Views on Life & on Equity Investing

Wonder, Wealth & Abundance

Investors guide to picking stocks

with 14 comments

 Below is a checklist which provides a general guidance for selecting stocks for the long term.

  • Business must possess a durable competitive advantage, this is relatively easy to find out. What is difficult is to agree on a combination of great price and good business 
  • Follow Michael Porter’s (MP) competitive strategy on forces of competition models

  1. Rivalry among existing firms 

     – Industry growth rate. MP prefers fast growing industries. I believe Micheal Porters model is incomplete for investing success. One needs to be early in fast growing industry and prefer slow or non growing industry, or strongest player in fast growing industry as a general rule.

     – Concentration and balance of industry

     – Is there customer stickiness to product

     – Is there steep learning curve in industry, economies of scale

     – Is there excess capacity in industry

     – Can industry customer base change rapidly

     – Product differentiation

  2. Threat of new competitors

     – Are economies of scale relevant

     – How easy is it for new competitors to enter

     – Do existing players have hard to replicate service / product

     – What is the moat, network effect, low cost, brand, high switching cost

     – Legal barriers or patents

  3. Threat of substitute products

  4. Bargaining power of buyers

  5. Bargaining power of suppliers

One needs to answer above questions to hold stocks for long term.  

Industry does not matter

An important lesson unlikely to be well learnt by most investors is, that in picking stocks, it isn’t important to assess how much an industry is going to change society, or how big the industry would grow. Its important to know how a company scored over its competitors and how long it can maintain this advantage.

Economics of the business matters

We need to look for business with good tailwinds and companies that require non linear capital input to grow sales. Nebraska Furniture Mart is lowest cost producer Louis Vuitton is premium brand, both possess moats.

ROE is important, so is Net Income / Sales

No company can grow net profits faster than its ROE over long period without debt, equity dilution or window dressing. ROE in future matters more than what it has been in past, which is a hint.

High profit percentage to sales can attract competition, low signifies poor fundamentals or commodity nature. 

Management

An ideal management team should be strong advocate of company’s shareholders. There are no corporate raiders to talk of in India yet, so one is at mercy of controlling family.

Do the owners only reward themselves with high salaries?

Has the management bought shares from open market?

Have they paid rational prices for acquisitions made?

Is there an event risk to businees upon demise of key management personnel?

Intrinsic Value

Discounted value of future cash flows

Rational price a private buyer would pay

Psychology towards investing

Availaibility Bias : Humans tend to have stronger recollection of information recently obtained or information that has had strong impression. An example is when someone tries to bring up a stock on news channel.

Representativeness: If a stock has gone up several years then it is bound to come down the next year, or market is likely to decline simply because it has gone up for the last 6 years.

Gamblers fallacy: Gamblers tend to believe that if a coin has landed on heads five times then it is likely to land on tails the sixth time.  Markets behave a lot like tosses of coin. Interesting patterns provide little guidance on how to predict patterns of the future.

Over confidence: Everyone thinks they are smarter than others and have more faith in their capabilities.

Anchoring: We tend to stay on a course of action once its been decided.

Illusion of Validity: Investors tend to ignore evidence that goes against their conclusions and place too high a value on evidence that conforms to their conclusions.

Hindsight bias:  False extrapolation of past trends into future. Frame dependence is another area where investor’s perceptions of risk and return and thought processing abilities break down. Loss aversion and loss realisation from poor idea, mental accounting (free shares or free money) and regret complex are three examples of frame dependence.

Loss results in 2.5 times the emotional impact of an equivalent gain. People are not able to take losses, this is the reason why many people sell stocks at worst moment. Lotteries are popular because amount of loss is less.  Investors sell their winners too early and hold their losers too long.

We should admit errors and book loss.

When investors lose 70% of their portfolio they would regret having invested anything at all in equity market.

From Graham:
” Now, let me close with a few words of counsel from an 80-year-old veteran of many a bull and many a bear market. Do those things as analyst that you know you can do well, and only those things. If you’re really good at picking stocks most likely to succeed in the next 12 months, base your work on that. If you can foretell the next important development in the technology, or in economy, or in consumer’s preferences, then concentrate on that activity, But in each case, you must prove yourself by honest, no-bluffing self examination and by continuous testing of performance that you have what it takes to produce worthwhile results.”

Written by amitdipsite

January 13, 2011 at 9:43 am

Posted in Uncategorized

14 Responses

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  1. These are qualitative criteria! what about quantitative?

    Bharat

    January 16, 2011 at 3:09 am

  2. I have covered two important quantitative factors ROE and Profit / Sales.

    – Near Debt Free

    – High FCF

    – Increasing operation efficiency

    – Increasing ROE

    – Increasing Margins

    – Increasing sales and profits

    are a very good start for a category of stocks. Every investment is unique and we may need to ignore some factors. Importantly investment style has to jibe with one's age, monetary amount, mental makeup.

    Amit Arora

    January 16, 2011 at 8:58 pm

  3. Hi Amit, I am eagerly awaiting a brand new multibagger from you.

    Avantika

    January 18, 2011 at 1:24 pm

  4. Hi,

    I'm afraid I do not have any to share. I need to see first what kind of human beings infant Elinchrom and teenager FILA grow up to be in India.

    Regards

    Amit Arora

    January 18, 2011 at 8:31 pm

  5. I had mentioned a stock in comments starting with alphabet T on the 21st of September 2010 in this entry.

    http://multibaggersindia.blogspot.com/2010/09/elinchrom-and-competition.html

    To overcome inhibitions of a high price tag, wise would do well consider it a 1 Rs Face Value share, earning 10 Rs per share available at market price of 150 Rs growing well over 30%.

    Best share can be the one you already own or owned. A single stock can go up 10 times and then again 20 times and then again 5 times and yet again 3 times.
    As long as story is strong, keep riding. Why sell it after its a 4 bagger.

    Amit Arora

    January 19, 2011 at 9:14 pm

  6. Hi Amit,

    Its really nice idea to divide all financial figures by 10 and then you a company with the figures you talked about so magnitude can seen relatively. How ever for a company to become 10 to 00 crore is easy, 100 to 1000 crore is still easy but 1000 to 10,000 is tough.

    What do you say?

    So its a good Buy at current valuation and on any consecutive dip of 5-10%?

    Cravatex, hiring:
    http://www.jobisjob.co.in/ahmedabad-bengalurubangalore-delhi/cravatex-limited/commercialcorporate-sales-manager–fitness–sports/job-offer-j4wuqolobhzfz7xdxgp6imo3le

    Rahul Kumar Paliwal

    January 22, 2011 at 4:23 am

  7. Thats right Rahul, its increasingly harder for bigger organisations to grow even larger. But sometimes we risk selling too early eg. Banks, Cellphone companies, Staple retailers. One of the tricks to make lots and lots of money fast is to buy 100-200 Crore turnover company that will clock 1000 crore turnover and will get a handsome PE rerating.

    There are couple of other dynamics too, tradeoff between Certainty vs Speed, overall industry size. We'll notice that certainty is very high for market leading 1000 crore companies to become 10,000 crores companies with slower speed, Amara Raja another example I missed from 100 – 1000 (I dont own). TTK has been 15 bagger since 2009, we cant expect same rate. Certainty is lower for 10 Cr company to become 100 Crore. Just as 50% startups last 1 year and only 1% last 5+ years.

    Better entry price is possible since it will pay 20 Rs only this year max as dividend if at all. I will only bet smaller part of portfolio for downside protection.

    Amit Arora

    January 22, 2011 at 6:07 am

  8. Regarding Photoquip, If propmoters were to hold only 48%, how did the rest 52% go to public? If any company were to start, promoters would have had at least 75% like cravatex and not sold anything if they belive the story is intact. Why did they reduce to 35%, then gradually started adding to bring to 48%? If the share price has to hit roofs, then promoter holding has to go to 75% then only we can expect decent spike in price.

    gvshiraguppi

    January 28, 2011 at 12:15 pm

  9. gvshiraguppi,

    Thats not at all how things are in real life. Hawkins Cooker for example has gone up 30 times over last 6 years without any action by promoters on buying or selling shares. Their holding is mere 43%. Some companies have gone up 100s of times where promoter holding is less than 30%

    You need to read about IPO and listing of companies on stock exchange.

    Amit Arora

    January 28, 2011 at 5:27 pm

  10. Photoquip has declared Q3 results. What is your analysis about results? Is it still strong buy?

    gvshiraguppi

    January 31, 2011 at 8:06 am

  11. What about liquidity?
    Buying shares for say Rs 1 lac is all fine.

    Your recommendation of Cravalex is hardly seeing any transaction activity these days, despite growing manifold.

    How will I then sell to recoup the investment?

    Arvind

    February 9, 2011 at 5:07 am

  12. @Aravind

    I am not recommending stocks just providing free opinion which can lead to loss of 100% of pricipal capital. Please use your brain, its your money and your loss.

    Disclaimer:

    I or my partnership may be holding positions in stocks written here. We will not be held liable for losses. Ideas expressed are only opinions in my personal capacity as individual. It does not constitute a recommendation to buy or sell. Investment in stock market is subject to risk, resulting in loss of principal capital. Please do your own due diligence before buying stocks and consult your broker and investment advisor.

    Amit Arora

    February 9, 2011 at 5:49 am

  13. This comment has been removed by a blog administrator.

    Jatin

    August 5, 2011 at 7:25 am


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