Stock Investment – Lesson 2

I talked about the power of equities and how small time investors like you and me can create substantial wealth.

Well, stock investing broadly can be categorised into two styles

  1. Trading
  2. Value Investing

Before I dive into the details, let me ask you a simple question.

Which would you choose, If you had to choose between

Option 1: Rs 1,00,000 every day for next 20 days

And

Option 2: Rs 5 on Day 1 and double every day for next 20 days

(Think for a while and I will come back to this question in a moment)

Now coming to the stock investing styles.

Trading focuses on making frequent profits over a shorter time frame irrespective of bull (rising) or bear (falling) markets.

During rising markets, trading involves buying at a lower price and selling at a higher price.

In falling markets profits are made by selling at a higher price and buying at a lower price, also referred to as shorting.

Note: Beauty of the trading is that you can make money even when the market is going down!

The holding period of the stocks is no more than few minutes in Trading or in some cases a maximum of few days.

People practising trading style make use of tools like technical analysis, study price patterns & trends to forecast the future price movement of the stocks.

But largely trading is driven by a lot of speculation.

Means, you are trying to guess what other market participants are thinking.

…. where other big investors are investing

…….. what business channel analysts are saying

…………. guessing how market will behave

All in the hope of making a quick buck from the market.

In the words of the legendary investor Warren Buffett

“So if I buy a farm at $600K and I expect it to produce $80K an acre for me in terms of its revenue from corn & soybeans. I’m looking at the return from the farm itself. I’m not looking at the price of the farm every day or every week or every year. On the other hand if I buy a stock and I hope it goes up next week, to me that’s pure speculation”

Traders buy a stock at Rs 10 and sell at Rs 11. Next week, they buy back at 12 and sell at 13. A week later sell first at 20 and buy back at 18.

For traders, the current price of the stock does not matter. The only things that matters is the direction in which the stock would move today.

They make money by repeating this process with multiple stocks….Of course they book losses as well.

Market is full of such examples who lost money indulging in trading.

Fluctuations in the market bring opportunities and threats. The more you learn the better you become in grabbing the opportunities.

I myself tried trading, made a profit of Rs. 10,000 on the first day and ended up losing more than Rs 20,000 in next few days.

I realised that trading is not my cup of tea.

I love to understand the business and invest with a long term strategy to create wealth.

Which brings us to the second style of investing – Value Investing.

Before moving forward..

…. you can read how to start value investing even if you have only Rs. 10,000 in your pocket.

Let me take the same example that I shared in trading section.

A value investor buys a stock at Rs 100 and hold for 3 years with the expectation to reached Rs 300.

Can you see the difference, both in styles and returns?

One style involves buying and selling a stock multiple times to fetch a small profit of Rs 3.

Other style involves buying and holding a stock for a longer duration to fetch 3X returns.

In value investing, investors study the underlying business of the stock, its financial details, the sector in which it is operating in, its relation with the country’s economy, the quality of management and use a combination of these to select and invest in stocks.

Value investing is about spotting companies (stocks) that are available at a bargain.

What’s a bargain?

Stocks whose market price is less than their intrinsic value.

Think like.. buying an apple at the price of a potato.

Why are they available at a bargain if they are really so good?

That’s because the market has not realised their true potential yet and so they are under priced.

In value investing, you are looking for such under priced gems.

Like I have shared the example of my stocks in my last email where I earned Rs. 4,50,000 in about 1 year.

Let’s talk about other examples..

Maruti Suzuki limited, manufacturer of one of the most popular cars in India.

Did your father or uncle own Maruti Suzuki car in 2003?

You see back in 2003, the government divested 25% stake in Maruti Suzuki Limited at Rs 125 per share.

From its issue price of Rs 125 per share, the company has hit Rs 10,000 mark in December 2017.

That’s a gain of 7900% percent.

If you had invested Rs 100,000 in Maruti Suzuki in the year 2003 rather than buying a car, the value of that investment would have been Rs 1,60,00,000 by now.

Yes, 1.6 Crore from 1L.

More than a provident fund retirement amount that my uncles received who retired in 2017.

A whopping 80X returns over a period of 14 years.

Value investing is about identifying under priced stocks and staying invested for long time.

It’s also a safer way of investing.

You buy stocks at low prices and this acts as a safety net even if the market falls, preserving your capital investment.

There are many Maruti Suzuki’s to be spotted in market even in 2020.

But, unlike trading, value investing requires you to invest in good stocks and hold on to them for a long period of time till you make a killing.

It could be 3, 4, 5 years, or even more depending on the stock.

When you hold stocks for such long period of time, the value happens over longer term.

Because the power of compounding comes into play.

Earlier, I asked you to choose between

Option 1: Rs 1,00,000 every day for next 20 days

and

Option 2: Rs 5 on Day 1 and double every day for next 20 days

Well, Option 1 would have given you Rs 20,00,000 (simple 1L * 20 days)

Option 2 had compounding at play since your money was doubling every single day over the 20 day period.

  1. 5
  2. 10
  3. 20
  4. 40
  5. 80
  6. 160
  7. 320
  8. 640
  9. 1280
  10. 2560
  11. 5120
  12. 10240
  13. 20480
  14. 40960

… do your account till day 20th..

Did you also come to sum up Rs 26,21,440

Yes, more than having 1,00,000 Rupees every day.

Good quality businesses (stocks) increasing their earnings & grow their profits multifold every year. You create huge wealth when you invest at the right time.

But, how do you identify such good stocks that are available at a cheap price?

You don’t have to carry a degree of MBA or finance expert to assess a business.

All Chartered Accountants and MBA degree holders are not making profits from the stock market. The real winners are who can win over their behaviour (Greed & Fear).

Common sense is more required than financial understanding.

I will help you understanding the basics of business and rest you can learn through experience.

You would need only 3 things for stock investing

  1. Demat and trading account (UpStox)
  2. Right stock recommendation (EquityMaster)
  3. Your own understanding (& patience) that you would build over time..

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