Are you fit to be an equity investor?
Posted by: Uma Shashikant on May 23, 2017, 08.27 AM IST
By Uma Shashikant
Investor attention turns towards buying equity shares when the buzz in the markets increases. Celebrations around the Nifty reaching the 10,000 mark would leave many gasping at the possibility of becoming wealthy by simply picking up a few stocks.
My consistent message to eager investors has been this: Equity investing is tough. It takes a lot to be successful. Do it only if you can persist, learn and persist even more. So what does it take to become a successful equity investor?
First, to invest in equity is to invest in a business. You should have a basic interest in how a business works and how it struggles through various challenges and ultimately succeeds. The richest equity investors are those who set up their own business and spent the best part of their lives working towards its success. The value they build over the years reflects in the shares they own as promoters, managers and stakeholders.
To be able to achieve such success as an outside public investor, who will have no direct control of any of the decisions the business makes, you have to be willing to learn what makes a business tick. This can only happen with time and equity investing is a long-term game.
Second, you should have the ability to put together a framework for growth of the business you will invest in. To do this, you should have training in financial analysis, or be willing to pick up the knowledge and skills required to understand how profits are generated and how the numbers come together. Every business whose shares you buy should be supported by an investment thesis, and you should be able to put that thesis down in words and numbers.
Third, you should have the perseverance to apply your framework on the potential stocks you could buy and come up with a shortlist. For example, you can have an investment thesis that says that you are looking at companies that are in businesses whose sales is growing at an even pace (plug a number), and whose return on capital invested is high (number here too) and the management is focused on growth without leverage or increasing costs (quantify these too).
There would be hundreds of stocks that would meet these criteria. You should be willing to sift, analyse, sift again and again. Your investment process will get more and more robust as you do this.
Fourth, you should have the risk taking ability to keep your money in the a few picks that meet your stringent criteria. There is no point in buying stocks that are in the news, or recommended by friends or relatives, or picked off random conversations or lists from the TV or newspapers. When you do not know why you are buying, you will stake too little. When you lack in conviction, you will take no risks. Then you will end up with a long list of stocks.
The problem is, even if some of them turn out to be winners, you won't have enough money in them for it to make a difference to your wealth. A portfolio with too many holdings will do as well, or worse than the index. You did not have to go through all the trouble to earn just index returns!
Fifth, you should have the discipline to keep investing in the stocks you picked while also tracking their performance. Without a good understanding of the business and the numbers, and a robust investment thesis, you will not be able to make up your mind about whether to keep or leave the stock as its performance unfolds. Even the best investment mind cannot forecast the growth path of a business.
The excitement of equity investing is the travel on this unknown path and the excitement of seeing a stock soar beyond your expectations. That would happen to just one or two of your picks. One or two will be just alright, and one or two would do worse.
Sixth, you should have the mental framework of a learner who is willing to be caught having made a mistake. If you are the kind of person who likes to always be right or seek complete control of things in your life, or like the comfort of everything going exactly as you planned, equity investing is not for you. You have to be able to take active calls on what is going wrong. There is no knowing the potential upside of a stock.
Every successful equity investor will tell you stories of being humbled by businesses that grew exponentially over time. But cutting losses when you have made a mistake is what protects your wealth. We are all victims of confirmatory bias and the cruel endowment effect, where we begin to love what we have too much and can only see what is right with it. Both attitudes are harmful to equity investing.
Seventh, you should have the patience of the farmer. As Kabir famously remarked, you can pour hundreds of pails of water, but the tree would flower and fruit when its season arrives. Your attitude should be one of a nurturer, who is willing to let the business you have invested in trudge along, knowing fully well how it is working and how its managers are steering it through challenges.
There is no point reacting to news and rumours and panicking at every unexpected turn. You should be able to wait for numbers to come in, sift and study them to see how they stack up against your thesis, and make the decision after carefully considering the qualitative aspects. It takes a few cycles to learn the game, and losses are the best ways to get enduring lessons.
Begin small, but begin with intensity and depth. If you like to stake a few rupees in this and that by staring at the screen of moving numbers, you are simply speculating. If you are lucky, you will make some money, but you won't be able to replicate it. If you are intimidated by the amount of work equity investing takes, you can buy the index or an equity mutual fund.
But if you nurture the secret ambition to run a business yourself; if you can invest time and effort to give the task the attention it deserves; and if you like the joys of dealing with unexpected twists and turns, equity investing is your game! Ensure that your vision is sharp, your hands are firmly on the wheel, and feet well balanced in the choice of the brake and the accelerator.
(The author is Chairperson, Centre for Investment Education and Learning.)
Disclaimer: The opinions expressed in this column are that of the author. The facts and opinions expressed here do not reflect the views of Economictimes.com
This article appeared in Economic Times dated May 23, 2017, 08.27 AM IST