The fundamental truth that evades most Equity Investors

Stock tickers flashing at the bottom of news channels, red and blue colour codes on the trading bolt, fast gainers & losers, 52-week highs & lows, etc., are all things which a retail investor associates equity stock markets with. They are usually more focussed on the daily price movements. They would also not hesitate to park money in a stock based on tips from friends, brokers and associates. They would invest money in a particular stock just because it gave handsome dividends in a particular year.

Amongst all these, they forget the most basic fact about equities. Beyond share price, every stock has an underlying business and value to it.

Warren Buffet, one of the most successful investors in the world, buys businesses, not stocks. Picking high quality businesses and not mere shares is his recipe for successful investing. He is least bothered about how the company fares on the stock market every day. He is only concerned with how capable a business is in minting money in the long run.

He has been consistent in his investment approach and only invests in simple-to-understand businesses. For instance, he mostly avoids technology stocks as he doesn’t understand them. He is not tempted to invest in the ‘next big thing’ be it the dotcom era of 2000 or the recent trend of investing in Bitcoin. He invests in businesses which he feels reasonably confident to be around for a long time. For e.g., Coca cola, P&G, etc. He prefers to invest in businesses with high profit margins, healthy cash flows, zero debt and ethical management.

Warren Buffet’s investment philosophy can be very useful while screening a company. Mindlessly tracking the share price movement and acting on tips is a half-hearted approach which has actually proved suicidal leading many investors to lose big money in the stock markets and making them equity averse. The bad experience emanates from an investor’s lack of knowledge about equities. Investing in equities is definitely risky but it can be managed with the right kind of information and understanding. It is about taking calculated risks.

As a popular saying goes –

A chance is what you take before you think about it. A calculated risk is what you take after you have evaluated all possible factors and have determined that risk
- Craig Eliot

Successful investing is not just about choosing the right company but also having the patience to stay invested. There are various factors which affect the daily fluctuations in the stock market. If you as an investor have the ability to understand why share prices fluctuate, you can figure out what matters most in the long run:

Geo political Factors

Political developments at the Centre affect the stock markets. For instance, when Congress unexpectedly came to power in 2004, the stock markets plunged for a brief period fearing a coalition government with leftist parties. Also, certain economic and political developments across the globe affect the share market. For instance, the global liquidity and the sub-prime housing crisis in 2009 led to stock markets going in a tailspin. Similarly, recessionary signs in developed countries, fed rate hike in USA, terror strikes temporarily affect the stock markets in India.

Macro-economic factors

Certain economic factors like rise/fall in crude oil prices, interest rate movements, announcement of GDP data, inflation data, trade data, industrial output data, etc affect the markets in general.

Fundamental factors

Ultimately, what matters is a company’s growth prospects and how it is conducting its business. Ethical management, competitive advantage over peers in product offering, earning results, new product development, takeover/merger, new major contracts received from government are developments which affect the value of the company. If a company is reporting good profit growth year-on-year, it eventually gets reflected in the share price irrespective of any political and macro-economic factors.

Once you understand that fundamental factors are all that matter which influence the share price of a company in the long run, you will not be disturbed by daily fluctuations. You will not be tempted to follow the herd.

Equity investing is no rocket science and is certainly not a gambling game. If you are in the IT business or marketing IT products, you must be having a brief idea of the business of Infosys, TCS, and softwares and associated services they sell. If you are in the construction business, you must be dealing with steel, cement, paints and machinery vendors and the products they sell. Even if you are a house wife, you will be having good idea of the various FMCG products that are being sold in the market.

The point is that you do not have to be a stock market expert. You just need to understand the business and the products which are being sold.

When a company makes profits, you as a shareholder not only benefit from the declared dividends but also an increase in its valuation which is reflected in its share price. So, as the company expands business and grows profits over the long run, you create wealth as a shareholder. That is the beauty of equity investing. Remember, whether you are buying 100 or 1000 shares, think as an investor who is buying a business.



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