How to invest in the stock market?
(The SIP approach)
The best way to hedge our uncertain future financial commitments is by becoming financially independent (more the money works for us, less the time we work for money) and one of the best hedging processes everyone can practice is through SIP. In SIP first, we have to identify the company we want to invest and we must also be aware of various biases that run through our mind which hinders us from making these simple decisions in SIP.
SIMPLE RULE BOOK FOR SIP (Simple Investment Process)
How to identify the company for SIPing
Qualitative aspects of the business
Quantitative aspects of the business
Quality checkup of promoters and auditors
Promoters holding a relatively high stake in the company and also increasing his stakes.
Remuneration of the promoters should be in line with company profits. For example, if the company earns 15% profit relative to the previous year and if promoter raises his remuneration by 35%, then it is a red flag.
Promoters should not have any fraudulent backgrounds.
Frequent change in auditors and sudden spurt in auditor’s remuneration is a red flag.
Industry and company
Avoiding cyclical industry because the sustainable quality of earnings is important.
Avoiding company which requires large capex every year to keep growing.
Avoiding industry where all the companies in the industry itself is not making any money consistently. For example, retail.
The company should have lived at least one business cycle completely. That is, the company should have survived in both bull and bear markets.
Profit and Loss Statement
Net profit increasing in line with revenue.
Increasing in net profit margin.
Company paying proper tax.
Increase in debt is a red flag
A drastic increase in trade receivables and inventories is a red flag.
Avoiding company having contingent liability larger than their revenue.
Consistently showing negative free cash flow is a red flag
A company should be paying dividends consistently.
Sample Excel Checklist
The above simple checklist consists of certain key variables for determining the company to invest, in more of conservative way. In the checklist box, the “right tick” indicates that the company satisfies our selection criteria for SIP and the “cross mark” indicates that it doesn’t satisfy our selection criteria. The more the “right tick”, the more the attractiveness of the company to invest.
One can include his own selection criteria for the company and track the checklist every year to see whether the company is going in the right direction or not. It is not necessary to have lots of checklists but we have to have a simple, efficient, effective and consistent selection criterion.
Calculating profitable growth
- Return on capital > cost of capital
- Return on equity increasing consistently.
One has to be very careful in selecting the companies because the companies that we are seeing today, may go even extinct in the span of 7-10 years. So, one must necessarily be very careful in, where not to invest.
The beauty of SIP
We must be clear of one thing, SIP is not a way of generating quick money but rather creating wealth in long run. We may think that the above checklist is not enough to select a stock but we must also understand that we are not doing lumpsum investment where we need to get a right and high conviction of everything before we invest. In SIP, we start with a small amount, we may even start building our portfolio with little conviction and as the days move on and when the management and the company delivers, we may build our conviction too and if the company doesn’t deliver, we may also change our asset allocation.
Selecting good companies for investing through SIP is only a small portion of wealth creation. The larger part goes to handling one’s own behavior and biases in implementing SIP regularly.
How to overcome our bias and invest regularly through SIP?
People calculate too much and think too little. Their lies the problem and origin of bias. We must understand that, the puzzle of personal finance is all about handling our behavior and not a math problem.
We must inculcate the below behavior and attitude strongly in our mind while SIPping
- Mental accounting
We tend to think that, from our income, we must first spend and then invest the remaining money but the reverse is the correct attitude, first invest and allocate the remaining for your expenditure.
How to overcome this attitude?
We must mentally account that we are earning less money. For example, if we earn Rs 26000 per month, then we must mentally account that we earn only Rs 20000 and plan our expenditure of around Rs 20000 only. The remaining Rs 6000 must go into investment. This trick is simple but powerful.
- Our fear and emotional instability lead to timing the market
We get fearful during the bear market and not invest our money. But this is not right behavior because we must first understand that market moves in cycles and volatility are the characteristics of the stock market.
In bear market, most people don’t do SIP fearing the short-term volatility and they think that they would save the money and invest the money allocated for SIP in next month altogether. People are timing the market and it simply won’t work.
How to overcome this Behavior?
Fix the date
The solution is very simple. Fix a day every month and regularly invest on that day itself. For example, let’s say that we fix the day as “I will invest my money on second Monday every month”. Whatever may be the circumstances, be it bull market or bear market or macroeconomic problem or political uncertainty or global meltdown or FIIs are taking their money from India and what so ever reason may be, you should go and invest on second Monday of every month.
We want to end this post by pointing one last thing on how to get wealthy,
How we can help you?
We at EQSIS strongly believe that SIP is the source of mass wealth creation in the long run. If we postponed the SIP investments day by day, we are indirectly postponing our financial Independence Day. If you want to get start the journey to financial independence, we are always ready to help you.