Stock Investing is Complicated? Is it worth an effort?

Stock Investing is Complicated?

Yes, stock investing can be complicated. Why? Because one must learn few skills before going full-out into the stock market. What skills are necessary?

Stocks vs Other Investment - Traits of good investors

To answer this question, we need to know what a successful stock investor does differently than others. They have three distinct qualities: First, they have an eye for good companies. Second, they know how to read and interpret the financial statements of companies. Third, They have the patience to hold their stocks for the long term.

These are the three main traits, learning which people can transform themselves into successful investors. But add to it another skill and, a person can see a transition into a pro-investor.

Knowledge of a company is the key. But know-how about the other competing companies of the sector can give a definite investing edge.

It is not necessary that only a ‘management degree’ holder can invest successfully in stocks. But it is also true that stock investing must be implemented more thoughtfully than buying a fixed deposit.

Stock investing is worth an effort?

What is the relevance of this question? On one side, we have an investment option like a fixed deposit or debt-based mutual funds. These investment options are risk-free. They can generate a fixed-return on investment. So why care about investing in a high-risk alternative like stocks?

If invested properly, stocks reward it’s investors handsomely. The reward is not only in terms of higher returns. It can also teach the investor a lot about business.

Successful investing in stocks needs its investors to know about how business works. Only a handful of people in this world can claim to have an understanding of business.

Does it mean that understanding a business is very complicated? No, it is not complicated. Instead, it is easier than learning about the skills of a job. But unfortunately, our education system is so structured that a child is exposed less to entrepreneurship.

Hence, I strongly encourage myself to keep enhancing my stock analyzing skills. It, in turn, helps us to appreciate how a business runs. Eventually, our entrepreneurial ability gets enhanced.

So let’s begin our deep-dive into the world of stocks.

What are stocks?

Not everybody can recognize the true meaning of buying and holding stocks of a company. Even less can realize that a share means a ‘piece in the business’ of its company.

A person holding stocks of a company has a claim on the companies profits. Stockholders can anytime sell their holdings and redeem their share of the profit. The person can also decide to hold on to his stocks. During the holding time, the value of its shares will also increase.

There are caveats to this rule. But for a growing company, it will happen.

A Private Company

Suppose three friends start a company. Each friend has contributed an equal amount of money to start the business. In this example, each friend becomes a 33.33% shareholder of the company. At this stage, we can say that the company is private.

Now suppose, the company becomes big over some time. At this instance, the company needs Rs.300 crores to finance its expansion plan. The company has two options. Either it can take a loan from a bank or, it can ‘go public.’

A Public Company

To go public, the friends must sell a part of their shares to the outside world. What is the outside world? Foreign investors, domestic institutional investors, retail investors, among others. This way, the company will get its Rs.300 crores (for expansion) without resorting to a bank loan.

Henceforth, instead of only three, the company will have a large number of shareholders. Moreover, the individual shareholding of the friends will also drastically come down. It will fall from 33.33% levels (for each) to some lower value.

For investors who have bought shares will become a ‘proportional owner’ of the company. Hence they have a proportional claim on the companies retained earnings and future decisions.

The higher will be the percentage of shareholding the, higher will be the claim on the company’s profit. Generally speaking, a person owning a 2-3% stake will have a lot of say in the company.

Example of Shareholding

For example, there is a company called Greaves Cotton trading in NSE and BSE. The total number of authorized shares of the company is about 38 Crore numbers. Out of the 38 Crore shares, around 23.12 crore numbers of shares are issued for public subscription.

Now, suppose there is a person who holds 1.1 Crore number shares of this company. In terms of the total authorized shares, the person is holding about 2.89% shares (=1.1/38). This kind of shareholding can give tremendous voting rights to a person.

So, this is a hypothetical example. But it can prove that stocks are not just a piece of paper. They are not only an investment option that one buys one day and sells the other. The potential power that shares can give to its shareholders almost makes them the owner of a company.

Even 2-3% ownership is considered large. Along with the company, the value of shares also rises and falls. Generally speaking, stocks of good companies see a rise in value over the long term.

Why do pro-investor prefer stocks?

There are multiple ways to invest money. My favorite alternative is investing directly in stocks. Why do I like stock investing more than others? The person that brought me closer to Stocks was Warren Buffett. In my initial days, I used to know Buffett as a person on the Forbes Rich List.

But gradually, I realized that Warren Buffett made a fortune as an investor. I was also intrigued to know that he has done it by investing in stocks of good companies.

While reading about Buffett, I began to realize the potential of Stocks as an investment option. The kind of returns that good stocks can yield, over the long term, far supersedes the return potential of other investment options.

But you might wonder that if stocks are so good, why everybody does not talk about it in the same tune. Some people have burnt their fingers in the stock market and hence abhors it. Stock prices can fall or rise drastically in the short-term. People who buy stocks blindly will often face the brunt of falling prices.

What is meant by blind investing? It means not knowing enough about the company and still going ahead and buying its stocks. What to know about the company? Two things: (1) if the financial health of the company is strong or weak and (2) if the price of the stock is fair.

People who can quantify the above two things will earn high returns from their stocks. The complexity of stock investing gives a clear edge to Serious investors. These people have learned the skill of stock analysis and hence, takes advantage of it by picking good stocks at value prices.

Which investment alternatives are available other than stocks?

Compare stocks, mutual funds, gold, real estate

Before we can conclude about stocks, we must also know about other comparable investment options available which are :

#1. Mutual Funds

Equity-based mutual funds can yield similar returns to stocks. But unlike stocks, people can invest in them without much research. Why? Because the responsibility of individual stock researches in on the fund manager.

Mutual Funds collect money from several investors. The pool of funds so accumulated is then invested in several stocks. The stocks are carefully selected to prepare a portfolio.

A mutual fund’s portfolio consists of several stocks. Hence, the price volatility of its Net Asset Value (NAV) is less than individual stocks. Suppose I bought a stock ABC at Rs.100 per share. The company became bankrupt and, its stock price fell to Rs.5. In this case, I’ve lost 95% of my investment.

But, had I bought a mutual fund having 65 number stocks in its portfolio, the situation would have been different. How? Suppose one of the stocks in the Fund’s portfolio was ABC. Now, the price of ABC falls from Rs.100 to Rs.5. How the price fall influences the NAV of the Mutual Fund? Not much. Why? Because of the low weight of ABC in the portfolio.

But on the contrary, for the same reasons as explained above, if the stock price of ABC went up by 95%, the NAV of the mutual fund having ABC in the portfolio will never see such massive gains.

Click here to Know What are mutual funds in detail.

Stock vs mutual funds

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Description	Stocks	Mutual Funds
Price Up	High Potential	Average
Price Down	High Risk	Average
Fees	Low	High
Research	Required	Not Required
Timing The Market	Important	Less Important
Beats Inflation	Yes	Yes
Potential Returns	Very High	High
Potential of Loss	Very High	High
Preferable Holding Time	> 5 Years	> 3 Years

Let it be stocks or equity-based mutual funds, return on investment (ROI) from both are not sure. Proper research will lead to a better understanding of future price movements.

Ideally speaking, a clever-mix of stocks and mutual funds will be an ideal combination for a retail investor. The weight of stocks in the portfolio will depend upon one’s ability to do a detailed fundamental analysis of stocks.

#2. Gold

Gold is an unofficial alternative currency for the world. That is the reason why Central Banks of all big countries hoard gold. The largest reserves of gold are available with the USA, Germany, IMF, and Italy.

Considering gold is a rare commodity, its supply is finite. But the demand for this precious metal is only increasing. The cause of increased demand is the increasing gold reserves of the Central Banks. Furthermore, as the purchasing power of people increases, they also tend to accumulate more gold.

People accumulate gold as an investment (coins and bars) and also as jewelry. In the last 30 years, the price of gold has increased by 10% per annum. What is the significance of 10% returns? It beats the world average inflation rate.

Mutual Funds Houses are also a big accumulator of gold. They offer investment vehicles like gold funds and Gold ETFs. Among retail investors, gold funds and ETFs are famous. Gold funds and ETFs allow people to buy gold indirectly as an investment.

In many ways, investing in gold requires much less effort than investing in stocks. People can buy gold and put it in a locker. After the lapse of 10-15 years, again check the value of gold. An 8% to 9% return per annum is almost a certainty.

#3. Real Estate

For us, investing in real estate means buying a home for ourselves. In India, the culture is to buy a home for self as early as possible. Read my take on living on rent or buying a home.

But buying a home for self-occupation is not an investment. Even if the property value appreciates with time, a self-occupied house is not an investment. Read more wealth building in the long-term.

But unlike gold, in real estate investing, people cannot expect to earn 8%-9% returns per annum by only buying and holding it for years. Keeping a property has a cost. Moreover, it requires deep involvement like loan payments, maintenance, property tax payments, among others.

But more than that, it is critical to buy the right property. There is a way to buy a property. Not going by the rules will only lead to mediocre returns and frustration. It is also true that liquidating a physical property is not as easy as selling stocks or mutual fund units.

Some people have made fortunes from real estate investing. But for sure, those are not people who buy a property with 70%-80% bank loans. Real estate is a very capital-intensive investment. Hence people resort to bank loans to finance it. But loans further decrease the return potential of a property.

Conclusion

The risk of loss associated with stocks is indeed high. Why? Because one may land up buying stocks of a weak company. They may also buy stocks at overvalued price levels. In both these cases, the chances of making losses are high. Hence experts always advise buying stocks upon proper fundamental analysis of its business.

Investing in stocks is an effort. The chunk of the labor goes into analysing stocks. But people who can find a way to analyze stocks can expect good returns in the long term.

In stock investing, good long-term returns can start from 12% per annum to higher numbers. In times like COVID-19 and the 2008 debt crisis, I’ve seen examples of 100% plus returns in a narrow time frame of 10-12 months. For instance, in the last ten months (Apr-20 to Jan’21), the Bank Nifty has risen from 16,000 to 30,000 levels (up by 87%).

But focus here is not on absolute returns. These returns will change. On good days the returns may show as 100%. On bad days, they can also fall as much as 50% plus. So, instead of focusing on absolute returns (or volatility of the market), the attention should be elsewhere. Where? On value investing.