The 7 stock market secrets/investment secrets of Warren Buffet have got unveiled here. These share market secrets will help you uncover and understand “How to win in the stock market”
Stock Market – Game or Gambling?
Gambling has lesser rules than a game. The winning in gambling is based on luck or chances. A gambler takes blind risk. Very less preparation and practice are done here. There are no sure-strategies for success in gambling.
There are people who gamble in the stock market. However, if we take the stock market as a game, it will help us become successful in the long run.
Stock market resembles more like a game
• Like a game, the stock market has its own rules. We will see 7 of the stock market rules in detail in this article.
• Following these rules will help you become successful in the stock market.
• Any decision, you take in stock market investment should have logic and rationality to get results.
• Staying the course even during financial storms with a never give up player mindset is important for stock market success.
• Emotional maturity, discipline, continuous preparation and practice are essential to winning the stock market game.
• You take a calculated risk in the share market and not a blind risk.
Why does these 7 remain as Secrets?
A fact or idea or strategy remains a secret because it is less known or not known to most of the people.
Ex: How does Google rank various web pages? This is kept as a secret by the people. Most of us don’t know about this.
The 7 secrets of investing in the stock market will not fall into this category.
There are another set of secrets. A fact or idea or strategy is available in open source but less practised or not practised by most of the people.
Ex: Values and life lessons explained in holy books. These are available to us in an open source, but are practised by a very few people.
The second set of secrets are not so easy to follow or implement but worth knowing.
The 7 secrets of investing in stock market may sound known already in some form. But will definitely give you a new perspective.
7 Stock Market Secrets
Secret No. 1: Look at quality businesses and not just the stocks
This is the first and foremost of the 7 Stock market secrets.
Warren Buffett said, “When I buy a stock, I think of it in terms of buying a whole company, just as if I were buying a store down the street.” Most investors don't analyse the businesses they invest in. They simply follow the symbols or brands of successful corporate houses.
If you are buying a shop, you will analyse about
• the products dealt by the shop
• overall sales
• consistency of sales
• competition for the shop
• competition strength of the shop
• how the shop will manage the change in customer trends
We need to apply a similar logic before choosing a stock. Don’t think that you are only buying a few shares of that company.
Will you buy the whole company if you have enough money?
Getting a satisfying answer to the above question from yourself is the first stock market success secret.
Thinking on these lines will help you uncover the first secret of stock market trading and investment.
10 Financial Ratios that can reveal the quantity and quality of a business:
An in-depth analysis of the below ratios will help us become successful with the first secret of the stock market.
1. P/E RATIO
2. PRICE-TO-BOOK VALUE
3. DEBT-TO-EQUITY RATIO
4. OPERATING PROFIT MARGIN
5. PRICE/EARNINGS GROWTH RATIO
6. RETURN ON EQUITY
7. INTEREST COVERAGE RATIO
8. CURRENT RATIO
9. ASSET TURNOVER RATIO
10. DIVIDEND YIELD
These ratios help us
• Understand the real worth of a company.
• Get to know the financial soundness of a company.
• Compare a company with its peers.
Please do your homework with these ratios of the company in which you are planning to invest. This homework will help you pass the first share market secret.
Long term Track record:
When we analyse a business, we need to analyse them for their long term track records. Short term returns during bull markets will not be able to substantiate the quality of the process followed in the business. During bull markets, even a mediocre business will make money. So a long term track record will reveal the real stability and ability of the company.
Studying the long term track record will help us choose the right company stock or a right mutual fund scheme which take strong long term decisions even if it affects the short term performance. An investor should not miss these investments with long term visions. Companies or mutual fund schemes with a vision of long term performance are always better than those who focus on short term performance.
The answers to the following questions will reveal how far you fair with reference to the first secret of share market investing:
• Do you clearly understand how this company makes a profit?
• Can you explain the above answer to a 12-year-old?
• Do you have unshakable trust in the future prospects of the company?
If you think, identifying a good share then you can choose a good equity mutual fund. The mutual fund manager will identify good stocks which will pass the above tests.
Secret No. 2: Are you willing to own a stock for 10 years? If no, then don’t own it even for 10 minutes.
Once you find a quality business, you need to decide if you will own this stock for 10 years, which is the second secret in the 7 Stock market secrets.
Stock Market – Voting machine or Weighing machine?
Only buy something that you'd be perfectly happy to hold if the stock market shut down for 10 years. In the short run, the stock market is like a voting machine–tallying up which firms are popular and unpopular. But in the long run, the stock market is like a weighing machine–assessing the substance of a company.
Looking at the short term opportunities in the stock market will not be a long term successful strategy. If you don't feel comfortable owning something for 10 years, then don't own it even for 10 minutes.
This second secret of stock market success can be rephrased as “Stop thinking short term and start thinking long term”
Stock Market – A place to be inactive
If you think, by making frequent active moves you can beat the stock market game, then you are wrong. You have to buy right and sit tight.
“We continue to make more money when snoring than being active. Inactivity strikes us as intelligent behaviour.” – Warren Buffet
According to the research done by Dalbar, investors earn less return because of these frequent actions.
“Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.“ – Warren Buffet
You are not rewarded for taking action in the stock market. You are rewarded for being right in the stock market.
Insights on the second secret of stock market investing
Don’t get infatuated with a stock because of the temporary rumour or hype in market. Don’t invest in a stock to make quick money. You may end up making quick losses as well.
Be a part of the long-term success story of the company and not to capitalize on the current news making situation of the company.
Peter Lynch says, “Invest in companies, not in the stock market. Ignore short term fluctuations.”
Secret No. 3: Check thousands of stocks and look for very high bargains
Avoid investing based on the stock market tips or recommendation. Do your own research. Analyse thousands of stocks before choosing the right stock to invest. That is one of the secrets to win in the stock market.
Identifying the undervalued stocks:
“No matter how wonderful a business is, it is not worth an infinite price. We have to have a price that makes sense and gives a margin of safety” – Charlie Munger.
Finding a right stock is one thing, but figuring out whether they are undervalued or not is a different thing and a difficult thing. By analysing the fundamentals of the company like earnings, revenue and assets, we can arrive at the intrinsic value of the company. If the intrinsic value is more than the current price, then the stock is definitely undervalued. It is worth investing in that company.
It is really difficult for an individual investor to analyse thousands of stocks and finding out the right time to buy a stock in the stock/share market. If this is the case, you can outsource this Portfolio Management Scheme to a professional financial planner or wealth manager. But you need to be careful in choosing a professional financial plannerwho is capable and at the same time customer centric.
The third secret of stock market success can be achieved if you have time and patience or by outsourcing it to the right expert.
Insights to implement the third secret of investing in the stock market:
In order to master the third secret of investing in stock market, you need to do these two simple things:
• Identify a good stock after doing a thorough and in-depth analysis of 1000 companies.
• Buy that good stock at a very good bargain
If it is not possible to identify the bargain, then you can follow a simple yet powerful strategy called Systematic Investment Plan. This will make the investing process much easier.
Secret No. 4: Scrutinize how well a management is using its resources.
Check how efficiently a management is using its resources like money, manpower and material. This management efficiency will in turn reflect in Return on Equity and Return on Capital.
This is a very simple and profound secret for stock market success.
A company will have resources of different types like
• human resources
• financial resources
• physical resources and
• Knowledge resources.
All these resources need to be used efficiently. Only when all the resources are used optimally, a company can continue to deliver consistent profits. For sustainability of the business, efficient resource management is important.
Any wastage or underutilization of resources by a company need to be taken as a warning signal when investing in the stocks.
This efficient management of different resources is the fourth and profound secrets of stock market success.
Secret No. 5: Always stay away from “THE HOT STOCKS”
Hot stocks are those stocks which have some attention catching activity such as severe volatility in share prices, high trading volume or when the stock market is in news. Stay away from these hot stocks.
Warren Buffett once said, “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
It is not advisable to chase the hot stocks or hot mutual fund schemes. All stocks and funds go through a performance phase and non-performance phase. A performance phase will be followed by a non-performance phase.
Instead of chasing a stock or fund which is hot (performing now), we can choose stocks or funds which has performed well over a period of time, and which has the potential to perform in the long run.
HOT STOCKS VS BORING STOCKS
Hot stocks can easily burst. Hot stocks become hot because of the sensation created by news media. This sensation increases expectation. The increased expectation will work against you.
Stocks which are not in the limelight, and stocks which are boring will eventually deliver remarkable results.
BORING STOCKS AND PLANTS:
Boring stocks are like plants.
• The growth is very slow.
• Less interesting to watch them grow.
• Watching the growth has less curiosity.
• But the end result is rewarding.
• Needs a lot of patience to wait and see the growth.
• No smart moves can bring quick results
Identifying the unnoticed and undervalued stocks is really an important secret to the stock market success. Not falling prey to popularity is an important stock market tip/secret.
Secret No. 6: How much money will you make?
Before investing in stocks or the stock market, calculate ‘how much money you will make’ in that investment. Of course, you need to make a few assumptions to do this calculation. But do calculate.
Most often investors tend to ask the share is undervalued or overvalued. Identifying the intrinsic value of a stock is difficult, and the various models available to calculate the intrinsic value are faulty.
Warren Buffett wrote in a report “Unless we see a very high probability of at least 10% pre-tax returns, we will sit on the sidelines.”
HOW TO ESTIMATE THE RETURN FROM A STOCK?
We need to take into account the expected dividend and the expected share price appreciation.
Share price appreciation can be estimated by taking into account the change in Earnings per share and change in P/E ratio.
Return on Equity = Net Income/Shareholder's Equity
Look before you leap. Calculate the ROI before you invest. This is a simple but sound stock market secret.
Secret No. 7: Get rid of the weeds and water the flowers — not the other way around
This is a very good stock market strategy when you review your share portfolio or mutual fund portfolio.
People have this theory of loss-aversion, i.e. when the share price falls down by 50%, they choose to wait. They convince themselves and others by saying “It will definitely come back”.
Also, people will rush to book profit when their shares go up just by 10%. In effect, investors tend to keep the loss making shares with themselves and they offload their profitable shares. Actually it needs to be the other way around.
This stock market secret of “keeping the winning stocks and getting away with the losing stocks” will pay a vital role in you becoming the successful stock market investor.
Instead of getting attached to the stocks or funds selected, we need to be attached to the logic behind the stock selection. If a stock or fund is not maintaining the good fundamentals which was there when you selected it, then you can consider them to sell.
EMOTIONAL BARRIER TO MASTER THIS SECRET OF INVESTING IN THE STOCK MARKET
Non-acceptance: Not able to accept the fact that we have made a wrong investment decision and the inability to accept the loss make us retain and continue the loss-making investments.
Pride and Impatience: To showcase our pride of achieving, we may tend to sell the profit making shares. If we could patiently wait longer, we can make huge profits.
Though this is the last secret of the stock market success, this secret is the most important and not to be neglected secret for the stock market success.
As investors practice stock investing with the above secrets, they come back to us with a few more challenges. We are discussing those challenges here with the secrets to face those challenges in stock investing.
Bonus 1: How to avoid Hazing in the stock market
First, let me explain ‘What is hazing in the stock market?”. Hazing is cognitive dissonance. It is the concept of people being torn between two opposite ideas or strategies or values.
Most of the times, before arriving at an investment decision, there will be conflicts in our mind. For example, a thought will argue ‘Markets are crashing. Your portfoliovalue is eroding. So, book profits ASAP.’ And another thought will counter argue ‘Markets are crashing. Stocks are available at discounted price. So, this is a good time to buy’.
When you hold both the thoughts continuously in your mind without coming to a logical conclusion, then that stage of confused thoughts is considered as hazing.
When you do hazing in the stock market, you will be emotionally imbalanced. This will make you take irrational decisions for which you will regret later.
As we have discussed in detail on what is hazing in the stock market, let us discuss on how to avoid hazing in the stock market.
• Write down the conflicting views
When you keep things in your mind. You may not get clarity. Put it on a paper. Divide a sheet into two columns. Write down the supporting points for each argument in each column. Search for additional points. Quantify the expected results of taking or not taking each decision. This will give you more clarity in taking decisions.
• Read the books of successful legendary investors
Read the books of successful legendary investors like Warren Buffett, Peter Lynch, Ben Carlson and Howard Marks. When you read these, the guiding investment principles followed by them will be internalised by you. So you will be strong in your mind with reference to these investment principles. Market noise will not disturb your mind.
• Create a financial plan with the help of a professional financial planner
A financial plan is created with logical steps and checklist. There is no room for emotional decisions in the financial plan. A financial plan is like a compass; it will give you direction when you are off-track or confused.
• Filter the financial news
Whenever you get a financial news, you just try to answer this question: “Am I going to worry about this news even after 1 year or 3 years or 5 years or 10 years?” Most of the breaking news today will be irrelevant over a period of time. The illusion they create today is temporary and not real.
I will suggest you an exercise. Read some of the old headlines and check how it impacted the investments. How do those headlines affect your long term goals?
What kind of hyped headlines did we get during demonetization? How is it affecting the economy? What was the index when demonetization was announced? What was the index level after 1 year?
When Trump won the election in US recently, what kind of market predictions ruled the media? What happened eventually?
You’ll find out that the majority of the headlines will have no impact or a very less impact on your long term financial goals.
Bonus 2: How to book profit in the stock market
• Ignore Booking Profit
When Warren Buffett chooses to invest in a company…
He is not concerned whether the stock market will eventually recognise the worth of the company.
But, he is concerned how well this company will make money from business in the long run?
As long as you have long term time horizon and right stocks or funds, you need not worry about booking profit.
• Book Profit when you near your goal
When you are about to meet your financial goal, you may have to book profits. When your long term goal becomes a short term goal over a period of time, then you may have to reduce equity exposure towards that financial goal so as to avoid the market fluctuations.
You are starting now to invest in equities for buying a property after 10 years. As 10 years is a long term time horizon, you can invest in equities. Down the line after 7 years, you will just have 3 years to buy the property. 3 years is a short term time horizon. It is not advisable to invest in equities for short term. So whatever the equities you have accumulated over the 7 years, needs to be withdrawn and reinvested in debt.
• Book Profit based on Asset allocation:
When you have predetermined asset allocation, in order to rebalance to bring back the asset allocation to its original ratio, we may need to book profits.
You have Rs. 10 lacs to invest. Based on the recommendation from your financial plan, you want to follow an asset allocation ratio of 70:30 (equity: debt). So you invest 7 lacs in equity and 3 lacs in debt. End of 1 year your equity portfolio value stands at 8.75 lacs and debt portfolio value stands at 3.25 lacs. Now if you look at the asset allocation ratio, based on the current value, it will not be 70:30. Now to rebalance it to 70:30, we may need to book profit from equities.
These 7 (+ 2 bonus) stock market secrets if applied properly in the Indian stock/share market, they would be your roadmap to riches.
In order to strengthen your roadmap to riches, you need a clear route map in the form of a financial plan.
Do you have any other stock market secret? Do you have any success stories based on the above stock market secrets? Kindly share in the comments section.