Stock investing is not only about buying the right stock

By S NAREN

Knowledge on the process of investing has been shaped over decades, through incisive communication by various thought leaders like Warren Buffett, Peter Lynch, James Montier, etc. On careful observation, it can be noticed that a lot of the investment theory is focussed on only one aspect of investing — buying, leaving behind the other two crucial aspects i.e. sizing (quantum of buying) and selling.

Aspect I: Buying
When it comes to picking stocks, as Peter Lynch puts it -there are five types of stocks — cyclicals, steady companies, companies based on trends, turnaround companies and asset backed companies. In my opinion, a beginner investor should keep away from both, turnaround and asset backed companies, since the quantum of knowledge required to take a call on either of the types of stocks is quite extensive. In comparison, it is relatively easier to spot companies which are cyclical, steady or are trend based.

Cyclicals: Many of the commodity-based sectors see cyclical trends as can be seen in metals, oil, shipping, sugar, commercial vehicles, capital goods etc. The point to remember while investing in these pockets is that there will be times when these companies will do very badly, which should be the ideal time to buy, and there will be times when these companies do very well, which are times to sell. The key understanding here is the best time to buy a cyclical stock is when their share price is low and not when their earnings are high.

For example, when sugar prices are at their bottom, sugar stocks will be at the bottom, but their valuation in terms of price to earnings, will be very costly. So it is important to buy cyclicals based on share prices rather than earnings.

Steady Companies: In general, steady companies (consumer, pharma) are most suitable for investors who want steady returns. However, in the last few years, these companies have done well and therefore, as a mutual fund investor, we have been careful about such names, not because these companies are not steady, but because their stock prices are high. When the market was at its peak in 2007, these steady companies were low on valuation and presented an exceptional opportunity to invest.

Trend-based Companies: Trends, as Peter Lynch says, is one of the easiest for a lay investor to identify and invest in. It was very apparent in 2005 that people were moving towards mobile phones. As a result, it was apparent that ecommerce would gather pace. Similarly, one of the big trends that occurred was that scooters were gaining at the expense of motor bikes in many parts of India. So, investing based on trends is easy for any layman who is able to observe these trends. Going forward, with improving penetration of health insurance and changing demographics, I believe healthcare (hospitals) as a trend provides a good long-term investment opportunity today.

Aspect II: Sizing Once the stock to be added to the portfolio is decided, the next vital step is the quantum of buying or sizing; this is one of the least talked about areas of investing. When the amount to be invested is small, then Warren Buffett says, it is better to run a concentrated portfolio, something which he did in his initial years of investing. At the same time, one has to be aware that this form of portfolio requires doing better homework. The conviction and concentration of an investment should always be based on risk and potential upside seen.

Aspect III: Selling What I learnt after a decade of being in investment management is — it is better to convert the word ‘selling’ to ‘switching’, because it is difficult to determine when to sell. If you view every selling decision as a switch and evaluate a switch, it is much easier to take a selling decision. This would ensure that one wouldn’t ruminate whether the selling decision happened at the right time or not.

Bubbles and Bursts In 2013, when Warren Buffett visited India, we got an opportunity to meet him as a part of a group. At that time, someone asked him what he learnt from his decades of investing; the answer presented an interesting insight. In his 6-7 decades of investing, he saw 6-7 bubbles and bursts. He alluded to this fact and said that what you do in a bubble and burst is the most important part of investing. In India, there were stock market bubbles in 1992, 1994, 2000, 2007 and bursts in 1998, 2002, 2008.

My experience has taught me that it is very important to be rational in both the situations as these are the opportunities to make sizeable long term money in the equity market. To sum up, investing is a very interesting area. If you enjoy it and make money, you should continue with it. If you enjoy it and lose money, invest into equities via a mutual fund. If you don’t enjoy investing, then too consider investing in a dynamic asset allocation fund today.

(Author is CIO, ICICI Prudential Asset Management)