While I have discussed my principles, experiences and learning as an investor through various posts in the past, some readers have asked for everything at one place.
So here is my investment philosophy for stocks…developed through practice over the past nine years…all at one place.
You might not agree to some of the parts of this philosophy note. But as I said, this is ‘my’ personal investment philosophy, which suits my personality as an investor. And you are completely different from what I am.
Anyways, here I go…
My Stock Investment Philosophy
1. I hold a mix of large and midcap/smallcap stocks in my portfolio, with a majority in favour of the latter (midcap/smallcap stocks). I am constantly in search for emerging blue chips and not the established ones. That is why I invest largely in midcap/smallcap companies. I believe that with time on my side, and the effort I put in to identify my stocks, even if 4 out of my 10 stocks go bad, I will still do well in the long run.
2. I am not after the ‘next Infosys’ (if it happens, I’ll count myself lucky)…but I believe that I (or any small investor) can do very well by identifying, buying, and holding a good proportion of carefully-selected midcap/smallcap stocks in my portfolio.
3. I don’t buy any stock whose underlying business I don’t understand. I have lost 50% to 200% returns in the past by missing on opportunities because those companies did not fit my style of investing…my circle of competence. But I have no regrets because the ones I hold have more or less made up for that…and I sleep peacefully at night knowing what makes up for my stock portfolio.
4. After the quality of a business, I give the maximum weightage to the quality of the management. I need to have confidence in the management of a business that I own. I like managements that put shareholder value above any superficial or selfish motives.
5. My preferred order of actions is to first assess the long term prospects of a business, then form an opinion of the management before finally taking the decision to invest if the share price is sensible.
6. I hold around 12 to 15 stocks in my portfolio. Here is a checklist I use to identify stocks for my portfolio:
7. Some specific numbers (and their long-term trend) I look for in a company:
- Sales and profit growth (level of growth plus consistency of growth)
- Return on equity. This number indicates whether a company is using its capital efficiently or not. I look for companies consistently earning more than 15% RoE.
- Debt to equity. I hate companies that have consistently had high debt to equity ratio (usually more than 1:1). Alternatively, I love companies with zero or minimal debt, simply because such companies can never go bankrupt.
- Capital intensity. I like companies that don’t require much of additional capital year after year to grow their businesses. This is because for a company that requires consistent infusion of new capital to grow its business, to take on debt on its books or to issue new shares becomes a necessity after some time. Both these factors (more debt and issue of fresh equity) hurt existing shareholders.
- Dividend (rising and consistent). I like companies that pay rising dividend year after year. Though I am not against those that don’t pay at all, some dividend is always appreciated.
- Free cash flow. A company that consistently generates free cash flow (what remains after paying off for everything, including new capital expenditure) is always a safe bet.
8. It takes me hardly a few hours to analyze a company, but it takes me days or sometimes weeks to make up my mind whether to buy that stock or not. This is because I believe that my heart (emotions) can often play a bigger role in my stock selection than my mind (rationality).
9. I calculate the intrinsic value of a stock I’m interested in by using several methods:
- Price to earnings
- Price to book value
- Graham number
- Earnings power value
- Dividend discount model
- Discounted cash flow
You can read my explanation on these methods in any of the StockTalk reports I’ve done till now.
I buy a stock only after I’m comfortable with the business (as described above) and only when the stock price is less than 65-70% of the stock’s intrinsic value.
10. I sell my stock(s) when any (or a combination) of these conditions are met:
- When I realize that I made a mistake in buying a stock.
- When a stock gets overvalued (its price moves much higher than its intrinsic value).
- When the business model of a company deteriorates.
- When the cash flows of a company deteriorate.
- When the debt on a company’s balance sheet crosses my comfort level (usually 50% of equity) and is expected to remain there for some time.
- When something happens to cast doubt on a company management’s integrity (like a bad diversification, or an overvalued acquisition).
- When the return on equity falls below 15% with no sign of improvement.
- When the stock surges at a rapid pace without any change in the underlying business fundamentals.
- When I identify a better opportunity (I sell the worst stock from my portfolio and reinvest the money in this new opportunity).
- When I need money for an emergency, which is more than what I’ve accumulated as an emergency fund (I start by selling the worst stocks from my portfolio).
11. Some other rules I follow for my stock investment portfolio:
- I am indifferent to whether a stock I own is from a specific sector…though I don’t own stocks from the energy, pharmaceutical, real estate, and textile sectors.
- I am indifferent to whether a stock I own is in the BSE-Sensex or any such benchmark index or not.
- My minimum holding in any one stock is 2% and the maximum is 8%.
What do you say?
So that was my entire stock investment philosophy.
What about you? Do you have your own stock investment philosophy? If yes, what is it? (You can share for the benefit of others in the Comments section below)
If you invest in stocks but don’t have an investment philosophy, why not?