warren buffett.png

Our editor for Valueoperations.com, mentioned that we get more hits on our website when we publish our post with headings like, ‘ 5 stocks value operations fund is digging for more information’ or ‘ 10 stocks to look for to invest in 2013’.

To better understand this trend I went on browsing for stock tips online on other sites, I was surprised to see majority of the sites had tips for the short term investment and purely in speculative nature, these tips did not provide any compiling reasons for why buy or sell stock in question.

With this firsthand experience now I understand why we get more hits on some post and not on the other posts. Let me reiterate, our mission is to educate our readers on how to think like a professional while investing in the equity market.

With this small exercise, I have learnt two important lessons. Most of the people think like traders rather than investors and novice investors wrongly equate value with the share price.

Following is the way most of us start out in equity market.

A colleague talks about the hot stock he or she owns, you go and buy that. A good and convincing article in the news paper or on the blogs like one of us talks about any stocks then we follow the suit. A very popular research or stock broking firm recommends buying any specific stock or sector we all again follow the suit. In this processes more literate you get in the investment field the quicker you realise need to transform form trader to investors.

Initially we all end up cloning a portfolio what I prefer to say as a ‘cocktail portfolio’ which has all the glamorous names and when things go haywire we justify by blaming all those resources that had created this cocktail portfolio.

Sound familiar? Don’t despair: many investors have lost their money on stocks thinking like a trader or speculator. The reason for this fall is,   focus was all about the price but not about value, the short term rather than the long term. We all were thinking about trading rather than investing. Moreover, the share market is far more geared towards trading rather than investing and to speculative rather than focused on quality investment grade stocks.

There is nothing wrong with experienced day trader betting on a loss making or any companies provided they understand the risk associated with those bets and have enough skills to overcome all those odds that are stacked behind it. Clearly, not everyone have those skills and most of the investors cannot cope with those monetary and emotional losses.

We did a simple search on all the listed companies on NSE market and found that approximately 10% of businesses report losses and same percentage businesses raise fresh equity to keep their business profitable. Approximately 30% of businesses do not compel to invest looking at their returns (ROE). In other words one of the two listed companies is not good to invest with. We also found that 25% of the businesses that qualify as investment grade by value operations platform looses its investment grade next year. In other words they can’t sustain their profitability and one of the sparks in their profits in certain year cannot be sustained next year.

You don’t need to trade in half of those listed business to boost your portfolio, leave them for the speculator or traders. There are plenty of opportunities still available every year to achieve those double digit returns by investing in the stock market without excessive risk associated with your investment. This is where you all as an investors should focus to invest and start thinking as the owners of those businesses rather than a renter of stock market scrip for the short term.

Many of the best fund managers have outperformed stock market every year including the value operations fund by holding exceptional companies for long period, and buying more when price rises. They know rising prices are following growing intrinsic value of those businesses.

To become a successful investor you need to have 3 core skills: asset allocation, stock valuation and asses and take advantage of market “noise”. Asset allocation is too big topic to be covered over here. Having a disciplined asset allocation plan should help you to think like part owners of the business rather than a short term trader of the stocks.

One of the very popular fund manager mentioned in regards to valuation this, “if you don’t have an estimate for the value of a business and you buy its shares, you are, by definition, speculating and betting someone will be willing to pay more than you just did.”

To keep this simple, imagine your friend approaches you to invest in his/her private business. As an investor I would ask him/her three basic questions before investing. The first question will be, “what are the chances of business going bust?” you would like to know how much profit it makes, how much debt it owns and can it comfortably meet its interest repayments.

Your second question will be, “Is it a good business?” you would like to know the industry they are operating is attractive, have excellent products to offer their clients, good customer list and most importantly profits are rising every year and its return on equity. Also do you think it will sustain or grow its ROE in coming years?

The final question I would ask is, “how much do I have to pay to get X per cent of the company?” after getting all the above information you gauge what the company is worth and compare it to the asking price for that business. Having a view on the business worth helps you to take decision whether to invest or not to invest in the business. You can do that because you understand the difference between the price and value of the business.

So what stops us to think as a part owner of those businesses and makes us trade and not speculate? Market ‘noise’ plays the big role in our decision. We get seduced by media headlines, finance channels, stock tips on internet and brokerage reports.

Investors need quiet, controlled detachment from the share market. Follow it, and don’t take decisions on what market is saying.  Don’t let market noise turn you as a short term trader or speculator.

As Buffet had suggested, enter the purchasing decision with all conviction of marriage – until death do you part. Of course this will not be the always case – there will be many justifiable reasons to break that relationship but you should have that quality of faith while buying any stock.