Sunday, May 24, 2015

Investing Without Tears

Investing is never 100% risk free. No matter how diligent and careful you are, a certain amount of risk is there. But with some knowledge and a good strategy, risk can be mitigated. Here are some guidelines:

1. Be an investor not a trader

Every stock has a company behind it. If you do an in-dept study of the company and you are convinced that the company is fundamentally sound and that your principal is safe in addition to an adequate return before you buy, you are investing. 

2. Don’t buy liabilities

A company with high gearings and no earnings or very little earnings is a problem company. It is a liability. Don’t buy it; don’t buy somebody’s problem. 

3. Follow the trend

Prices move in trends. A trend in motion is likely to move in the same direction. Follow it. When you see higher highs and higher lows in a chart, that’s an uptrend. A down trend is when you have lower lows and lower highs. 

4. Avoid the herd mentality

Just because all your friends are buying a certain stock, and therefore it is safe to follow, is a wrong way of thinking. In the stock market, there is no safety in numbers. You need to think independently as an investor. 

5. Be aware of what is cheap and what is low price

Many people assume that a low-priced stock is cheap. In reality, a higher-priced stock is often cheaper. You must look at the intrinsic value before you decide which is cheaper relative to its price.

6. A stock market is not a casino

The stock market has no mercy for those who treat it as a casino. All amateur gamblers lose money. Trading and speculations are akin to gambling. 

7. Be aware of your own ability

The problem with most people is that they tend to over estimate their own ability. 
Imagine what chance you have if you pit yourself against the professionals who are there ‘playing’ the market full-time.

8. Insist on value when you buy

A stock has three prices. It has a market price, a book value and an intrinsic value.
The market price is easy to understand. It is the last traded price at the end of a trading day. 

The book value is simply the net tangible asset (NTA) as shown in its balance sheet. 

The intrinsic value is the most difficult to calculate. I do not know of any formula for this. At most, it is only an estimation. You have to factor in many metrics such as barrier of entry, calibre of management, earnings potentials (present and future) growth prospects, patents, etc.

So, what should we do? For me, I make it simply. I look at the track record relative to its earnings, earnings growth and dividend yields. The higher these are, the higher the value. 

Buying a stock at high earnings per share (PE) is risky. Unless the forward PE is  expected be much lower, avoid stocks trading with high PE. (A PE of over 16 is too high for me.) 

To value a stock, here are some metrics or key ratios to consider: EPS( earnings per share); D/Y (dividend yield); NTA (net tangible assets); PEG (price to earnings growth); NPM (net profit margin); ROE (return on equity); D/E (debt to equity ratio) C/R (current ratio); PCF (price to cash flow). One other thing to carefully consider is the core business of the company. Here, you need to think about barrier of entry, patents and competition.

9. When is the best time to sell a stock

Close to 100% of all stocks will at one time or another be selling at extremely high valuation that they should be sold. At other times, they will be selling at overly undervalued prices that they should be bought. We want to sell a stock when it is very much overvalued.

Understanding the value of a stock is crucial in this respect, and with the help of technical analysis, you have the advantage of the competitive edge.  

10. Control your emotion

Taking action for action sake is a weakness that many people fail to control. Some people need to move in and out of the market often enough to overcome boredom. 

They forget that transaction costs eat into their earnings. 

Buy and sell with good reasons and not simply with intuition and the need for action.

Following the guidelines mention above will go a long way to help you to invest intelligently. 

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