Pat Dorsey's four moats cover

Pat Dorsey’s Four Moats for Picking Quality Companies

While picking a quality company for long term investment, one of the key element to check is the company’s sustainable competitive advantage or Moat.

If you are new to the concept of Moat, I would suggest you to first read this blog post. Anyways, in general, the Moat can be defined as something that keeps a company’s competitors away from eating away their profits/margins for a stretched time. And hence the companies with big moats are able to generate economic profits for a longer time period.

Although there may be dozens of factors that may be counted as a moat for a company like patents, management, technology, switching cost, entry barrier etc. However, in the book “The Little Book that builds wealth”, Pat Dorsey, ex-director of equity research at Morningstar and founder of Dorsey Asset Management, described that there are only four moats that really matters while picking stocks.

Rest all are either confused moats or not durable for a very long time period. In this post, we are going to discuss Pat Dorsey’s four moats for picking stocks.

A little Introduction to Pat Dorsey’s Moat

“FOR MOST PEOPLE, it’s common sense to pay more for something that is more durable. From kitchen appliances to cars to houses, items that will last longer are typically able to command higher prices, because the higher up-front cost will be offset by a few more years of use. Hondas cost more than Kias, contractor-quality tools cost more than those from a corner hardware store, and so forth.

 

The same concept applies to the stock market. Durable companies — that is, companies that have strong competitive advantages — are more valuable than companies that are at risk of going from hero to zero in a matter of months because they never had much of an advantage over their competition. This is the biggest reason that economic moats should matter to you as an investor: Companies with moats are more valuable than companies without moats. So, if you can identify which companies have economic moats, you’ll pay up for only the companies that are really worth it. 

(Source: Chapter 1 — The Little Book That Builds Wealth)

In his book, ‘The little book that builds wealth’, Pat Dorsey suggested that as a company expands, it attracts more competition. And here, the biggest element that helps the company to remain profitable and beat the competitors consistently, in the long run, is their durable economic moat.

And that’s the reason why a few companies remain highly profitable for decades even in competitive spaces. A few examples of such companies can be Apple, Microsoft, Coca-cola, P&G etc.

Pat Dorsey’s Four Moats That Matters:

Here are Pat Dorsey’s four moats that you should look in a company while picking quality stocks with huge sustainable advantages:

1. Intangible Assets

Intangible assets are those assets that you can’t touch or see. A company can have intangible assets, like brands, patents, or regulatory licenses that allow it to sell products or services at a bigger margin that can’t be matched by the competitors.

For example, Coco-cola. If you look at their products, they are just carbonated sugar water and not much different from any other soda shop that you visit locally to buy cheaply priced drinks. However, when this carbonated sugar water meets the brand value of coke, they are priced way higher than what its competitors do, and still able to make way way more sales and revenue.

Similarly, in the pharmacy industry, if a company has got a patent over a specific drug, it may enjoy high sales without worrying much about the competition. And that’s why Pharmacy companies spend a lot of money on their Research and department (R&D) units.

2. Customer Switching Costs

If the customer has to cost a lot of money, time, efforts or resources to switch from one product to another, it is considered as the switching cost. If the products or services offered by a company has high switching cost (or really difficult for the customers to give up those products) then the firm enjoys a bigger pricing power and profit margin.

A great example of a customer switching cost is MS Excel. Although a lot of better tools compared to Excel are available publicly, however, to make all your employees learn any new tool, the company may have to cost a lot of time and resources.

Similarly, a few other software companies with high switching costs can be Adobe Photoshop, Auto-desk, MS Office etc. All these complicated programs cost a lot of efforts to learn and switching from one to another can be really difficult for the users. Unlearning and relearning these tools demands a lot of time, money and resources like pieces of training, courses etc.

3. The Network Effect

These are those companies whose value increases as their number of users increases.

A few examples of companies with a big network effect in recent days can be social platforms like Facebook, WhatsApp, Instagram etc. People are moving into these platforms as all their friends/peers are using them which makes them more valuable. So even if there are another better social media available, however, if your friends/family are not using them, you might be reluctant to switch there.

A few industries like e-commerce or food-delivery especially enjoy the networking effect. More customers are moving to ‘UBER Eats’ because more restaurants are associated with them. And on the other hand, more restaurants are associating with UBER Easts because more customers are moving into that platform. Overall, the users are inviting the restaurants and vice-versa and the platform benefits from the networking effect.

Another great example of industries with networking effect can be ‘Credit card’ industry. Here, customers are getting attracted to a credit card as they are accepted widely by many merchants. On the other hand, more merchants partner up with the credit cards as they have a bigger customer base. Overall, it’s all about networking effect for these companies.

4. Cost Advantages

These are those companies which are able to find better ways of producing their products or services. They enjoy cost advantages by improving processes, finding a better location, greater scalability, or access to a unique asset, which allow them to offer their products or services at a lower cost than competitors.

In general, the cost advantage is most useful in those industries where substitutes are easily available or for those products/services where the price matters the most for the customers while making their purchase decision.

A few examples of a company with cost advantage can be MacDonald (Standardized, low-cost approach and low-price menu), Walmart (low-cost advantage being scaled up to the massive effect), Vanguard (low-cost index fund that made an enormous impact on the investment world) etc.

Anyways, out of all the different sources to improve cost, Process-driven cost advantage should be carefully studied while evaluating companies. This is because processes can be easily copied. On the other hand, if the company enjoys cost advantages with greater scalability, it can do wonders for the businesses and investors.

Also read:

Closing Thoughts:

In addition to the four moats that matter, in his book, Pat Dorsey also discussed a few other confused moats (things that are not exactly moats) or the eroding moats (the ones which fade away with time) like Technology, Trends, Market Position, and management.

To understand a better picture, I would highly recommend you to read the book “The little book that builds wealth”. It will help you to learn the concept of moat far better while picking quality companies. And moreover, the book is only 210 pages long. You can easily read the entire book within a week.

Finally, there’s one more point that I would like to add before ending this post. A moat on its own is not enough. There are multiple examples of companies with big moats but saturated profits. However, a combination of a moat with strong management, and growth potential is what makes a company a great investment.

3 Dumb Stock Picking Strategies That You Need to Avoid cover

3 Dumb Stock Picking Strategies That You Need to Avoid!

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” – Charlie Munger

Over the last couple of years, since I’ve started investing, I’ve come to know so many strategies followed by different investors. Whether they are- Value pickers (those who buy great businesses at a discounted price), growth picker (those who prefer stocks which are growing at a high pace compared to peers or industry) or income stock pickers (those who invests in stocks which give huge dividends), I have heard of them all.

Apart from them, another category of popular stock picking strategy are the ones who rely on algorithms, programs, expensive arrangements or robo-advisory to pick stocks. And they are also quite successful in making money from the stock market.

However, after interacting with thousands of the Trade Brains’ blog subscribers and also through my personal experience, I’ve also come to know a few dumb strategies that many people use to pick stocks which mostly turn out to be a disaster a few years later down the road. (Btw, I’ve also been a victim of a few such strategies during my rookie days. Therefore, do not feel too bad if you have been using these strategies to pick stocks.)

Now, I totally understand that picking these stupid disastrous strategies are not entirely the fault of the beginners. After all, we are neither educationally trained or psychologically programmed to pick the best strategy that suits our interests. As humans, we generally prefer taking shortcuts and this is one of the biggest reason for the individuals to pick these dumb stock picking strategies.

Nevertheless, knowing the strategies which may turn out to be a catastrophe in the future may help the newcomers to avoid them. Therefore, in this post, we are going to discuss three dumb stock investing strategies that investors need to avoid else it may turn out to be a disaster in the future.

3 Dumb Stock Picking Strategies That You Need to Avoid

1. Investing based on Free Tips/Recommendations.

You are getting consistent stock tips on your phone to buy/sell equities and you finally decided to give it a try. This is one of the most dangerous stock picking strategies. Better you should put that money on a lottery ticket if you are willing to take such a risk.

Moreover, the majority of the free tips or recommendations that you receive on your phone via SMS or WhatsApp these days– are SCAMS. Don’t believe me, then read further regarding the same here: 3 Most Common Scams in Indian Stock Market That You Should be Aware of.

Besides, let’s say you’re discussing the market with a colleague/friend/neighbor and they advised you to invest in a particular stock. Unless they are professionally trained in the market (such as research analyst or investment advisor), most of these recommendations are crap and a definite path for future regrets.

2. Picking a stock because a big investor recently invested in it.

Seriously, this is your strategy? Are you planning to match your investing strategy with that of a big successful investor?

As a matter of fact, you should understand that you can never meet the risk appetite, resources, and exit-strategies of the big investors. There are hundreds of things that may go wrong in this strategy and hence, it’s never a good idea to blindly picking a stock just because a big stock market player invested in it.

Anyways, I agree that following the stock picking strategies and portfolio of big investors can be good learning. However, do your own research before investing and avoid being anchored with big investors’ stock picks.

Also read: Is Copycat Investing Hurting Your Portfolio?

3. Picking a stock because it is continuously going higher

If there is a single lesson that you should learn from this post, then remember this- “Stock prices going upwards is not a reason to buy and prices going down is not a reason to sell.

You should never pick a stock just because it is going higher. Stock prices movement on its own tells nothing.

Here, you need to look into the fundamentals, recent quarterly/annual results, corporate announcements, and other related news to find out the reason of price movement. Always make an informed decision after properly analyzing the company, rather just the price movement.

Bonus

4. Picking a stock because you feel it will go high

Recently, I was talking with one of my friends, Manish, and we begin discussing the equity market. After debating various investing ideas, Manish said that he is planning to buy Tata Motors share because he thinks that its price will re-bounce in upcoming months (Btw, at the time of writing this post, Tata’s share was down by over 57% in last one year).

I knew that Manish didn’t have much investing experience and hence I simply asked why he thinks that Tata Motor’s price will go up. He replied that the price is really down and he’s getting a feeling that the share price will recover and go up in the future.

Now, the share price of Tata Motors ‘may’ or ‘may not’ go up in the future. This is an entirely different discussion which I do not want to start right now. However, the answer that he gave to explain why Tata’s share price may go up is really stupid, right?

If he had talked the stuff like the sales of Tata Motors is going up, or their profit margin is increasing or Tata’s are launching a new vehicle in a segment which may be demanding among the audience, then I might have considered the reasoning. I mean, if someone gives me a factual reason why they believe that the price will go up, then I might discuss it further. However, if the reason is your ‘intuition’ or ‘gut feeling’, I can’t argue much regarding the same.

While investing in stocks, remember that you are not predicting whether it’s gonna rain today or not. Here you are analyzing companies which have fundamentals. There are a lot of pieces of information like the company’s financials, the board of directors talks/speeches, related news etc which are publically available to analyze companies. However, if instead of using these informations, you are making an investment decision based on your intuitions, you should rather be ready for an investment disaster.

Also read:

stock market meme 31

Closing Thoughts:

According to Benjamin Graham, the father of value investing, investment can be defined as “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

If you want to make decent returns from the share market, you need to stop speculating and making decisions based on these dumb strategies. If you are new to investing, take your time, learn and start building your own repeatable strategy by properly analyzing the companies which may produce consistent returns in the long term.

That’s all for this post. I hope it was helpful for you. Happy Investing!!

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21 All-Time Best Quotes by Charlie Munger

Charlie Munger, 95, is a name that doesn’t require any introduction for those involved in the investing world. If you are new to investing, you might have heard Charlie as Warren Buffett’s right hand. However, even individually, Charlie Munger is considered as one the world’s wittiest investor.

Anyways, let me first introduce Charlie Munger to the newbies. Charlie Munger is an American investor, businessman and a self-made billionaire with the net worth of over $1.7 Billion (as of Feb 2019). He is the vice chairman of Berkshire Hathaway, the conglomerate headed by Warren Buffett. And like Buffett, Charlie Munger is also an active philanthropist and has donated millions of his personal wealth for good causes.

Interesting, if you look into his background, Charlie Munger never took any course in investing, finance or economics while he was in university. During World War II, Charlie studied meteorology at Caltech to become an army meteorologist. Later, he earned a degree in law from Harvard Law School.

Charlie Munger and Warren Buffett met in 1959 during a dinner party and got along immediately. Although they knew each other for a very long time, however, they built their informal partnership by investing together only in the 1970s. Later in the 1980s, both started the present structure of Berkshire Hathaway and have been running in profitably ever since by building wealth for themselves and their investors. Here’s what Warren Buffett thinks of his business partner Charlie Munger:

We’ve got an extremely good partnership and business is more fun — just as life is more fun — with a good personal partner and to have a great business partner. You know it’s just — we’ve accomplished more but we’ve also had way more fun.” -Warren Buffett

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Charlie Munger’s wisdom is an asset for all the investing community. The knowledge and success that he has gained in the past many decades is quite inspirational.  Therefore, in this post, we are going to highlight twenty-one evergreen quotes by Charlie Munger that every investor should know. Let’s get started.

21 All-time best Quotes by Charlie Munger

Charlie Munger Quotes on investing wisdom

“People calculate too much and think too little.”

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

“What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ’em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head. And you’ve got to array your experience — both vicarious and direct — on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and fail in life. You’ve got to hang experience on a latticework of models in your head.”

Charlie Munger Quotes on Wealth Creation

“The big money is not in the buying or the selling, but in the waiting.”

“What are the secrets of success? -one word answer: ”rational”

“It takes the character to sit with all that cash and to do nothing. I didn’t get to where I am by going after mediocre opportunities.”

“To get what you want, you have to deserve what you want. The world is not yet a crazy enough place to reward a whole bunch of undeserving people.”

“All I want to know is where I’m going to die so I’ll never go there.”

Charlie Munger Quotes on Importance of learning

“There isn’t a single formula. You need to know a lot about business and human nature and the numbers… It is unreasonable to expect that there is a magic system that will do it for you.”

I paid no attention to the territorial boundaries of academic disciplines and I just grabbed all the big ideas that I could.”

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time — none, zero. You’d be amazed at how much Warren reads — and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

“Spend each day trying to be a little wiser than you were when you woke up. Day by day, and at the end of the day-if you live long enough-like most people, you will get out of life what you deserve.”

Also read: 31 Hand-Picked Best Quotes on Investing: Buffett, Munger, Graham & More.

Charlie Munger Quotes on Circle of Competence:

“Knowing what you don’t know is more useful than being brilliant.”

“If something is too hard, we move on to something else. What could be simpler than that?” 

I try to get rid of people who always confidently answer questions about which they don’t have any real knowledge.”

“We have three baskets: in, out, and too tough. … We have to have a special insight, or we’ll put it in the “too tough” basket.” 

Charlie Munger Quotes on life rules to live by

“Mimicking the herd invites regression to the mean.”

“Remember that reputation and integrity are your most valuable assets — and can be lost in a heartbeat.”

Just because you like it does not mean that the world will necessarily give it to you.”

“Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand — you must learn to handle mistakes and new facts that change the odds.”

Take a simple idea, and take it seriously.”

Suggested Readings on Charlie Munger

Book: 

Articles: 

thematic investments

Why You Should Try Thematic Investments?

Suppose you believe in an idea and confident that it will perform well in future. For instance, let’s say you are optimistic towards the renewable source of energy. Here, you are assured that the grid and other conventional sources of energy will be replaced by the renewable source of energy like solar or wind energy in the future. And therefore, you want to invest in this idea.

However, you are not certain of the best leading company in this segment to invest. Moreover, you also do not want to invest in the entire energy sector through any sectoral mutual fund as you want to focus just on the renewable energy-related companies. How to proceed further with your investments? Enter the thematic investments.

What is Thematic Investment?

As you might already know, mutual funds also provide an option to invest in different sectors via sectoral funds. For example, pharmaceutical funds focus on pharma companies or banking funds focus on investing in companies in the banking Industry. However, thematic funds are different from the sectoral fund.

Thematic funds are growth-oriented equity funds that focus on investing in a set of companies based (or closely-related) to a particular theme. They follow a top-down approach and targets a broader macro-economic theme on which the fund manager has a good knowledge of. Here, the thematic fund investors studies and understand the impact of structural shift in economics, political, technological, corporate or social trends on sectors, demographics etc which may reveal investable opportunities.

For example, electric vehicles (EVs) can be considered a theme. Here, the thematic fund based on EVs do not just need to focus on one automobile industry, rather they can include a set of industries which are a part of the theme. For example- this theme may include companies from the automobile industry, battery industry, Metal companies involved in making battery parts like Graphite, Aluminium, Carbon, etc, auto-ancillaries industry or any other companies related to the EVs.

A few other popular themes in India right now are digital India, make in India, technological progress, Internet of things, blockchain, environmental sustainability, social security etc.

thematic investments approach-min

Mutual funds vs thematic funds:

As I already mentioned above, thematic funds are different from the mutual funds and here are a few major differences between them:

— Mutual funds are over diversified while thematic funds are compact. Mutual funds invest in somewhere between 40–100 stocks. On the other hand, the number of stocks in thematic funds are smaller, typically between 5–20.

— Mutual funds are rigid and not easily customizable. Although there are thousands of mutual funds available in the Indian market, however, they are not customizable. On the other hand, it’s easier for investors to choose their ideas/sentiments and factor their risk appetite through thematic funds.

— The costs involved with mutual funds are high. For managing a popular active fund, the fund house may charge an expense ratio as high as 2.5-3%. However, the fees involved with thematic funds are comparatively cheaper.

Advantages of Thematic Funds

Here are a few common advantages of thematic funds:

—  Thematic funds are potentially more rewarding compared to diversified mutual funds.

— As thematic funds offer a compact theme, they have a concentrated impact because of news or happenings in other non-related industries.

— There are a lot of publicly available popular themes in the Indian market and hence, finding the right investment opportunity is not a tough task for investors. For example, you can use FYER’s thematic investment platform to try new different themes.

— Thematic funds allow strategic exposure to the investor’s portfolio and encourage common sense investing as themes represent the investor’s ideas and thoughts.

The risk associated with thematic funds:

There’s no denying the fact that no investment strategy is perfect. And the same goes to the thematic investments. By making investments in thematic funds, you are preferring a concentrated theme. This portfolio concentration makes these thematic funds comparatively riskier over diversified mutual funds.

Moreover, there’s also a controversy regarding thematic investments which says that investing in a concentrated idea which is still untested and underappreciated, may not be a sound approach.

Also read:

Closing Thoughts:

A major difference between thematic investments and traditional ones is that the thematic investors look into the future and makes decisions based on the predictions on the future trends or upcoming shift in the structure. On the other hand, traditional investors check the history and weights more importance to past performance, market behavior etc.

Moreover, we cannot deny the fact that themes change fast with time. In the last two decades, we have witnessed massive changes in the industrial and technology theme. Therefore, if you are planning to make thematic investments, be observant and careful regarding the entry and exit decisions. Only enter these funds after you have researched the idea thoroughly.

Nonetheless, if you are able to invest in right thematic funds, they are capable of giving huge returns to the investors compared to other index or diversified funds.

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What is Sunk Cost Fallacy? And how it Can Affect Your Decisions?

Have you ever been in a situation where you went to watch a movie in the theatre, however, it turned out to be terrible? What did you do next? Did you walked out of the theater or continued watching it till the end because you were afraid that you have already paid for the ticket? If you choose the latter, you have fallen for the sunk cost fallacy.

In this post, we are going to discuss what exactly is a sunk cost fallacy and how it can affect your investment decisions. But first, let us understand what are sunk costs.

What are sunk costs?

Sunk costs are those irrevocable costs which have already been occurred and cannot be retrieved. Here, the costs can be in term of your money, time or any other resource.

For example- Let’s suppose that you bought a brand new machine. However, after using it for three months, you realize that the machine is not actually working as you desired. And obviously, the return period of the machine has surpassed. Here, even if you sell the machine, you will get a depreciated value compared to what you originally bought. This cost is called the sunk cost.

In general, people should not consider sunk costs while making their decisions as these costs are independent of any happenings in the future. However, humans are emotional being and unlike robots, we do not always make rational decisions.

Examples of Sunk Cost Fallacy

Sunk cost fallacy, also known as Concorde fallacy, is an emotional situation where the individuals take sunk costs into consideration while making the decisions.

We have already discussed the example of watching the entire movie (even if it is terrible) just because you, as a consumer, won’t get back the money of your ticket. This is a classic example of sunk cost fallacy.

Another example can be when you eat foods that you do not like because you have already bought that food and cannot revoke that sunk cost. Similarly, overeating after ordering foods in restaurants because food has been already ordered is also an example of sunk cost fallacy.

Further, a typical example of the same fallacy is when you keep attending the miserable classes of your college (that you do not enjoy) because you have already invested a lot of time in that course and also have paid the tuition fee. Besides, salaries, loan payments etc are also considered as sunk costs as you cannot prevent these costs.

A quick point to mention here is that not all past costs are sunk costs. For example, let’s suppose you bought a shoe and you didn’t like it after reaching home. However, as the shoe is still in the return-period of 30 days, here, you can return the shoe and get back your purchase price. This is not a case of ‘sunk cost’.

Sunk Cost Dilemma

Sunk cost dilemma is an emotional difficulty to decide whether to continue with the project/deal where you have already spend a lot of money and time (i.e. sunk cost) or to quit because the desired result has not been achieved or because the project has an obscure future.

Here, the dilemma is that the person cannot easily walk away from the project as he has already spent a lot of time and energy. On the other hand, continuously pouring more money, time and resources in the project also do not seem a good idea because the outcomes are uncertain. This dilemma of deciding whether to proceed further or to quit is called sunk cost dilemma.

For example- Let’s say you started a business and invested $200,000 over the last three years. However, you haven’t achieved any wanted result so far. Moreover, you cannot see the business working out in the future. Here, the dilemma is ‘what to do next?’. Should you bear the losses and move on, or should you invest more resources in that uncertain business?

Another common example of sunk cost dilemma can be a bad marriage. Here, the couples find it difficult to decide whether to save themselves (and their spouse) by splitting up when they are sure that the things are not going to work out. Or should they hold on to the marriage just because they have already spend a lot of time together and breaking up will make them look bad?

Sunk cost dilemma in Investing

Even investors are common people and they face the sunk cost dilemma while making their investment decisions.

For example, let’s say that an investor bought a stock at Rs 100. Later, the price of that stock starts declining. In order to minimize the losses, the investor averages out the purchase price by buying more stocks when the price kept falling (also known as Rupee cost averaging). Here, the dilemma happens when the stock keeps underperforming for a stretched period of time. Here, the investors are uncertain whether they should book the loss by selling their stocks, or should they continue averaging out with the hope that they may recover the losses in the future.

Another example of the sunk cost dilemma is people buying/selling aggressively in risky stocks once they have incurred a few major losses in the past to ‘break even’ those losses. However, the losses have already been incurred and investing in risky stocks to cover those losses won’t do any good to such investors. The better approach would be to choose those stocks that can give the best possible returns in the future, not the imaginary aggressive returns that they expect to match up the sunk cost.

As an intelligent investor, people should ‘not’ consider the sunk costs while making their decision. However, this is rarely the case.

Also read:

Closing Thoughts

It is no denying the fact that nobody likes losing and hence the past losses can influence the future decisions made by the individuals. However, one must not consider sunk costs while making their investment decisions.

As sunk costs cannot be changed (recovered), a rational person should ignore them while making their judgments. Here, if you want to proceed, first you should logically assess whether the project/deal is profitable for the future. If not, then discontinue the project. In other words, try to forecast the future and react accordingly.

Anyways, a few methods of solving the sunk cost dilemma is by opting for incremental wins over the big ones, increasing your options (not just to completely quit or go all in) and in the terminal case, cutting your losses. When stuck in this dilemma, try to make minimum losses by looking at the mitigating options.

75x Returns by Sensex in last 30 Years of Performance.

The 3 Words that may be holding you back from investing in stocks.

Fear of Losing!!

Since childhood, we are taught to save money. “A penny saved is a penny earned.” And the idea of losing money is something which we are not psychologically programmed to opt for.

When you invest in stocks, there is a probability that its value may decrease if you have made the wrong investment choice. Unlike most other investment options like Fixed deposits, Gold, Real estate, bonds etc, the stock market is a place where your invested amount can fluctuate a lot within hours. And these daily fluctuation of prices ignite the fear of losing. And trust me, no one likes losing, especially their hard-earned money.

Moreover, when you invest in stocks, there is no guarantee that it will give you good returns. Even the safest stocks may decline in value because of unforeseen reasons. And that’s why, a majority of the population tries to keep a safe distance from the stock market.

But, there’s one thing that most of these people forget.

You are already losing money!!!

When you are not investing, you are losing the value of your money. How?

The old common answer- “Inflation”

Inflation can be described as a continuous increase in the general level of prices. And when the price increases, obviously the purchasing power of your money will decrease. The money in hand that you have ‘today’ is not of the same worth in ‘future’. Therefore, no matter how much safer you are keeping it in a vault or bank account, you are losing your money.

Currently, the predicted inflation rate in India is +4.89%. Therefore, if you are not making interest on over 4.89% on savings, this means that you are not beating the inflation and in other words, losing money. Frankly speaking, most of the savings account in India do not offer such high-interest rate. And in the worst case, if you are keeping cash, you won’t getting any interest at all.

inflation in india

(Source: Statista)

Historically, stocks have out-performed all other investment options.

Traditionally, people in India used to invest in gold and property. The came savings, fixed deposits, bonds etc. And finally, since the stock exchanges became more active in India, the next investment options were stocks and mutual funds. Anyways, history says that the returns from the stock market has out-performed all the other investment options.

sensex last 30 years

Also read: 75x Returns by Sensex in last 30 Years of Performance.

You can reduce the risk while investing in stocks.

Although you cannot completely get rid of the risk, nonetheless, you can definitely reduce it by following a few simple rules. And when the risk reduces, it will also decrease your fear of losing money. Here are a few methods which can help you reduce the risks while investing in stocks:

Diversify your investment:

It’s true that no one cannot correctly and precisely predict the future returns from any stock. However, you can increase the chances of being correct by making multiple good bets in different companies.

Even if two out of ten doesn’t perform well or fails miserably due to whatever reason, if the other eight stocks are performing decently, you can get decent returns and minimize the harm done on your overall portfolio. Portfolio diversification is the easiest approach that investors can follow to reduce the risks while investing in stocks.

Also read: How to create your Stock Portfolio?

Invest in blue chips

Blue chip companies are large and well-established companies with a history of consistent performance. These companies are financially strong (usually debt-free or very low debts) and are capable to survive in the tough market situations.

Most of the blue-chip companies are the market leaders in their industry. A few common examples of blue chip companies in India are HDFC Bank, ITC, Asian Paints, Maruti Suzuki etc. These companies are comparatively safer to invest vs mid or small cap companies who are associated with high risks.

Also read: 10 Best Blue Chip Companies in India that You Should Know.

Get an investment advisor.

This is the easiest approach that people anyone can follow to minimize the risk without limiting the investment options. If you do not have time to study or research stocks or your own — hire a financial planner for making your investment decisions instead of you.

Now I understand that most people are reluctant to hire investment advisors or financial planners. But think of it in this way — If you can hire a doctor for taking care of your physical health, why cann’t you get the help of an investment advisor to take care of your financial health?

Ovearll, if you find investing by your own boring or do not give sufficient time to research in order to make the right investment decisions, then hire a professional.

Apart, a few other ways to reduce risk in your stock investments are rupee cost averaging, investing in index funds and having a big margin of safety.

Closing Thoughts

It’s a fact that the fear of losing cannot be completely detached when you are investing in stocks. However, the ability to overcome this fear to make wise decisions is necessary skill to learn for the individuals if they want to build good wealth. Therefore, mind these three words and make sure that ‘fear of losing’ is not the actual reason why you are losing money.

Is Negative Price To Earnings of Stocks a Bad Sign for Investors cover

Is Negative Price To Earnings a Bad Sign for Investors?

Price to earnings ratio is definitely one of the most frequently used valuation ratio used by the investors to evaluate a company. Although I do not use this ratio too often, however, every now and then I check the PE of companies and industries to try to look them from a different angle.

Recently, I was going through the list of companies which are not making profits, in other words, losing money. Therefore, I run a simple query on stock screener to find the list of companies with negative earnings per share for the trailing twelve months.

Not surprisingly, I found the names of a lot of big companies in that list. A few of such companies with negative Earnings per share (EPS) for the trailing twelve months were State bank of India (SBI), Lupin, Adani Power, Tata Communication, Idea, Bank of Baroda, Future consumers etc. Here is a detailed list of such companies:

company with negative earnings

(Source: Trading View)

And obviously, when the earning of a company is negative, their Price to earnings will also be negative. Seeing so many big names in the list of companies with negative PE, it is easy to conclude that there will be thousands of people investing in companies that are losing money.

Therefore, in this post, I decided to discuss whether negative price to earnings of a company a bad sign for the investors. Let’s get started!

How Price to Earnings ratio is calculated?

As the name suggests, Price to earnings ratio is calculated by dividing the current market price per share by its earning per share.

PE ratio

For example, if the share price of a company is Rs 100 and the annual earning per share is Rs 20, then the Price to earnings ratio will be equal to 100/20 i.e. 5.

PE ratio of a company reflects how much people are willing to pay for that share compared to each Rs 1 in earnings. For example, for a company with a PE ratio, 5 means that the people are ready to pay a premium of 5 times for every Rs 1 of earnings. And obviously, the lower this premium, the better it is for the investors.

PE ratio is frequently used by the investors to find if a stock is undervalued or overvalued. Usually, a company with a lower PE ratio is a better valued. For example, a company with PE of 8 is comparatively undervalued against a company with a PE of 12.

Also read: No-Nonsense way to use PE Ratio.

Negative Price to Earnings

Basically, the share price of a company cannot go negative. Therefore, if the price to earnings is negative, it means that the company has negative earnings.

Although it is advisable to invest in companies with lower PE ratio, however, when this ratio becomes negative, it might not be favorable for the investors.

A negative price to earnings means that the company is not making profits and hence, why do you wanna invest in companies who are losing money? As a thumb rule, avoid investing in companies with negative price to earnings. If you want to live by a single rule for PE, then this might work perfectly well for you.

Moreover, a company with consistent negative PE means that it is not able to generate profits for a long period of time and therefore, it may fall into trouble while running its normal business operations and in the worst case, it may face the risk of bankruptcy.

Quick note: Most financial websites do not show the negative price to earnings for a company. In general, they will use the word ‘Not applicable’ or ‘ — ’ for the companies with a negative price to earnings.

When negative price to earnings might not be a bad sign.

A few industries like pharmaceutical or technology may have negative earnings if they are extensively spending in their research and development. Although it may be unfavorable for them in the short run, however, if they are able to spend their money in the right direction, it may be a good expenditure for the long term.

For example, if a pharmaceutical company is able to build a medicine for a rare disease and gets a patent for it, the company may generate a lot of profits through that research in the future.

Similarly, if a technology company is able to create a disruption through its research (a few of such trending technologies right now are artificial intelligence, deep learning or blockchain), they might be able to create a competitive advantage and generate profits in long run. And therefore, many investors are willing to invest in such industries even when they are not making money.

Note: Sometimes, a company may also have a negative PE because of the change in accounting norms or because of a few unexpected occurrences. In such scenario, you should not consider it as a bad sign and may wanna investigate further.

How to correctly analyze negative PE ratio?

While studying the price to earnings of a company, compare the PE with the competitors and historical performance. If the company’s PE is consistently falling for the last many years, it may be a warning sign. Further, if the PE of all the other competitors is positive and decently high, then the negative price to earnings for that company may be a caution sign.

Further, comparing the price to earnings of the company with the industry average can also give you a rough idea regarding the situation of that company.

Also read: #19 Most Important Financial Ratios for Investors

Closing Thoughts

In general, it is preferable for the investors to stay away from companies with a negative price to earnings. As an investor, you should find fundamentally strong companies to invest which are consistently making money.

If a company is consistently reporting a negative PE for a longer duration of time, then you should be concerned about it. Anyways, in a few industries, have a look at the company’s expenditure on Research and development by peeking in their income statement. This can give you an idea if the company is working on any cutting edge research or simply losing money in their operations.

Finally, never make your investment decision based on just one ratio. Price to earnings ratio is just a valuation tool. Apart from PE ratio, also look into other quantitative and qualitative aspects before making your choice.

inventory on balance sheet cover

How to Evaluate Inventory on Balance Sheet?

In the past two decades, we have seen countless companies which turned from zero to over billion rupees in market value with very limited inventories. It’s true that companies in the information sector (which only require a laptop and internet connection) doesn’t need a lot of inventories. After all, if the sole purpose of a company is running their mobile app (Android/iOS) and offering services through them, then what physical inventories they actually need apart from hosting, customer support and a few other development tools.

On the other hand, if you look into manufacturing companies which offer goods to the people/organization, inventory analysis plays a crucial role. The inventories of those companies are their most valuable current assets as they contribute directly to the source of revenue.

In this post, we’ll discuss what is an inventory and how to evaluate inventory on balance sheet.

What is an inventory?

inventory-control

Integratory can be defined as the goods available for sale and raw materials used to produce those goods. In other words, these can be the raw materials, goods in process and the finished goods.

There are a number of advantages of keeping sufficient inventories for a company. For example, if the company has the necessary inventories, it can quickly meet the customer orders. Stock in hand improves customer experiences. Moreover, in a few sectors, high inventories may make an attractive display and increase conversions.

On the other hand, delays in fulfilling orders, empty shelves and products out of stocks might drive away customers to the competitors. And therefore, inventory control is a key area for the company’s management to focus.

Excess Inventory

inventory

In case the company has excess inventories, it may be a little troublesome for them.

Too much inventories involve a higher cost of storage, damage issues, and insurance costs. It may also lead to increased wastage of goods if the inventories are perishable or the threat of obsolescence in case the products changes fast.

Moreover, if the company is spending a lot of money on excessive inventories, it is fixing that money which they could have used in other potentially rewarding opportunities. And that’s why excessive inventories should be controlled by the company.

How to Evaluate Inventory on Balance Sheet?

The Inventory level of a company can be evaluated by using the inventory to current asset ratio. This ratio reflects how much percentage of the current asset is kept as inventory.

Inventory to current asset=Inventory/(Current assets)  ∗100

Although the ideal inventory to current asset ratio varies industry-to-industry as a few industries may require more inventories in their shelves for timely operations compared to other. However, as a thumb rule, this ratio should be less than 40%.

Moreover, try avoiding to invest in companies with inventory to current asset ratio greater than 60% as this might reflect too much inventories and the management’s inefficiency in inventory control.

For example, here is the balance sheet of Hindustan Unilever (HUL). Let’s calculate its inventory to current assets ratio.

inventories hul

Balance sheet HUL

For Hindustan Unilever, if you calculate the inventory to current assets ratio, you can find it equal to 30.75% for the year ending March 2018.

In the last 5 years, this ratio has been continuously increasing- 21.55% (2014), 24.87%(2015), 26.87%(2016), 28.54%(2017), which means that HUL is spending more on their inventories. As the inventory to current assets ratio is still under satisfactory level, this can be considered healthy for the company.

However, to get a better idea, you need to compare the inventory to current assets ratio of HUL with its competitors in the consumer goods segment.

Note: If you are new to the financial world and want to learn how to effectively read the financial statements of companiesfeel free to check out this awesome online course on Introduction to Financial Statements & Ratio Analysis.

Summary

Although inventories are often ignored while evaluating companies in many industries, however, they are still one of the most crucial assets of a company. And that’s why inventory control is an important area to focus.

A low inventory level may lead to delays in completing orders, empty shelves and out of stocks which are not a good experience for the customers. On the flip side, excess inventory might lead to higher cost of storage, damage issues, insurance costs, spoilage costs or the threat of obsolescence. In order for a company to work effectively, its necessary to have sufficient (but not excess) inventories.

Also read:

margin of safety cover

Three Words That Matters: Margin of Safety

When I worked as a Trainee at Tata Motors, I got to know about the term payload. In easy words, it is simply the load carried by a vehicle. The payload helps the owner to determ­ine how much they can fit in their vehicle and moreover how many trips they have to take to carry a specific load.

During that time, once I was walking with my manager and we were discussing a light truck – Tata 407, which could carry 2.25 tonnes of payload. And we started talking about its payload. My manager told me that most of the commercial vehicles in India are almost always overloaded and easily crosses the prescribed payload. I asked him why do the Tata trucks perform so well then and why it doesn’t break? Obviously, if you overload the truck with twice its capacity, it should snap. And his answer was Margin of safety!!

Before developing any new vehicle, there’s a comprehensive study done on consumer behavior. And the R&D team of Tata knew this Indian behavior of overloading the truck in order to reduce the total number of trips to carry out the goods. And that’s why the load capacity of the Tata trucks are always more than what specified in the manual.

Moreover, here having a safety is a must for Tata trucks as they are known for their strength and the brand image matters a lot while selling vehicles in the automobile segment. They couldn’t afford to get their brand image ruined by not having a margin on their vehicle’s load capacity.

A similar concept of safety is used in the investing world to reduce the risk and maximize the profit. In fact, it is the central concept of value investing.

What is the Margin of Safety?

The margin of safety means purchasing the stock when the market price of the company is significantly below its intrinsic value. Here, the difference in the intrinsic value and your purchase price is called the Margin of Safety (MOS).

The fundamental analysts believe that there is a true (intrinsic) value for all the company which can be found by reading financials of the company. Moreover, they also believe that the stocks do not trade at their true intrinsic value at most of the time because of speculations and other short term market behavior. A stock can be overvalued or undervalued at any moment of time. And that’s why Investors can make good profits by purchasing stocks when they are trading at a discount i.e. below their true value.

The margin of safety helps to safeguard the investments against calculation error, human error, judgment errors or any other unexpected occurrences concerning the market or stocks.

margin of safety chart

The margin of safety plays a significant role while purchasing stocks.

For example, if you think a stock is valued at Rs 100 per share (fairly). Then, there is no harm in giving yourself some benefit of the doubt that you may be wrong with your judgment and calculation. And hence, you should buy that stocks at Rs 70 or Rs 80 instead of Rs 100. Here, the difference in the calculated intrinsic amount and your final purchase price is your margin of safety.

The ideal margin of safety depends on the risk tolerance of an investor. The strict value investors may have a MOS of over 50% to minimize the downside risk. On the other hand, aggressive investors may choose a comfortable MOS of 10–15%. As a rule of thumb, always have a margin of safety of between 10–30% on the intrinsic value of the stock while making your investment decisions.

Moreover, apart from the risk tolerance of the investor, this margin of safety percentage also depends on how risky the investment is. If you are investing in a safe blue chip stock, this margin of safety can be comparatively lower than the MOS on high-growth riskier small-cap stocks.

Methods to find Intrinsic value:

The concept of Margin of safety was poularized by the legendary investor, Benjamin Graham (also known as the father of value investing). He used his ‘Graham formula’ to find the true value of companies, and if the stock was trading way below the intrinsic value, only then he would purchase them. This concept of MOS was later inherited by Warren Buffett, a student of Ben Graham.

There are different tools to find the intrinsic value of a company. While many prefer using PE or Book value to find if the stock is undervalued, one of the most popular method to find the true value of a company is the discounted cash flow. DCF analysis is a method of valuing a company using the concepts of the time value of money. Here, all future cash flows of a company are estimated and discounted by using the cost of capital to find their present values. (Read more here: How to value stocks using DCF Analysis?)

A few other methods to find the intrinsic value of a company is the dividend discount model (DDM), EPS valuation, relative valuation etc.

Also check: Intrinsic value calculators

Closing Thoughts

Having a margin of safety in the investments helps the investors to minimize the downside risk. However, an important point to highlight here is that having a MOS does not guarantee that the investment will always be profitable. Finding the intrinsic value of the company correctly also plays a crucial role here. And therefore, you should spend a significant amount of time valuing the stocks suitably.

Nevertheless, a meaningful discount on the purchase price compared to the intrinsic value can limit your losses and maximize the profits on your investments.

face value market value and book value cover

What is the difference between Face Value, Market Value & Book Value?

Recently when I was navigating my Quora profile, I got an answer request for the question what is the difference between face value and market value of a company. Although both these are elementary terms related to stocks, however, they may be a little confusing for the beginners. Therefore, I decided to write a simple blog explaining the difference.

In this post, we are going to discuss the difference between Face Value, Market Value, and Book Value of a stock. Let’s start with the easiest.

Market Value

Market value per share is the current value of the stock. This is the price at which market values the stock. For example, if a stock is trading at a share price of Rs 100, then this is the market value per share of that company. The market value per share of a company fluctuates continuously throughout the trading time period.

Further, the total market value of a company, also referred as the market capitalization of the public company, is calculated by multiplying the current share price of the company by its total outstanding shares. 

face value and book value-minFace Value

Face value (also known as par value) is the value of a company listed in its books and share certificate. The company decides the face value when it offers shares at the time of issuance. The face value of a share is fixed (until the company decides to split or reverse-split the shares).

For example, during the IPO of Avenue Supermart (Parent company of D’mart Supermarkets), the management decided the face value per share to be Rs 10. Here is the details:

D mart IPO-min

(Source: Avenue supermart IPO details- Chittorgarh)

In general, the face value of a company is lower than its market value. For example, when a company goes public, it can have a face value of Rs 10. And it may trade at a market price of Rs 500.

However, this case is not always true. For example, in the case of penny stocks, the face value of the company may be higher than its market value. Penny stocks are those companies which trade at a share price less than Rs 10. Therefore, here the market price may be Rs 5 and the face value of the company may be Rs 10.

Further, the face value of a company is not affected by whether the market price goes up or down. However, the face value of a company will reduce in the case of a stock split. For example, if the current face value of a company is Rs 10 and it announces a stock split in the ratio of 1:1. Then, the face value of that company will split in the same proportion. Here, the face value will change to Rs 5 as the total number of share doubles after the stock split.

Also read: Stock split vs bonus share – Basics of stock market

Book Value

In simple words, the book value of a company theoretically means the total value of the company’s assets that shareholders will receive in case the company gets liquidated i.e. when all company’s assets get sold and all the liabilities are paid back to all the debt-holders. Therefore, book value can be considered as the net value of the company reflected in its books.

The book value is calculated as total assets minus intangible assets (patents, goodwill) and liabilities. When you divide the book value of a company by it the total number of outstanding shares, you arrive at the book value per share.

You can compare the book value per share of a company with its market price to find whether the company is under or overvalued. Further, its always advisable to invest in companies with growing book value over time.

For example- here is the book value of ASIAN PAINTS:

face value and book value-min

(Source: Moneycontrol)

Where to find the face value, book value and market value of a company?

The face value, book value and market value of a company can be found on almost all financial websites.

Whenever you open the company page on any financial websites, the first thing that you’ll notice is its market value per share. However, just by cruising a little, you can easily find face value and book value per share of the company. For example, here is the face value, market value and book value per share for Asian Paints. (Source- Screener).

screener face value market value and book value-min

(Source- Screener)

You can also find this information on other popular financial websites like Yahoo Finance, Marketsmojo, Equitymaster etc.

Also read:

Bottom line

By now, the meaning of face value, market value, and book value should be clear to you. All these three terms are different and one should not get confused among them while studying any company.

Market value per share is the current value at which the stock is trading in the market. Face value is the value of a company listed in its books of the company and share certificate. And finally, the book value of a company is the total value of the company’s assets that shareholders will receive in case the company gets liquidated.

That’s all for this post. I hope it was useful to you. Happy Investing!!

How to find the last 10 year financial statements of Indian companies cover-min

How to find the last 10 year financial statements of Indian Companies?

Reading the financial statements of a company is a key part of fundamental analysis which no investor should ignore.

Here, the investors need to read at least 5-10 years financial reports of the company in order to understand its performance, growth rate, trends, consistency etc. For example- a high profit for just one or two years is not sufficient to approach at any conclusion. However, if you can find that the bottom line of the income statement is consistently growing at a good pace for the last 5-10 years, this may be a healthy sign for the company.

In short, it’s imperative for the investors to read (and understand) the financial statements of a company before investing.

However, for the beginners, finding the last 10-year financial statements of Indian companies may look a tedious job. Besides, because of so many paid/subscription-based plans available for detailed financial statements of companies, it might be a little challenging for the newbies to decide whether to go for a paid plan or surf the internet to download the reports for free.

Paid plans are generally beneficial as they provide comprehensive reports and tools. However, they are often more useful to the professions, rather the retail investors. For the common investors, it’s better to use the free websites/resources to find the last 10 year financial statements of Indian companies.

In this post, we are going to discuss the free websites and resources to find and download the financial statements of Indian companies. Let’s get started!

How to find the last 10 year financial statements of Indian companies?

1. Company’s official website

The company’s website is the first and foremost source to find its financial statements. You can download the quarterly and annual reports of any company by visiting its official website and navigating to the ‘Investors’ or ‘Investor’s relations’ page.

tcs website

However, to arrange the last 10-year reports, here you might have to download the annual reports one-by-one manually. Nonetheless, this is the best source for the investors to download the financial statements of publically listed Indian companies.

2. Financial websites.

There are a number of free financial websites in India which provide the customized five to ten years financial statements of Indian companies, all at one place. Two of simplest financial websites that beginners should know are:

Screener is a simple, clean, yet powerful website. Here, you can also download the financial statements of a listed Indian company in the excel sheet.

For downloading the financial statements, simple go the screener website and search for your interested company in the search bar. Next, go to the company page where you can find ‘Export to Excel’ option.

screener asian paints

Quick Note: You need to create a login account on Screener in order to download the excel report.

Money control is probably one of the most popular financial websites in India for researching stocks and other financial instruments.

To download the financial statements of the Indian company, go to the company page on the money control website. Next, select the ‘financials’ option in the left tab and click on the financial statement (profit and loss statement, balance sheet or cash flow statement) that you would like to download.

moneycontrol

A few other websites that you can visit to find the financial statements of Indian companies are Yahoo Finance, Equity Master, Marketsmojo, Marketsmojo etc.

Also read: 7 Must-Know Websites for Indian Stock Market Investors.

3. Stock exchange websites

bseindia-min

Finally, you can always visit the stock exchanges (NSE/BSE) website to download the financial statements of an Indian company. The exchanges are continuously working to improve their website and its UI is far better compared to what it used to be a few years ago.

To download the financial statements, search for the company name in the top search bar and open the company page. You can find the annual results and reports in the financial section on the company page. 

Also read:

Closing Thoughts:

Although there are so many options for the investors to find the last 10 year financial statements of Indian companies, however, the easiest and best one is the company’s official website.

A notable problem with the financial websites is that they have to adjust the financial data a little to customize with their layout and hence the data shown on their website may not be exactly accurate. Moreover, there have also been cases where the financial data reflected on these financial websites doesn’t match with that of financial statements declared by the company (this may be because of human or computer error while gathering the data). Therefore, its always advisable to download the annual reports of the companies from their official website while researching the company as it is a more reliable source.

Nonetheless, an easier approach that investors can follow is to use these financial websites for a quick study and later download the annual reports from the company’s website/NSE/BSE while performing the detailed study.

That’s all for this post. I hope it is useful to you. Happy Investing!!

Measurement Scales Balance Swinging Swing Equality

Is Stock Market Investing a Zero-Sum Game?

One of the most debated questions regarding stock market is that- Is stock market investing a zero-sum game? If someone makes money in the stock market, does it means that someone else must be losing money?

In this post, we are going to demystify this question and try to answer whether stock investing is a zero-sum game or not.

What is a Zero-Sum Game?

A Zero-sum game is a situation where one person’s profit is equivalent to the another’s a loss so that the net change in wealth is Zero.

A few popular examples of zero-sum game is Poker and gambling. In poker, the amount won by one player is equal to the combined losses of the other participants. Please note that there can be two or multiple participants in such games.

Moreover, Zero-sum games are contrary to win-win situations.

poker

Is stock market investing a Zero-sum game?

When it comes to the stock market, the majority assumes that the market is a zero-sum game. After all, the money made by someone should come from a source and most believe that it costs from the other losing participant.

However, this is not true. Investing in stock can be mutually beneficial.

In the share market, trades are based on future expectations and because of the different risk tolerances of the participants.

Just because someone is selling their stock, doesn’t mean he is losing. He might have made substantial profits and willing to book profits. And similarly, if one sells, there’s no reason to think that the next investor can’t profit too. Here, both the parties can be winners.

Overall, a zero-sum game isn’t the right description of investing. As the company expands and becomes more valuable, the stock market can increase the wealth of both the participants & economy over time.

win win situation stocks Is Stock Market Investing a Zero-Sum Game?

Dividends…

An important factor which is invariably ignored while studying the stock market as a zero-sum game is the dividends. As corporations generate profits from the sales, they share a portion of this profits with their shareholders as the dividends.

(There are even cases where the investors get back more money than the original invested amount just as dividends over time.)

If the market was a closed system with just buyers and sellers, somewhere it could be possibly considered as a zero-sum game. However, it is not a closed system as money is consistently pumped into it as dividends by the companies.

Quick Note: The exception to these scenarios are the companies that do not pay dividends.

Also read:

Closing Thoughts

Investing is not a zero-sum game and both the parties can be winners.

Here, the profit for the participants doesn’t come from the stake of losses by other participants, but from the value created by the company. If one sells a stock, there’s no reason to think that the next investor can’t profit too. As long as the business is performing well, the stock will keep on increasing value without anyone losing the money.

Overall, there doesn’t need to be one winner and other losers. Stock market provides an opportunity for a win-win situation for all.

rule of 15*15*15 sip calculator cover

Why You Need to Know The Rule of 15*15*15?

When the newbies enter the world of investing, one of the biggest questions that they may face is ‘how much’ and ‘how long’ should they invest? Enter the rule of 15*15*15.

In this post, we are going to discuss what is the rule of 15*15*15 (and the rule of 15*15*30) and how it can help you to make your investment decisions.

The rule of 15*15*15

The rule of 15*15*15 says that if you invest Rs 15,000 per month in an investment option which gives a return of 15% (CAGR), for a consistent period of 15 years, you will build a final corpus of Rs 1,00,00,000 (One crore).

Here,

SIP Amount = Rs 15k per month
CAGR =15%
Time horizon =15 Yrs
Final corpus = Rs 1 Cr

rule of 15*15*15 sip calculator

(Source: SIP Calculator)

Interestingly, your total invested amount is equal to just Rs 27 lakhs. However, over the time period of 15 years, you will build a total wealth of Rs 1 Crore.

Rule of 15*15*30

The rule of 15*15*15 gets even better when we double the ‘time horizon’ keeping all the other factors the same.

Here, you invest Rs 15,000 per month in an investment option which gives a return of 15% (CAGR), for a consistent period of 30 years.

Can you guess the final corpus build in this case?

The final corpus built after 30 years will be Rs 10,00,00,000 (Rs 10 Crores). And yes, that’s right — not a typo error…

Here,

SIP Amount = Rs 15k per month
CAGR = 15%
Time horizon = 30 years
Final Corpus = Rs 10 Crores

the rule of 15*15*30 sip calculator

(Source: SIP Calculator)

Here your total invested amount is just Rs 54 lakhs. However, as the power of compounding is working in your favor, you will accumulate a final corpus of Rs 10 crores. Only by doubling the time horizon, you can get ten times the amount compared to the rule of 15*15*15.

And that’s why the power of compounding is considered the most substantial factor for wealth creation. Here’s a quote regarding the same by one of the greatest scientist of all time, Albert Einstein:

Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.” -Albert Einstein

Quick Note: In the scenarios discussed above, 15% is considered as the average compounded annual growth rate (CAGR) over the years. However, you must understand that it is just an average as no market can give consistent 15% returns. In the bull market, the returns can be as high as 30–40%. On the other hand, in the bear market, the performance can be as low as -10% to 5%. Here, the 15% is taken as the average of the returns over the 15 or 30 years.

Warren Buffett Wealth Creation

The name ‘Warren Buffett’ needs no introduction, especially for the people involved in the world of investing. His wealth creation story is an interesting topic to discuss in this post.

Fascinatingly, unlike the young tech billionaires of this century like Mark Zuckerberg, Evan Spiegel, Bobby Murphy, John Collison, etc. Warren Buffett did not build his wealth by creating a super-tech company like FB, Snapchat, Google, etc.

Warren Buffett built most of his wealth over time through their investments (and acquisitions) by his company Berkshire Hathaway. You may get surprised to know the fact that the World’s third richest person become a billionaire only in his 50’s.

warren buffett net worth growth over time

The biggest factor why Warren Buffett was able to build such a huge wealth was his amazing returns for a consistently longer period. His company, Berkshire Hathaway, give an average yield of around 21.7% per year for over five decades. This return for such an extended time period is way-way better than what we discussed above. The power of compounding played an important role in Warren Buffett’s wealth creation story.

Resources:

Closing Thoughts

The time period is a significant factor when you are investing.

In this post, you can notice how by doubling the time horizon from 15 to 30 years; you can get ten times bigger final corpus. And that’s why it is recommended to start investing as soon as possible.

To end this post, here’s an amazing quote by Mr. Buffett:

“Someone is sitting in the shade today because someone planted a tree a long time ago.” -Warren Buffett

7 Powerful New Year Resolutions For Equity Investors!

A new year always excites everyone. It’s a time for the people to make different personal and professional resolutions like to learn how to swim, join the gym, travel abroad, learn martial arts, create a new blog/youtube channel, learn a new language, maintain a journal etc.

Personally, I’ve always loved new years and enjoyed making plans for the next year. This time also I’ve made a few resolutions. On the top of the list is to travel all the 29 states and 7 union territories in India by the end of 2019 (Spoiler alert: I’ve already been to +20 entities).

Anyways, stock investors are ordinary people and hence, they also like to make resolutions for their new investing journey. However, if you an equity investor but do not have made resolutions for the new year yet, then we’ve got you covered.

In this post, we are going to discuss seven powerful new year resolutions for equity investors. All these resolutions are designed to make you a better investor by the end of the calendar year.

7 Powerful New Year Resolutions For Equity Investors

Here are the seven best new year resolutions for the Indian equity investors. I would recommend you to challenge yourself and accept as many as resolutions (out of seven) as possible.

1. Save enough, Invest more

This is something which most youngsters struggle with. Although the older generation is doing much better in the art of saving, however, when it comes to intelligent investing — they too are not much mature.

If you are struggling with savings, plan to optimize your expenses this year. Track your spendings and perfect them wherever possible in order to increase your savings. However, do not just stop there. Invest those savings in different investment options based on your needs and risk tolerance. For beginners, investing in blue-chip stocks are a good option to get started.

2. Start goal-based investing

investment goal

Goal-based investing is a new way of wealth management where the individuals focus on attaining specific objectives or life-goals through their investments. Here, before starting to invest, the individual tries to answer the question- “What exactly are you investing for?”. The best part about the goal-based investing is that here the investors do not focus on getting the highest possible returns. But the aim of this investment is to reach the desired returns that meet their goals.

This year, switch from the traditional investing to goal-based investing. Set a specific goal and start investing to achieve it. This goal can be owning your new house, funding your business venture, corpus for your kid’s education/marriage, retirement, travel fund etc.

3. Increase your circle of competence

circle of competence

Because of different background, qualification, or experience, everyone has built up a greater knowledge in a specific area. In this certain field, these people have the expertise and hence, have a significant advantage. This is called the circle of competence.

The circle of competence might vary from people to people depending on the criteria mentioned above. For example, a doctor might have an expertise in medicines, healthcare or pharmaceutical and he can consider this area as his circle of competence (COC).

This year, make a resolution to increase your circle of competence.

For example, let’s say you might have been ignoring tax saving mutual funds or ELSS or any other investment option just because you were not competent earlier. But this year, spend some time and efforts to get comfortable in those investments.

Even for stock investors, there might be different industries or sectors that you may be ignoring. This can be because you do not have good knowledge of that industry and hence not inside your circle of competence. This year, learn those new industries and expand your circle of competence.

4. Be consistent

Consistency is the key to build long-term wealth. If you invest in equities just in a bull market and shy off during the bear market, it’s definitely not a good strategy. Bulls and bears are the part of market and stocks are characterized to go up and down.

This year, make a resolution to become consistent in your investments.

If you have got a monthly SIP, then consistently keep investing in that plan. If you are a direct stock investor, then fix an allocation of money that you’ll invest in the market throughout the year, whenever you find the best opportunities. Overall, to win the game, you need to stay in the game. And that’s why you need to be consistent in your investment plans.

5. Become more Socially Responsible Investor

Socially Responsible Investing or SRI is choosing to invest in stocks that provide a financial gain as well as do social good. For example- investing in companies promoting health, cleaner energy, healthy foods etc. The companies are evaluated based on the ESG index: environment, social justice, and corporate governance.

Being an investor gives you a lot of power in the financial world. This year, make a resolution to realize the power and influence you have as share investors to make a positive impact on society.

solar panel cells

6. Continue your education:

The stock market is very dynamic and things keep on changing very fast here. New technology, a new sector, new research tool etc. And that’s why the biggest resolution that you need to make this year is to continue your education.

This doesn’t mean to go and enroll in a university. You simply have to keep learning more. Whether it’s through courses, seminars, workshops, books or youtube videos, it’s up to you. But make sure that you keep on learning. One best way to continue your education is by taking a resolution to read at least one investing book each month. This is not a tough resolution and easily achievable. If you are not sure which books to read, here is a list of ten must-read books for stock market investors.

7. Diversify

This is the last resolutions to make this year. No matter how good you are in equities, do not invest all your money in the market. Stock market investments are subjected to market risk. And if you’ve allocated all your money in the market and it doesn’t perform well (because of whatever reason)– you are doomed.

This year, make a resolution to expand your investment options and look into alternative investment options. Maybe investing in real estate or diving into startups as Angel investor. Diversify your investments and reduce the potential risks.

Closing Thoughts

The new year is the best times to ‘make the change’ or ‘be the change’. Whether you want to meet your needs/goals or become a better investor, this is a great time to start working on it. Through the new year resolutions, take your investing to the next level this year.

Wish you all the best!

biggest mistake stock market

The Biggest Investing Mistake that 90% Beginners Make!

Suppose you bought two stocks- Stock A and Stock B. The buying price of both these stocks is the same, i.e. Rs 100.

After two years, you checked the returns from both these stocks and found that the current price of stock A has moved to Rs 180. On the other hand, the market price of company B has fallen to Rs 60. What would you do next?

Would you sell stock A and book a profit of 80%? Or Would you sell stock B to get rid of your losing stock?

scenario stocks

I will give the answer to this question in a few minutes. But first, let’s discuss another scenario in a similar context.

Let’s say, you have a garden where you’ve planted three vegetables- Ladyfinger, tomatoes, and Cabbage.

garden-min

Out of the three, Ladyfinger and tomatoes are doing exceptionally well. They are growing big and healthy. And that’s why you are able to make huge profits by selling them.

Anyhow, the third vegetable i.e. cabbage is just not doing well. It is not growing enough, no matter how much time, money and efforts you spend on planting those vegetables. It simply dies out without producing anything worthwhile to sell.

What’s the logical step here for you as the gardener?

Shouldn’t you get rid of the Cabbage which is not growing no matter how much efforts you put and focus more on growing the other two vegetables which are giving you awesome returns? After all, those two vegetables are the ones who are making you profits.

A similar concept should be applied in the stock market world.

Out of the two stocks- Stock A (which went up by 80%) and stock B (which fell down by 40%), it’s logical to hold the winning stock and get rid of the losing one.

Why do you want to sell Stock A to book a profit of just 80%, when it can get returns of 100%, 200%, 500% or even 1,000% in the future? If the company is fundamentally strong, selling its stocks just to book short-term profits doesn’t make much sense.

On the other hand, keeping the losing stock just to break even is also not a wise strategy. If you get rid of that stock and invest the same money in stronger companies, it can give you better returns. Holding the losers just to break even may lead you to loss of both time and money.

Here, the biggest lesson that every beginner should know is- “Hold your winners and cut your losers!!”.

But sadly, most people follow the totally opposite approach while investing. Even if the stock moves up by 30%, most beginners are eager to sell that stock, book profit and boast among their friends. 

The majority of the investing population would prefer to sell their winning stocks just for instant gratification of short-term profits. However, booking short-term profits should not be the goal of the investors if they want to build long-term wealth. After all, the consistent returns should always be preferred over a one-time profit.

The only reasons when you should sell your winning stocks is A) when the company’s fundamental changes and the stock is not as strong as when you originally invested, B) When you find a better stock to invest with bigger opportunity and C) when really need the money. For all the rest cases, you should stick with the stock.

Also read:

Besides, one more thing that most beginners ignore while booking short-term profits is taxes. When you sell your winning stock in short-term for booking profits, you are obliged to pay short-term capital gain (STCG) taxes of 15% on your profits.  Therefore, this portion of the profit is already gone to the government.

Nonetheless, you can easily avoid/delay this STCG gain tax by NOT selling your winning stocks and keeping it for the long term. After all, you only have to pay taxes when you book profits. Moreover, Long-term capital gain taxes are comparatively smaller (i.e. 10% of your gains). Therefore, by investing for long-term, you can save a few additional bucks.

Overall, whether you are investing in stocks, mutual funds or any other investment option, the first and biggest lesson is the same- “Cut your losers and hold your winners!”.

That’s all for this post. Happy Investing!!

goal based investing cover

The Real Truth About Goal-Based Investing!

Goal-based investing, also known as Target based investing or Goal-driven investing has been into a lot of buzzes lately. The name itself defines this investing strategy.

However, still many investors do not know what exactly is a goal-based investment and how to pursue it. In this post, I’ll try to answer the most frequently asked questions regarding goal-based investing. Here are the topics that we’ll discuss today:

  1. What is a goal-based investing?
  2. How is goal-based investing different from traditional investing?
  3. Why goal based investing is the key to long-term success?
  4. How to get started with goal-based investing?

This post may change the way you look towards investing. Therefore, make sure that you read this article till the end. Let’s get started.

1. What is a goal-based investing?

Although goal-based investing is not a new concept and many financial experts have been following this strategy over a long period, however, it started getting fame recently.

Goal-based investing is a new way of wealth management where the individuals focus on attaining specific objectives or life-goals through their investments. Here, before starting to invest, the individual tries to answer the question- “What exactly are you investing for?”.

The best part about the goal-based investing is that here the investors do not focus on getting the highest possible returns. But the aim of this investment is to reach the desired returns that meet their goals.

In a goal-based investment, the individuals periodically measure the progress on their returns against the specific goals. Instead of trying to outperform the market, they try to attain their goals within the desired time horizon.

Moreover, the goal can be person specific like planning for children education, retirement fund, buying a new house or even financial independence. A few factors included while planning goal-based investments are the aim of the person per age, risk tolerance, financial situation, and investment horizon.

2. How is goal-based investing different from traditional investing?

The main motive of traditional investing is to get higher returns and generally to beat the market.

Here, the individuals compare their returns with the index such as Sensex or nifty in order to find whether their personal investments are over or underperforming.

On the other hand, goal-based investing redefines the success based on the individual’s goals and needs, rather than whether they beat the market or not. This strategy tries to shift traditional investing to a personal financial goal approach and helps to invest based on needs and risk tolerance.

The problem with traditional investing is that they do not focus on the individual’s needs. In such a scenario, no matter, how good are the returns, if the individuals are not reaching your final goal, then the returns might not be good enough for the individuals. After all, investing is a long-term activity and NOT a phenomenon of beating the market for a year or two.

Goal-based investment allocates the funds depending on the individuals’ situation and aims. For example- if your goal is retirement, then you might choose a conservative strategy with a majority of investments in debt funds. On the other hand, if your goal is to build a corpus for your children’s marriage, you might choose an aggressive strategy with 50% investment is equity and rest 50% in debt.

goal based investing trade brains

3. Why goal based investing is the key to long-term success?

The biggest advantage of goal-based investing is that it increases the individual’s commitment to invest consistently in order to reach their life goals. Unlike traditional investing, here the individuals participate actively and observe the progress towards their goals.

Moreover, having a long-term strategy helps the individuals to avoid making impulsive decisions based on market fluctuations. As the individuals are more focused to achieve their goals, they are less inclined to make spontaneous decisions just with an expectation to get a little higher return. Goal-based investing prevents rash investment decisions by providing a clear process of identifying goals and choosing strategies to achieve them.

Lastly, it also avoids the situation of under-saving (and under-investing). As goal-based investing continuously monitors the progress of individuals towards their goal, and hence they remain updated on how far they are from their goals. In a case where they are under-investing, they can re-improvise their strategy so that they can reach their goal in time.

Also read:

4. How to get started with goal-based investing?

Although planning a goal-based investing requires a detailed study of the individual’s goals, financial situation, time-horizon, and risk tolerance. However, here are a few simple steps that can give you a rough idea of how to get started.

The first step is to clearly define your goals and the time horizon to attain them. The goal can be building a corpus for buying a new house, savings for children education/marriage, retirement etc. You can even have multiple goals and differentiate them as short-term, mid-term and long-term.

The next strategy is defining your strategy of where you’ll invest and how. Depending on the risk-tolerance, required rate of return and time horizon, you can choose different funds like equity, debt or a combination of both. Further, you also need to decide your monthly, quarterly or yearly contribution to all these funds.

The next step is to be disciplined in following your strategy. To attain your goals, you need to make consistent investments.

Finally, periodically monitor and review your progress towards your goal. If your progress is not in line with your purposes, you might need to revise your strategy and re-allocate your funds so that you can reach your goal in time.

Closing Thoughts

Goal-based investing is a relatively new way to achieve personal needs by investing in a definite strategy. It’s a good alternative over traditional investing which does not focus on the individual’s goals and financial situation.

Most individuals start investing in the market without any goal. There are even a few who invest in the market just for fun and to make a few extra bucks alongside their primary income source.  And it’s perfectly okay to start like that. However, with time you need to eventually decide a goal for your investments. It will help you reach them in time and to avoid situations of taking unnecessary risks just in order to get some extra returns.

Besides, another benefit of goal-based investing is that it helps in ‘Guilt-free spending’. Here, as you already know that all your goals have been taken care of, you can spend the additional income on something that you love without any guilt.

Final thoughts, “Investing is good. But it is even better when attached to a goal.”

Financials Signals That A Company May Be Declining cover

3 Financial Signals That A Company May Be Declining.

Do you know that out of the 30 companies in the constituents of Sensex in 1992, only seven are still the part of it?

Yes, that’s true. The remaining companies couldn’t maintain their growth & value and hence were thrown out of the list of the biggest thirty companies in India with time. (Read more here: The Sensex story in the 25-year reform period —The Hindu Business Line) .

Although becoming a large-cap company is a dream of most of the businesses, however, after becoming a mature company, many companies find it a little challenging to maintain their growth.

Moreover, the problem arises when they are not able to sustain their profitability and starts declining. There are a number of examples of companies which were once a market leader, however, couldn’t keep a sustainable profit margin and later either shut down or went bankrupt. The most common example is Kingfisher. 

Declining companies do not have much growth potential left and even the returns (and value) of their existing assets keep on sinking.

Therefore, as investors, it’s really important for us to continuously monitor the growth of our invested company. And if we are able to find some signals that the company is declining, it might be the time for exit from them.

After all, no matter how much we love our invested company, the main goal of our investments is to make money and if the company is continuously declining, there’s no point remaining invested. It’s really difficult for the declining companies to reward their shareholders. Further, we as investors have thousands of other options available to invest in the market. Then, why to stick with the declining companies?

In this post, we are going to discuss three clear signals that you can study from the financial statements which show that a company may be declining.

Besides, these financial signals are very simple to identify (even for the beginners). Therefore, make sure that you read this post till the very end. Let’s get started.

3 Financial Signals that a company may be Declining.

Although evaluating the exact financial health of a company requires a serious study of the statements of profit & loss, balance sheet and cash flow statement of the company. However, there are a few financial tools which send an easy signal for the investors to identify the declining companies. If all these three financial signals are negative for a company, then the company might be in a little trouble.

Here are the three simple financial signals that you can study to evaluate if a company is declining:

1. Declining Revenue:

If a company’s revenue is continuously declining for the past multiple years, it may be a warning sign for the investors.

The revenue of a company is the TOP LINE of the income statement. And if the TOP LINE is declining, in general, all the lower levels will follow the same trend.

Even a stagnant (flat) revenue for a continued longer period of time is a sign of caution for the investor. After all, there’s a fixed extent up to which a company can control its expense. And if the company want to increase its profit, then it has to increase its revenue eventually.

A flat or declining revenues for past multiple years is an indicator of operating weakness. Moreover, if you can find that the revenue of the competitors (and the industry) is growing over the same perio, then it sends even a stronger signal of a weak management and poor health of the company.

For example- here is the income statement of Reliance communication for the last five years. Here, you can easily notice the declining net sales (and total revenue) for the past multiple years.

Reliance communication income statement
Source: Equity Master

And this decline is in line with the stock return of this company. In the last five years, Reliance communication’s share price has shrunk by over 88%.

2. Negative Profit margin:

Profit margin is calculated by dividing the net profits by net sales realized over a given time period. It represents how much percentage of sales has turned into profits. In other words, the percentage figure indicates how many cents of profit the business has generated for each rupee of sale.

If the profit margin of a company is negative, it shows that the company is not able to generate profit from its regular business. A negative or declining profit margin of the company for a continued longer period of time can be taken as a warning sign for the investors.

Declining companies generally lose their market share to their competitors. And in order to keep up their sales, they often have to either give bigger discounts or to cut their profits. Moreover, they also lose the pricing power which further leads to a fall in the margin.

While evaluating companies, you can look into the three levels of the profit margins- Gross profit margin (GPM), Operating profit margin (OPM) and Net profit margin (NPM), each being a more refined level of profitability. As a rule of thumb, avoid investing in companies with a negative profit margin.

Anyways, if you’ve already invested and now find that the profit margin of the company is continuously declining for the past multiple years, then it might be a signal that this company is declining.

3. Big dividend payouts:

Dividend payout is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company.

It can be calculated by dividing the dividend per share (DPS) by earnings per share (EPS) of a company in a year. For example, if the DPS of a company for the current year is Rs 2 and its EPS is Rs 10, then the payout ratio is equal to 2/10 i.e. 20%.

If a company gives a consistent dividend to its shareholder, it is a healthy sign.

However, the problem arises when the company starts paying a major portion of its net income as dividends. In such a scenario, the company is not retaining enough income for investment in its growth or future plans.

There should be a balance between rewarding shareholders and the retaining income for its own growth. After all, if the company is not investing enough in itself, it will eventually become difficult for them to increase (or to maintain) their profitability in the future.

Declining companies generally pay out large dividends to their shareholders as they have a very little need (or scope) of reinvestment. As a rule of thumb, payout ratio greater than 70% for a company can be a warning sign for the investors.

Other financial signals:

Another financial tool that can give you a better picture of the financial situation of a company along with the above three financial indicators is the company’s debt level.

If the debt level of a mature company is continuously increasing at a high pace, it is a sign that the company has been aggressively financing its growth with debt. You can use debt to equity ratio to evaluate the debt level of a company. A high debt to equity ratio (greater than one) can be considered a high risk for the company.

Apart, there are also a few handfuls of financial ratios like Return on assets (ROA), Return on equity (ROE), interest coverage ratio etc that you can also study to check if your company is declining. A continuously declining ROA, ROE and interest coverage ratio can be a warning sign.

Also read:

Closing thoughts:

Even big mature companies are capable of declining over time and losing their value. And that’s why it is important for the investors to continuously monitor the growth of their invested company.

In general, a flat or declining revenue, negative profit margin and huge dividend payout can be considered signs of a declining company.

Anyhow, if the company takes necessary steps, it may recover back on track or even become a turn-around. However, if the management doesn’t take the significant steps in time, the company may decline further destroying the shareholder’s investment. 

what are intangible assets

What You Need To Know About Intangible Assets!

Evaluating the intangible assets of a company is a crucial part of the fundamental analysis, especially in a generation with a lot of leading companies in the technology and service-based industries.

However, most investors ignore this part and focus more the physical assets like land, building, equipment etc. One of the major reasons why people skip the part of studying intangible assets is because these assets are a little difficult to evaluate. After all, how would you correctly measure the value of a brand or non-physical assets of a company?

In this post, I’ll try to demystify intangible assets in simple words so that you can understand what exactly are intangible assets, why are they valuable for a company and how can you evaluate the intangible assets of a company.

Overall, it’s going to be an exciting post. Therefore, please read it till the end because I’m sure it will be helpful to you in assessing companies better.

What are intangible assets?

Intangible assets are those assets that are not physical in nature, yet are valuable because they contribute to the potential revenue of the company.

A few of the common examples of intangible assets are brand recogintion, licenses, customer lists, and intellectual property, such as patents, franchises, trademarks, copyrights etc.

Quick Note: Contrary to these, TANGIBLE Assets are those assets that have a physical form. For example- land, buildings, machinery, equipment, inventory etc. Further, financial assets such as stocks, bonds etc. are also considered tangible assets.

Although intangible assets do not have an obvious physical value such as land or equipment, however, they can be equally valuable for a company for its long-term success or failure. 

For example, companies like Apple or Coca-Cola are highly successful because of the significant brand equity. Since it is not a physical asset and tricky to calculate the exact value, still brand equity is one of the primary reasons for the high sales of these companies. In India, companies like Hindustan Unilever, Colgate, Patanjali, etc also enjoy benefits of enormous brand value.

Further, a few more examples of intangible assets can be marketing-based (ex- Internet domain names, non-competition agreements etc), artistic-based (ex- literary works, musical works, pictures etc), Contract-based (ex- franchise agreements, broadcast rights, use rights etc) and technology-based (example- computer software, trade secrets like secret formulas and recipes etc). [Credits: Examples of intangile assets- Accounting tools]

what you need to know about intangible assets cover

Moreover, in a few industries, intangible assets are more valuable.

Unlike manufacturing companies where inventories and fixed assets contribute to the majority of their total assets, in a few industries the intangible assets are more valuable:

  • Consumer product companies depend on the brand name. For example- Hindustan Unilever, Godrej, Colgate, etc. The bigger the brand name, the easier are the sales. 
  • Technology companies get the most success by their technical know-how and skilled human resource. Ex- Infosys, TCS, etc.
  • Banking companies have their computer software license, stock exchange cards and electronic trading platform (websites). Ex- HDFC bank.
  • Telecom industries use their bandwidth licenses (including spectrum) to enjoy benefits. Example- Bharti Airtel
  • Drugs and pharmacy companies protect their sales through patents, which means that they can sell unlimited medicines of patented drug and their competitors can’t enter or replicate the same. Ex- Dr. Reddy’s Laboratory, Glenmark Pharma etc.

And that’s why, the leading companies in these industries spend a lot of money in building these intangible assets. 

For example, in the IT industry, training and recruiting are more prominent than investing in physical assets like buildings.

Similarly, the pharmaceutical companies spend a lot of capital in the Research and development (R&D) which may help them get a patent on a revolutionary drug. And that’s why, while evaluating companies in this industry, the capital expenditure of the different companies/competitors in their R&D work should be carefully evaluated. 

If you look into the consumer product companies, they spend a lot of money in advertisement just for brand awareness. Although, this may not lead to instant sales and may add overhead expenses, However, over the long term. branding help these companies to generate more profit. 

Valuing Intangible Assets:

Intangible assets of a company can be found on the asset side of the balance sheet of a company. For example- here is the intangible assets for Hindustan Unilever (HUL)

hul balance sheet

Source: Yahoo Finance

You can use the intangible to total asset ratio to evaluate the worth of intangible assets in a company. For example- in the case of Hindustan Unilever, its intangible assets make around 2.05% percent of its total asset.

However, valuing intangible assets are easier said than done. One of the biggest reasons equipment high sales of HUL in India is its prominent brand recognition. A few of the popular brands of HUL are Lux, Lifebuoy, Surf Excel, Rin, Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove, Clinic Plus, Sunsilk, Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan, Kwality the and Pureit

Here, do you really think that the brand value of HUL contributes only around 2% of its net assets? I don’t think so. It must be worth more. However, there’s no easy way to correctly evaluate the worth of the brand recognition and other non-physical assets. 

Quick fact: According to Forbes, COCA COLA’s brand value amounted to 57.3 billion U.S. dollars. It is the only company in the top seven list that sells carbonated sugar water beverages. Rest all are technology companies with Apple and Google as leaders. This is the power of branding. Read more here: The world’s most valuable brands. 

Also read:

Bottom Line:

Although intangible assets do not have a physical presence, they add a huge value to the company. There may be even cases where the intangible assets are of far greater value than the market value of the company’s tangible assets. 

However, while valuing such companies, you may have to put some efforts to study these assets as the accounting conventions do not always value the exact worth of a few intangible assets and they may be reported below their true value in the balance sheet.

Any how, look for the intangible assets that are definite (i.e. stays with the company for as long as it continues operations) and difficult to replicate.

top down and bottom up investing approaches

What is Top Down and Bottom Up approach in stock investing?

While performing the fundamental analysis of companies, two of the most common strategies to research stocks that are used by investors are top down and bottom up approach.

In this post, you’ll learn what exactly is top down and bottom up approach, how they work and which one may be more suitable to you.

Top down approach

Have you ever heard any investor/analyst saying something like- “The electric vehicle industry looks particularly promising now. The industry is growing at a fast pace and I should invest in this industry”.

Well, here the investor is following the top down approach to find stocks.

In the top down approach, the investors first look into the macro picture of the economy and later work down to research the individual stocks.

The overall steps involved in top down approach is to first look at the big picture of the world i.e. which economy is doing great, then look at the general market in that economy, next find the particular sector that may outperform and finally research the best stock opportunity to invest within that sector.

For example, let’s say you studied that the European economy is growing at a very fast rate. Next, when you looked further into the European market, you found that especially the biotechnology industry in outperforming. And finally, you researched some appealing stocks in that industry to invest. This is the top down approach for stock investing.

Here, you start with the big picture and ultimately move down to find the suitable investing opportunity. Top down approach looks at the performance of the economy & sector and believes that if the industry is doing good– the chances are that the stocks in that industry will perform too.

A few of the major areas where the top down analysts pay attention are economic growth, GDP, monetary policy, inflation, prices of commodities, bond yields etc before moving into the specific industry study.

top down approach investing

The biggest advantage of top down approach is that there’s no pre-conceived notion about what may work and the selection of economy, industry & stocks are based on the real-time studies. Further, as they focuses on the strong sectors, the chances of underlying companies performing well are favorable.

However, one of the major flaw of top down approach is that here you may miss out a few good bargain stocks in the eliminated industries.

Also read:

Bottom up approach

This approach is exact opposite of the top down approach. Here, you first start with company research and later move up to find the other details.

Bottom up approach tries to study the fundamental of the company regardless the market conditions, industry or the macroeconomic factors. While performing the bottom up approach, the investors studies how fundamentally strong the company is by focusing on its revenues, earnings, financial ratios, products/services, sales growth, management etc.

The key here is to find the potentially strong company which may outperform the industry and market in future. If the fundamental factors are good, then regardless of what the industry is doing, the bottom up investors will pick such companies to invest.

The biggest advantage of the bottom up approach is that the investors may find the best potentially strong company which can outperform even if the economy or industry as a whole declines. Bottom up approach helps in picking quality stocks.

On the other hand, one of the cons of bottom up approach is that the investor may have some pre-conceived notion of the company and in such condition, their investment decisions may be a little biased. Further, as these investors ignore the longer economic influence and market conditions, some investment returns may be adversely affected because of these factors.

Closing Thoughts

Top down and bottom up are entirely different approaches to analyze and invest in stocks. However, both have their own advantages and disadvantages.

The top down approach first looks at the broader economy and macroeconomic factors, and then move to the specific industry and the company within. On the other hand, bottom up approach starts at the company level and later moves up for the other important details.

In general, top down approach can be little easier for the less experienced investors as they do not have to perform the intense stock research and analysis. They can start studying the most appealing industry and find the companies within to invest.

Anyways, both approaches have their own effectiveness and hence, difficult to say which one is better. Moreover, it also depends on the knowledge and preference of the investor. My final advice would be to better try out both the approaches and find out which one suits you the best for your investment strategy.

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SWOT Analysis for Stocks: A Simple Yet Effective Study Tool.

SWOT Analysis for stocks is one of the most widely used tools for performing the ‘qualitative’ study of the company. It helps to understand the company’s market position and competitive advantages.

In this post, we are going to discuss what is SWOT analysis and how to use this tool for qualitative analysis of a stock.

What is SWOT Analysis?

SWOT Analysis focuses on four important factor while evaluating the quality of a company. Here’s what SWOT Analysis for stocks looks at:

  • S—> Strength
  • W—> Weakness
  • O—> Opportunity
  • T—> Threat

swot analysis for stocks

Our of the four factors of SWOT analysis, ‘strength’ and ‘weakness’ are the internal factors of a company and hence are controllable.

On the other hand, ‘opportunities’ and ‘threats’ are external factors and it’s little difficult for a company to control these factors. However, using the SWOT analysis of stocks, the management can identify the threat and opportunities and hence can take proper actions within time.

For example, Bharat Stage (BS)- IV fuel was launched in India in April’2017. This means the ban on the sale of all the BS-III compliant vehicles across the country after the launch date.

Those automobile companies who have already realized this big opportunity might have started working on the BS-IV vehicles months before the expected launch date. On the other hand, companies who haven’t done the opportunity/threat analysis properly would have faced a lot of troubles. They cannot sale the old BS-III model vehicles. Hence, a big loss of the finished products and the inventories.

Also read: BS-III vehicles: Auto-industry to absorb losses over Rs 12,000 crore.

Why use SWOT Analysis for stocks?

Here are few reasons why SWOT analysis for stocks is beneficial:

  • SWOT analysis is one of the simplest yet effective approaches for the qualitative study of a stock.
  • It helps in identifying weak points of a company that may become an issue in future.
  • It helps in finding the durable competitive advantage i.e. moat that will help to protect your investment in future.

Quick Note: During swot analysis for stocks, only include valid/verifiable statements. Do not add rumor/misleading pieces of information in the study.

Components of SWOT Analysis for stocks:

1. Strength

The strength of a company varies industry-to-industry. For example, a low non-performing asset (NPA) can be the strength of a banking sector company. On the other hand, cheap supplier or cost advantages can a big strength for an automobile company.

Here are few other strengths of a company that you should take notice while performing SWOT analysis of stocks:

  • Strong financials
  • Efficient Management (People, employees etc)
  • Big Brand recognition
  • Skilled workforce
  • Repeat clients
  • Cost advantages
  • Scalable business model
  • Customer loyalty

Also read: Why You Need to Learn- Porter’s Five Forces of Competitive Analysis?

2. Weakness:

The ‘reverse’ of everything discussed in the ‘Strengths’ can be the weakness of a company. For example- Weak financials, in-efficient management, poor brand recognition, unskilled workforce, non-repetitive clients, un-scalable business and disloyal customers.

Besides, there are few other weaknesses that may affect the company:

  • Outdated technology.
  • Lack of capital
  • High Debt

For example- many companies in telecommunication industry ran out of business as they were using outdated 2G/3G technology. Similarly, in the energy sector, renewable power generation is the future technology and those companies who are ‘not’ working on the new technology might get outdated soon. In short, outdated technology adversely affects most of the industry.

3. Opportunity:

A company with a lot of opportunities has a lot of scopes to succeed and make profits in future. Here are few points that you need to consider while evaluating opportunities for a company:

  • Internal growth opportunity- (New product, new market etc)
  • External growth opportunity (Mergers & Acquisitions)
  • Expansion (Vertical or horizontal)
  • Relaxing government regulations
  • New technology (Research & Development)

4. Threats:

In order to survive (and moreover to remain profitable), it’s really important for a company to analyze its threats. Here are few of the biggest threats to a company:

  • Competition
  • Changing consumer preferences/ new trends
  • Unfavorable Government regulations

The changing consumer preferences are one of the repetitive threats that many industries face. Here, if no proper action is taken to retain the customer, then it might unfavorably affect the profitability of the company.

For example-  The new trend of ‘health awareness’ among the people may result in a decline in the sales of beverages/Soft drink companies. (These companies are fighting back this threat by introducing ‘DIET-COKE’).

Similarly, a preference towards ayurvedic products in India has already reduced the sales of non-ayurvedic FMCG companies (and a rise of PATANJALI).

Also read: How to Invest Your First Rs 1,000 in The Stock Market?

How to use SWOT ANALYSIS of stocks to study companies?

Swot analysis of stocks is quite useful while performing the comparative study of companies. Using these analyses, you can study the comparative strengths and weaknesses of different companies.

Let’s say there are two companies- Company A & Company B.

‘Strength’ of COMPANY A can be the ‘Weakness’ of COMPANY B. Similarly, ‘Opportunity’ for COMPANY A can be a ‘Threat’ to COMPANY ‘B’. For example-

  1. The loyal customers can be the ‘strength’ of company A. Whereas, disloyal customers can be a ‘weakness’ for company B.
  2. A new Merger & Acquisition (M&A) is an opportunity for company A. However, it is a threat to company B.

Also read: SWOT Analysis of FORD Motors.

CONCLUSION:

SWOT Analysis of stocks is a useful tool to analyze stocks based on their strengths, weakness, opportunities, and threats. If done properly before investment, SWOT Analysis can help an investor to understand the competitive advantages/disadvantages in order to make a reasoned decision.

New to stocks? Want to learn how to invest in Indian stock market from scratch? Then, here is an amazing online course: INVESTING IN STOCKS- THE COMPLETE COURSE FOR BEGINNERS. Enroll now and start your share market journey today.

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