Stock Investing Basics

What is Investing?

An investment is an operation “That promises the safety of principle with satisfactory results”

Investing is not a science, it is Discipline in which both skill and luck play a major role. Security analysis is the prescription for maximizing the influence of former and minimizing the later.

What is Stock Market?

Stock Market is a place where you can own a Part ownership of a business. If the business you own makes money you will also make some money, it’s as simple as that.

So the game is how to select a profitable business?

If you have the temperament to behave like a real owner of a business, over a long period of time you can be wealthy.

What is an ‘Auction Market’?

An auction market is a market in which buyers enter competitive bids, and sellers enter competitive offers at the same time.

The price at which a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell.

Matching bids and offers are then paired together, and the orders are executed.

The stock market is an auction-driven market.

 Why is Stock Market so Volatile?

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ― Benjamin Graham

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How can you take Advantage of Volatility in Markets?

Mr. Market is an allegory created by investor Benjamin Graham. Graham asks the reader to imagine that he is one of the two owners of a business, along with a partner called Mr. Market. The partner frequently offers to sell his share of the business or to buy the reader’s share. This partner is what today would be called manic-depressive, with his estimate of the business’s value going from very pessimistic to wildly optimistic. The reader is always free to decline the partner’s offer since he will soon come back with an entirely different offer.[1]

Since its introduction in Graham’s 1949 book The Intelligent Investor, it has been cited many times to explain that the stock market tends to fluctuate. The example makes it clear that the sole reason for the change in price is Mr. Market’s emotions. A rational person will sell if the price is high and buy if the price is low. He would not sell because the price has gone down or buy because the price has gone up. Graham instead believes that it is important to focus on whether the stock valuation of a company is reasonable after calculating its value through fundamental analysis.

How to Select a Stock/Business?

We want the business to be:

  1. One that we can understand with favorable long-term growth prospects,
  2. That has a Competitive Advantage,
  3. Operated by honest and competent people, and
  4. Available at a very attractive price.

What is a Good Business?

A Good Business is one which is

1. Strong barriers to entry (Great Moat)
2. Limited Capital Requirement
3. Reliable Customers
4. Low risk of technological obsolescence.
5. Abundant Growth possibilities

And thus Abundant growth possibilities

Eg:
LIC, Britannia, Nestle, Bata, Colgate, Amazon, Google, Coca-Cola

How to Value a Business?

It’s an estimate of the current value of the future expected cash flows of the company discounted at the appropriate rate.

Valuation of a business requires you analyzing the financial filings of the company. Intrinsic value is an estimate rather than a precise figure.

e.g

Current Earning of Company A = 1.03

Both Earnings and Dividend expected to grow at 15% pa

If Earnings grow at 15% next 5 years Future Price to earnings will be 10 times earnings, this is the estimate of the analyst.

Discount rate to us is 12% (in general we will use the interest rate on long-term bond)

FV = (PV * (1+r)^n)

FV = Future Value
PV = Present Value
r = Rate of return per year
n = Number of terms

Since we expect 10X of future earnings

Price = 10(1.03(1+.15)^5)
5Y FV Price = 20.71

Now Discount it to Today value at 12%

PV = FV/(1+r)^n
PV = 20.71/(1+.12)^5

PV = 11.75

Conservatively valued Company A is valued at 11.75 (We did not consider Dividend and taxes), if the current market price of Company A is 7.5 you will have a margin of safety of 40% which make a good buy.

How Common Stocks Compounding works?

If the companies in which you invest earns profits, and if the management of those firms retains a portion of those profit into business, and if those retain earnings, in turn, produce future earnings, the principal value of the portfolio would tend to increase in accordance with the operation of compound interest.

Stock Market history

Fear and Greed Plays a Major role in investing.

Be fearful when others are greedy and be greedy when others are fearful.

-Warren Buffett

Below Chart Shows the Market volatility with growth higher than previous levels.

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Conclusion

“The most important investment you can make is in yourself.”
― Warren Buffett

 

Thank you for reading this Blog, if you like it please share with your friends and please share your comments.

All the very best for your Investing Journey.
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