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NIrali Shah

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One common mistake investors make is by asking what to buy? But instead, investors should ask what not to buy! Because by knowing what should be avoided, investors will learn to pick true jewels of the stock market. Simple companies with easy to understand businesses turn out to be wealth creators in the long run. For example, if you would have invested in Nestle (the famous Maggi maker) at the start of 2017 then by Dec 2019 you would have made a compounded return of over 30%.

The Art of saying No to Stocks

“The difference between successful people and really successful people is that really successful people say no to almost everything.” -Warren Buffett

Warren Buffett has always focused on quality over quantity and picking quality stocks will come through elimination. Now before picking a stock, you should ask yourself only 10 simple questions:

1) Does the Company innovate? – A company has to keep updating its technology to improve efficiency. Kodak, Nokia are examples of big brands which failed to innovate and ignored the power of technology. When better products came into the market, these companies suffered because they didn’t update themselves.

2) What is the size? – Avoid a small fish in a very big pond such as a JK Tyre. In fact, prefer large companies in a big pond such as MRF because with their scale, networking and brand power they will be able to grow faster when times are good. As seen from the chart, JK Tyre has given -39% while MRF has returned 61% absolute returns to investors in the past four and a half years.

3) Is it a falling knife? – Never put your hands in a stock which is already falling. PC Jewellers, Suzlon are examples to stay away from in order to avoid making losses.

4) Is it a low ROE business? – The sole reason for investments is returns and a company with a history of low ROE won’t improve overnight. Investments in high ROE companies will create value for shareholders.

5) Should you look for cyclical plays? – Cyclicals such as cement, sugar, auto can be loss-making when picked at the peak of their cycle. Timing is everything in cyclicals and requires caution. Therefore, secular companies are safer than cyclical.

6) Are the shares liquid enough? – When a stock suddenly falls, you panic and want to sell it but can’t; it is all because of low liquidity. Lower volumes and liquidity will prevent from finding buyers when you want to sell a stock or vice versa.

7) Does it have poor corporate governance? – Satyam is an example of poor corporate governance. Management and board of directors should be ethical and reliable.

8) How transparent is the Company? – Companies should explicitly disclose their related party transactions to maintain transparency to avoid cases such as the Karvy episode. A qualified auditor’s report is also essential to highlight the authenticity of a Company’s transactions.

9) Is it a penny stock? – High risks can make higher returns but it can also make you lose money if the company goes bankrupt or if a scam surfaces. It is best to avoid penny stocks.

10) How much has the promoter pledged and how much do promoters hold? – Companies with a high promoter pledge or low promoter holding are red flags. To release pledged shares, the Company will have to generate sufficient cash flows. Also, a low or declining promoter holding may imply that the promoters don’t have faith in the growth of their own company. If a promoter himself is invested in his own company, then he is more prone to take unbiased business decisions and will allocate capital keeping the longer objective in mind.

Investors who ask these 10 questions will be able to avoid riskier and default making companies. Additionally, companies with high debt or who are capital hungry and are always looking for regular CAPEX should be avoided. Such companies might provide lower returns on investment as they might not be able to generate returns at the same rate as the capital infused. Airline and infrastructure industries belong to this category.

low risk

Safe investing should be your new mantra! Long term secular bets with consistent earnings will prove to be good return generators. Investing in a group of stocks will also help you make money as it will provide sufficient diversification and margin of safety. StockBasket is a product which has baskets curated keeping all the above 10 points in mind. Companies with high debt, poor corporate governance, bad visibility, cyclical, lack of innovation or transparency and illiquidity are excluded from StockBasket which makes it a reliable product for long-term investments.

Begin right and learn to say NO to low-quality stocks to create wealth!

More than 95% of retail investors lose money in the stock market

Stock Markets are perceived to be money makers for the common man but did you know that 95% of retail investors actually lose money instead of compounding wealth. These are shocking stats which a retail investor will realise only after he has lost money. The major reason that financial inclusion and penetration of equity investing in India has not taken off is because retail investors actually end up losing money and this needs to be changed. Because if done right, stock markets can be a game changer. Firstly, investors are not picking good quality businesses, secondly, they aren’t patiently holding them to see the magic of compounding. If you get these 2 things right, you can create massive wealth to secure your future. 

To better analyse why retail investors end up burning money in stocks we conducted a Wealth Destruction Study. After some rigorous number crunching, the facts stunned us. There are lesser than 20% stocks that actually beat the 15% expected returns required in equities. Also, a whopping 55% of companies actually generate negative returns. Shocked right! As an investor you just want to make money more than what a FD will give you. But you end up losing much more since 70% of companies never beat FD returns. All these stats point out to one conclusion – “Less than 1 out of 5 stocks actually generate the return to justify the risk of equity.”

You must be wondering how to recognize wealth destructors? The divergence between shareholders owning wealth creators and destroyers is massive and this gap can be reduced only by conscious quality picking. If you look at the FMCG large cap Hindustan Unilever, it is owned by a mere 4 Lakh shareholders. Colgate and Dabur are owned by only 2 Lakh shareholders each. While such quality businesses have within 5 Lakh shareholders, companies which are under the burden of massive debt and have difficulty in repaying their creditors such as Reliance Power have over 31 Lakh shareholders. Suzlon too has around 10 Lakh shareholders. This proves that wealth destructors have a much larger shareholder base than the wealth creating companies.

Elimination can be another method to avoid wealth destructors. Investors should check for these 5 factors – Businesses with low ROE, moderate ROE but poor free cash flows, lumpy or unpredictable cashflows and large discretionary products, commoditized businesses and overpriced businesses while picking stocks. If companies fall in the above category they should be avoided. Only then a common investor can exceed the 20% mark to earn the expected required return. But unfortunately, there are a handful few who do a good job at appropriate stock picking. Even mutual funds sometimes become extremely aggressive and buy a lot of companies in their funds. The idea can be to diversify the risks in a portfolio but the same can be achieved through lesser number of quality companies. Stock selection is extremely tricky and is an art with a success rate of less than 20%. And investors are at a serious disadvantage when they focus on quantity over quality.

Another revelation from the Wealth Creation study is that retail investors tend to sell stocks too soon either because they are loss making or because they feel that the stock will fall now that it has given decent returns. The average holding period for most companies is below 2 years. For example, from 2011- 2020, Jubilant Foodworks has delivered a consistent CAGR return of 20% but the average holding time frame for investors is a mere 1.99 years. If an investor had held it for the entire 10 years he would have made 422% today in absolute terms compared to a 2 year return of 110%. This is the power of compounding which investors tend to miss out on by selling a stock early. Holding wealth creators for a number of years will ensure you make sound returns while riding the bull curve of the stock.

“The rich invest in time, the poor invest in money” – Warren Buffett.. If you as an investor follow these 2 rules – pick quality and patiently hold the stocks, you will definitely create immense wealth. And StockBasket is one product which follows both these ideologies. It contains companies which are fundamentally strong with a high margin of safety to enable investors compound their capital invested. Wait no more, invest in StockBasket to safeguard your future by being among the few investors who make the 15% returns in stocks.


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