It is true that a lot of money can be made in the stock market and that too by just following a few basic principles. The first prerequisite for making money in the stock market is one’s risk-taking ability. Equity investments are inherently risky and one can quickly lose money if one happens to be in the wrong stock. Therefore, equity investments are only advisable for individuals with some risk appetite. There are only two basic principles that an equity investor needs to follow to become a millionaire — pick the right stock and know when to exit. Infosys Technologies, TCS, Eicher Motors, Relaxo Footwear, Avnti Feeds are just a few stocks which have turned their investors into millionaires in 10-15 years.
Basics to pick the right stock: One does not need to be a financial wizard to pick the right stock; basic financial statement reading and some common sense can lead one to a potential multi-bagger. A few basics tips for stock picking are:
# Look for companies with consistent revenue growth. In case of new companies, one should look for those with high potential revenue growth and high free cash flow.
# Revenue distribution of a company should be distributed and not concentrated from a few accounts.
# Identify companies with sufficient free cash flow and ability to raise fresh capital. Avoid companies with leveraged balance sheets and huge debt.
# Pick market leaders in businesses which have high barriers to entry. In case of newer companies, identify companies who have a differentiated product and are focused on innovation.
# Do not opt for companies which are highly dependent on the government for their revenue.
# Pick companies which have simple business model and only invest in business that you can understand.
# Do not buy a stock just because a company is popular and gets a lot of coverage in the media because often it's paid for.
# Do not blindly follow ace/celebrity investors because their risk and return profile are different than an average investor.
# Do not change your investment thesis on a stock just based on a few bad quarters.
# Do not cling to a stock if the fundamentals of the company have materially deteriorated.
Know when to Exit: The most difficult part of investing is in knowing when to sell. If the company's fundamentals are intact, one should consider to exit only when
# The existing price is fully backed by the business growth, i.e, the stock has become overvalued, or
# There is a better opportunity available. If you find something better than what you already hold, it would make sense to switch.
The most common mistake that costs investors dearly is the timing of the exit. Some investors are too eager to book profits regardless of the fact that the investment has matured or not. On the contrary, some investors bail out on a stock just because they have lost patience, although the company is still in a good shape and has strong fundamentals. The simple rule to maximize your profit is to stay invested as long as the business is gaining market share and beating its own performance (ignore any temporary variances). If the business potentials are high, but your stock is going nowhere, then you must have to spend time with the idea, and learn to scale up positions as the business starts performing, rather than exit out of frustration. A good business sometimes takes years to achieve full potential and the reward of holding such companies is exceptionally higher.
Investing in the stock market is not for the faint-hearted and is not easy. The key to success, therefore, lies in patience and discipline. If you have picked the right stock, you should stick with it regardless of short-term blips. If you have picked a wrong stock, then it’s better to admit the mistake and make amends. No other asset class can beat the returns of equity investment in the long term. There is some real money that can be made by following some basic rules that we have discussed here.
(By Rahul Agarwal, Director, Wealth Discovery/EZ Wealth)
(Disclaimer: These are the views of the author. Readers are advised to consult their financial adviser before making any investment)