SECRET OF INVESTING
The secret of
investing in share market is that there is no secret. There is no magic wand
that will make you rich immediately. There is no shortcut in share market.
The only thing is
that you have to identify a great company and buy their share great price. Now
the question is how you will identify a great company so there are some
suggestion from great investors of all time.
All great business
essentially has three important characteristics: a Sustainable Competitive Edge,
an excellent Financial Track Record, and Trustworthy Good Management.
Sustainable Competitive Edge: “A good business is like a
strong castle with a deep moat around it. I want sharks in the moat. I want it
untouchable” – Warren Buffett
What would qualify
as a real competitive edge, a moat?
If you had to buy
Soap, which name comes to your mind? Most of us would think of Lifebouy soap,
and many of us would buy it. Why? Because this is a name many in India have
come to trust over the years. It is quite easy to make Soap, maybe even better
than Lifebouy, but without the Lifebuoy brand name, you will sell very little
in India. This is the power of the Brand – the first moat. A strong
brand helps a business to command a large market share and higher prices and
makes it very difficult for competition to grow.
Wouldn’t we love to own a company that was the only one who could
manufacture a particular product means no one can produce that product and had
no direct competition? That is exactly what happens if a company has a Patent
or a Trade Secret – the second moat. The most common examples: pharma
companies with patents, and food and beverages companies with unique and
usually patented recipes like Coca Cola and McDonald’s fries (which are made
from specially grown potatoes!) Another secrets company is Pfizer. They make Lipitor and a lot of
other drugs that they patent and have exclusive rights to for many years. A company like Dow Chemical, which creates a lot of products using
their technology and secrets in the lab that they then also patent. A secrets
company is a big moat company.
We use
expressways/highways for hassle-free travel — fast, safe and comfortable. And we have to pay a toll for using it, but
we still prefer it. Wouldn’t you love to own a business that makes money every
time someone uses it, and people have no option but to use it? Some companies
have exclusive control over particular areas. That gives them the ability to
collect a Toll – the third moat. For example, If you want to advertise a
product in South India on a television network, you would have no option but to
advertise on Sun TV, because of its very high viewership. Google AdWords is
another example of a toll moat — you can’t reach people searching for something
on the net without using Google AdWord because Google is the most popular search
engine used by people!
The next moat is found in business which make it costly to
switch to different suppliers. This occurs when the cost of shifting from one
supplier or product to another is too expensive for companies to consider - the fifth moat. For example:
Costs like redoing all of your software that links your
network together are often so high, CEOs would not consider making a change.
This is why it’s tough for companies to shift off of Microsoft, into say
something like Apple.
Another company that has a nice switching moat is Intel.
Once a company like Apple has built their computers on an Intel chip, it’s
really hard for them to shift to some other competitor.
Another example is ADP Payroll Services. Once they get in
your back office and start doing your payroll, they’re there forever. The cost
to switch services is just too much
One of the biggest
factors on which companies compete on is price – the fifth moat. A
company which can price its products very low and still makes a profit makes it
difficult for the competition. For example, consider D-Mart (Avenue Supermarts
Ltd.); its strong retail network and value retailing format combined with its
large scale of operations enables it to offer good discounts on products.
So, the five types of
moats that a company can have that can stand the test of time are Brand,
Secret, Toll, Switching Costs and Price. A company can also have other moats
like network effects, distribution network, etc.
The more the
better, a good company have at least three moats hence your job is identify the
moats and then you will move forward to next step that is financial track.
Tracking an
excellent financial record is not an easy task, one have to study 150+ annual
report and look at these 6 financial indicators to identify great company:
- Earnings per Share (EPS)
- Net Operating Cash Flow
- Net Profit Ratio
- Book Value per Share (BVPS)
- Return on Investment(ROI)
- Debt-to-Operating Cash Flow
If these indicators shows that company is
performing well it means if company is financially strong and you may choose to
invest in it.
The next and final step in identifying a great
company is to identify working of the management.
Company having a good management leads to new
heights and Bad management can impact employees and a company's overall
operations.
When you are investing hard-earned money, it makes
sense to take your time and get comfortable with your decisions. If a stock
doesn't "feel" right, take a pass. You will get lots of opportunity.
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