6 pointers to be an astute equity investor

By Morningstar |  02-09-21 | 
 

This article has been written by Vivek Mashrani.

Finding and buying a hidden microcap is overrated and every investor’s fantasy. But buying known great businesses at the right time (during a temporary fall) and then holding on to it for extended periods of time is underrated.

As an investor, the ups and downs of the market are not in your control. Neither is the market sentiment or the various cycles. What is in your control are 5 decision points:

  1. What to buy
  2. When to buy
  3. How much to buy
  4. When to sell
  5. How much to sell

Buying is part of the process, so is holding. But one must know when to hold, and when to fold. Having an exit strategy is one of the most important aspects of investing. So, if you cannot answer any of the above, there is a serious flaw in your investing process.

Now, I would like to take it a bit deeper.

Buy-and-Hold will make you RICH. But averaging up as they keep performing is what will make you WEALTHY.

The Pareto Principle is ubiquitous and finds an expression in virtually every aspect of life. Some examples:

  • 20% of the population own 80% of the world’s wealth
  • 20% of time spent on various activities produce 80% of results
  • 20% of customers generally bring in 80% of the revenue
  • 20% of focussed employees create 80% of the impact in an organisation

If we observe our own investing portfolios, a similar trend would show up: 20% of stocks generally produce 80% of the returns. But, if you don't ride the winners, the remaining duds will keep dragging the overall portfolio performance.

Long term value investing is not only about accumulating more of a stock when the price falls, but to keep buying when the value of business goes up. Have a process to average up your winners.

Every business is conceived as an idea, moves into a start-up phase, then commences the journey from a micro cap to a small cap to a mid cap and eventually, a large cap.

No matter how brilliant the idea, or how adaptable and relevant the business, there are the inevitable challenges. Distribution network, supply-chains, deploying the right technology, employee training, management bandwidth, logistics etc. Not all the companies which started from idea phase can grow big.

Your portfolio returns are the sum product of allocation and returns generated. Naturally, we need our winners to have a higher allocation and ride them, at the same time trim laggards to prevent them from dragging portfolio returns.

Averaging up –adding allocation to businesses which keep growing and scaling-up with time, will automatically mean that your winners are increasing in size. Eventually maximizing portfolio returns. So, we are not only staying invested in our stellar performer – be it 3M or Asian Paints or Pidilite or HDFC, -- but also allocating higher as they moved from strength to strength.

Says the legendary Peter Lynch on this subject…

It's easy to make a mistake and do the opposite, pulling out the flowers and watering the weeds. If you're lucky enough to have one golden egg in your portfolio, it may not matter if you have a couple of rotten ones in there with it.  Let's say you have a portfolio of six stocks. Two of them are average, two of them are below average, and one is a real loser. 

But you also have one stellar performer.  Your Coca-Cola, your Gillette.  A stock that reminds you why you invested in the first place. 

You don't have to be right all the time to do well in stocks.  If you find one great growth company and own it long enough to let the profits run, the gains should more than offset mediocre results from other stocks in your portfolio.

Few pointers to keep in mind

  1. Don’t be afraid to sell a loss-making stock to buy a winner.
  2. Don’t be reluctant to keep adding to your winners, even if the price is increasing. A good business will see its stock price rise.
  3. A low-priced stock need not mean a cheap stock; cheap is always with reference to its valuation.
  4. Market is not a shortcut to creating wealth. The market is a long game. Rs 10 lakh, even at a CAGR of 20%, will become Rs 10 crore in 25 years.
  5. Always have an investment strategy in place with pointers for the 5 decision points that I mentioned at the start of this article.
  6. Avoiding borrowing money to trade and invest.
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