The last three years have been great for equity investors as stocks have outperformed most other asset classes such as gold, silver, industrial metals, real estate and fixed-income instruments like bonds and fixed deposits. The Indian equity benchmark BSE Sensex is up 65 percent cumulatively in the last three years and continues to show strength. This continues to draw new investments in equities as is evident from strong inflows into equity mutual funds and the opening of new trading and de-mat accounts by investors.
Having said that, equity investors are still a minority in India and the vast majority of savers and investors largely put their money in bank fixed deposits, life insurance, real estate and gold. But if you are thinking of taking your first dip in equities, this is the right time to go ahead.
The Indian equity market has taken a breather after a year of rally and valuations have also become reasonable. The BSE Sensex index was up 15 percent during the 12 months ending September this year but is now showing weakness. The benchmark index is now down over 2000 points from its recent 52-week high made in the middle of September. This has also resulted in a moderation in equity valuation which is good for long-term equity investors.
The BSE Sensex is currently trading at a trailing 12-month price-to-earnings multiple of 23.6 times, the lowest in the last six months. This provides a reasonable degree of downside protection to new investors and opens up a window of opportunity for them.
Equities however remain a risk asset and investors run the risk of a big capital loss if they get too adventurous in the market. A wrong investment decision can wipe off most of your capital in a matter of days. Alternatively, a portfolio of good stocks can become a golden passport to financial freedom and worry-free retirement.
Here are five investment tips that will help you avoid costly mistakes and greatly improve your chances of earning high returns on your equity investments.
1. Invest in small instalments
Stock prices tend to be volatile and directionless in the short-term so it’s best to invest in small instalments without stretching your cash flows and living expenses. This way, any potential loss from an investment in a “wrong” stock will not hurt your finances or the family budget. If your initial bets succeed, you should not take it as a sign to go full hog and invest all your savings in the market in one go.
As a matter of principle, you should only invest that part of your savings in stocks which you may not need over the next two years.
Secondly, stay invested in a particular stock for at least a year before you sell it for a profit (if it has rallied after your investment) or exit if its price has fallen. In other words, don’t change your investment decision based on daily or weekly fluctuations in the share price of your stocks.
2. Don’t just make bets but build a portfolio
Equity is a volatile asset and prices can move widely in both directions in the short-term. As an investor, you need to protect yourself against these wild swings in prices as this can wipe off your capital. Diversification is one of the best ways to minimise the downside risk and increase the chances of superior returns over the longer term.
The best way to achieve diversification is to invest in a portfolio of 15-20 quality stocks rather than invest in a handful of hot stocks that may be popular among investors and traders at any point in time.
Equity markets move in a cycle and a particular kind of stocks or sectors lead the rally at any given time while others languish or wait for their turn. A well-balanced portfolio would ensure that some stocks in your basket will always be rally leaders and more than compensate for the poor show by laggards.
3. Stop chasing multi-baggers
Finding multi-bagger stocks is often a matter of luck or being at the right place at the right time. Searching or asking for tips for potential multi-baggers could lock your capital and time in value traps. Value traps are stocks that have always been cheap on key valuation parameters such as price-to-earnings multiple but hardly ever participate in any rally.
Investment in these seemingly cheap but potential multi-baggers can destroy your wealth over the longer term.
Instead, invest in stocks with proven track records of financial success and shareholder reward even if they look expensive at first glance. Quality always comes at a price and you should be willing to pay the price if you want to succeed in the longer term. Always remember that a bad stock remains a laggard in the best of the market while quality stocks outperform even in a dull market.
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4. Every day companies make the best portfolio
It’s a fallacy that you require special skills or a degree in finance or economics to create a great portfolio. Anyone with an eye for detail while doing weekly grocery shopping for their families can create a great equity portfolio. Most companies that manufacture and sell the products we buy and use on a daily basis are financially successful and often have great stocks.
So start by investing in companies whose products and services you buy and understand. Another way is to invest in the stocks of industry leaders like top banks, the biggest car makers, top two-wheeler companies or the biggest FMCG companies.
Market leaders most often have the best finances in their industry and their stock prices fall the least during a recession and are one of the first to rally when growth is back in the industry.
5. Invest in businesses that you understand
Equity investment is not about making wild bets on the future but investment in companies and businesses that can generate returns on capital higher than their cost of capital without going out of the business in the process. Given this one should always invest in the shares of companies whose business model is easy to understand and analyse.
This helps you to avoid costly mistakes and take corrective action at the first sign of financial trouble in your company. Remember, you don’t need to capture all industries and sectors in your portfolio. Stay with companies whose businesses you understand and where information is easily available. With the passage of time, your horizon will widen and you can invest in more sectors.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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