A few tips for investing in equity to make money grow

Written by Brijesh Damodaran | Updated: Oct 30 2012, 07:32am hrs
Samir had just completed his graduation and was in his first job. At 22, he had heard a lot from his dad, Vijay, about the power of compounding. Samir now wanted to use this power to create wealth. With no financial responsibilities towards the family, he could use a major part of his salary income for wealth creation.

Vijay suggested that Samir meet a few advisors before embarking on his investment journey. He himself met a few relationship managers from banks, an insurance advisor and also a freelance agent. Finally, Samir met Vish, his father's advisor. While discussing various investment options, Samir asked Vish whether investing in stocks was a gamble.

Here was a young executive forming an opinion on one of the effective methods of wealth creation. As Vish said both yes and no, Samir was slightly confused. Vish now proceeded to explain in detail. If you are going to invest based on tips, rumours and hearsay, it is a gamble.

Also, if you are going to invest based on your gut feeling or price movements (without doing an indepth analysis), you are a gambler. Gambling is not about winning or losing.

It is all about taking a bet, a position, without knowing the outcome of the initial action undertaken. You gamble to win, but more often than not, you lose and you lose big.

Investing is a process, be it in direct equity or any other financial products. Investing in direct equity is akin to investing in a business enterprise. So, before investing in equity, look at the financial health of the enterprise, its balance sheet and growth over various time periods the larger the better. Also, look at the return on equity, return on investment, dividend yield and/or dividend payout ratio, debt-to-equity ratio and the interest coverage on debt.

The above are only a few of the basic indicators that are used while investing. This is the fundamental method of investing, practised by money managers. At the same time, there is also another method, which the more aggressive investors take the technical side of investing. Based on various tools as in RSI, Bollinger bands, Candlestick and trend analysis, a person invests in direct equity.

If the rules for each of the above process for investing are not pre-defined by the investor (trader) and he falls prey to his emotions on account of the price volatility, then the difference between being an investor and being gambler becomes thin.

Fundamentally, invest in equity for a longer time horizon, typically in excess of three years. This is basically because there could be price volatility in the short term, which would mark down the portfolio; or when the country is going through recession, the enterprise may be affected in the shorter term.

However, this patience could be rewarded with dividend payouts and capital appreciation, which leads to wealth creation. The value of R1 lakh when invested in BSE Sensex in 1978 is worth R1.75 crore now, which is an inflation-adjusted return of 7.75%. This is only data, as most of us do not have the patience to hold on to for more than three decades.

At the same time, if you had entered the equity markets on January 1, 2008, the absolute returns till September end 2012 would be 7.69%. But if you had entered the markets in January 2009, the absolute returns would be in excess of 93%.

And if you had invested from January 2012, the absolute returns would be in excess of 20%. When you invest in the equity, another important things is where you invest.

All the above data can be misleading if looked on a standalone basis. But if you study the data and analyse it over multiple time periods, it could be your friend in the journey of wealth creation.

Extreme greed causes losses for example, if you had invested in 2008 and wanted to make a quick buck. On the other hand, if you had invested when fear and pessimism were pervasive, you would have had your gains.

Gambling is a chance where stakes are loaded against you, whereas in investing, especially in long-term equity, the stakes are loaded in your favour, though there are exceptions. Paul Samuelson once said, Investing should be more like watching paint dry or grass grow. If you want excitement, take the money and go to Vegas.

Wealth creation

* Investing is a process, be it in direct equity or any other financial products

* Investing in direct equity is akin to investing in a business enterprise

* So, before investing in equity, look at the financial health of the enterprise, its balance sheet and growth over various time periods the larger the better. Also, look at the return on equity, return on investment, dividend yield and/or dividend payout ratio, debt-to-equity ratio and the interest coverage on debt

* Invest in equity for a longer time horizon, typically in excess of three years. This is basically because there could be price volatility in the short term, which would mark down the portfolio; or when the country is going through recession, the enterprise may be affected in the shorter term

The writer is founder and managing partner of Zeus WealthWays LLP