1. Investing: Rules of equity investment

Investing: Rules of equity investment

The stock market expectations in terms of earnings growth have been considerably toned down. However, investing in stock market should be looked at long term as the purpose of investing in stocks is to build wealth.

By: | Published: April 26, 2016 6:08 AM

The stock market expectations in terms of earnings growth have been considerably toned down. However, investing in stock market should be looked at long term as the purpose of investing in stocks is to build wealth. The near-term volatility should not be a major concern unless the fundamentals of a particular stock or a sector doesn’t look encouraging.

Look at fundamentals

Before investing in stocks directly, investor must look at the fundamentals of the company. The best strategy for common investors is to select few good companies and invest in them. To generate higher returns from equity, investors must look at both fundamental and technical valuations. Whether an investor wants to base the investment decisions on fundamental analysis or technical analysis, one must be aware of the principles. Majority of the long-term investors often shun technical analysis because it is thought to be a tool used solely for short-term speculation.

Analysts say valuations should be are looked in terms of cash flows, earnings, corporate governance, debt-to-equity ratio and returns. The primary valuation matrix that every investor must look at is the price-to-earnings (P/E) ratio. It is computed by dividing the market price with the company’s earning per share. Stocks with low PE ratio are known to have cheaper current price and expected to generate higher return in subsequent period.

Trading versus investing

A trader, on the other hand, buys for the short term. It can be even for a day, which is called day trading. In case of trading, the trader is concerned with the short-term fluctuations. The tools most often used in trading are charts of various types, also known as technical analysis. There are other trading activities such as short selling, options, and future which are for those who understand the markets well and can take market risks.

Analysts say individual investors who still like to trade in the stock market, should set aside a limited amount of money for trading and closely track the performance as trading requires one’s your undivided attention. Unless an investor devotes a significant amount of time in understanding and analysing the stock market trends, stock volumes, prices, and events, it is extremely difficult to make money.

Mutual fund route

If a retail investor finds it difficult to select the right companies with strong fundamentals, then he should invest in a mutual fund with systematic investment plans (SIPs). It helps an investor create wealth by investing small sums of money every month over a period of time. There are twin benefits: rupee cost averaging and the power of compounding. In fact, SIPs are like a recurring deposit which enables an investor to buy units on a given date each month and the amount can be automatically drawn from the investor’s bank account.

One can start with a minimum amount of R500. One of the biggest advantages of an SIP for a retail investor is that one does not have to time the market and worry about the volatility. When an investor times the market, he usually misses out on the rally or enters the market at the wrong time — either when the valuations have peaked or when the markets are on the verge of declining. Investing every month ensures that one is invested during the highs and the lows.

As an SIP is meant to tide over volatility in the markets, the longer the investment horizon the better it is. Investors must keep in mind the characteristics of the scheme like the fund manager and his long-term track record, asset management company and its philosophy, fund expenses and investment style.

Analysts say SIPs make the volatility in the market work in favour of an investor and help average out the cost. This is called rupee cost averaging. For instance, with Rs 1,000, one can buy 50 units at Rs 20 per unit or 100 units at Rs 10 per unit, depending on whether the market is up or down. More units are purchased when a scheme’s net asset value (NAV) is low and fewer units are bought when the NAV is high. If you start out young, equity funds should constitute around 80% of your portfolio as this asset class has been found to be the best bet for growing money over the long term.

Advantage of starting early

Starting the investment early helps one’s corpus grow. If one invests Rs 10,000 every month when he is, say, 40, then, in 20 years, the amount saved will be Rs 24 lakh. If that investment grows by a very conservative 7% a year, the total amount would be worth Rs 52 lakh when one reaches the age of 60.

On the other hand, if the same person had started investing the same amount of money 10 years earlier, the amount saved would be Rs 36 lakh over 30 years. And if the average annual return is 7%, one will get Rs 1.20 core at the age of 60. Also, investing in equity is tax friendly too. If you invest in equity for the long term, you don’t have to pay any capital gains tax after one year.

Taking stock

Before investing in stocks directly, an investor must look at the fundamentals of the company.

The primary valuation matrix that every investor must look at is the price-to-earnings ratio.

If a retail investor finds it difficult to select the right companies with strong fundamentals, then he should invest in a mutual fund with systematic investment plans.

As a sytematic investment plan (SIP) is meant to tide over volatility in the markets, the longer the investment horizon the better it is.

Analysts say SIPs make the volatility in the market work in favour of an investor and help average out the cost. This is called rupee cost averaging.

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