The Warren Buffet way

This blog is to encourage more and more people to invest in the stock markets. India has 8% retail participation in market investments as against 20-33% in South Korea and China. Presently only 2.6% of India’s total savings come to capital market, and 85% of total trading is from only 5 cities. This section of the blog (in addition to my first blog) caters to the general fears that prevent these people from entering into the market. It is true that there is no surety to the returns on our investments, but with the right thinking and logic, I am sure making money in the stock markets would not be that difficult.

Let us have a different approach this time. Anyone who likes to invest in stock markets must have heard about Warren Buffet. He is one of the greatest icons in the investment world. Over the years, I have tried to learn from his ideologies which have helped me big time. Before moving any further in my blog, I would like to re-stress on some very crucial points (some very famous quotations of Warren Buffet) that we need to keep in mind while investing in the equity markets.

1)     We should never invest in a business we cannot understand: When we buy common stock, we should approach the transaction as if we were buying into a private business. As a common investor, we should have some idea about what the business is all about and what are the internal and external factors that might affect the top-line and the bottom-line of that company. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. Once we have bought the shares of any company, we should hold to it with the same tenacity that an owner would exhibit if he had owned all of that business.

  

2)   Unless we can watch our stock holding decline by 50% without becoming panic stricken, we should not be in the stock market: Stock market is a place which, unlike banks, provides no guarantee to our investments. As an investor, we should invest only that money, which if we lose, it would not affect our daily lives much. We need to be free from all the fears and excitement. Fear to lose can be a great hurdle in our path of making profits.   

3)   Wide diversification is only required when investors do not know what they are doing: We already discussed this in detail in my previous section “Investing Dilemma for small investors”.

4)   Much success can be attributed to inactivity: Most investors cannot resist the temptation to constantly  buy and sell. As already explained in my previous blog “Investing Dilemma for small investors”, the ability to say no is a tremendous advantage for an investor. We should buy stocks based on some data and reasoning. There is no need of trading continuously and daily. Daily trading increases the scope for making wrong decisions. Patience is one of the most crucial profit making tools in the world of investing. 

Investing Dilemma for small investors

I have been investing in the stock markets for the past 6 years. And as every investor, I have always found it fascinating to see how unpredictable the market can be. We always come across such statements as “Stock market is only for the riches and the small investors enter this market only to squander away their money so that the rich could get richer”. In this blog, I would like to focus on why big investors have an upper hand in the investing world and what measures can be taken by small investors to prove the above statement wrong. To start with, let us find out where do big investors have an upper hand over the small investors like us.

1)   Availability of instant news about the companies: The major difference lies in the availability of instant information with the big investors who can afford to have one. By the time news becomes public, these big investors have already made their moves. Now, in order to understand this, we first need to understand the difference between a trader and an investor. In layman terms, a trader is someone who invests for a relatively shorter period of time. Their decisions are majorly dependent on the instant news. An investor, on the other hand, invests in stocks for a longer period of time. Their decisions are majorly based on fundamental and technical analysis of the companies and the sectors (both at micro and macro level analysis).

As far as I think, small traders, who have less money to invest, cannot make larger profits. When very short term trading is concerned, there is not much upside or downside in the share values in most of the cases. Now, let us evaluate trading by a simple example. Let us call Small investor – SI and big investor – BI. Now, SI has Rs. 1 lac to invest in a particular share and BI has Rs. 1 crore to invest. Let say, a positive news comes about a particular company which leads to a 3% rise in the share value of that company. Now, the profit made by SI is Rs. 3000 whereas the profit made by BI is 3 lacs. So, small traders like us has not much to gain (infact we have more to lose). I believe it makes more sense for people like us to be an investor rather than a trader.

2)    Money begets Money: The more you invest the more u can earn. As far as losses are concerned, putting a stop loss can save you big time from heavy losses. Big investors have larger sums of money for investment. As a result, their income from the upside is also big. When I say “the more you invest the more you earn”, I do not mean that we invest in various different companies with small amounts thereby having a portfolio with diversified companies with lesser number of shares of each companies. This will be dealt in detail in the next pointer.

3)      Diversity in the portfolio leads to lesser profits if any: We are generally made to believe that diversity in our investing profile can lessen the burden of losses. But, the fact is, diversity also leads to less profits. I believe that when we buy the shares, we are in fact buying the company. So, it is important for us that we do proper research before buying the shares. Diversity in our investing profiles only means that we are not sure of our investments. Buy those shares which you will be ready to hold for your life time. It is all about “high risk, high reward”. We are in the stock market not for security of our money or just nominal gains. We invest in the stock markets because we are looking for higher profits. If we are not ready to take that risk, believe me, fixed deposits, provident funds and bank savings are some of the investment routes suggested.

4)      Emotion has no role in Investing: Stock market is not for emotional people. You are in the market because you want to make some money. And fear to lose can only inhibit your profit making capacity. Now, let us first understand the concept of bullish and bearish market. A bullish market is one where a large number of investors have a positive sentiment about the market and is accompanied by the rise in value of the market. In a bearish market, large number of investors holds negative sentiment about the market and the market indices see a downfall. It is generally seen that in the bearish market, small investors (due to their lack of confidence and their less risk taking appetite) indulge is a selling streak (they end up selling stocks at lower price) whereas they end up buying the stocks in a bullish market when the prices are rising (thereby buying stocks at higher prices). In fact, it should be the other way round.    

5)      Lack of knowledge and understanding of the financial markets by a common man: This is another major problem faced by us. Most of us tend to buy stocks based on what our friends and brokers have to say. In this way, we generally find ourselves lying on a pile of stocks of different companies from varied sectors (companies and sectors we do not understand at all). Instead, if we can just be a little more patient, and if we can just try and concentrate on one or two sectors (or five to six companies for that matter), I think we can avoid ending up with a number of worthless shares in our portfolio.

What makes us buy so many different stocks is our concern that if we do not buy it, we might lose the opportunity to make huge profits. In fact, what we should do is let the opportunity go because it is not an ‘opportunity’ until and unless you are sure about it. We need to be calm and patient. Let our friends and brokers do what they want to do. Let us not cave in to rumors, fear and excitement. Stock market is not a place where there is any dearth of opportunity. We need to sit down and do our homework before taking any decision. And once we have made our decision, we need to be loyal to the share and stick to it regardless of what market mongers has to say.