- While selecting stocks, you need to ensure that your holdings are not concentrated in one or two industries or companies following the same business cycle
The raging bull market is a self-advertisement of the investment potential of stocks. It’s natural then, to want to participate in equities. However, with the recent buoyancy, it can become very difficult to sift the wheat from the chaff. In order to help you navigate this, here are 7 mantras for selecting stocks-
Recognize your investing goals: Before beginning stock selection, you need to evaluate your investment goals. This may seem a bit off-track and not directly related to picking a strong equity portfolio. However, a thorough understanding of what you want to accomplish can dictate the companies you want to buy. Some are interested in wealth creation; others may prioritise steady income through dividends.
Invest in businesses you understand: When you buy stocks, you become part-owners of the business. Comprehending elements that make up the core of the company will be advantageous in estimating its future potential, or probable pitfalls. In-depth knowledge of a business is not merely a superficial understanding of its products and familiarity with its direct competitors. Understanding also involves knowing how much cash it can generate, estimating its intrinsic value and betting on its future estimated potential. Contrastingly, stay away from companies whose business you don’t understand.
Quality management is key: Capable and experienced management plays a crucial role in determining the fortunes of a company. Many investors tend to overlook this aspect of a stock, but often times it’s just these simple things that have a huge impact on its trajectory. Integrity and capability are the two of the key factors that determine a management’s quality. If you find any red flags in terms of management conduct, it’s a definite indicator of rejecting the stock, even if it checks all the other qualitative factors.
Focus on competitive advantage or moat: A moat or a competitive advantage allows a company to fend off competition and earn consistent cashflows into the future. A strong moat is a credible signal of good earnings over a long period of time.
Concrete track record: Though the oft repeated axiom states “past results do not guarantee future performance”, a company that has a good past track record is less likely to go astray in the future. Historical performance also reveals a lot about a company’s financial health and how it has managed unexpected events in the past.
Diversify: While selecting stocks, you need to ensure that your holdings are not concentrated in one or two industries or companies following the same business cycle. Spreading your capital across a variety of industries will shield you from the backlash of a sudden disruption or prolonged financial downturn relegated to specific sectors.
Think long-term & seek your Margin of Safety: This mantra sounds very simple, but it’s not easy to accomplish. Investing in a stock is easier than holding the stock through its volatile trajectory. The path to achieving your investment goal is not necessarily linear, and more often than not, requires you to shut-off market noise and hold on to your conviction, even if it makes you seem exceedingly contrarian. However much one strategizes, things might not pan out the way it’s envisaged. When you have a process that necessitates a good margin of safety it ensures that your plan has a very high probability of success and the outcome will be favourable as well as rewarding.
Mrinal Singh is the CIO and CEO of InCred AMC
