Four rules of investing in equities: Things to remember to avoid losses

Investment

We all know that stock markets are riddled with uncertainty and often leaves people at wit’s end as to how they should approach it (especially if you are starting anew!).

Then, there are some who equate it to gambling and not bother moving away from their fixed deposits. I deal with clients coming from both sides of the spectrum, and they all face a singular problem – how they should approach equity investing.

Therefore, I offer 4 rules everyone should follow prior to investing in equities.

1. Do not buy on tips:

The first rule to keep in mind, regardless of the source, never accept any stock tips you receive as valid. When it comes to make an investment decision, it’s a good idea to be guided by more than just your gut instinct.

Always do your own analysis on a company before investing your hard-earned money. While tips sometimes pan out, long-term success demands deep-dive research.

Even if you don’t have a finance background, don’t let that stop you from becoming your own personal stock portfolio analyst.

To get you started, the three principle financial statements you should definitely look at are:
• Income Statement
• Balance Sheet

• Cash Flow Statement

These statements will help you build a general perspective on the functioning of the company and assess the stock better.

2. Apply screeners to pick stocks:

While picking a stock, as a good practice, you could always use screeners to filter your choices such as sector and industry. Screeners offer users additional features such as sorting companies based on market cap, dividend yield, and other useful investment metrics. Some of the points which you should keep in mind:

• Check how much debt the company has accumulated over the time period. Generally speaking, a company with more debt is likely to be more volatile because more of the company’s income has to go to interest and debt payments.

• Keep diversification in mind while opting for any screener. As an investor, you could use a combination of strategies to choose which particular stock fits appropriately in your investment cycle.

3. Avoid herd mentality:

I have seen this happen so many times. Investors choose to invest in a particular stock purely based on its recent strong performance.

The feeling that “I’m missing out on great returns” has probably led to more bad investment decisions than any other single factor. If a particular stock or a category of stocks are generating strong returns for the past year, we know one thing with certainty: we should have invested in them a year ago.

Now, however, the particular cycle that led to this great performance may be nearing its end. The smart money is moving out, and the dumb money is pouring in. Stick with your investment plan and rebalance, which is the polar opposite of chasing performance.

4. Avoid cyclical stocks for long-term investment:

The first thing you should do as an investor is to identify an investment horizon while buying the stocks.

I am sure you have heard several success stories, where people have made money by trading heavily to buy a stock at a low point of a business cycle and sell them at a high point of the same cycle. Such stories might acquire the status of a pulp fiction, but there is nothing more to those than that.

It is important to remember that cyclical stocks are highly volatile and tend to markedly outperform the market while their cycle lasts.

Hence, every investor who is just starting out and looking for investing in the long-term should completely avoid cyclical stocks, as they are bound to suffer losses in case the cycle reverses.

(The author is Head, Personal Wealth Advisory, Edelweiss)

Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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Written by Loknath Das