We are back this week to deliver on our promise to help you understand common sense equity investing insights. Today's IM will discuss how-to pick-up elements from our own environment to choose the investing avenues.
You need to master the three skills. Understanding the economic engine, awareness of your surroundings, and the most important mastering your emotions!
Reiterating, equity investments always come with risk - Don’t underestimate the role of risk, and the rewards will be worth the risk!
So, let us roll the dice! And it’s three. Yaay!
1. Economic Cycle mapping
If you observe the stock market, one particular thing to notice is that every stock does not go up on the same day. Or all stocks don’t perform the same over an extended period of the economic cycle. Each sector is influenced by the phase of the economy we are in right now, and by influence, we mean that each phase of the economic cycle presents an opportunity for a particular sector to grow faster than the other sectors.
Therefore, we encourage to use economic signals to see what investments may shine at what turn in the business. Each industrial sector performs differently during various phases of a business/economic cycle.
A business cycle is an economic cycle consisting of two major phases – an expansion and a contraction.
Investors who follow the business cycle approach on the performance of industrial sectors instead of individual stocks are likely to make some good investments, now this is common sense investing!
Once you identify your investment goal and time horizon, look out to understand the current phase of the economy and then map your investment (read industry) to the right opportunity. Let us explain the mapping of each sector to the different phases of the economy with an illustration.
Blue graph represents the economic cycle while the red line graph represents stock market cycle.
Looks interesting and relevant, right? If you found this a bit confusing, wait for our next newsletter or watch-out our LinkedIn page for a layman explanation.
A closer look at this infographic will throw light on one key observation. - The cycle of the stock market does not replicate the economy, rather it precedes the economic cycle.
Carefully following the industries is the best way to get the rhythm of the economic cycle of investing. Observe the stage of the economy (read about economic parameters for better outlook), map it to the sector corresponding on the stock market cycle and voila, you have the sector you need to focus on.
Note: Despite the cycles being more or less followed, some stocks might still under perform or outperform owing to company-specific factors.
2. Behavioural Pendulums (Market Emotions)
Do you remember the three pendulums from our initial IMs, where we discussed the economy, stock market, and our minds? If not here is a refresher course.
It’s more than obvious that the stock market and economy set our minds to swing when it comes to investment in these unpredictable times. As the market swings, it causes our emotional makeup also to go through phases in response.
Master your emotions!
The most essential common skill (which is quite uncommon) is DO NOT follow the extreme herd behavior in the market. For a better explanation let’s take an example: In the most recent aftermath of the market collapse in March owing to the potential damage from COVID we observed several shares fell by as much as 50% or even more. And this did not just hit the small companies but even the big shots with large-cap and a great legacy.
Note: Reiterating, the stock market is proactive, not reactive.
Coming back to our example, the stock market foresaw bad times coming ahead, and therefore, it corrected itself. However, imagine a company like Infosys, or Reliance, or Tata Motors, and hundreds of others correcting by more than 40-50%. Does that mean that these well-established companies are shut down or won’t recover?
What does an investor understand from all this?
The emotions and fear take us on a ride and imply that bad times always last. However, common sense (centered-mind) tells us it’s temporary and only a result of panic-driven heard behavior. What does this create for us? A buying opportunity. Likewise, when everyone thinks good days always last, and everyone wants to buy its a selling opportunity.
Investors understand this but the notorious emotions can short circuit their common sense. Here's an illustration to understand the market of emotions to help you make better-investing decisions.
3. Observational Stock Picking
"A thoughtful investor always has a story behind the stock pick ".
So, you have decided to start investing! With thousands of stocks to choose from, how do you select a few worth buying? The most powerful weapon in your arsenal for cherry-picking the ideal stocks is being aware of the surroundings, daily news, trends, events that drive the economy and general buying habits of people around you.
Let us begin with some simple observations.
Stock 1: Did you buy any vitamin supplements as precautionary measures against COVID? We bet you did! Did you notice the brand name on the strips?
Stock 2: Global warming is on the rise and it’s boiling hot.
Did you buy an AC this year? Perhaps, you bought more than one and so did your neighbor...and his neighbor. Did you observe this business?
Stock 3: Try and recollect a day in the past one month when you've not crossed a construction site...dream homes...offices...apartments...
Apparently, there is relentless construction going on...and cement and paint buckets are used by the tonnes. Did you observe a common company name on many?
Stock 4 & 5: You’ve probably fought your way out of the grocery store with a ton of groceries...Did you notice the brands before picking up your needs...
Perhaps, you couldn’t...and we don’t blame you...
It’s always jam-packed at these stores...and they never seem to run out of buyers.These grocery chains are an indispensable necessity...that could only grow...
and... rapidly...to that effect.
These and dozens of other examples around you, just based on your everyday routine activities are successful businesses to invest in and yes, we might as well term them "multi-bagger stocks"! All you need is a sense to look at products and services around you as investment opportunities!
Disclaimer: The above examples are only for reference and not stock recommendations from The Investor School.
We conclude this article with a note to state that these are few of the simple strategies for stock picking, however, we are in no way undermining the importance of extensive research. Company research still holds stronger ground, and lets keep that aside for another day's discussion.