Beginners in equity investments generally keep high-return expectations, failing to understand short-term returns are mostly of speculative nature. By expecting short-term high returns, they also underestimate the power of compounding. Once they burn their figures in short-term trading, their loss-making positions continue to be inherited for long term.
To maximise returns, have realistic expectations from the markets. The stock markets cannot yield high returns continually but long-term investing can. Over the last two decades, market has provided about 14 % returns on a compounded basis; about 6-7% higher than fixed deposits.
Long-term capital gains are fully tax exempt while short-term gains are taxed at a concessional rate of 15%. This outperformance further goes up significantly if holding period increases. The compounding power continues to provide higher returns as time increases. To achieve the compounding effect, one needs to know basics of fundamentals and follow it. Invest for long term in a good company at a reasonable valuation, after knowing about its business and future prospects. Find out companies which are having quality businesses with superior product offerings, sustainable business model. An important factor to note is the status of the company on the debt front - Is it scaling its business using cash flows generated through operations? Is the company growing organically or is it growing inorganically? Too much debt on balance sheet means most profit would go in interest payment.
Find out the valuation. A good company with strong growth and return rates would have a good valuation. So, if a company is trading at premium valuation than peers, we must find out reasons behind this. Same goes if stock is trading at discount to its peers. Hence, look at private equity ratio adjusted for sustainable growth.
Let me also warn you that in most cases, deep discount valuation could be a value trap and this must be avoided. A huge crash in the price looks like a bargain hunt but it may not necessarily prove to be an investment case.
Assess credibility of the management and their expertise to run the business? Not all companies that have raised money through the IPOs have become successful in scaling up their business and generate superior returns. The key difference lies in the management of the company and their ability to run the company in disciplined and ethical ways.
Finally, remember that companies do not grow overnight, and have to build factories, open stores and employ staff which takes a long time. So, give some time for the company to perform and avoid selling shares of good companies in hurry.
In a nutshell, generating maximum returns is a function of knowledge, patience and discipline. If you hold a good company throughout the good and bad period, you can still generate good returns by keeping calm, absorbing the short term turbulence and letting the investment grow.
KNOW IT WELL
- Invest for long term in a company after knowing about its business and prospects
- If a company is trading at premium valuation than its peers, find out the reason behind this
The writer is senior equity research analyst, Angel Broking
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