12 Things to consider before starting Stock Investing

8/2/20236 min read

Contents

Why start with large caps
Calculating returns on investment in terms of CAGR
Why to avoid cyclical stocks
Why to avoid highly regulated sectors
Unpredictable (in shorter timeframe) and irregular nature of stock market income
Importance of focus on capital protection first
Compounding as 8th wonder
Importance of psychology in investing and FOMO ( fear of missing out)
Fear and greed drives the market, why historical patterns repeat over and over again
Random buying vs rule based investing
Invest only in businesses you understand
Observe indices (Nifty) on charts on weekly basis

It's only when the tide goes out that you learn who has been swimming naked
- Warren Buffet

1.Why start with large caps

Better to start with large cap companies ( top 100 companies wrt Market capitalization, currently > 50000cr can be take as criteria) and stick to them for first 1-2 years. These are relatively stable and most reputed companies with predictable earnings, and downward fluctuation in prices (drawdowns) during market correction phases are least, in other words less volatile.

2.Calculating returns on investment in terms of CAGR

Returns on investment to be calculated in terms of CAGR (Compounded Annual Growth Rate) over years. You may often have heard that Rs 1 lakh invested in a certain stock in 1995 would have become 1 crore today. It may sound very exclusive but in terms of CAGR it is 17.9% . Comparison benchmark can be Nifty50 (Nifty long term CAGR is 12-13% ). Now you get an idea that the stock has outperformed Nifty over 28 years, which is good.

Performance of a stock always to be evaluated in terms of CAGR returns wrt Nifty50 returns, if it is a large cap, can be evaluated wrt respective Mid cap or Small cap indices if the stock is Mid cap or Small cap. Performance wrt the sectoral indices or peer companies ( similar sized companies producing similar goods) can also be judged.
Like TCS can be compared with Wipro, Infosys , HCL Tech.

3.Why to avoid cyclical stocks

At the start, better to avoid cyclical stocks ( earnings of cyclical stocks goes through up cycle and down cycle, as these businesses are closely tied up with some commodity cycle - where commodity prices increases for some years and then decreases, accordingly, margins of companies fluctuate )
Steel, Metals, Chemicals are cyclical sectors. Understanding the commodity cycle may become difficult for a retail investor who is new.
No doubt that pro investors who understand these cycles well make outsized returns investing in these companies.

4.Why to avoid highly regulated sectors

Also, at the start, better to avoid sectors with highly regulated framework like Defence, Airlines, Telecom - where changes in govt. regulations can drastically affect the earnings of the company. Banking too is regulated- but earnings of major private banking stocks are consistently growing in long term.

5.Unpredictable (in shorter timeframe) and irregular nature of stock market income

Stock market returns are like business income, unpredictable in nature and irregular.
If you have decided for yourself that 15% returns will be generated every year, it does not work that way. Market may offer greater returns than your expectation for some years, and may give lesser returns for some years, or even give negative returns in some year. Overall CAGR returns over a longer timeframe, at least 4-5 years to be evaluated for a correct understanding

6. Importance of focus on capital protection first

So for the first 1-2 years, rather than generating returns, focus should be on capital protection, and learning as much as you can about the market. That will ensure you will remain invested in the market even after 2 years, and will feel more confident to add more investments. If you lose capital in 1st 2 years, that takes you at least 5-6 years backwards( 3-4 more years to match the returns lost on total portfolio)

It's more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones -Howard Marks

7.Compounding as 8th wonder

Compounding is known as 8th wonder. To illustrate, Warren Buffet's net worth at the age of 60 was $ 3.8 billion. In 2023, at the age of 92, his net worth is $ 118 billion, even though his wealth has compounded at a slower rate of 8% CAGR for last 20 years ( earlier years were much faster), taking his average of 21% over his lifetime,with such a huge amount. So compounding works like that, grows exponentially in later years.

8.Importance of PSYCHOLOGY in investing and FOMO ( fear of missing out)

Control on emotions, mindset (investing psychology) is THE MOST CRUCIAL ATTRIBUTE to develop. As an investor, when market goes down, your stocks will usually go down too. In a market correction of 15%, stocks may go down 20-30% (even large caps), so as an investor, sitting on a portfolio in deep red when all news are negative is a skill to develop.

Many retail investors, even if their stock selection is right, cannot hold on to them when market falls, eventually sells them at losses and lose capital. And then, when the market recovers a lot, and there is positive news all around (euphoria), then feel FOMO (fear of missing out) and then re-enter the market at higher prices when big players are selling or about to sell.
Thus, right psychology and mindset is the most important skill to be developed in order to make money from stock market.

Study successful investors, and you'll notice a common denominator: they are masters of psychology. They can't control the market, but they have complete control over the gray matter between their ears. -Morgan Housel

The record shows the advantage of a peculiar mindset: NOT seeking action for its own sake, but instead combining extreme patience and extreme decisiveness.
-Charlie Munger

9.Fear and greed drives the market, why historical patterns repeat over and over again

Fear and greed are the 2 factors that drive the stock market. Since human emotions have not changed since ages, similar price patterns are observed on charts of stocks and indices that used to happen 100 years ago ( US stock market has 100 years history, Indian market does not). So same patterns repeat over and over again. Nothing has changed despite so much change in technology and advancement in methods of investing ( mobile apps).
So learning from behaviors of past phases of boom and bust with right historical background and knowledge of the companies can give a lot of insights and edge to an investor looking to crack the world of investing faster and thus an important hack to shorten the learning curve. Do consider that.

10.Random buying vs rule based investing

There may be impulses based on recency bias to act to market feeds while buying stocks like positive news, hot stocks circulating in groups, social media, recommendations on TV channels, youtubers, emotionally a stock looking good to you, some emerging themes like EV, green energy, defence stocks.

Never give yourself away to hype if you don't want to lose money in market. If a theme is emerging, dig deeper to understand how will that actually affect a stock.

If you have a written investing framework ( read more here) in place and follow a strict discipline not to sway with these external triggers, you will reduce your chances to lose money in market by a lot. All information incoming from these triggers has to be evaluated whether it fits into your investing framework or principles you have decided for yourself. If it doesnot, ability to give it a pass however attractive it may be will give you an extra edge in the market.

11.Invest only in businesses you understand

Defining your circle of competence is very important while investing, Warren Buffet emphasizes this factor again and again and he himself practises the same. You may start with businesses related to your field of operations, where you already know certain things. If you are an IT guy, you would likely be able to comprehend the IT industry better than others. If you find it difficult to comprehend Pharma business, better avoid, however attractive the industry may appear. No FOMO. This will make you more comfortable and give you more confidence to hold on to your investments when markets are down. It is this ability to hold on in downturns is what will make you money in good times. If you don't understand the business and strengths of the stock you hold, you may panic in bad times and sell of resulting in uncalled for losses. (read more here)

I know what I know, and I know what I don't know pretty well.
I've got a circle of competence...Within that circle I'm perfectly willing to act, ACT FAST, and ACT BIG.
-Warren Buffet

12. Observe indices (Nifty 50) on charts on weekly basis

While you learn investing, it is also good to learn how the overall market functions through observing the charts of major indices on weekly basis. You may observe Nifty 50 historical behaviour, how much % it fell during market crashes, how much it fell during a market correction, and during pullbacks. Also the rise during market bull run phases, how long did they last, and so on.

Now since stock market index is considered one of the indicators of the economy ( since top 50 companies price performance over longer timeframe is reflective of the profit growth/ de-growth of the companies, and these top 50 cos constitute 50% of India's market cap, so it has correlation to how the economy as a whole is performing.

A better measure can be Nifty 500 index. So comparing the historical performance of stock market with economic cycles and key policy reforms, RBI lending rates etc can give more insights into the functioning of the market. Even if you are not interested to study in depth, you can just watch Nifty 50 every weekend on any user-friendly software ( Tradingview is one that is widely used).

#stockanalysis #investingpsychology #themoatinvestor #DMoatInvestor

12 Things to consider before starting Stock Investing

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