Investing sensibly in the stock market

POSTED BY manish ON April 16, 2010 COMMENTS (47)

The common view of the stock market is that, it’s a place for gamblers and risk takers. Only if you have the capital, and the nerve to take risks, should you invest money in the stock market. Otherwise one is better off staying away from the stock market and putting money in safe fixed deposits. The truth is far removed from myth, if one looks at the stock market with a different perspective, and avoids the hype and hysteria associated with it. Let’s look at different aspects of investing in the stock market.

Let start with the basics – What is the stock market?

The stock market is a place, where buyers and sellers meet to buy and sell companies or rather small pieces of it. That’s all there is to it! Nothing more, nothing less! The small pieces are called shares and they represent a really small ownership of the company. Owning such a share, entitles the investor to his or her share of the profits, the business makes. This generally, is paid out to the investor, as a dividend. The management does not give out all the profits to the investor, of course. They retain some portion of the profits to re-invest and grow the business. Learn How to start in Stock Market

So how should one invest?

If you agree with the above definition of the stock market, the idea of investing in the stock market boils down to investing your money in a select group of companies. If the purpose of an investor, is to make a decent return on the money invested by him, then he should choose companies or businesses which are sound, consistently profitable for a long time and run by shareholder friendly management.

Finding a good company

investing in stock markets

Let’s explore the above statement a bit further. The long-term return for a shareholder, (where long-term is 5 years or more,) equals the underlying returns generated by the company. The returns for a shareholder can fluctuate from year to year based on the market moods and sentiment, but over the long run, investor returns always track the returns of the company. If the company can earn 20% on its capital, then the investor will make around the same returns over the long-term. Thus, we now arrive at the first criteria for successful long term investing, i.e., To make above average returns, one should invest in above average companies.

The above criteria is not a revelation to most people. However very few people want to follow the obvious as they think, that there’s some hidden magic in the stock market.

So how does one find the above average companies?

Look around you. Do you see products which have been around for quite some time and are used by a lot of people? Find out the companies behind them… That would be a good place to start. (Cue, the groans — I never said investing in the stock market does not require work. 🙂

Analyzing the company

Once you have identified a few names, the next step would be to get the annual report of the company and browse through it. The mention of reading an annual report sounds really daunting or off-putting to most people. However if you bring yourself to do it, it will place you ahead of 90% of the people in the stock market! The idea of browsing through the annual report is not to become an expert at it, but to get a feel for the nature of the company. One can focus on some of the following sections to see if the company is worth putting your money in,

Management discussion and analysis – This is the section where the management describes the business and lays out the plan for the company.

Profit and loss and balance sheet – This is the section which tells you, if the company is making a profit or not, how much debt is held by the company, the amount of dividend etc. If you come across a term you don’t understand – search for it on the internet or talk to a friend or someone with a background in finance.

A few important factors should be checked when analyzing the annual report. A short list of these factors can be

  • Is the company profitable and has it made profits consistently in the last 10 years?
  • Has the company paid dividends consistently in the last 10 years and has the dividend increased over the same period?
  • Has the company kept the debt equity ratio constant or better yet reduced the debt?
  • Has the company been able to introduce new successful products in the market?

An example

Let’s look at an example – Asian Paints. This is one of most well-known companies in India. This company has been the number one paint company for the last 20+ years. The company’s products like tractor distemper and emulsion, apcolite enamel, Apex exterior etc are well known and are widely available. The company has been in business for over 30 years and hence we can be confident that the company has done something right consistently to be the no.1 paint company in India.

The annual report shows good performance over a long period of time. The ‘ten year review’ in the annual reports shows an increasing profits and dividend over the years. The company has used these profits to reduce the debt, pay out an increasing amount of dividend and re-invested the balance in the business to grow it over the years.

The above performance has been reflected in the share price too. An investment of Rs 1000 in 1998-1999 would now be worth around 19000 which translates to an annual return of around 31%! And this doesn’t include annual dividends!

When to buy?

The immediate question which comes to mind is when should one buy the stock? There is an army of people out there, whose job is to advice investors the exact time to get in and out of stocks. I would personally say an investor would be far better off if he or she switched off the TV and ignored the advice of these so-called experts. If one is able to find a stock like the one above, the best approach is to invest in the company on a regular basis. If one can save Rs 2000 per month, then go ahead and invest 6000 Rs every quarter. A regular  program of investing in good companies on a regular basis, while ignoring the noise and chatter of the stock market pundits, will give you very good returns and also good sleep at night.

Conclusion

So… what’s the catch ? The catch is — us! A lot of investors like to get all excited and thrilled, when investing in the market. They want to chase the hottest stock, so that they can boast about it to their friends. At the same time, they ignore the gems lying right in front on them.

Investing is simple, but not easy. If one can find a few good and high quality companies and invest in them on a regular basis while ignoring the noise and chatter in the media, then that individual is likely to do well and have a really good amount of money secured for his or her retirement.

This is a guest article from Rohit Chauhan. He writes about his thoughts and analysis of various companies and industries and how to apply value investing principles, His blog is http://valueinvestorindia.blogspot.com

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47 replies on this article “Investing sensibly in the stock market”

  1. vinit says:

    there is a book named “new buffetology ” which has all the answers of asked question,explain what is great price to buy,what is expected price of sell.and book is available in pdf form over the internet free cost.

    1. Vinit

      Thanks for this info .. I will find out this 🙂

      Manish

  2. Chirag says:

    Nice one! I have also written a post about “How to identify Multibagger Stocks ” – http://www.squamble.com/2009/04/22/how-to-identify-multibagger-stocks/

    Do check it out and give feedback!

    1. Chirag

      Good one .. but should be more detailed ?

      manish

  3. Anup C says:

    Hi Manish,

    I’m planning to invest my money in SJVN Ltd IPO.

    Have studied the market for SJVN Ltd. and looks like its a good buy. But before i actually go ahead i need you opinion on this. Please advice.

    Note : I’m investing around 20,000 for short term say 6 months to 1 yr

    1. Anup C

      I dont do IPO analysis , I dont know how to do , Deepak Shenoy or Rohit Chauhan might be able to help !!

      Manish

  4. dr kishan says:

    dear manish
    this was a really nice article for the newcomers to stock market. u should publish such guest posts more often. really, Rohit Chauhan has explained the start up of the stock market in easy and simple manner. the analysis of all the good AMCs by pramod was astouding. he really deserves a great applause for that. but i personally feel that stock market investing is also dependant upon the risk apetite of a person. i personally feel that if one is satisfied with around 14-15% returns (like i would be – if i get them) over one’s investments then no need to go to stock market.
    good job manish
    dr kishan

    1. dr kishan

      Definately risk appetite is one of the top most things one should look at before entering markets , anything less than 15% , one should not go to markets . mutual funds are good enough to target that much

      Manish

  5. Manoj says:

    Won’t it be a good idea to invest in stocks that make bulk of Sensex or Nifty for a long term investment (10 years plus).

    1. Manoj

      I am not sure , but the stocks are not choosen in Sensex or nifty because of what will happen to them in future , its more about their size and how much they impact” , we should not just rely on them as “best investments”

      Manish

  6. Pramod says:

    Value investing is the key to investing but the fact is that it is very painful to practice. Everyone knows it is good to buy low the good companies and then hold but 95% of the investors (including yours truly) do not have the guts to practice. In March 2009 I told my friend that ICICI Bank is trading at 300 and its Book Value is 430 so it is a value buy. And interestingly most persons in my office knew about such companies but none of us bought anything, however many of us had bought Reliance Energy at 2200. -:(
    The biggest hurdle in value investing is that one has to have a conviction in the idea and guts to go against the herd. By definition value investing means to buy when company is good but ignored by masses and then wait. It is like to be the first person to move outside Delhi in 1980 to a dry hot land with the conviction about its potential (Delhi has limited space and it people have to move outside it ) and then wait for 25 years till the place becomes Gurgaon.
    It is like planting a tree and then wait for the fruits. At times value investing can be painful because you buy first with a belief that the stock is good and later when masses will realize this fact they will queue to buy it and the price will go higher. When that happens is anybody’s guess. So have patience.
    P.S. – ICICI Discovery and Templeton Growth were the big ladders in the bull run of 2007. In 2008 and 2009 these were the great performer. Value investing can test your patience for long before rewarding you.

    1. Pramod

      Nice comment . I would say the problem is focus, which is lost because of amount of noise present , its hard to ignore it . The biggest reason one sells his “value stock” , is the perception that “Its going down anyways, I can buy it anytime again and it will be less price” , but then it never happens , the problem is not sitting tight with what you have and equating “action” with “good investing habit” . ”

      Good investing is very boring” . what do you say Pramod

      Manish

    2. dr kishan says:

      dear pramod
      reading ur both the posts i can conclude that u are either working in a finance company sort of institute or are a great research freak. where and how do u do all these researches. is all this information available on the internet or do u read some special magazines. please enlighten us so that we too can benefit by following ur foot steps. since how long are u into mutual fund investing
      thanks
      dr kishan

      1. I second that .. Pramod has amazing insight in these topics , I got to learn a lot of stuffs 🙂

        Manish

  7. Marshal says:

    this is tip of ice berg, I think u should give reader pointers like value investing principles of graham or buffet. PE ratios, dividend yields, book value there are many more financial tools that investor should be aware of

    1. Marshal

      Why dont you start ? Please put some points here

      Manish

  8. M Chakrawarty says:

    I think the article is basic and good starting point for those who are looking at investing. The key is to know how to choose good companies who have long performance track record and sound business model. One of the excellent websites / forum I have come across is
    http://www.theequitydesk.com.

    For those who are looking at investing in stock market, it might be a good idea for them to identify sectors first and then assess the performance of companies and shortlist.

    1. M Chakrawarty

      You have raised a nice point , where we have a selection model in which we have different cycles of elimination of stocks based on some criteria . for example

      1. first we find out all the companies which are 5 yrs old.
      2. Now we find all the companies which are showing profits for more than 3 yrs
      3. then we find companies which are showing growth in profits from last 3 yrs
      4. blah blah ..
      5. More blah blah ..

      And so on . I guess this way we can identify good stocks , be in right track and not get confused with plenty of stocks .

      What do others feel about this ?

      Manish

  9. Pradeep says:

    Great article Rohit. You write these complex topics in so simple terms, it’s always a pleasure to read.

  10. Jagbir says:

    Nice to see Rohit’s thoughts here. After reading both of your blogs since long time and equipped with some good books, I am able to look around and understand some facts. Though, unable to find any good stocks as of now which can fit in criteria, but to start the journey.. created position in ‘very few’ stocks which interested me. Of course, already decided my limits and to hold myself under fluctuations. Let’s see how long I can swim in this ocean 🙂

    One of the most important quality which count here is patience. It’s equally important while finding good stocks, researching on them, making position in them, holding them, ignoring experts advices if you are satisfied with your research etc. to finally reap good benefits.


    Jagbir Singh

    1. Jagbir

      Exactly, you have put the whole value investing gyan in 2 lines . Can you also share alteast 1 stock you hold and the reasoning why you hold it still ? may be others get a chance to put their views on that .

      Manish

  11. Shatrughan says:

    Isn’t it good idea that conman salaried ppl (who does not have enough time for analysis & can’t take much risk) start with SIP kind of instruments only.

    1. Pramod says:

      You are right but Mutual funds are not a guarantee either. How can we say that the fund manager is competent. Look at some recent IPOs. The retail and HNI portion could not be subscribed because ipo is overpriced. But the man handling your and my money does not think so. So QIB portion bails out the ipo and many of them are trading at 40% lower than the issue price. Dont you think their is some problem.
      Also in the crisis the funds got bust, Lehman and Bear Stern got bust but common man prevailed.
      Moral of the story- Mutual funds do not owe you good performance. I agree have SIP but not blindly. Hand over your money to a fund house that can think bout investor and then look for the fund manager. Now I never invest outside Sundaram, HDFC, DSP and Franklin. It may mean some less return in bull markets but the pain is equally less in the downturn.

      1. Pramod

        Whats the reason you are not going for any other fund than these 4 fund houses ? also please elaborate on QIB , what they are , how they work ?

        Manish

        1. Pramod says:

          Manish,
          What I look for in a fund house is a) Whether it has some discipline and process set for investments or it is only a One man show i.e. fund manager is calling all the shots. The former is always better.
          b) Whether the fund is keeping an eye on the funds if they are being true to their mandate and the fund manager is not deviating from the mandate for the sake of returns.
          c) Whether The motive of fund house is to make maoney for investors first for the long term or just to Raise it’s AUM via a flurry of NFOs.
          d) What is the performance and association of the investment team with the fund house. Is it changing fund managers every year ? if so then a big problem.
          e) I dont know about others but to me the important point is the credibilty of the parent company.
          Let us evaluate fund houses on above parameters
          1. Sundaram has a strict cap that none of its diversified funds will invest more than 5% in a single stock (Except select focus – Its mandate is to remain focus), At FT the stock selection is done by a team of experts and the same is true with HDFC. These things make sure that one person can not skew the investments to his will.
          2. Sandip Sabharwal is arguably the shrewdest fund manager India have ever seen. If you see the portfolio of SBI funds then you can observe that all the diversified funds had 90% stocks in common, so a global fund a contra fund a midcap fund and others were same despite their different mandates. Now look at DSP top 100 it doesnt have a single midcap stock, DSP midcap not a single large cap. Same with HDFC Top 200 and Sundaram midcap or Growth fund. When I invest in a large cap fund I know that I will be geting a large cap fund for sure. FT bluechip and Prima do not have a single stock in common.
          3. DSP has only seven equity funds and is winning so many awards based on that only. HDFC has only one sectoral fund. Sundaram recently has lauched some new funds but if you comapre these houses are conservative with new launching. They have every kind of funds and that is good. Look at Tata , Birla, Reliance they work like NFO Factory. The sole aim is to get money via NFOs.
          4. Fund managers, – Prashant Jain is with HDFC for 10 Years, Naganath with DSP for a decade, Sukumar ans Siva Subramaniam with FT for over 12 Years. other that Anup Bhaskar no fund mangaer has left Sundaram in a long time. Can others (of course Nilesh Shah and Madhu Kela are there) boasts of such long relations.
          5.Finally the corporate governance, Check yourself about the credibilty of Sundaram and HDFC. Other two are internationally acclaimed.
          OK that is the criteria I used, There are some others which may be fitting in these parameters but then performance is foremost and you can check about the conssistency for these funds over many years. It has not been a fluke.
          Keep a watch on IDFC and ICICI. Former is transforming itself and the latter is relatively new. Somehow I feel that 2010 will beling to these two guys. In the first quarter fall they have shown charecter.

          Secondly Manish QIB is Qualified Institutional Bidders. A 50% of IPO is reserved for them because it is believed that Institutions have a better understanding of the companies and so retail investor can take a clue from them. Also it makes it safe when 50% of float is with big guys. QIB is any institution in financial space ie. Banks. MF, LIC, Insurance Companies. Pension Funds and FIIs etc.

          1. Jason says:

            Wow Pramod!

            This was a really lucid & logical explanation!

          2. Pramod

            Thanks for this update . good points .

          3. Milind says:

            Nice comments.
            I like it.

      2. Milind says:

        I think Franklin and HDFC is fine. DSP- Need to re-look. Sundaram funds are good but not able to gather AUM.
        May be you stick to Funds than Fund Houses. I don’t like Reliance MF for their race to get AUM and Number in industry but Reliance Growth never let me down. Same is case with Magnum Contra Fund. Mr. Sandeep Sabarwal left that fund house long time ago still up in charts.

    2. Shatrughan

      I would say more than “enough time” and “less risk appetite” , once should look at interest and your expectations . What do you expect as returns ? if its less than 15% , then why stocks ? Better go to mutual funds , atleast you diversify the risk a bit , if not whole risk then atleast some , and you save time on analysis , tracking etc .

  12. Anu says:

    All so called ‘in-depth’ researchs are readily available on the net with little effort spend of searching and some more effort spend on analysing them or checking them. Also the company website itself is a good place to start with.
    But the difficult part is going thru them (balance sheet, profit n loss) and understanding the terms….
    As manish said “Investing is simple, but not easy” especially for stock markets.
    I have just started reading Rohit Chouhan’s site from last 1 month or so. It is a really nice blog. Keep up the good job !

    1. Pramod says:

      Hi Anu,
      I am also a fan of Fundamental Research but as Sir John Tempelton the legendary investor has said, “Always begin with a prayer.” So first of all pray to god that the information available to you is correct. The analysis starts from the Balance sheet and P& L account of the Company and these two papers are the basis of all the research that can be done in this regard. Now imagine what if this base itself is baseless then what can be done in this regard.
      And very sadly it is not a secret that how many of the promoters present wrong information in their books. When Satyam (What a pity it means truth) which is a sensex company. Owned over 50 % by FII which means they must have done their research, tracked by every Tom Dick and Harry, Audited by PWC can manage to cook books then what else can you be sure of. And the great thing is that they lied about Rs. 4000Cr of Cash and anyone having a 10% knowledge about finance can tell you that cash is the easiest of asset to verify, track and evaluate.
      Just imagine what the books of a small company relatively under researched can have in store. What faith we can have in this research is a big question.
      “God save the investors!!! that my prayer.
      By the way, Who so ever says Harry Potter is the greatest wizard, probably does not know about Ramlinga Raju. 🙂

      1. Pramod

        Tough you have made good points , dont you think the only thing way to fight with this problem is diversification . I understand that the problem you mentioned about Satyam is correct , but out of the pool of all the stocks and past 20-30 yrs , how many cases has happened like that , once an investor diversifying his investments along various stocks , this risk which you mentioned can be rectified if you fully eradicated .

        Dont you think so ? What are the other ways one can take care of this risk ? any suggestions ?

        Manish

    2. Anu

      Yup , the main point is that, things are available , there is need to “doing” things . We all know what to do in life , like we need to exercise, we have to eat healthy , blah blah , how many do it ? the problem is not “knowledge” , its “determination”

      manish

  13. Hitesh says:

    I still feel, stock investing is not for an average investor as for a normal person with a full time job, it is not possible to do so much of in-depth research adn then invest the money.

    All investments without the reserach are pure risk and gamble.

    Just a personal opinion though.

    Thanks
    Hitesh

    1. pratik says:

      I think in todays scenario investing is gamble for everyone. Markets and rates are always manipulated to suit some people like promoters.

      But you can research on which shares promoters are working on raising the price of there share to exit, or else who are bringing the rate down in order to make fresh investments.

      This is my personal view, at-least I myself trying to invest based on that.

      1. Pratik

        Why do you feel so ? The value investing principles never change , there are always companies which are available at attractive prices , just one needs dicsipline and courage at right time to pick them . I guess you are mixing Trading in short term with Investing ? please clarify ?

        Manish

        1. pratik says:

          I well understand the difference between short term trading & long term trading.

          “RIGHT TIME”. This is what I mean. How we can know the right time in share market?

          There is no rationale for a share to move up or down. A company with huge growth in profit will show a fall in its price & that with huge losses in current year will show an increase. So how can we know right price?

          Suppose I am a long term investor. After checking out P/E, Book Value, Management, Competitors and all I invest in that share, suppose at Rs 55. Now what I see after 2 month the rate comes to Rs 35 or so.
          Thats fine that I am a long term investor & after say 2,3,4 or5 years I get good return. But I failed to guess right time i.e Rs 35. And the reason I failed to guess that right time is there is no rationale in share price movement.
          And what I feel is this fall in price to Rs 35 is due to manipulation. There are few chunks of people close to company who know well at what price to buy.

          1. Pradeep says:

            Dear Pratik,

            You have confused certain aspects of value investing.

            The first cardinal rule is always buy at the right price. Buying at the “right price” means you buy at a discount to its intrinsic value and the discount must be considerable, say 30 to 40%.

            Secondly you find the share price going down further and now it has touched 35 Rs in 2 months from 55 Rs. There are two things you can do. If you have capital and are convinced about your intrinsic value estimate and think market is mis pricing it, increase your position and reduce your average cost of purchase. Else, let it pass if you don’t have capital or don’t want to take more risk. But at that point, the moment you start cribbing that you purchased at the wrong time and hence value investing is crap, you are coming to the wrong conclusion and have got your analysis wrong. You are being driven by greed then. Value investing does’nt say that stock price wont drop further after you have purchased. All it tells is that, sometime in the future, the stock price must rise up to the value level and you can benefit at that point by making a sale. If you want to benefit by buying exactly at the minimum and selling exactly at the maximum, that means you are not exactly a value investor. You do not have neither the buying discipline nor the selling discipline for “Value investing” and unless one both of these, it is very difficult to succeed in the long run as a “Value investor”. My 2 cents.

            1. drkhann says:

              The problem is .. How do you calculate the ” Right price “.. It needs extensive research and a healthy knowledge of accounting.. Most people in full time jobs dont have the time for it.. And even if they have the time they cannot understand the accounting terms being used.. Thats the catch

    2. Hitesh

      Agree with you . But I would say that we should not generalise with general common man here . There are many people who are in full time job , but have immense interest to understand direct investing . These kind of people can do very well considering they have enough patience and understanding of the subject. Atleast they can start managing their equity portfolio on their own . Its not suitable for common man , who does not have much interest and return expectation of around 12% . They can just invest in mutual funds without another thought .

      What do you feel now ?

      Manish

      1. geo thomas says:

        Hi manish, good article, is there any website where you have a training on how to read balance sheet, results etc. keep on the good work, i am with you.

        1. Geo Thomas

          Tough to answer that , there will be some tutorials on youtube , yu will have to search , read rohit chauhan blog , i am sure you will get distributed knowledge , but after you have read enough , it will be at one place 🙂

          Manish

      2. Hitesh says:

        Hi Manish,

        I agree with you, but the main point in the above topic is again getting it “right”. ‘Right time and Right Price.’
        I also want to invest in direct equity, but get daunted by the whole thing.
        Few of my friends just blindly pick the stock recommended in magazines like outlook money etc. Thats literally scares me from taking the plunge. Till now all i have been doing is investing in mutual funds as that requires extensive research only till i invest in the right fund. after that it is only periodic monitoring.

        Take the e.g. of me. I work full time for 9 hours a day. I only have weekends off for extensive research. Now i want to invest in direct equity. What do i do??
        The question i am trying to ask is that i want to learn these nittigritties. but from where? I do read a few points here and there. though i have gained immensely from your blog. Learnt everything about ULIPS, Insurance and MFs from your blog. But Getting into direct equity is a diffrent ball game altogether and needs lot of learning, and there no place where i can do that.

        Would be really grateful if you could start a series for newbie direct equity investors like me.

        Thanks
        Hitesh

  14. SENSEX rules senses 🙂

    1. Hemant

      You might want to elaborate that ?

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