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If salt loses its saltiness what will you season it with? –Luke 14:34

26 Feb 2019

STOCK MARKET--Some Rules to Follow When Picking Stocks For Investment--

Before I start, let me give a clear disclaimer. I’ve read some of the answers here and mine will sound very basic in comparison. I don’t want to take away anything from the other answers. They’re all legitimate. After all, there are lots of ways to research and analyse.
But I believe in simple tricks—and there are lots of them.
Let me start with my favourite—observe around you. For example, you start noticing that there are more Hero bikes around or that everybody seems to be buying more of Royal Enfield bikes on the road.
You saw that more and more people are opting for Airtel SIM cards or conversely, shifting from Airtel to Jio.
You observe more of your friends opening or recommending accounts with private banks over public sector banks; or opting for loans from private banks despite lower interest rates in government-owned banks purely because of better service.
In any or all the above the examples, you could decide to buy the company’s stock after observing a phenomenon, wanting to partake in the company’s higher sales and profits.

Essentially, what I am trying to say is that there are lead indicators all around you. Just observing and drawing connections could help you gauge where consumer behaviour is headed. This helps because mostly, companies perform or don’t perform basis consumer demand and behaviour. And their stock prices—in the long run—track the company’s performance. [Point to focus on here is ‘long run’, because in the short or even medium term, there are many factors in play like sentiment, trading volumes, herd mentality, and what not. Analyses of these factors falls in the territory of technical analysis. Learn the difference between Fundamental and Technical Analysis here.]
So next time you see a house being constructed, take a look at the steel or cement being used. Or simply look at the lollipop that your neighbour’s kid prefers.
That’s my simple mantra. But that said, I also believe in value investing and fundamental analysis. The prime reason is that it’s not just about identifying stocks, but also investing at the right time.
This is because you can invest in the best stock and still lose money because you bought the stock at the peak price. Let’s take the 2008 crisis for example. The Sensex hit a peak of near-21,000 levels in 2008. Let’s say you invested Rs 21,000 in the Sensex, which usually represents the largest of the companies in the market. Post the crisis, the Sensex fell to near 8,000-levels. Meaning, you lost Rs 13,000 or 62% of your investment. This is despite choosing stocks of good companies.
This is where value investing and fundamental analysis come to your rescue.
Value investing teaches you something simple—what is the real value of the stock? Is it really worth the XXX amount it is trading at currently?
The answer to this question lies in (surprise, surprise) the company’s fundamentals. Meaning—it’s core financial health and profitability. After all, it’s about the profits for an investor, right. Not just today’s profit, but even the future profit.
So value investors and fundamental analysts look at the company’s past and current financial health; look at all the other factors that could potentially contribute to the company’s future profits; the state of the management, and most importantly, the profit-making ability of the business. (Learn how to perform fundamental analysis)
Basis all this, they then estimate the stock’s real value. (They can only estimate. It’s always a game of forecasting the future. There can never be a 100% certainty to anything)
They then compare this value or price with the stock’s current price. And if the current price is higher than the real value, they wait.
They wait until the price falls.
That’s right. If you want to be a good long-term investor, you need to wait for the prices to fall and then swoop in to buy at discount. Unlike so many other investors who run at the sight of a falling market, a good value investor or fundamental analyst waits for prices to ‘correct’. That’s when they buy low to sell at a high in future. It’s all about investing in ‘cheap stocks’.
Of course, it’s not always about buying. You can ‘realise’ your profits only when you sell. This requires fundamental analysis too. When the current price rises much higher than the real value, and it is expected to continue to be so, many value investors sell the stock and book their profits.
That said, I must warn you. It’s important that you keep in mind the below factors while making your decisions:
1) What’s your investment duration?
A company may seem like a great stock to hold and really cheap because you are considering all the profits it could earn from a new project over a 20-year period. But it may be a poor choice over a 5-year period because the project is expected to take 7 years to break even.
Bottom line: Time matters. All your financial factors could look completely different if you simply change the time factor.
This is one of the reasons why it’s important that you read recommendations the right way. (We explained this for mid-cap investors during the recent sell-off. Click here to read how investors should read research reports on mid-caps)
2) What’s your risk appetite?
This matters A LOT! It can be the difference between you choose large and blue-chip stocks and mid/small-cap stocks. It can also be the difference between you earning 40% in one year and losing 20% in another, or earning 13% in one year but losing only 2% in another. You must choose your amrit—and your poison.
3) What is your end goal?
Many investors play it differently. Some want to choose dog stocks—companies that will give a regular dividend. Their aim is simple—earn a secondary income. Others, however, prefer stocks of companies that would rather invest the dividend money back in the company for higher future profits. Their aim is long-term growth. What would you prefer?
I can go on and on, honestly. But I am choosing to put an end here.
What I am trying to say is that at the heart of it, stock investing is simple. It’s like crossing the road. It comes intuitively to all of us. But before you do cross, just look to the left and right once for any on-coming traffic. And if you see any car zooming by, have the patience to wait.
A friendly suggestion/shameless plug: If you really want to learn about the stock market and investing, you can head to Kotak University—it’s our knowledge bank for all gyaan on stock markets. You can also get a regular weekly update on all things stock market with Meaningful Minutes, our weekly newsletter. Many have found it a useful resource. You may want to try it too!

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