Investing in stocks is not as complicated as it seems. Be it amidst a bad market or a good one if you follow a few basic rules, you are bound to succeed.
Here are five simple rules to help you start and generate wealth over the long-term.
1 . Invest in what you know
One of the most common questions beginners have;
How to start investing? What kind of stocks should I buy, they ask.
A simple solution is to examine your environment. The products and services that surround us can make for great investments. If you think about it, it makes sense. Some of the top companies in the world Apple, Amazon, Unilever all deal in goods and services we use regularly. And suffice to say their stocks have performed exceedingly well.
So, going by this logic if you encounter a fascinating product at the supermarket, like a brand of jewellery (Tanishq, Titan Ltd) or a pizza service (Dominos Pizza, Jubilant Foodworks Ltd.), make a note. So you can do some background research and learn more about it.
Now, we are not saying that you must buy these stocks just because they like/know the underlying business. All we are saying is that such companies can make for great investments and serve as a fantastic starting point.
Thereafter look at their business plans and earnings prospects as the value of the stock is purely a function of its earnings potential.
Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market. - Warren Buffet.
The idea is to know the business, so you are within your circle of competence. It will enable you to understand the business better, highlight economic moats and map out its future value.
2 . Never invest any money you may need in the near -term
Thanks to the business news channels, people often perceive stock markets to be a get-rich-quick scheme. Treating them like casinos, they think that they can make a quick buck with continuous buying and selling.
People who believe this misunderstand the basics of stock markets completely. They forget that behind every stock, there is an underlying business. And no matter how good the underlying business is, it requires time to grow and make money for itself and its stakeholders.
you can make fast money in the stock markets or that your money is safe in the stock markets in the near-term will be wrong. The only way to invest successfully is to invest for the long term. Hence you are better off keeping your short-term money away from the stock markets.
3 . Pay the right price
People often presume the key to succeeding is by finding a great company to invest. Unfortunately, finding a great company is only winning half the battle. The other half is all about getting it at the right price.
No matter how good a business is, it will only make you money if you get it at the right price. As the stock price of any company eventually converges to the fair value of the underlying business. So even if you buy a great company at the wrong price, chances are you will never make any good money.
But now the question is, how do you define the right price? To arrive at that, you first need to determine the fair value of the business. The fair value of any business is a function of its earning potential or the value of its future assets. So start by assessing the business potential, analyse its economic moats. It will help you chart out its fair value.
Once you know the fair value, factor in a discount to arrive at the right price. Buying the business at a discount to its fair value serves two significant purposes:
It increases the probability of a higher profit and, minimises losses.
The discount acts as a buffer, so on the off chance the business fails to perform as expected, you have a built-in cushion to lessen the blow.
4 . Know when to sell
Knowing when to sell is as important as buying a great business at the right price.
As the markets get volatile, investors begin to worry. Which, honestly, is a normal reaction. But what follows is a flurry of bad decisions which can hamper any long-term growth. Investors either panic and sell just because the markets are falling or they lose patience, just because the stock has not moved in a couple of years.
Imagine investing in Biocon @76 in 2014 for a long-term goal. The stock did not perform well until 2016. You get impatient and sell it, assuming you choose poorly. But, towards the end of 2016, the stock doubled to Rs.160 and continues to grow to what is now Rs.450.
Similarly, imagine panicking and exiting the stock markets altogether in the meltdown of 2008. Or now, when the Covid-19 crisis hit the country. You would have missed out, on what is perhaps, one of the fastest V-shaped stock markets recovery in history.
These examples highlight two crucial aspects of investing;
never let your emotions guide your investing decisions and
you can never time the markets successfully at all times.
All you need an investment plan that matches your investment goals. A plan that lets you ride the market troughs and peaks with ease. A plan that keeps you calm and rationale at all times and spells out all your investment decisions for you. All this will stop you from making any irrational decisions.
Anytime you feel like you should sell a stock ask yourself; do the initial reasons I bought the stock still hold? Has the underlying business reached its full potential?
As sometimes, stock price movements do not always paint the real picture of the fundamentals of the company. And sometimes, markets punish good business unfairly.
But if you still feel something is seriously wrong, look into the issue first. Understand the crux behind the movement in the price and act accordingly.
5 . Bet selectively
'To me, it’s obvious that the winner has to bet selectively' – Charlie Munger.
The key to supernormal returns is to spot the few hidden gems and bet on them, aggressively.
Unfortunately, most investors end up building a portfolio of 50-70 stocks, under the garb of diversification. But this will not only minimise your losses but also marginalise your returns. They fail to realise that all you need are a few great stocks. Just a handful of these out-performers can create all the wealth you will ever need.
So your primary focus should be towards building a small concentrated portfolio with 10-12 stocks at the max. Look for companies that are leaders in their line of work. Start with some background research, map out their future and wait to buy them at the right price.
'All you need for a lifetime of successful investing is a few big winners. In this business, if you're good, you're right six times out of ten. You are never going to be right nine times out of ten.’ - Peter Lynch.