In the last article, we have discussed what you can do when there panic in the market, which sectors are good when there is a slowdown in the economy and why to avoid debt-ridden businesses in recession.
Today we will discuss about my investment philosophy which helps me before picking stocks. Investment philosophy can differ from person to person depending on experience, risk-taking capacity and many other things.
2 simple to understand but difficult to follow rules on investing :
As warren buffet said “Rule no.1: Never lose money and Rule No. 2: Never forget rule No.1 “it’s a simple quote but very difficult to follow. Most of the retail investors are more interested in tips from friends, brokers or relatives and they get these tips during bull markets when all the stocks running like crazy and invest in them and as soon as they invest in them,the party gets over and the stocks which have gone up starts falling with 2X speed and retail investors keep wondering what is happening. They don’t know what to do with these stocks during this time, sell, buy or hold them and most of the time the broker which gave you those tips goes missing.
WHY DO I NEED INVESTMENT PHILOSOPHY :
An investment philosophy is a must before you invest in any business and it will help you :
1)When there is tough time
2)To avoid bad quality stocks
3)To hold on good quality stocks when they are in loss
4)To reduce your losses
In another quote, the warren buffet said: “Be greedy when others are fearful and be fearful when others are greedy”. Your investment philosophy will help you when there is euphoria and when there is pessimism in market, these 2 are completely opposite human behavior. Temperament is the most important aspect of investing and creating long term wealth. But most of the investors panic during the crash, actually it’s the best time to pick quality stocks and hold them for the long term.
We should be ready with our homework on valuations, business model, sector analysis, competitors and then quitely wait till the stock gets undervalued. It is like fishing, you should be patient enough to wait till you get fish and then strike at the correct time.
HOW DO I DEVELOP MY INVESTMENT PHILOSOPHY :
Developing own investment philosophy is not that difficult, you should be aware of what you know and what you don’t know and then focus only on what you know. As warren buffet said
“What an investor need is the ability to correctly evaluate selected businesses. You don’t have to be an expert on every company or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
You can watch my video on the circle of competence here
Following tips may help you to develop your own investment philosophy :
- Define which sector you can analyze and understand and which you can not.
- Research deeper in those sectors which you can understand and avoid others
- Define if you are growth investor, value investor or both
- Define which qualities you looking for in management. E.g.Integrity, intelligence, energy, age.
MY INVESTMENT PHILOSOPHY (S.M.A.L.L.):
Small in size:
I generally prefer the market cap of 5000 to 15000 cr. These are generally small to mid-cap stocks. Mostly I avoid well-discovered blue-chips or large-cap stock as their growth rate is lower and these stock very rarely comes down to fair valuations. Similarly, I avoid micro-cap stocks below 2000 cr, these are the stock which generally doesn’t have a proven business model and very less information is available about promoters.
Management integrity and sector growth:
Management quality is very important before investing in any stock, especially in India where lot of frauds are going on. We as small investors can not do much if something goes wrong in business. So management with clean background is a must before investing.
According to my circle of competence, I have chosen certain sector to invest in which i have better idea than others. Like an automobile, FMCG, Consumer staples, banking, chemicals and metals in my circle of competence but I kept pharma, IT, power, energy out of my circle of competence.
Available at a fair price:
One should come to valuations at the end when the business analysis is done. I use discounted cash flow (DCF), payback ratio, Price to earnings and price to book value to value different businesses.
I generally invest in those businesses which have something unique in them compared to its competitors. It is called moats, moats can be of different forms like a low-cost producer, quality product, the leader in that sector and so on.
This is the life cycle of business, how long it can grow? 5-10-20 years? It depends on the sector to sector. It gives me a rough picture of how long I can stay invested in that stock.
What is your investment philosophy? Let me know in the comment.
[Your Wealth Doctor]