Table Of Content

wwwwww..ddrrvviijjaayymmaalliikk..ccoomm PEACEFUL INVESTING A Simple Guide to Hassle-free Stock Investing Dr Vijay Malik [email protected] www.drvijaymalik.com 11 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com Table of Contents 1) Getting the Right Perspective towards Investing ................................................................. 4 2) Choosing the Stock Picking Approach suitable to you ......................................................... 7 3) Why I Left Technical Analysis And Never Returned To It! ..................................................13 4) Shortlisting Companies for Detailed Analysis .....................................................................18 5) How to conduct Detailed Analysis of a Company ...............................................................25 6) Understanding the Annual Report of a Company ...............................................................31 7) How to do Financial Analysis of a Company ......................................................................43 8) 7 Signs to tell whether a Company is cooking its Books: “Financial Shenanigan s..”...........52 9) Self-Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company......6 0 10) How to do Valuation Analysis of a Company ..................................................................68 11) Hidden Risk of Investing in High P/E Stocks ...................................................................73 12) How to earn High Returns at Low Risk - Invest in Low P/E Stocks .................................81 13) 3 Principles to Decide the Investable P/E Ratio of a Stock for Value Investors ...............8 8 14) How to do Business & Industry Analysis of a Company ................................................ 103 15) Is Industry P/E Ratio Relevant to Investors?. ................................................................ 112 16) Why Management Assessment is the Most Critical Factor in Stock Investing? ............. 121 17) Steps to Assess Management Quality before Buying Stocks (Part 1) ...........................1 33 18) Steps to Assess Management Quality before Buying Stocks (Part 2) ........................... 144 19) Steps to Assess Management Quality before Buying Stocks (Part 3) ........................... 156 20) 3 Simple Ways to Assess "Margin of Safety": The Cornerstone of Stock Investing. ...... 161 21) 7 Important Reasons Why Every Stock Investor should read Credit Rating Reports..... 171 22) Final Checklist for Buying Stocks.................................................................................. 181 23) 5 Simple Steps to Analyse Operating Performance of Companies ............................... 185 24) How to Monitor Stocks in Your Portfolio........................................................................1 92 25) Understanding & Interpreting Quarterly Results Filings of Companies .......................... 197 26) How Many Stocks Should You Own In Your Portfolio? ................................................. 210 27) Trading Diary of a Value Investor .................................................................................2 15 28) When to Sell a Stock? ..................................................................................................2 22 29) 3 Guidelines for Selecting Stocks Ideal for Retail Equity Investors ............................... 227 30) Premium Services ........................................................................................................ 235 22 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com 33 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com Every investor has a dream that she should create a portfolio of stocks, which should generate wealth for her. The portfolio should become an alternative source of income for her. The portfolio should support her in the hard work to sustain and improve the financial position of her family, her lifestyle and if possible give her an opportunity to retire early and fulfil all her dreams: travel, adventure and doing things she is passionate about. I have the same dreams and desire that my stock portfolio should generate sufficient income; so that I might not need to work at a job as a necessary means to earn my livelihood. Monitoring my portfolio would be the only thing needed and I do not think of portfolio management as a job. It is my passion, which makes me feel lively and rejuvenated. Many acclaimed people have already achieved that dream through stock investments, both in India and abroad. The accomplishments of Warren Buffett and Rakesh Jhunjhunwala can be cited as good examples. Warren Buffett buys the stakes and stocks in the companies, in which he would like to, invests through his parent holding company Berkshire Hathaway. Those companies, in which he has invested earn profits and send the majority of the cash back to the parent company (Berkshire), which Warren further invests. Warren, currently 84 years of age, enjoys his job so much that he often says that if loving one’s job ensured long life, then he would never die. His personal wealth is about $ 67 billion. I do not know whether my portfolio would ever be able to reach those levels. It is in the time to come when we will see how far I will be able to go. I believe that anyone who is able to put in the required hard work can do the same. It is the single most important quality required in a person who wants to be a successful stock market investor. Many successful investors like Benjamin Graham, Peter Lynch etc. have written books sharing their knowledge about stock investments. They have explained the stock picking process in a very simplified manner. Reading these books is the first step in this journey of stock investments. This is another very important quality needed for a good stock market investor. The role of emotions in investments has assumed such significance that a separate field called “Behavioral Finance” has been created for it. Stock market investing requires a long-term approach and you have to stay invested in the market for a long time to reap the benefits. Investors face many emotions during their stay in the stock market. Emotions like fear, greed and frustration make investors take impulsive decisions of entry and exits during short phases of market ups & downs. When stock prices go up, the investors try to make short-term profits and thus sell their investments early. Many times, after investors sell, stock markets keep on rising further and investors are not able to reinvest their money and the market runs away from them. Market movements are highly unpredictable. Investors need to stay invested in stocks of good companies for long periods to make significant wealth. Jeanne Sahadi, a CNNMoney.com senior columnist writes: 44 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com "Missing out on those high-return months (the timing of which you can't predict) can cost you a lot. A hundred dollars invested from 1926 to 2006 in the S&P 500 would have yielded $307,700, according to Ibbotson. But if you missed the 40 months with the highest returns you would have ended up with - no kidding - $1,823 only." When stock prices go down, many investors fail to analyze the reasons of fall in the stock prices. Some investors are gripped with fear. They sell a good company whose stock price had fallen due to general market sentiment and not due to poor performance of the company. They should actually be buying more stocks of that company at cheaper valuations. Other investors show opposite behavior and do not sell a poor performing company despite the huge decline in its stock price because they hate to book losses. It is said that one should buy stocks; the way they buy their vegetables & groceries; one should buy more when prices are down. Therefore, one needs to be in control of one’s emotions and should develop the patience to delay the sh-ort term gratifications. One should be able to visualize the wealth, which markets are able to create over very long periods. Reading about the behavior of successful investors and observing their actions during different phases of stock markets, will help in developing the emotional control required to be a successful investor. Finance & investing are not rocket science. Business families have been able to teach fundamentals of finance to their children within confines of their homes. The same phenomenon of simple conceptual understanding always stands true in finance & investing. You need to get clarity on some basic concepts of finance and you would have gained the foundation to start investing. Good reading habit will help you to build on that foundation. You do not need to be a mathematician to succeed in stock market investing. The math you will need for investing is taught during school education. You do not require more than the ability to carry out the basic calculations. If someone says that, you need advanced mathematics for investing, she is confusing you and you should ignore such advice. Investing requires a lot of common sense and control of emotions. If you are able to learn basic concepts, are able to read further to build upon the existing knowledge and keep patience & self-control during stock market highs & lows, then you have what it needs to become a successful investor. Once one has read the required books of successful authors, the person will be able to understand the basic framework about stock market functioning. She will also get to know about various characteristics and 55 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com parameters of stocks to be looked into while doing stock investment. She should note down and keep a list of these parameters with her when analyzing stocks to see how these parameters apply when doing the actual stock analysis. Then she should start exploring stock markets to identify the best stocks for her. Financial newspapers (e.g. Business Standard, Economic Times etc.), business magazines (e.g. Business Today), stocks magazines (e.g. Dalal Street, Capital Markets etc.) and websites (e.g. Moneycontrol etc.) are good sources to start looking for potential stocks for detailed analysis. 66 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com If we read about the experiences of successful investors, we will find that each one of them had their own specific methodology of picking stocks. They, in turn, might have been inspired by other successful investors. However, there is not any one specific approach of stock picking, which has made them successful. Benjamin Graham focused on investing in stocks that were selling at a discount to their fair value. This is an example of Value Investing approach. Philip Arthur Fisher (Phil Fisher) focused on investing in stocks that were capable of growing at a faster pace as compared to their peers. He justified paying a premium for such high growth stocks and did not stress too much on finding stocks selling at a discount to their fair value. This is an example of Growth Investing approach. Warren Buffett studied under Benjamin Graham during college and therefore focused more on value investing in the initial stages of his career. However, later on, he incorporated guidelines of Phil Fisher in his investment philosophy. Now, as per Buffett, his investment methodology is a mix of about 85% Graham and 15% Fisher. So we can see that there is not only one single defined approach to achieve success in stock picking. In fact, it is rightly said that ‘All roads lead to Rome’. However, each one of these approaches has their own pros and cons. These stock-picking approaches might differ in terms of the types of the stocks they focus on. These approaches might also differ in terms of the amount of time & effort required from investors and in many more ways. A stock-picking approach, which is suitable for one investor may not be suitable for another. However, it is easy to find the stock-picking approach or a mix of the approaches, which will be suitable for an investor. This chapter would help the readers in find such a suitable stock-picking approach. I have discussed various approaches to stock picking below. We, as investors, should learn a bit about these different stock-picking approaches and then select the approach or the mixture of approaches, which appeals to us. Fundamental analysis of a stock involves understanding the underlying business of a company. While doing fundamental analysis, the investor tries to find out a company, which has a very good product, well-known customers, stable suppliers, honest & capable management etc. Once the investor finds such a company, she can invest in its stock and expect to benefit from the future growth of the business of the company. Fundamental analysis is very similar to the in-depth analysis, which an entrepreneur will do before starting a new business. I believe that the fundamental analysis approach to stock picking is, in fact, a form of entrepreneurship. 77 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com Technical analysis involves analyzingcharts of the past movements of a stock’s pirce and its trading volume over the different time periods. It involves understanding the patterns in the charts containing data of a stock’s price movement in the past. The investor then tries to predict futu rperice movement of the stock based on these past patterns. Once the investor finds a stock whose price is expected to move higher, she buys it and holds it until the chart patterns indicate that the price is expected to fall or become stable. The investor following technical analysis is concerned only with the past prices and trading volume data of the stock. The investor is indifferent to whether the stock is a manufacturing, an agricultural or a financial services company. Most of the successful stock market investors have followed the fundamental analysis. Fundamental analysis treats stock investment as a way of having ownership in a company’s business. This approach allows an investor to benefit from the enormous wealth, which is generated by owning a successful business over a long period of time. On the other hand, Technical analysis tries to predict the next ‘up move’ in a stock’s price and is indifferent to the company’s business. In fundamental analysis, once an investor has found a good company, she stays invested in its stock for decades. Hence, if the investor was able to make at least a few good stock investing decisions in her life, she will be able to earn a great amount of wealth. In technical analysis, the investor buys a stock just before the next ‘up move’ in its price. She sells the stock after the up move has happened or if the up move does not occur and the buying decision has been proved wrong. In technical analysis, the investor keeps the stock with herself only for a few days or weeks. Many a time, investors try to buy and sell stocks with a few minutes during a day. Such kind of investment behavior requires the investor to keep finding right stocks every few minutes/days/weeks. Almost all the successful investors say that finding good stocks for investment is difficult. Therefore, if an investor has found such a stock, then she should stay invested in it for long periods. Selling a good stock only after one ‘up move’ in ist price is not a winning decision in long term. Stock markets are very volatile and the periods of up & down moves in a stock’s price are going to be very frequent. Therefore, an investor should not fall prey to greed and she should not sell her stock when the prices move up immediately after she buys it. Moreover, the investor should stay invested in the stock until the company keeps on growing its business consistently. I started stock market investing in 2006 by learning technical analysis. However, with the continued reading and personal experiences in stock picking, I realized that fundamental analysis is a better approach to stock picking. Therefore, I have been selecting stocks by using fundamental analysis since 2008. 88 ||Page Copyright © Dr Vijay Malik. All Rights Reserved. www.drvijaymalik.com Fundamental analysis has different sub-approaches to stock picking. All these sub-approaches focus on the underlying business of the companies. However, they differ in the methods of selecting stocks for detailed analysis and the features of stocks, which are focused on future gains. TToopp DDoowwnn aapppprrooaacchh:: Top down approach to the fundamental analysis is also called EIC (economy-industry-company) approach. In the top-down approach, an investor tries to identify those economies (countries) of the world, which are expected to grow at a faster pace than other economies. Once the investor has found such economies, she studies them in detail. Within these economies, the investor tries to identify the industries, which are expected to witness higher growth than other industries. Once the investor has identified high growth industries in selected economies, she tries to find out the companies in these high growth industries, which are expected to benefit the most from such expected growth. Once the investor has finalized the list of such companies, she buys stocks of these companies. The investor expects to benefit from the higher earnings, which these companies are expected to create over next many years. BBoottttoomm UUpp aapppprrooaacchh:: The bottom-up approach to the fundamental analysis involves identifying companies, which are expected to grow their business without restricting the stock-picking search to any particular industry or economy (country). All the stocks listed on all the stock exchanges in the world, irrespective of country or industry of operation, are open for selection to the investor. The investor uses various selection criteria to search for the best stocks. Such selection criteria help an investor find out the companies he likes e.g. the fastest growing companies across all sectors or the companies, which are selling at a discount to the cash in their bank accounts. Once the investor finds a good company, he buys its stock and expects to benefit from the future growth of the business of the company. CCoommppaarriissoonn bbeettwweeeenn TToopp DDoowwnn aanndd BBoottttoomm UUpp aapppprrooaacchheess:: Top down approach limits an investor’s analysisof stocks of only a few countries and a few industries. However, the bottom-up approach does not have this limitation. The bottom-up approach provides an investor with the option of investing in those companies, which are doing very good but are in industries, which are currently not doing well. Such companies are known to make huge wealth for investors. Peter Lynch, the fund manager of Fidelity Magellan Fund from 1977 to 1990, has recommended investing in such companies in his book One Up on the Wall Street. Thus, we can see that bottom-up approach gives an investor more options to choose his stocks for investment. 99 ||Page Copyright © Dr Vijay Malik. All Rights Reserved.