India have this moat?
A great brand and patents/trade secrets are a couple of competitive advantages that a company can have. These help a company increase its Sales and Profits making it a winner in the long-term. Another such competitive advantage which a company can have is an exclusive control over a product or area. This can translate into very good growth for the company.
But, in a free market how do companies end up having an exclusive control and how does it work for them?
In a highly competitive market, where companies struggle to get repeat business from the same client; what is it that helps a company lock in its customers for life? It is the advantage of having ‘High Switching Costs’. These costs are monetary, psychological, time and effort-based – which makes switching from the product almost impossible.
But, how do companies gain this advantage & how does it work for them? Which are the companies in India that have this advantage?
In today’s world of intense competition, companies are always looking for strategies to be unique. With this aim to be unique, what is that one powerful strategy that helps companies attract consumers and hence, stand out. It is the ability to price very low.
How can companies gain this advantage & mold it into a winning strategy for the long-term?
Which companies in India have this advantage?
Stock Shastra #10: Look for a trustworthy management, that respects the interests of minority shareholders
Having an excellent financial track record and a sustainable competitive advantage are 2 important characteristics to shortlist a wonderful company. But, one more characteristic is required to guarantee a future winner and that is a trustworthy management. You need to understand whether the company’s management is someone who will protect your (investors) interests and is someone you can trust your money with.
So what are the signs/clues for you, as an investor to check whether the management is trustworthy and respects the interests of the shareholders?
A company that has an excellent financial track record, sustainable competitive edge and a respectable management is indeed, a wonderful company worth owning. But, before investing you need to find the right value for the stock, in order to buy at the right price and get high returns.
So, what is the right value for a stock and how do you use this insight?
The MRP (Maximum Retail Price) of a stock is it’s right value and is a benchmark for selling the stock. But, the price at which you buy the stock will eventually determine your returns. Hence, in order to minimize your risks and earn great returns, you need to buy the stock at a discount from its MRP.
So, before buying stocks, what is the discount from MRP you should look for?
To mitigate risk and earn great returns, you need to buy a stock at 50% discount to its MRP and sell once it crosses MRP. But, there are certain considerations you need to keep in mind while selling; so that you don’t sell early and lose out on higher profits or sell later and lose some gains.
So, what are these considerations and how do they help you in deciding when to sell the stock?