Responding to numerous requests from fellow investors, colleagues and clients, we have decided to distill the invaluable lessons gleaned from the most successful investors in the field. In an effort to share these insights, we are consolidating over 6000 pages of investing wisdom in one blog.
Stock: A stock is seen by many as a cryptic piece of paper whose prices wiggles around continuously.
That’s one way to look at stocks. A far better way, suggested by Benjamin Graham, is to think of them as an ownership stake in an existing business. For eg- One of the reasons to invest in McDonalds stock is to have ownership in 40,000 real estate properties globally as McDonalds owns all the outlets run by its franchises on which it earns rent as well as royalty. The stock has appreciated from $2 in 1983 to $262 in 2023 – a yearly return of 18% excluding dividends.
When investing in stocks, you’ve got the company’s growth on your side. You’re a partner a prosperous and expanding business (if chosen right).
Risk: Investing consists of exactly one thing: dealing with the future. And because none of us can know the future with certainty, risk is inescapable. Hence, great investing requires both generating returns and controlling risk.
Respect uncertainty: Disorder, chaos, volatility and surprises are not bug in the system but the features. We can’t predict the timing, triggers, or precise nature of these disruptions but we need to expect them and prepare from them.
Risk vs. volatility: Risk entails the potential for a permanent loss of capital and is distinct from volatility, which refers to the temporary fluctuation in share prices.
Stock vs. bond: Equity investments appear risky due to the volatility in prices, while fixed income securities appear safe as their prices do not fluctuate. In reality, the factor of inflation makes the fixed income much riskier.
Market corrections are routine: The future may be unpredictable but this recurring process of boom and bust is remarkably predictable. Once we recognize this underlying pattern, we are no longer flying blind. You can’t know the future but it helps to know the past.
Market oscillates between greed and fear: Market is made up of emotional people whose decisions are based upon the prevailing sentiments in the environment. At times they display greed and at other times they display fear. Bouts of greed and fear make the stock prices volatile. An investor with poor emotional quotient gets trapped in such volatility to lose fortunes.
Indian equity markets witness 10-20% temporary declines almost every year yet 3 out of 4 years ended with positive returns.
Margin of safety: One should buy a stock only when it’s selling for much less than your conservative estimate of its worth. The gap between a company’s intrinsic value and its stock price provides a margin of safety.
Buying price matters: Buying an exceptional business at an exorbitant price makes it a mediocre or even bad investment and buying a mediocre business at a bargain price makes it a good investment.
Factors when buying a stock:
a. Quality of management
b. Sustainability of business
c. Good cash flows
d. Reasonable return on investment
e. Right valuations
Only a few winners in portfolio: If six out of ten stocks perform as expected, you should be thankful. That is all it takes to produce an evitable record on wall street.
Investment styles:
Value: Investors aim to come up with a security’s current intrinsic value and buy when the price Is lower
Growth: Investors try to find securities whose value will increase rapidly in the future i.e. companies having a bright future.
Processes are more important than the outcome: In the stock markets, a small percentage of people end up being successful in the long run whereas a majority of the people, in spite of being successful in the short run, end up losing money in the long run.
Four valuation techniques: 1.Discounted cash flow analysis calculating NPV of company’s future earnings 2. Company’s relative value, comparing it to price of similar businesses 3. Company’s acquisition value, figuring what an informed buyer might pay for it 4. Liquidation value, analyzing what it would be worth if it closed and sold its assets.
IPOs: Majority of the IPOs are against investor interest as most of listing happens during a bull run and investment bankers dump stocks at outrageous valuations.
Returns:
For an investor, there are two components of stock returns:
a. Dividends
b. Capital appreciation
In the long run, Stocks are a slave of corporate earnings
Sources of returns: The returns from equities are dependent on two sources:
a. Fundamental: Growth in Earnings per Share (EPS)
b. Speculative: P/E expansion and contraction
19. Time in the market > Timing the market: Warren Buffet is worth 118$. of That 117B$ was accumulated after his 50th birthday.
20. Longevity of returns > % returns in short period: Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time.
Emotional Quotient > Intelligence Quotient: Investing is a field of simplifications and approximations rather than of extreme precision and quantitative wizardry. I also have realized that investing is less a field of finance and more a field of human behaviour. The key to investing success is not how much you know but how you behave. Your behaviour will matter far more than your fees, your asset allocation, or your analytical abilities.
Interest rates are to asset prices what gravity is to the apple.
Forecasting: If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market (Benjamin Graham). There are 60,000 economists in the US, many of them employed full time to forecast recessions and interest rates, and if they could do it successfully twice in a row, they’d all be millionaires by now. But most of them are still employed. (Peter Lynch)
Leverage: If you are leveraged five times of your capital, a 20% move in your preferred direction can double your capital, but a similar move in the opposite direction can wipe you out.
When to review your portfolio: Check the portfolio at most a month: 1. if the fundamentals are better – increase allocation 2. if the fundamentals are weak decrease the allocation to equities 3. if it’s the same, don’t do anything
Equity mutual funds are the perfect solution for people who want to own stocks without doing their own research. Investors in equity funds have prospered handsomely in the past, and there’s no reason to doubt they will continue to prosper in the future.
