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Overview
- Wealth Creation: Billionaires have built their wealth through the stock market, either via direct trading or indirectly via. entrepreneurship.
- Investment Caution: Blindly following investment advice from friends or brokers can lead to significant losses. Don’t invest in businesses you do not understand.
- Investing in Quality Stocks: If a stock has strong fundamentals, don’t hesitate to invest more, even if its price has already doubled or tripled. A stock at a 52-week high can still appreciate if it’s a quality investment.
- Avoid Attachment: Treat stocks as investments, not possessions. Once you achieve significant returns, exit and redeploy your capital elsewhere. Clear reasons for purchase make exiting easier.
- Cut Losses Early: If an investment turns out to be a mistake, exit quickly rather than waiting for a potential recovery.
- Avoid Market Timing: Don’t sell stocks to buy back at a lower price, as timing the market is difficult. Instead, average your buying price over time.
- Emotional Control: Refrain from checking stock prices daily to avoid emotional decisions and premature profit-booking.
- Diversification Strategy: Be cautious of over-diversifying. A portfolio with 80 stocks can still be poorly balanced, while a focused portfolio of 10–20 stocks is ideal. Diversify across sectors, but don’t end up creating an index, you’re better off investing in an Index fund.
- Quality Over Quantity: Don’t split investments by market cap unnecessarily; holding only large-cap quality stocks is fine if they’re strong. The stock’s past price movements don’t guarantee future performance—only fundamentals do.
- Capital Preservation: Protect your capital, frequent trading leads to high frictional costs. During market corrections, focus on accumulating high-quality stocks. Frictional costs are Securities Transaction Tax (STT), service tax, exchange fees, and Capital Gains Tax (CGT).
- Gold as a Hedge: Gold can be used as a hedge against market volatility.
- Avoid Red Flags: Steer clear of companies with a market cap below ₹200 crore and promoter holdings under 20%, except for professionally managed firms like L&T. Be cautious of all-time low stocks to avoid catching a “falling knife.”
Retail Investors
- Retail Investor (RI): An RI is someone with a regular job who invests part of their income in stocks.
- Avoid Complex Instruments: Intraday trading and Futures & Options (F&O) are risky for retail investors and are better suited for institutions and high-net-worth individuals.
- Real Estate vs. Stock Market: Real estate requires substantial capital, making the stock market a more accessible option for retail investors.
- Bull Market Illusion: In a bull market, even poor investment strategies may seem effective.
- Long-Term Strategy: Invest in solid businesses and allow time to grow your wealth.
- Risks of Borrowing to Invest: Using borrowed money to invest, especially by pledging stocks, can lead to forced liquidation to cover collateral requirements.
- Return Expectations: Investments earning less than 9% CAGR are losing money; a target of 12%+ CAGR is preferable.
- Financial Independence: Achieving a 20%-30% CAGR over 15-20 years can lead to financial independence.
- Risk and Return Expectations: People often accept a 7% return from fixed deposits but unrealistically expect 50% returns from equities.
Valuation
- Valuation Challenges: While valuation models may be theoretically sound, they are impractical due to the difficulty of predicting future cash flows. Even small errors in assumptions can lead to large discrepancies.
- Value Investing: Buying low PE stocks isn’t automatically value investing. Always conduct a thorough fundamental analysis (FA).
- Valuation and Growth: A company’s valuation depends on the potential for future earnings growth.
- Valuation as an Art: There is no perfect or universal method for valuation;
- Discounted Cash Flow (DCF): This method estimates a company’s present value based on future cash flow projections, discounted to reflect that future money is less valuable than current money. – Most common model.
- Other Valuation Methods:
- Asset-Based Valuation
- Liquidation Value Method
- Reproduction Cost Method
Qualitative Metrics to consider:
- Profit vs. Cash Flow: Large profits or sales don’t necessarily indicate good cash flow, as financial figures can be manipulated. Amateur investors often focus on these figures without understanding underlying financial health.
- Importance of Management: Quality management can transform underperforming companies. Indicators of management quality include shareholding patterns, dividend yield history, and consistent ROE.
- Shareholding Pattern: The division between promoters and the public matters. An increase in promoter stake is a positive sign, while the reverse is concerning.
- Institutional Investors: FII (Foreign) and DII (Domestic) investments can indicate confidence in the company.
- Competitive Advantage (Moat): Companies with a strong moat have superior products/services, customer lock-in strategies, and high switching costs, like the difficulty of moving from WhatsApp to Telegram.
- Industry and Growth Potential: Analyze the overall industry size and the company’s total revenue. If growth potential is limited, the stock price may decline.
Quantitative Metrics to consider:
- ROE (Return on Equity): Indicates the profit a company generates from shareholders’ funds.
- Dividend Consistency: A steady dividend payout signals a stable and solid business.
- Reliable ROE: Consistent ROE suggests genuine financial performance, as manipulating sales and profits would affect ROE.
- Valuation Matters: Even the world’s best company can be a poor investment if bought at the wrong price. Pay attention to Price-to-Earnings (PE) ratios.
- Valuation Ratios:
- Price-to-Sales (PS): Useful for assessing cyclic stocks.
- Price-to-Book (PB): Relevant for banking and NBFCs but less so for service companies.
- Stock Prices: A stock’s price doesn’t necessarily indicate its value. A low-priced stock can be overpriced, and a high-priced one may be undervalued. Price alone is just a number.
- Financial Metrics for Screening:
- 3-year ROCE where ROCE > 20%
- Debt-to-Equity (DE) < 1
- Pledged Promoter Holdings (PP) < 1%
- Sales growth rate (Sales R) > 10%
- Profit growth rate (Profit R) > 12%
- PE Ratio Strategy: If a stock’s PE ratio fluctuates within a known range (e.g., 18–21), buying below the average (e.g., 20) and selling above it can be effective, assuming all other fundamentals are strong.
- Banking Stocks: Pay attention to Non-Performing Assets (NPA) and Net Interest Margin (NIM) for banking investments.
Closing Notes
- Performance Realism: Outperforming a mutual fund (MF) doesn’t mean you’re a genius. MFs face stricter regulations and compliance.
- Market Behavior: The market may react erratically in the short term, but it follows fundamentals over the long term. If a stock underperforms despite seeming strength, investigate thoroughly
