Stocks Prasenjit - Paul

1. How to Avoid Loss in the Stock Market

No actionable item here.

On the contrary, the interesting fact is that almost all billionaires in the world have created their fortune through the stock market, either directly or indirectly. “Directly” refers to the direct stock investing and “Indirectly” refers to listing their companies on the stock market. One of the world’s richest persons, Warren Buffet created his fortune from direct stock investing while other well-known billionaires like Bill Gates (founder of Microsoft), Mark Zuckerberg (founder of Facebook), Larry Page (founder of Google) made their fortune by listing their companies on stock market. Even in India, you will find many billionaire investors (e.g. Rakesh Jhunjhunwala) who created their entire wealth from direct stock investing.

As per statistics, 80% retail investors suffer overall loss from equity investment. Now, the most important point that arises is why maximum retail investors (small investors) lose their hard earned money in this market while a group of people are creating their fortune?

Net Profit and loss calculation from trading

1st Transaction 2nd Transaction
Buy Rate 100 100

This is one of the most important reasons of losing money in trading. The odds are against you. The system is designed in such a manner that it is next to impossible to make money consistently. Brokers, stock exchange and government – only they can earn consistently from trading. Every time you trade you need to pay all of them. They don’t bother whether you are gaining or losing. I hope now the reason is clear why your broker, media and several websites always encourage you to trade frequently. They all want to earn money for themselves, not for you. Do you still want to make them richer?

The reality is that during the bear market, quality stocks are available at a cheap rate, and thus it is one of the best times to invest. Moreover, if you select quality stocks then overall market movement rarely matters. High-quality businesses are always poised to do well in any market situation. Don’t get carried away by any analysts.

Overconfidence

Suppose, you started investing during a bull market and successfully earned 45% return at the end of first year. All your purchased stocks were performing well. In such a situation, you may start thinking that you have mastered the subject very well. As the market moves up, so moves your confidence level, you keep on increasing your investment amount. You are now too aggressive. Suddenly market crashes and there comes a prolonged bear market. It is the bear market that separates intelligent investors from others. Don’t get lured and invest aggressively if you find your portfolio giving above average return during a bull market. The stock market doesn’t move linearly. It’s quite easy to make money during the bull run but difficult during the bear period. To become a successful investor, you need to learn the art of making money across all market situations.

The only way to earn consistently from the stock market is to invest in the great business and hold them for the appropriate period. Check the details of any billionaire equity investor across the world. You will find one thing common to them. They simply chose high-quality stocks and remained invested over the long run. Warren Buffett, world’s most successful investor, and one of the world’s richest persons, created his fortune from 22% annualized return over more than 50 years from equity investing. He didn’t jump into intraday or Futures and Options. Just think, 22% annualized return consistently over 50 years creates a billionaire, and these trading tips providers claim 50%+ monthly return! What do you say?

Forget about intraday; short term trading, Futures & Options. Remember, there is no shortcut to earning quickly. Every quick-money makings tricks are eventually money-losing tricks. Investing in high-quality stocks and holding them for the correct period is the only way to create wealth. This statement is easier to say than to execute. Here come the obvious questions

  • What do you mean by “high-quality stocks”?
  • How to select high-quality stocks?
  • How to separate quality business from others?
  • What is the correct holding period?
  • When to buy and when to sell a stock?
  • How to construct my portfolio?

Point to Remember

  • The only way to accumulate wealth from the stock market is to invest in high-quality business (stock) and hold the same for the long run.
  • You can’t make money consistently via any form of short term trading. (Intraday, Futures & Options, margin trade, etc.)
  • Your broker, stock exchange, and government can only become rich from short-term trading.
  • Don’t get tempted by fancy stories in the stock market.
  • Don’t invest in stocks with borrowed money. It carries a significant amount of risk.

2. Stock Market is Not Risky at All

Not actionable item here.

For the person in the highest tax bracket, it is as high as 30.9%! Even if you are in the lowest tax bracket, then you need to shell out around 10% tax on the interest income from bank’s fixed deposit.

Well, many tax-efficient debt investment options are there which offers steady return and also serve the purpose of diversification. The problem is many of us are not aware at all.

Irrespective of educational background and specialization, anyone can learn the tactics of successful investing. It’s simple but not easy. “Simple” in the sense that it doesn’t require high intellectual. “Not easy” because it requires years of practice, discipline, dedication and willingness to learn.

Historically it is proved that only stock market and real estate investment can offer an above-inflation return in the long run.

Surprisingly in the stock market, investors are ready to trade frequently. A mere 10% rise in stock price tempts to book profit while 10% drop in stock price creates panic. The more you trade the chances of losing money will widen. If you can consider yourself as a partial owner of the business, then you can restrict yourself from frequent trading.

More than “what to do” you need to learn “what NOT to do”.

Points to remember

  • Equity investing is not risky rather staying away from equity investment is risky.
  • After adjusting tax and inflation, bank’s fixed deposit yield a negative return.
  • Equity investment is the most convenient option for long-term wealth creation.
  • Investment in stocks is just like driving a car. If you can master the subject, it becomes easier.
  • Lack of knowledge is the primary reason for widespread misconception and lowest retail participants in the stock market.
  • A stock is nothing but a partial ownership in the business. Treat yourself as an owner of the business.
  • Before considering equity investment, invest in knowledge. Investment in knowledge pays the best interest.

Bookmark - 27.July.2023

3. Fist Step of Picking Winning Stocks

Points to remember and Actionable items.

Now, here is the big question - if we should put the least priority on profit and sales growth numbers then what will be our priority? The answer is Return on Equity (ROE). As a shareholder, you need to follow how promoters are utilising shareholder’s money. Are they creating value for their shareholders or themselves? Let’s have a look at the details of Return on Equity.

However, Return on Equity (ROE) offers an approximate view. Increasing ROE over the last 5-10 years with improved operating margin and cash flow is a signal of sustaining economic moat.

Debt to equity ratio is the measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity. It indicates what proportion of equity and debt the company is using to finance its assets. So, debt to equity ratio = Total Liabilities/Equity.

Before investing in any stock, have a look on its debt to equity ratio. The ratio is available on various financial websites. You need to check the ratio for at least last three years. Debt to equity ratio of greater than 1 (and increasing continuously) carries red signal. It emphasises that the company may face difficulties to serve debt in the near future. Don’t invest in companies where the ratio is above 1 and increasing rapidly over the last few years. Investing in high debt companies carries inherent risk. (Also note, debt to equity ratio is not relevant for banking and NBFC companies. There are different set of ratios for analysing banking and NBFC companies). In the following chart let’s have a look at the companies having high debt to equity ratio and their stock price performance.

After getting any stock idea, just figure out its Return on Equity (ROE) and Debt to Equity ratio. Profit and sales growth analysis will come later on. If you find the stock having ROE of less than 12% (and decreasing) and debt to equity ratio of more than 1 (and increasing), then discard it.

Points To Remember

  • Companies can alter profit and sales figures. So, the priority should not be on the profit and sales growth numbers.
  • There are plenty of stock recommendations are available here and there. Before following any of them just conduct a basic test of your own.
  • Return on Equity (ROE) is the single most important parameter to analyse a stock. Considering all other parameters remain same, higher the ROE better is the investment option.
  • Investing in companies with wide economic moat during their early stage can generate a multibagger return.
  • Companies can create economic moat by offering better products/service or utilising their brand strength or locking customers from competitors.
  • Increasing ROE over the last 5-10 years with improved operating margin and cash flow is a prominent signal of economic moat.
  • It is highly recommended to avoid high debt companies. Avoid stocks having debt to equity ratio more than 1 (increasing) and ROE less than 12% (decreasing over the last few years).
  • Higher debt translates into higher interest outgo that eventually minimises profits and erodes shareholders value.

Actionable

  • Companies can alter profit and sales figures. So, the priority should not be on the profit and sales growth numbers.
  • Return on Equity (ROE) is the single most important parameter to analyse a stock. Considering all other parameters remain same, higher the ROE better is the investment option.
  • Investing in companies with wide economic moat during their early stage can generate a multibagger return.
  • Increasing ROE over the last 5-10 years with improved operating margin and cash flow is a prominent signal of economic moat.
  • It is highly recommended to avoid high debt companies. Avoid stocks having debt to equity ratio more than 1 (increasing) and ROE less than 12% (decreasing over the last few years).

4. How to Evaluate Management

We all know that good management can turn around a poor business while poor management can ruin the quality business.

I am going to present the simplest way for getting an idea about the management credibility. From the comfort of your home, you can evaluate those simple and easy-to-understand methods! Only three inputs are required for our purpose

  • Shareholding Pattern
  • Dividend History and Tax Rate
  • Return on Equity (ROE)

Promoters and Promoter Group

Promoters are those who incorporated the company. They can be either domestic or foreign entity (or group of individuals). Relatives of promoters owning shares also come under promoter group.

Public Group

Shareholders other than promoters constitute Public shareholding pattern. FIIs, DIIs, banks, money managers, mutual funds, insurance companies, individuals, etc. come under this group.

Remember, the shareholding pattern in isolation is not sufficient enough for taking any investment decision.

Promoters increasing their stake

It feels like; you are not the lone buyer, owners of the company are also buying just like you from the open market. So, just go ahead.

For the retail investor, it is not mandatory to dig dipper on “Why Promoters are increasing their stake?” because whatever be the reason the result would be positive (mostly).

Increasing promoter holdings either results in price appreciation or downside protection of the stock. If the promoters raise their stake, it is comprehended that they has high confidence in the business.

Promoters decreasing their stake

Promoters decreasing their stake can have either positive or negative effect on the stock price. Forced selling by promoters might cause major crash in the stock price. I will discuss the “forced selling” in the latter part of this chapter. Prior to that let’s have a look from different angle

Try to avoid companies where promoters have small shareholdings or they are consistently reducing their stake by a huge percentage.

However, reducing promoters’ stake is always not bad. The reason behind this is that even promoters have the right to enjoy the profit of their company. It is nothing bad in it if they sell some part of their stake. Moreover, they are in the business for earning money, and they have been working for it since 10-15-20 or even 50 years!!! For an example, promoters of Page Industries were reducing their stake during 2012-2015; still the stock price was appreciated by more than 200% during the same time. One of my investment, Atul Auto is another example. During November, 2013 promoters reduced their stake. Initially, I was worried; however detailed analysis revealed that one of the promoters sold his partial holding to an institutional investor. Initial entry of big institutional investor is the first sign of good times. I had increased my stake based on the entry of the institutional investor. The result paid off. Within the next one year, the stock generated 150%+ return!

So, you need to dig deeper whenever promoters are reducing their stake. It may have a negative or positive effect. Don’t take the decision based on the numbers. You need to dig deeper for the real picture behind numbers.

FII

Higher FIIs stake is interpreted as positive, and a lower FII stake means low confidence of FIIs in the company. If FIIs increase their stake, it is considered positive as they invest funds only when they are optimistic and confident about the future of the company.

Just like promoters, If FIIs sell their shares then it does not mean that the company is fundamentally weak. Their selling may be due to the economic or political changes, legal problems in their home country or it’s just that they want to enjoy their profit. Whatever be the reason, if they offload massive quantities then a huge fall in stock price is witnessed.

Key of multibagger return

The key to successful investing lies in identifying a stock that can become favourite among FIIs in the near future. In such case stock price multiplied by 3-4 times or more within 1-2 years. For example, I had invested in Ajanta Pharma during December 2012. Back then, the stock was not tracked by brokerage house. The company didn’t get enough attention from institutional investors. Slowly, with improved fundamentals, strong financial numbers and better future outlook, the company attracted institutional investors. Since December 2012 to March 2014 FII increased their stake by 3.81%, resulting in an increase of around 184% in FII holdings. No, wonder, since then, stock price generated around 500%+ return (more than six times return) within two years. So, you can create wonder if you can invest in stock before it attracts investment from FIIs (or institutional investors).

Effects of Individual Investors

Individuals have the least amount of knowledge and are mostly carried with emotions. On the other side, institutional investors are the most knowledgeable (after the promoters). So, you should be cautious if increasing individual shareholdings is resulted due to a significant decrease in institutional holdings.

Pledging of Shares

Like we take loans to fulfil our desire or necessity by mortgaging properties. Similarly, promoters also raise funds by keeping their shares as collateral. High pledging of shares is always dangerous for retail investors. It can cause a sudden crash in stock price. Let’s have a look at various aspects of pledging.

If any company has a pledging percentage up to 2%-8%, then it can be ignored.

Point to Remember

  • It is almost impossible for small investors to visist the management/factory before investing in the stock. There are alternatives for management analysis that can be done from the comfort of your home.
  • Promoters increasing their stake from the open market purchase have very positive impact in the stock price.
  • Promoters can decrease their stake for various reasons. It can have either postivie or negative impact on stock price.
  • Stay away from companies where promoters plege more than 30% of their holdings (and increasing)
  • Significant increase in institutional holdings result in sharp stock price apprecication
  • If tax rate is not matching with profit numbers, then you need to dig deeper.

Actinable

  • Promoters increasing their stake from the open market purchase have very positive impact in the stock price.
  • Promoters can decrease their stake for various reasons. It can have either postivie or negative impact on stock price.
  • Stay away from companies where promoters plege more than 30% of their holdings (and increasing)
  • Significant increase in institutional holdings result in sharp stock price apprecication
  • If tax rate is not matching with profit numbers, then you need to dig deeper.

5. Valuation. It Matters Much

6. When to Buy and When to Sell

7. Do’s and Dont’s to Avoid Loss in Stock Market

8. How to Construct Your Poftfolio

9. Is it required to follow an Equity Advisor

10. Quick Formula for Picking Winning Stocks

11. Little Bit of Myself - Important Lesson to be Learned.