How to choose good stocks: Why eliminating the bad makes it easier to pick the good You need to consider dozens of factors to decide whether a company is worth investing in, but even one or two strong negatives are enough to decide that you must not invest in the company
Dhirendra Kumar
CEO, Value Research
Here’s the most common advice given to equity investors: “Invest in good stocks, monitor these closely, and hold for years.” It sounds like an easy thing to do. Now, let’s reverse this advice for a moment: “Avoid investing in bad stocks. Whatever remains is good.” Doesn’t sound very exciting, does it? There’s no sense of achievement in just avoiding bad investments. Surely, the secret to making pots of money in the stock market is to identify great companies; the greater, the better. If you think about it, both approaches are the same, but one is easier. Can you guess which one is it? Some months ago, I had an interesting conversation with Samir Arora, CEO of Helios, a new mutual fund company being set up in India.
Arora has a long and illustrious history of being an equity fund manager, and his approach to stock picking as well as his philosophy on equity investing is compelling. I found his broad approach on how he classifies the universe of investable stocks engaging and useful. As he describes it, the first thing to do is classify the companies as good and bad. So far, so good. Everyone does that. No, everyone does not do that. In fact, hardly anyone ever does that. Most investors are completely focused on companies and considering the best stocks to invest in. Instinctively, they feel that this is the right thing to do. There are many good options, but surely we must find the best.
However, this is quite hard to achieve. As Arora says, as long as you can be well above average, you will be all right. If an investment manager with a long and illustrious track record can admit to that, surely any investor can. As he says, within your investable universe, you can start by choosing the companies that are good, or you can start by choosing the companies that are bad. The key point is that it’s very difficult to choose between good and good, but it’s easy to choose between good and bad. You need to look at dozens of factors to decide whether a company is worth investing in, but even one or two strong negative points are enough to decide that you must not invest in the company no matter how positive the rest of the factors are.
He also points out that most selections in life should be made in a similar manner, including the person you marry. He has a point. Those of you who are at such a stage may also want to consider this approach in your personal lives. The problem is that asking someone to identify and buy ‘good stocks’ is similar to asking them to buy low and sell high. In the world of stock trading, the golden rule every investor lives by is to only invest in what they perceive as ‘good stocks’. You’d be hard-pressed to find an investor who knowingly goes out of his way to put his money in what he considers a ‘bad stock’. Quite simply, it doesn’t happen. However, here’s where the plot thickens.
‘Good’ is a highly subjective term in investing. The definition is fluid, varying from one investor to the other. Yet, they all play by the same rule; they put their money where their belief is. This belief is always centred on the notion that the stock they’re investing in is a ‘good’ one. However, the same is not true of a bad stock. It’s far easier to be sure that a stock is bad. With this one parameter alone, one can eliminate half or more of the starting investable universe. This is a great starting point; doing just this much puts you above the average investor or the general market. Now, the task that remains is choosing between good and good. However, a mistake in these good versus good choices will not have a disastrous impact on your investment. You might do well or a bit better, but you’ll be fine. You’ll meet your financial goals. The job will get done.
(The author is CEO, VALUE RESEARCH.)
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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: India Times - Author:Faqs of Insurances
