Equity Investment is all about…

An equity investment is money that is invested in a company by purchasing shares of that company. Equity investment in business is buying an ownership stake - a "piece of the pie." Equity investors provide capital, almost always in the form of cash, in exchange for a percentage of the profits and losses.

The main benefit from an equity investment is the possibility to increase the value of the principal amount invested which comes in the form of capital gains and dividends.

There are two extremes to equity investing;

One where someone bought a penny stock and it made millions and he realised his dreams from that one buy or someone who actually believed in the story of a particular business and had the conviction to remain invested in the stock, most likely one of the promoter group, key employee, business associate or someone else closely associated, who multiplied his investment manifold over the years.

In hindsight, it may seem very easy, It is easy to look back and track how brilliantly a stock has moved over the years. An actual investor in the stock will tell you how volatile that ride was, and how there were many instances during the journey, where all seemed lost and still he stayed invested. In most cases, millions were made by those who had no alternative but to stay invested or by those who didn’t even know they had those stocks and suddenly came across some old papers and suddenly realised they were sitting on a fortune. Most investors I know, will sell a stock and book profit partially or fully as soon as it turns a 100% profit or becomes a multi bagger rather than have the tenacity to remain invested till it became a 100 bagger like so many stocks in the last 25 years.

On the other end are people who have no faith in  equity investing; They see it as a zero sum game, some equate it with gambling; some are suspicious because money seems to be made easily; some dislike anything that does not come with guarantees like their loved Fixed Income and fixed return securities and deposits.

For one success story in equity, there are a hundred failures which no one usually talks about or one has heard about, those who lost faith mid way and booked their losses and exited, who somehow believed in get rich quick stories in equity and lost a fortune in derivatives, who traded their hard earned money and lost it all, who entered at the peak and exited at the nadir and moved away from the asset class for all times.

But, the truth about Equity investing lies somewhere in between.

Equity investing offers you a fair, democratic, and efficient opportunity to take part in the success of business enterprise. It gives you the flexibility to invest as much as you can and gives you a proportionate share of business and profits. The free market gives you the opportunity to buy and sell as per your requirement and convenience and ensures complete liquidity of your investment as against some other asset class.

Not investing in equity totally does not help, because it shuts your portfolio from an otherwise legitimate and democratic way of multiplying it manifold as against relatively low returns of other asset classes.

Equity has given the best returns in the last 40 years and has outshone all other asset classes. In the last 40 years of the Sensex, it has grown 400 times from 100 to 40000 as against FD, Gold, and Real Estate etc., which have grown in low double digits.

What should an ordinary investor know and keep in mind about equity investing?

In today's world of direct investing, “Click to buy and sell” and subscription based recommendations; many investors confuse investing with trading.

Stock prices rise due to a number of factors: earnings growth; acquisition by a larger company at an above-market price; stock repurchases by the company; and an increase in the price the market is willing to pay for one rupee of earnings due to increased institutional and investor interest.

The first rule of equity investing is preservation of capital and then later comes Appreciation of capital.

When you buy a stock, keep in mind that you have a sufficient Margin of safety and you Buy at a discount. What it means is that the Current price of the stock should be less than its intrinsic value. Warren Buffett himself offers the simplest explanation of intrinsic value, “It is the 'discounted value of the cash that can be taken out of a business during its remaining life.”

Here is an easy explanation by Buffett of intrinsic value. 'Let's say you decide you want to buy a farm and you make calculations that you can make $70/acre as the owner. How much will you pay [per acre for that farm]? Do you assume agriculture will get better so you can increase yields? Do you assume prices will go up? You might decide you wanted a 7 per cent return, so you'd pay $1,000/acre. If it's for sale at $800, you buy, but if it's at $1,200, you don't.' (Berkshire Annual Meeting 2007).

Here's another way to look at intrinsic value. 'If you were thinking about paying $900,000 or $1.3 million for a McDonald's Franchise, you'd think about things like whether people will keep eating hamburgers and whether McDonald's could change the franchise agreement. You have to know what you're doing and whether you're within your circle of competence,' said Buffett. (Berkshire Annual Meeting 2008).

Whatever the market condition, you should buy your stock with a margin of safety and at a discount. When market sentiment is Positive; Price = (Value + Sentiment) and the market Price is at a premium to Intrinsic value whereas when market sentiment is negative; Price = (Value – Noise) and market price is generally at a discount to Intrinsic value.

You will invariably make a profitable trade if current market price of the stock is at a discount to intrinsic value. Also remember that

If you buy at 10% Discount – Return will be 11%

@ 20% Discount – Return is 25%

@ 30 % Discount – Return is 43%

@40% discount – Return is 67%

@50 % discount – Return is 100%

In today’s market scenario there are several stocks, which are currently available at a discount to intrinsic value and with a sufficient margin of safety.

The next rule in equity investment is to pay a keen attention to quality.

The first is the quality of financials. In the published data, you can get all the detail that is required. There are sites in public domain, wherein you can filter stocks based on Piotroski F-Score, G Factor, Altman Z score and other variables like Debt Equity, PEG, ROCE, Mkt cap to sales, PB etc., to shortlist your preferred stocks.

According to us, there is one golden rule apart from the above financials, and that is, Free cash flows. Business is to make profits and generate cash, which can be used for further opportunities or distributed. As they say, Cash Flow is the only reality; growth means only growth in cash flows. Everything else can be manipulated; the sales, the profits but cash flow is reality and Cash is King.

The next aspect of quality is the quality of Management; there should be no governance or integrity issues. How the management has handled failure and crisis, generally tells a lot about quality of management.

Next is the Quality of Business – Does the business have an economic Moat. Quality is a company strongly entrenched as the sales leader in a growing market or a company that’s the technological leader in a field that depends on technical innovation.

Quality is a strong management team with a proven track record.

Quality is a well-capitalized company with zero debt that is among the first into a new market.

Quality is a well-known trusted brand for a high profit-margin consumer product.

The most successful firms are those that boast some sort of sustainable competitive advantage. These firms are able to maintain their success despite the inevitable attacks from competitors. Companies with wide economic moats operate business models that are difficult -- or in some cases even impossible -- for competitors to rival. The presence and size of an economic moat correlates to a company's ability to sustain long-term profitability.

Then comes the question whether the business model offers opportunity for growth in business. Quality of growth is more important than quantum of growth. Does the business offer consistent growth; the Certainty of growth is more important than rate of growth e.g. Talking of waterproofing as a business, Bharat Purl, the MD of Pidilite, once mentioned in an interview, that growth is not an issue as the penetration of the product category is in low single digits and even if the market doubles, the penetration will only be in high single digits. Thus one can safely assume consistent and profitable growth for a sizeable number of years.

Equity Investment is not buying mediocre businesses at low prices but about superior businesses at fair value or at a discount.

Finally Equity Investment is all about compounding; it is all about reasonable outcomes over a long period of time.

Re 1 invested in AP in 1988 is about Rs 720 today,

Re 1 Invested in Bajaj Finance 10 years ago is worth Rs 180 today,

Re 1 in PI Industries 10 years ago is worth Rs 200 today,

RE 1 invested in Gruh Finance 15 years ago is worth Rs 160 today

However if you don’t buy quality and buy structurally weak companies, then the outcome will be totally different. Have a reason for buying every stock and as soon as the reason comes into doubt, ask yourself if it is time for a change.

Tata Motors is at the same value as 10 years ago,

Tata Steel is at the same value as 10 years ago,

PNB is at the same value as 10 years ago,

Airtel is now at 50% discount as compared to 10 years ago,

And several Blue chips of yesteryears have eroded by more than 90% in value and are now Penny stocks.

At any given point, the market is driven by fear or greed.

The devil as they say, lies in detail. The fundamental rules don’t change. When others are afraid, you needn't be; when others are unafraid, you'd better be.

As Buffet famously said, “the most fundamental part of what Graham taught me was, you are not buying a stock, you are buying part ownership in a business. You will do well if the business does well, provided you didn't pay a totally silly price to buy it. That is what Equity investment is all about!”

Develop the Discipline to buy quality, discipline to buy value, discipline to have patience with the market and discipline to keep your eye on the goal and ride the volatility.

In the end, just remember that in your investment journey, to be successful; Invest and don’t gamble, buy boring, mundane businesses which are simple to understand, don’t go for sexy and finally all the stocks that you buy will not do well. In your portfolio, some stocks will do mediocre, some will do okay, and if one of two of them goes up big time, your portfolio shall produce a fabulous result.

Consult your financial advisor today for a profitable investment journey.

Happy Investing!

Stay Blessed Forever

Sandeep Sahni

Note: All information provided in this blog is for educational purposes only and does not constitute any professional advice or service. Readers are requested to consult a financial advisor before investing as investments are subject to Market Risks.

About The author

Sandeep Sahni

Sandeep is an alum of IIM Lucknow with a Post Graduate Degree (MBA class of 1988). His also an alum of Shri Ram College of Commerce, Delhi University (B.Com. Hons. Class of 1985.)
Sandeep's investing experience and study of the Financial Markets spans over 30 years. He is based in Chandigarh and has been advising more than 500 clients across the globe on Financial Planning and Wealth Management.

He has promoted “Sahayak Gurukul” which is an attempt to share thoughts and knowledge on aspects related to Personal Finance and Wealth Management. Sahayak Gurukul provides financial insights into the markets, economy and Investments. Whether you are new to the personal finance domain or a professional looking to make your money work for you, the Sahayak Gurukul blogs and workshops are curated to demystify investing, simplify complex personal finance topics and help investors make better decisions about their money.

Alongside, Sandeep conducts regular Investor Awareness Programs and workshops for Training of Mutual Fund Distributors, and workshops and seminars on Financial Planning for Corporate groups, Teachers, Doctors and Other professionals. Through his interactions and workshops, Sandeep works towards breaking the myths and illusions about money and finance.He also writes a well read blog; 

https://sahayakgurukul.blogspot.com https://www.sahayakassociates.in/resources/our-blog
He has also conducted presentations, workshops and guest lectures at Management institutes for students on Financial Planning and Wealth Creation.He can be reached at:+91-9888220088, 9814112988sandeepsahni@sahayakassociates.com 

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