Got money to invest? Here are five ways for prudent investing

Summary

• Investing in financial markets requires a skillset that is honed after years of study and experience.
• To sustain for a long term, a company cannot depend on external factors and needs to have its own edge.
• The management needs to be ethical and capable enough to understand the economics of the business.

There’s an interesting saying about stock markets that over 90% of people eventually lose money in stocks. The primary reason for this high failure rate is the lack of investing know-how. Most of the people rely on others for their investment decisions, which generally turn out to be loss-making investments.

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Investing in financial markets requires a skillset that is honed after years of study and experience. To select a potential winning stock, there are thousands of methodologies that have worked for many investors. However, these methods may not work for everyone, and it depends on every investor’s own financial goals, knowledge, investing experiences, psychology, etc.

But there are a few general tips that could come in handy for all investors, irrespective of their investing style. Let’s have a look at a few of them

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1. Economic moat

Investing is a long-term game, unlike trading. Therefore, an investor needs to find those businesses that have a long-term and sustainable competitive advantage. In the short term, a lot of businesses could do well, especially with supportive economic conditions. One of the best examples of this is commodity-based businesses such as metal and mining companies, which generally do well in an inflationary period.

However, to sustain for a long term, a company cannot depend on these external factors and needs to have their own edge. This edge could be a strong brand value, pricing power, high switching cost.

2. Sectoral outlook

This is probably the most overlooked factor in investing. Most of the people directly focus on the companies that they want to invest in, without analysing the sector they belong to. A sector with a strong outlook is as important as the outlook on the company in that sector. This helps increase the chances of investments delivering a good return.

 “A rising tide lifts all boats” – This stock market adage simply means if the sector itself has a strong potential to beat the broader market, then even the mediocre companies could do well. Likewise, if the sector is having a rough patch ahead, even the strongest companies would feel the heat.

3. Management’s competency

As a captain can navigate a ship to its destination or far away from it, similarly the management of a company can steer the firm towards its goals or away from it.  The management needs to be capable enough to understand the economics of the business, its vision and the challenges ahead to achieve its goals.

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Not only competency, but the management also needs to have a long track record of being ethical and transparent to its shareholders. It is somewhat difficult to judge the management as there are no quantitative parameters to analyse. An investor needs to rely on his judgement by keeping a close eye on the top honchos of the company.

4. Cheap isn’t always good

Investing is all about buying lower than the intrinsic value of the business and selling it at par or above. However, this does not mean that every business that is up for grabs at a discount is a good deal. Most investors fall in the trap of buying a steeply discounted business in a hope to make a windfall profit, without understanding the “why” aspect of the falling share price.

Before jumping the gun, try to analyse why the market is steering clear of this company. If the reason seems justified, try to look for another opportunity, else making a contrarian bet could reap high returns (if the business does well in the future). 

5. Steer clear of the noise

The final tip we would like to give is, stop chasing the buzz. Most of the times, when a stock does exceptionally well over a period of time, it attracts a lot of attention from the street. Media houses, investors, market experts, financial advisors, etc. all start to recommend these ‘hottest’ stocks. There’s no harm in buying a stock that’s rising in value. However, you need to ask yourself a question – “is it too late, or the company is still undervalued?”

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Generally, when the buzz spreads around a stock, and the crowd starts flocking in, this is the time when astute investors, who are holding the stock from the bottom are exiting. Therefore, doing your own due diligence is always recommended.

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