King-sized returns necessitate a winner's strategy

Quit scrounging for hard-to-come-by ‘sure' tips that will help you improve your stock market returns. Instead, adopt a winner's approach to investing, and assure yourself of long-term gains and [last but not the least] a sound night's sleep!

You see, winners don't fret over their decisions, simply because they don't base their stock pickings on hushed tips given by supposed investment pros. Take Warren Buffet, an undisputed star in the field of investments. When it comes to making and profiting from your holdings, the man himself cites know-how as a winning factor. By know-how, Buffet implies investing in businesses that you understand. In other words, there is no point in dabbling in businesses you don't have a clue about, because you are unlikely to be able to gauge the long-term prospects of their product/s.

Pick companies and products to back, not stocks

Based on the above, here are some practical takeaways to help you hone your investment strategy:

Review the company's earning prospects:

Invest in companies that enjoy an ‘endless demand' for their products, such as essential food commodities. ‘Endless demand' in itself assures the company of great long-term prospects - at the very least, think 10 to 15 years hence. Such companies will ride out competition, either because they enjoy a competitive advantage in the form of a well recognized brand or a near-monopoly status in a geographic area.

Other kinds of companies that are worth investing in are those that sell products the price of which may be raised without causing consumers any major concern.

Give start-ups a miss:

Steer clear of companies that have introduced something new to the market, as such investment is fraught with risk. For instance, in the late 70's and 80's, Buffet gave the emerging IT sector a miss as he was unable to evaluate its long-term prospects. His approach was - "Why search for a needle buried in a haystack when one is sitting in plain sight?" Buffet's play safe major investments - American Express, Coca-Cola, Gillette (now Procter & Gamble) and Wells Fargo - were all founded between 1837 and 1886. No wonder he is known to have opined "start-u2ps are not our game."

Allow quality, not quantity to prevail:

Next, don't worry because you don't know too much about companies operating in every sphere of the economy. As far as Buffet is concerned, at any one point, there are unlikely to be very many outstanding investment opportunities. Granted - in order to play safe, you may desire not to keep all your eggs in one basket, so to speak. But even so, spreading your investment too thinly over a large number of companies isn't such a wise decision. Need convincing? Apparently, Buffet's portfolio at Berkshire Hathaway rarely numbers more than ten stocks.

Good companies are run by good people:

Buffet's focus has always been the companies he invests in, never the stock market, as he explains that good companies can rise even in the midst of a falling market, or else will pick up over time. But a good company essentially requires an able, efficient and trustworthy management you can relate to, as it shares your objectives. It may sound old-fashioned, but that is the leadership style Buffet relied on. Lest this have you looking for companies run by highly qualified managements, consider that Buffet never perceived the most qualified people as the best to run a company. Apparently, Susan Jacques, chief executive of his jewellery retailer Borsheims joined the company 25 years ago as a $4-an-hour saleswoman. Nevertheless, her smartness and love for the business and her associates beat having an MBA degree.

Size doesn't matter:

Just as character traits, not degrees count when evaluating a management, it's not size but efficiency and financial health that count when evaluating a company. So apply yourself to closely examine a company's fundamentals and financial performance. And no - you don't need inside information for this process. All the figures you need are available in the documents listed companies make public every year. Buffet emphasizes, "The market may ignore business success for a while, but eventually will confirm it."

Accept that you're investing for the long-term

Buffet was and is undisputedly an investor, not a speculator. What's the difference between the two? Investors invest not only their money, but time and effort in understanding the market. They realize they're in it for the long-term. Consequently, their emotions don't swing with the stock market. They don't feel elated when stock prices rise and depressed when they fall. In fact, they look to pick up stocks of good companies that are temporarily low when the market cumulatively falls due to investors fear. In other words, a fall in the market represents a golden opportunity to buy for an investor.

Quite the contrary, speculators rejoice for every little gain in their holding and feel down in the dumps when the market falls, even ever so slightly. Sadly, they do not realize that there are no short-cuts to runaway success. The bottomline - speculation and investment are mutually exclusive scenarios.

Interestingly, Buffet's long-term approach indicates that contrary to what many newbie players think, you don't need heavy turnover activity to prove you are an investor. He points out that over-trading is neither tax-efficient as it attracts capital gains tax nor an economical investment approach as it incurs frequent brokerage charges.

Timing is everything

This leads to an understanding of timing - there is a time to buy and a time to sell, the former being dependent on the price of a share and the latter on its perceived potential. Further, until you reach a stock's potential, you stay invested come what may - bull or bear run.

So when should you buy a stock? "The price tag of a share," says Buffet "should be sensible." Ideally speaking, you should invest in a stock only when it offers you a considerable margin of safety. A margin of safety is broadly defined as a difference between value and price. If the fundamental value of a share is higher than the price you pay for it, you have a high margin of safety - buy such shares! On the other hand, if the price you pay for a stock is greater than its value, you have a low margin of safety - shun such stocks! As to how long you should stay invested, as long as its market price is lower than its value, hold onto it.

Buffet's approach is thus less price-wise, and more focused on valuing a stock. The easiest way to know where you stand with regard to a stock is to calculate its price-earnings to growth ratio (PEG), by dividing its P/E ratio by the growth rate of the company's profits. As a rule of thumb, a PEG of less than 1 implies that you have a margin of safety to turn to your advantage, while a PEG of greater than one indicates a low margin of safety.

All said and done, Buffet's investment methodology is fairly easy to understand, and once you get the hang of researching a stock, not so difficult to apply. However, it does call for a lot of patience and calm when your stocks move against you, especially when the markets overreact on the downside. But at the same time, this approach guarantees you a sense of calm, simply because you are only required to do what you know to be right. Then you sit back, and wait for others to come to the same conclusion!

You can do it too!

In the 43 years that Warren Buffet led Berkshire Hathaway, its assets grew at 21.1 percent a year, a little more than twice the 10.3 percent annual gain in the S&P 500. Further, while the US benchmark index grew by 6,840 percent over that period, Berkshire's book value soared by 400,863 percent, or from $19 a share to $78,008. In all these years, Buffet failed to beat the market on only six occasions.

Sounds unbeatable? Well, you know what they say - ‘if you can't beat them, join them!'

Ekta Grover, who works as a software engineer in SAP labs (Bangalore), follows the markets. She too has applied Buffet's method, though "conservatively, as it requires careful selection/picking of stocks, and more than that an extensive study of the organization's business and the numbers, for the numbers speak for themselves." She perceives this approach as applicable to every stock market at all times, including India's currently swinging scenario, as it a means to create wealth in the long-term as opposed to merely chasing the market for short-term gains.

Coming from a non-finance background, Grover thinks this method is ‘a little tough to figure out', but do-able. Of course, it requires you to be patient to actualize the results and shed your fears in the meantime! Speaking of its low-applicability to mutual funds, she opines that "as most mutual funds deal with a span of three years, fund managers believe in cashing the market to maximize the returns for the investor, their appraisals, and the fund's reputation. However, it scores vis-à-vis mutual fund investments by saving the 2.25 percent entry load!

Adopt, adapt, and score!

Interestingly, Vipul Kapadia, an avid investor has adapted some of Warren Buffet's strategies according to his own thinking to guide his investments. For instance, he observes that Warren Buffet invests mostly in large companies when the price is lower than the book value and intrinsic worth of the company. Kapadia has adopted a similar strategy but applies it to small-size companies (mid and small cap companies). However, as investing in smaller size companies is riskier, Kapadia has spread his portfolio across a larger set of companies.

Kapadia describes the approach as a contrarian kind of technique where you buy stocks of companies that are currently out of favour or neglected by the market. Some stocks that have done well for him are Karur Vysya Bank, Nagreeka Exports, Nirlon Ltd, Adani Exports, Ispat Ind, and Shiva Cement.

So - what stocks will you pick up next, and when? 

Charu Bahri is an author, freelance writer, columnist and [part-time] manager - projects and information systems at J Watumull Global Hospital & Research Centre. More about her at http://charubahri.googlepages.com

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