Do you want to be a value investor?

I came across a Question on Quora, the Q&A website, and would like to share my Answer here:

The question was – How do I start value investing?

To a new individual investor, learning Value investing can open the doors to wealth and a nice side income. In fact if Indians take to investing like in the developed countries, half the population may eventually have at least some money in stocks.

Here’s what to Do: 

You may find some points are from an Indian context:

  1. Start by looking at your finances. Can you set aside some money for a 2 year period without needing it, and which if your experiment fails, you can lose? This is your seed money.
  2. Get a brokerage account. If you are internet savvy, online only accounts are sufficient. Look for convenience and low brokerage. Buying or selling a share today is as easy as eCommerce.
  3. Next you need to find listed companies whose products or services you (or people around you) love. It could be your bath soap. Or your savings bank. Or your biscuit snack. Whats the brand? And company. Connect backwards. Use moneycontrol.com to see if the company is listed.
  4. Now Research this company identified. What else do they make. How are their finances. Who owns the firm. Are the promoters good people. Have they done well in the past. What are growth plans. There are some financial ratios that you need to check. The P/E, P/B and D/E should not be too high. Look for companies with high RoE. There are other ratios, but this is a good start. Value stocks are those that are worth much more than indicated by their current share prices. The research can result in a fundamental thesis for a company, like “with a new factory revenues will grow 45% and profits 60% in 2 years”, or  “the 40% fall is share price is unjustified and we expect a full recovery plus 20% based on growth of financials”.
  5. Investing is like growing a tree. It can’t be hurried. It needs care. Embed from Getty Images
  6. If you feel good about the research for a certain company, start your investing exercise by buying a few shares, a fraction of your seed money, say 20%.
  7. Repeat above exercise in some time to find 2-3 more companies and add 20% of the seed money for each. Track these firms for a few months. Keep reading up about them. See if the news flow is positive or negative.
  8. Review your company in 3-4 months by relooking at (4) questions periodically, say after the quarterly results. Sell the company if (4) answers on review don’t add up or price has gone too high. Buy more if the company performance is good but price goes low.
  9. Remember, a fall in share price and a notional loss for you is not necessarily a sign of a bad company. Check against (4) questions. Similarly the converse. A gain in share price may not necessarily be the sign of a good company.
  10. Build your learnings. Find non consumer companies that you understand or are comfortable with, to invest. Read books by great investors like Warren Buffet, Peter Lynch and our own Mohnish Pabrai. Keep learning.
  11. Cut out investing noise. Any stock tips you get should only be starting point for research with (4). There are a lot of hot stock picks floating around. But who is tracking it for you?
  12. Both greed and the pain of loss will hit you over the years. There will be times where you see a 30% notional loss in a share. Just check against (4) questions for buy and sell decisions. Try to stay satisfied with past decisions, while learning from them.
  13. Be humble. You will be wrong many times, but you have to bounce back.
  14. If you get it right, over the years you can outperform the Sensex / Nifty Indexes, equity Mutual Funds and Portfolio Managers. If you grow in learning and confidence over months and years, as does your portfolio, this door has opened for you. Congratulations.
  • This is how I did it. This is my process and some lessons learned over 12 years as an investor. I am now a SEBI registered and certified Research Analyst.
  • Visit JainMatrix Investments  to fast track your above process, or to get an experienced stock market Analyst to partner and help you. Note that not everyone can be a good value investor, or even spare the time required. A section called Investor Education has been created only to guide you along.
  • Read Disclaimer below also …… one point from there I would like to emphasise is – The suitability or otherwise of any equity investments will depend upon the person’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor.

Upvote my answer on Quora if you liked it – Quora

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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High Risk and High Return in Equity

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Here is a short article that re-examines the myth of High Risk and High Return in Equity.

What is Risk?

Risk defined by Investopedia is “The chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment”.

One of the rules that is commonly believed is that ‘higher risk needs to be taken in order to earn higher returns’. This is intuitively obvious. The entrepreneur invests in a new business knowing that there is a probability of failure. The Venture Capitalist invests in a portfolio of businesses knowing that some may give him 30X returns and others may fail.

But lets review this in the context of Equity investments.

Asset Classes

In investing, this risk-return rule is true across asset classes. The following graphic Fig 1 illustrates the Risk and Return rankings across different asset classes. Fig 1.

JainMatrix Investments

Fig 1 – Asset Classes (click to enlarge) JainMatrix Investments

  1. Here we can see that Cash is the safest asset.
  2. FDs come next, as they are of fixed duration and fixed returns, guaranteed by a Bank.
  3. Next come Debt, Bonds, and Endowment Life insurance. Insurance of course is a very high gestation investment product.
  4. Debt and Bond MFs are products packaged by the Mutual Fund industry into Units.
  5. Gold and Gold ETFs are another investment option.
  6. Real estate may come next. It of course varies by location, and commercial/ residential.
  7. Equity ETFs and Equity MFs.
  8. Direct equity is the highest risk investment product. It also provides potentially the highest returns of these asset classes.

Note that these are strictly the author’s personal views of the most likely scenarios, and these may vary under different circumstances. The graphic Fig 1 is only a conceptual map, and indicates relative values.

Risk in Equity

Direct Equity as an asset class has two types of Risk:

  1. Systemic risk is applicable across all sectors. A significant political event, for example, could affect your entire equity portfolio. It is virtually impossible to protect yourself against this type of risk.
  2. Unsystematic risk is sometimes referred to as “specific risk”. This kind of risk affects a few of the assets. An example is news of a sudden strike by employees, that can only affect a specific stock. Diversification is the only way to protect yourself from unsystematic risk.

Even equity can be split into equity classes, where the risk profiles are different, see Fig 2. Speaking in general, Large Caps are most stable, and have lower risk, next are Mid-caps and next Small caps.

JainMatrix Investments, Equity Risk

Fig 2 – Equity Risk (click to enlarge) JainMatrix Investments

The Risk-Return Relationship

However, once we look at individual stocks for investing, higher risk may not give higher returns.

  1. The high performing firms in the stock exchange over longer periods are those that are more predictable in terms of growth, costs, investments, new projects and brand strength.
    • Example – HDFC Bank over the period of 2009-13 has given fairly predictable 30% YoY growth in profits. As a result investors gave it a superior valuation and it became the bank with the highest market capitalization, even though it was smaller than peers on other parameters.
  2. Sharp swings for a firm from profit to loss and the reverse too are not seen positively, especially if these happen unexpectedly.
  3. The ability of growth companies to execute on new initiatives is very important. Such firms need to launch in new markets, create new products or set up new manufacturing plants. Here the track record of such firms in these initiatives is important.
  4. Monopolies are seen as very positive situations for firms.
    • Example – ITC has for several decades dominated the Indian cigarette industry with 75-80% market share. This is a profitable and steady growth industry and so the ITC share has performed well over 10-15 years.
  5. Typically the fundamentals based approach to the stock market involves projecting financials for a company over 1-3 years, assigning target prices and identifying high potential investments.
  6. Warren Buffet has taken predictability to the extreme by investing in a bunch of consumer companies (Coca Cola, Procter & Gamble, Kraft Foods, Wal Mart, etc.) where these products are strong brands that are daily consumption habits and so growth is quite predictable over decades rather than years.

The Role of the Equity Researcher

It is the task of an equity researcher to identify, prioritize and assess the risks associated with an investment in a firm. Thus a good equity researcher is actually able to lower the ‘specific risk’ of making an investment, identify potential situations of a company’s future and increase the chance of profitable investments.

JainMatrix Investments approach to Investing

  1. The JainMatrix Investments approach to investing is to start with a top down approach to first identify the attractive sectors that are likely to outperform the next 1-3 year perspective.
  2. Next we drill down to the company level to analyse the fundamentals of firms and identify outstanding Large, Mid and Small cap firms. This research is published periodically.
  3. From this universe of good firms, a few are hand-picked and sorted into Model portfolios. By aligning the portfolios with their risk appetites, we help investors invest better.

Large Cap Model Portfolio

  • The objective of the LCMP is to outperform the Sensex and Nifty by 5-10%.
  • It consists of 7 large cap shares which are the current or future leaders from attractive sectors of the Indian economy.
  • This is a low risk portfolio.

Mid and Small Cap Model Portfolio

  • The objective of the MSCMP is to outperform the Mid and Small Cap indices by large margins.
  • It consists of 7 mid and small cap firms that are emerging out-performers from identified 3-5 high potential sectors.
  • This is a medium to high risk portfolio.

The performance of these portfolios over the last 20-21 months has been excellent –

JainMatrix Investments Model Portfolios

Fig 3 – JainMatrix Investments Model Portfolios

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