long term investment

Stock Market Puzzle

Share market investment has always been a puzzle and area of confusion for common people. Common people prefer to stay away from share market and opt for low return investments like provident funds, fixed deposits, mutual funds etc. But these same people when properly advised on share market investment have made good money from share market. Investors make more money than traders. Investors are like a 45 km marathon runner and a trader is a 100 m sprinter. Traders are like a sprinter covers a large distance due to their fast speed but ultimately looses their steam very quickly. A trader focus is to buy shares at a low price and sells at higher price. A day-trader does this every day. Of course they are making money from this trading but question is this the best way to make money in share market? The answer is big no. Investment is the superior way of making money in share market than share trading. What an investor does differently from trader will be discussed here.

To understand the mind of an investor one must understand the concept of share market first.

Ideally no business owner would like to sell the shares of his company. They would rather own 100% holdings of the company. If the company makes profit, then he owns the full share of the profit. Suppose the turnover of a company is $100 million, if company makes even a marginal profit (PAT) of 5%, even then the owner will have a massive $5 million in his pocket each year. At this stage the owner decides to expand his business for which will need some $100 million. At this point the owner decides to break down the ownership into smaller parts called shares. Each shares corresponds to a fraction of the total ownership of the company. Lets say that total ownership of the company is subdivided into 10 million shares. The owner decides to hold 51% holding and balance he decides to sell in share market. On basis of reputation of the company and its book value of $50 each, lets assume that on average 49% shares (4,900,000 nos) are sold at market price of $80 each. This way the owner is able to generate fund equal to 4,900,000x$8=$392,000,000. The owner has one big advantage of selling his shares to public, he can use the money generate by selling shares to fund the expansion and modernization projects. Let us assume that by doing these projects, company is able to increase the turnover from $1000 million to $1500 million and profitability from 5% to 9%. It means the cash in hand profit will be increase from $50 million to $135 million. Owner has 51% ownership means he will have $135×51%= $69 million. The balance $64 million can be reinvested to expand and modernize the plant. When a company makes profit, the market value of shares also starts to rise; the share which once cost $8 may rise to $12. This way the share holders also benefit from growth of the company. But a trader is not bothered about long term value appreciation of company’s shares. But investors make huge money by selecting good company and sticking to it for a long time. The ultimate objective of good companies listed in share market is to increase the stockholders value year after year.

So as an investor the most important is to look for companies who focus is to increase stockholders value.

Identification of such companies is not easy. Its like searching a needle in haystack. But we will discuss some fool proof rules that will help in identification of such companies.

• Rule 1 – Identify sectors which are growing very fast or have huge scope of growth in future. Like real estate, banking, power, steel, cement, engineering etc.
• Rule 2 – select top 3 companies of each of the identified sectors comparing their sales and profit.
• Rule 3 – create a portfolio watch in Google finance of all these companies and start tracking their market prices.
• Rule 4 – Always compare the market value with the book value of the company. When the market value falls to 2/3 of its book value; then buy the shares.

Always try to buy shares of big companies with good brand name. The bigger the better, once you are able to buy shares of a good company at 2/3 of its book value, hold on to it forever.

If i will hold the share forever (never sell) how i will make money?
This is my favorite question because the answer is not simple. But I will try exemplifying, suppose you decide to save $100 each month in the savings account of your bank. At the end of the year you will have $1200 in your account which will give you interest @3.5% p.a. on your deposit. The advantage of maintaining a savings account is that it drives you to transfer and save $100 each month from your salary account instead of just spending it on food, movies, clothes, fees, bills etc. In addition it gives you a return of 3.5%. At the end of each year you are getting $1200 richer plus interest. The savings account gives you a huge liquidity. You can use your account linked debit card to dray cash or pay by swapping. Suppose in next 20 years you are able to accumulate $0.5 million dollars. This $0.5 million is your net worth. Any day you can put this whole money in fixed deposit and make enough money to pay for your daily living just from the earned interest. This will give enough financial independence so as to allow you to take early retirement from your job.

Treat your share portfolio as your saving account
A share portfolio is same as your savings account. It allows you to save and invest your money, preventing you from spending on liabilities. Secondly it is capable of giving you much higher returns than savings account. You earn higher interest because you are ready to take risk by investing in shares. Your interest also gets multiplied when you follow 4 rules as discussed above. With higher interest rate you will be able to create your net worth of $0.5 million dollars much faster, say in 15 years. Thus by maintaining share portfolio you will achieve financial independence faster than any other investment option. if you require, any day you can sell your portfolio and achieve financial independence. But till you reach the value (say $0.5 million) that matches with your financial independence calculation, you shall continue accumulating shares as per rules mentioned above. Of course you will sell your shares but day but that point is now well defined.

Enjoy the process of investment. It is much more than making money. If few more investors like you stand together and focus on long term investment rather than trading, then the whole country will benefit.
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