5 Secrets To Success In Investing Subject: 4 Best Practices For Investors
Successful investors are not lucky. They got there with hard work and made numerous mistakes in their investment journey. However, they persisted relentlessly to get their investments right till they eventually succeeded. Their success manifests in the form of multi bagger returns from carefully picked stocks that they closely monitor. And here is the most important rule they follow – they are patient. In other words, success does not happen overnight in investing.
We are fortunate to live in a period that offers tremendous opportunities to grow our personal wealth through investments in new ideas and industries. There is no dearth of investment opportunities. The key is to spot the right opportunities that will grow your investment multifold. Use these five closely guarded secrets that successful investors follow to make your investment journey fruitful:
Secret 1: Buy ‘high’, not ‘low’
Buying anything ‘cheap’ comes at a cost. In case of vegetables or fruits, you will, in all likelihood, find it to be nearly rotten; in case of any processed food, it would be nearing its expiry date… similarly, in case of stocks, buying ‘cheap’ usually implies the company is facing challenges such as losing market share to competition, rising costs, etc. Buying ‘cheap’ in stocks is not a wise decision. The truth is, there are no ‘bargain buys’ available in the stock markets. The old adage ‘Buy low; Sell high’ is misleading. Ignore it. Instead, buy a stock that is on an uptrend. This is an indication that the company is doing well. In fact, buy a stock that is nearer its high; it indicates investors’ interest in the stock (especially institutional investors) and chances of the stock moving further up. Here is another strategy – buy more when the stock is on its way up; an up-trending price proves that you have made the right stock selection.
Secret 2: Look at EPS, not PE
If you read research reports, you will see that most stock analysts make their ‘buy’ or ‘sell’ recommendations based on the stock’s P/E (P/E is the current market price per share divided by the earnings per share). A ‘buy’ decision is based on the fact that the company is trading at a ‘low P/E’, and vice versa. However, extensive study of price moves over the past has indicated that P/E is a misleading indicator. Instead, focus on the ‘E’, i.e. the company’s earnings per share. This is computed by dividing the net profit by the total number of outstanding shares of the company. This tells you clearly how much the company has been able to earn for every share it has issued. The EPS should be assessed over a period of time to see whether it is rising, has remained stable or is falling. A company with a rising EPS indicates growth in its business. In fact, you may often find that a company with a high and rising EPS will be trading at a high P/E. This is because the market has recognized the company’s ability to grow its business and is buying into the stock.
Here is another insight on P/E. Analysts usually compare P/Es of stocks in the same industry group and declare that the stock with the lowest P/E is the most investment worthy. In reality, that would be the stock you must avoid completely. It would indicate that the company is not performing well vis-à-vis its competitors. Instead, select the company with the highest EPS in its industry group.
Secret 3: Understand the true meaning of ‘long term’
‘I buy a stock with a holding period of 20+ years and don’t look at it. When I see its price after 20 years, I’m sure it will be so high that I’ll be rich!’ This statement indicates how a typical investor thinks about investing for the ‘long term’. The truth is – this could lead to disastrous results. The business climate is constantly changing; a company may face competition from anywhere – a company in another sector, a new company with more advanced technology… it could face internal upheavals which may result in the company becoming defunct… in other words, there is a lot that could go wrong during your holding period. While you would rest easy with the false notion that your stocks will grow, the truth on the ground may be just the opposite.
So, what is ‘long term’? It implies that while you hold the stock without focusing on the day-to-day price moves, you do keep a close watch on the company’s business growth, which can be assessed from its quarterly results, new initiatives announced, takeovers, mergers, etc. In other words, every corporate action should be assessed to judge their implications. This will alert you early if there is a possibility of a downturn in the company’s business. You can then take action to book profits or cut losses early.
Secret 4: Watch the interest rates
Changes in interest rates usually impact the stock markets. As a rule, when the RBI reduces the interest rate, it usually implies the end of a bear market. However, there are numerous other factors that also impact markets, so this may not hold true always. In any case, lower interest rates are positive for the stock markets for two broad reasons – companies will have access to funds for expansion at a lower cost (borrowing costs are low) and investors will find debt securities less attractive (they will earn lower returns from debt investments), which, in turn, will drive funds into the stock markets. The reverse, that is, a rise in interest rates will typically be negative for the stock markets since it implies greater demand for liquidity, which makes borrowing expensive for corporates. This could result in companies delaying their expansion plans while investors will prefer debt securities, which would offer attractive returns. Keep your eyes on RBI’s interest rate resets to judge the impact on the stock markets.
Secret 5: Face your ‘mistakes’/losses head on
Humans live on hope. This also reflects in your investments. When a stock has fallen below your purchase cost, it’s only natural for you to hope that it will rise, and you can then exit at cost (without having to bear any loss). In all likelihood, your hope will remain just that – a hope. In fact, there is a greater possibility of the stock price falling further, thereby increasing your losses. And you would still be holding on with the thought ‘I can’t bear to book this loss.’ The truth is – the loss is already staring you in the face. Booking it (selling the stock) and moving on may be the wisest thing to do. In fact, sell the stock and use the cash to invest in a stock with attractive growth prospects. You have a good chance of not only recovering your loss from the original stock, but also seeing your investment grow multi-fold.
If you are still hesitating to sell the stock, ask yourself this question, ‘If you were to buy this stock today, would you?’ No? Then sell!
Some investors don’t just continue holding a losing stock, they go a step further and invest more in the stock to ‘average down’ their purchase cost. This is simply foolhardy. If a stock is falling, it implies that it could keep falling and you don’t know when it will bottom out. Besides, why put more money into a losing stock when you have numerous attractive investment opportunities? Avoid averaging down. It usually doesn’t work.
We started this note stating that successful investors make numerous mistakes till they get their investment strategy and stock picks right. Making mistakes is a natural part of the learning process. It should not make you lose your confidence in your investment ability. We often hear people say, ‘I burnt my hands in the stock markets and I’m never going to invest in stocks again.’ They are missing out on one of the best investment opportunities to grow their wealth. A mistake is similar to a battle lost; it doesn’t mean you have lost the war. Keep investing and keep learning. You will only reap the benefits.
It takes hard work to become a really good investor. More importantly, successful investors don’t let their ego get in the way of booking losses. In fact, they take pride in recounting their mistakes and what they learnt from each of them.
Investing is a complex exercise that involves many elements – global and domestic events, actions of stock market participants, climate factors, technological innovations, and so on. Each of these elements impacts the stock markets, which, in turn, impacts your investments. Staying on top of all these factors and understanding their implications on your investments requires skill and more than 24 hours each day! Investment advisers do just that for you. They closely track markets and make sure your investments are performing. You can simply leave it to them to manage your investments. All you need to do is select the right investment adviser!