Direct Equity

Direct equity investment can be very rewarding. Simultaneously this is also true that risk of loss in direct equity is high.

People who can balance risk and return while dealing with direct equity are the winners.

But how can one balance the risk and reward? The risk associated with direct equity comes from complexity of information

Its not so easy to decode information’s related to equity.

Information’s related to equity is contained in companies financial reports like balance sheet etc. Let me explain this to you with an example.

How many of us know how to calculate ‘capital employed’ by a company? I am sure only a handful will be able to answer that.

While buying stocks, one of the most essential parameters to evaluate about company is ‘return on capital employed (ROCE)’.

This parameter is so important that a true investor cannot buy stocks without noting it. In India alone, there are millions of people who invests in stocks.

But why only a handful know how to calculate ROCE? This lack of know-how generates the ‘risk of loss’ associated with direct equity investment.

Millions of people buy stocks, only few has the critical know of reading and analyzing balance sheet.

These minority people are the ones who are making huge money in stocks market.

For balance, stocks market is more like a casino because they are investing blindly. Direct equity investment can be very profitable if one has those critical know hows.

Is there no other way-out? No, direct equity investment cannot be consistently profitable if one does not know to decode financial statements of companies.

But there is a great alternative to direct equity. Mutual funds are such products which are designed for common men.

People who do not have time to gather financial know-how can select a good mutual fund and enjoy the returns.

In direct equity, timing the market is important. But timing market is not easy.

If one can invest in equity through SIP (indirect equity), they need not care about market-timing.

Rightly timing the market is one essential trait that one must have while dealing with direct equity.

Historically investors have found timing the market very rewarding.

This is why investors invest in lump-sum in bear market. All big investors have bough stocks in 2001, 2008, 2011 etc.

Investors know that how rewarding it can be to time the market to perfection.

HOW PROFITABLE CAN BE DIRECT EQUITY INVESTMENT?

Compared to any other asset class, direct equity is more risky.

Best investing skills generates maximum profits here. Direct equity is risky but it also open doors for higher returns.

Return of direct equity (in long term) can outperform any other asset class.

But the only precondition is, one should know to value stocks and time the market.

In last 15 years, share market in India jumped from 113 to 27,000 levels.

If we would had invested in an index fund in year 1990, our annualised return would be >44% per annum.

It means in last 15 years our principal amount would have got multiplied by >230 times.

Isn’t this fantastic? This is the benefit of direct equity investment in long term.

Direct equity investing is all about long term growth. When one buy stocks, he/she becomes part-owners in that company.

This way one becomes eligible to share both profit & loss made by company. Investors prefer equity because no other investment option promises long term growth as high as equity.

As a result, equity also beats inflation very conveniently in long term.

TO BECOME A SUCCESSFUL DIRECT EQUITY INVESTOR ONE MUST FOLLOW FEW SIMPLE RULES:

Choose Right Companies– It is important for an investor to select right companies.

This means selecting a company which offers good growth opportunities.

A company which has strong business fundamentals are good stocks to buy for long term.

Invest at Right Time & Hold it Long– Buying and selling of stocks at right time is most important.

That right time is when stocks are trading at undervalued price levels.

Most likely time to find undervalued stocks is during market crash like 2008-09.

In short term, stock market is driven by speculation. But in long term companies fundamentals overshadows speculative forces.

Hence only longer investment horizon allows to take advantage of company’s growth. Company cannot show growth in short term.

Their growth is more visible in time span of 7 years or more. It means if we are investing directly in equity we must assure holding time of 7 years or more.

Buying shares of right company at right price is what is required to make money in stock market.

No matter how good is the company, if purchase well we will not get the desired results.

Timing the market means buying shares at undervalued price levels.

ONE CAN EARN TRIPLE DIGIT RETURN FROM DIRECT EQUITY?

Stay invested for long term, direct equity will surely beat inflation. Generally speaking, returns of equity beat inflation by about 4 percentage points.

It means, if average inflation in last 20 years is 7% per annum then average return of stock market will be 11%. Return of direct equity can be increased by practicing above mentioned simple rules.

In short term, direct equity is very risky due to price volatile. In short term people play stock market like gambling.

There are few examples where people have made 100% returns in short term.

But there are far more examples of people going broke because of short term share trading.

Abnormal returns are possible in stock market but probability of you making one will be like 0.00000008%.

Better option is to practice value investing and buy stocks like Warren Buffett.

Value investing has made Buffett one of the richest person on earth.

HOW TO INVEST DIRECTLY IN EQUITY?

One can invest in a equity either directly by buying shares or indirectly through mutual funds.

DIRECT EQUITY – BY PURCHASING SHARES FROM STOCK MARKET

When a company offers its shares to the public for the first time it is called as IPO. In an IPO the company sells a certain percentage of its ownership to the public at certain price.

Once all issued shares in IPO are consumed by public, stock exchange facilitate trading of those shares in secondary market .

Now companies interference in buying and selling its shares is not required. Any body at any time can buy shares of any company which is listed in stock exchange.

If we want to buy share of company XYZ, we can offer higher price and buy it from someone else.

Why somebody will sell their share to me? Because I am offering higher price to own those stocks.

For buying and selling of shares one need a demat account and online trading account.

Through online trading account one can trade shares online.

But just having online trading account in not sufficient.

To trade shares profitably an investor should do slightly more than buying and selling. Lets see what required to be done to invest profitably in shares:

Invest for long term– One must invest in shares only for long term horizon of > 7 years

Diversify your investments– Do not put all eggs in one basket. As a thumb rule, one should not have more than 50% of portfolio composition in stocks.

Too many stocks (of different companies) is also not good. It will be difficult to monitor them.

One shall not hold more than fifteen to twenty different shares in ones portfolio. Include other asset class like debt, real estate, gold etc in portfolio.

This will make the portfolio very well diversified.

Invest intelligently– One need not be a genius to be a successful investor.

Disciplined investing is all that is requiried. (1) Before buying shares, write down objective so as to why you are buying this share.

(2) Analyze company’s balance sheets profit and loss accounts and its cash flow statements.

(3) If a share is not performing in tune with the markets performance, do not hesitate to sell it.

Example, suppose in last 3 years SENSEX appreciated by 10%, but a stock you are holding has appreciated only 3%, better is to sell it

Short-selling is not a crime – If you have decided to short-sell a share you must have a good reason for doing it.

Short selling is taxable and we must try to avoid it unless we have good reason for doing it.

It is not a crime to sell stocks quickly.

If business fundamentals are indicating the opposite, why people should hold on to a stock.

This will be like willingly accepting losses.

Resist the temptation to buy more only because you want to average your cost– Never buy shares of a company just because its prices are falling.

There are times when you know that you have bought share of an excellent company but at a very high price.

In this case you can consider averaging your cost by buying at price dips.

But one must remember that this approach will only work if one holds the share for long term.

Do not hesitate to correct the mistake even if it means to sell your shares for a loss– There are times when we buy a share and a very high price.

But holding on to the share for a long time is even a bigger mistake.

We must sell such shares, and buy other shares which are of more value (like pays higher & regular dividends).

TAX IMPLICATION WHEN WE INVEST DIRECTLY IN EQUITY

Capital gain tax – If we sell shares between a year of its purchase, capital gains tax of 10% will be applicable on profit. However if we sell share after holding time of one year it will not be taxable.

Tax on dividend – All dividends are tax free.

HOW AN INVESTOR IS BENEFITED BY BUYING DIRECT EQUITY?

When investor invests directly in equity they is benefited in three ways:

Dividend Income– Dividends is a form of profit sharing by company among shareholders.

Level of dividends is decided by the board of directors of company.

Dividend income is like a assured income of shareholders that will come once a year.

Not all companies pays dividends.

So if one wants to invest for dividend income, one must check how regularly the company has paid dividends in past.

It is also important to checks dividend yield.

Capital Appreciation– Growth stocks rarely give high dividends because they re-invest all profits within company to maintain high growth rate.

Share price of growth stocks grows faster than other companies stock price.

So by investing in growth stocks, investors gets benefited by growth in market price of stocks.

Bonus Issue– Sometimes a company may decides to distribute additional shares (free of cost) to their shareholder.

Like two share for every share holding by investors (1:2 bonus share).

It means if I have 10 shares of a company, I will get 20 shares in bonus, in total now I will have 30 shares.

Generally bonus issue is practiced by companies when they do not want to give dividends instead they distribute free shares.