The Sensex, after touching all time highs of 52,500, is behaving like a pendulum. It fell by up to 5% due to hardening of bond yields, increase in commodity prices and lockdown fears.
It then made a comeback led by RIL’s O2C spin-off announcement and lifting of embargo on private banks for government business.
But volatility is the new order of the day. It fell by over 500 points again on Friday. Having already reached the year-end targets of many brokerages, the Sensex is facing stiff resistance at 52,500 levels and needs a trigger to break this.
How does one pick stocks to invest in during these times?
First of all, we need to understand that wealth-creation needs time and discipline. Warren Buffet became a billionaire at the age of 65. He has been investing in the stock markets since the age of 10. It takes decades to generate wealth from investing in stock markets.
1. Long track record
The companies you invest in today should pass the test of time. They should survive for the next decade or decades. So, it is better to invest in companies that have a good track record, have been in the business for a long time and survived various business/market cycles.
A business’s value today is made up of a long string of profits extending out into the future. The vast majority of a business’s present value——comes not from this year’s earnings, or next year’s, but from the earnings that should accrue over the decades.
2. Quality of management
The quality of top leadership of a company is a key determinant. This is very difficult to gauge, though. Is the management trustworthy? Does it deliver return to shareholders? Does it have the ability to tide over difficult times?
How is its dealings with suppliers, customers and employees? Does it consist only of family members of promoters or does it include professional management? All these questions need to be evaluated.
3. Low debt and strong balance sheets
In the post pandemic era companies with low debt have a higher chance of survival and revival. When there is a pressure on sales, high debt companies face issues in interest payments and debt servicing. Now we see a race amongst companies to become zero debt / net debt free.
Liquidity is king during this era. Companies with strong balance sheets can take advantage of new opportunities presented by the pandemic.
4. Leadership in business
One should select companies which are in the Top 3 positions in a particular sector / industry. Market dominance is very crucial as market leadership provides a distinct competitive advantage.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” —.
5. Consistent compounders
We need to find stocks which have delivered consistent returns, CAGR of 25%+ / 30%+ over the past few decades. The index has delivered a CAGR return of close to 17% since inception.
Most of the stocks which fulfil the above four criteria will end up delivering such returns. A one rupee stock which delivers a CAGR return of 25% for two decades becomes worth rupees 87 at the end of the period.
The five criteria above will help one to select stocks which would deliver superior returns in these volatile markets.