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    Successful equity investing requires hard work, analysis, market understanding, not 'tips'

    Synopsis

    Successful equity investing is not about doing nothing. You have to educate yourself about businesses, analyse how the markets work and respect the processes.

    My cousin popped the inevitable question last week: “The markets are crashing. Can you suggest a few good stocks to buy?” She has taken charge of her investments only recently and is still learning. She is enamoured with the idea of investing in equity and is bewildered when I turn her away rather harshly. Investors can’t help but think that investing in equity is only about picking the right stocks at the right time. Why is this simplistic view so common?

    There is a bias in the way the stock market returns are published. In the academic world, we call it the survivorship bias. When we say that the Sensex has grown from a value of 100 to 30,000 over the years, we focus so much on the positive outcome that we forget the underlying process. The 30-stock index mirrors the performance of the top stocks across sectors tracked for their price on a daily basis. However, it holds only the winners. It is designed to keep only the largest, liquid and successful businesses. Therefore, it is a diversified portfolio, which periodically throws out losers. Except, it has no manager like a mutual fund, and only a committee that monitors it. To do as well as the Sensex, or better, we need that process, not just names and favourable timing.

    Many investors reject the idea of a portfolio and seek stock names instead. They hear about the single stock that changed the life of a humble driver; or the one IPO that was enough to turn the fortunes of a family; or how holding a good stock for a long time would result in massive wealth. They fail to see that the odds of picking the right stock from among so many competing choices are too low. It is a free market and a free world, anyone can start a business and hope to make it big. The secret formula for success that will work each time, every time, has not yet been found. Everyone tries his hand, and for the few who succeed spectacularly, many fail miserably. To imagine that someone can pick just the winners is to hope to get lucky. Investors believe in that possibility and want the world to help them get there.

    This column does not mention names or recommend funds, products or stocks to buy. That is a conscious choice not only to remain unbiased, but also to desist from trivialising the investment process. There is an industry that feeds this easy and lazy way to take a shot at investing. It is no different from placing a bet or buying a lottery ticket, and those who respect their money will steer clear of this racket. Students of science will tell you that an experiment whose results cannot be replicated each and every time is not worth looking at. Telling investors what to do seems like focusing on the actual execution, but I would rather focus on the how. What can keen investors like my cousin, who wants to try her hand beyond her mutual fund SIPs, do instead?

    First, develop a keen interest in business. Be curious about how businesses are set up, how they are run, and how they succeed. Track, watch, read and discuss. The complexity of making the choice about where to invest can be fully understood only when multiple models of success and failure are understood. There may be no patterns and templates to fit on each prospective idea, but a good understanding of what works and what does not can be learnt over time. It is a rewarding journey of discovery and to be a blue-blooded equity investor, one should develop a fascination for business.

    Second, learn financial analysis and enjoy the math. When you invest, you pay for the equity share today with the expectation of profits tomorrow. Behind the lofty talk about equity is the elegant mathematical equation according to which today’s price has to be the discounted value of the future cash flows that the stock could generate. Given the innumerable factors that can influence this equation, it takes time and effort to analyse, evaluate and decide whether the price we pay today may be worth it. It is both a science and an art, and immensely fascinating for the intelligent mind. Be willing to be thorough and intensive in your research, analysis and valuation.

    Third, work with a group of like-minded people. The thronging crowds at stock-picking websites that throw names about are an abomination. Shun them for their needless simplification and sensationalism. Analysis of stocks requires specialisation. It is easier if a group of like-minded people is able to work on businesses they like and bring to the table their abilities to delve deep into specific areas. There are investor groups that have rules for entry to admit only the serious investors who are joyously willing to work hard. Create your own group if you can make it work. The collective experiences of like-minded investors offer a good learning ground.

    Fourth, develop humility towards the equity market. The most successful investors do not brag about their methods. They know that the uncertainities of future can foil their best strategies. If you choose to be a coat-tail investor, who relies on tips, tricks and tactics, you will stake small sums on the names that come your way because you will lack conviction. Soon enough, you will have a large number of picks with a mixed bag of performance. You will find that no one is telling you when to sell, and even if they did, you are unable to do so for a variety of psychological reasons. Then you will end up as one of the million selective braggers who speaks only about what works, pushing what did not under the carpet. The disservice to the fabulous machine that equity markets are, will continue. There are no shortcuts to making money. When someone tells you that you just have to buy one or two good stocks and hold them for the long term, you have to pause and ask: how could there be a market that pays for such simple actions? Why would the world set out to make you rich for doing nothing? Good stocks are not good forever and you won’t even know when yesterday’s good became today’s bad. Invest in the process; the outcomes will take care of themselves.

    (By Uma Shashikant, Chairperson, Centre for Investment Education and Learning)

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