The bears are at it, but this too shall pass. Now is the time to sit down and strategise — to live to fight another day.

THERE ARE many kinds of bears. There are the small ones that you often see in street corners with a leash around their necks and doing tricks. They can easily be mistaken for large dogs, and it seems easy to escape from one of those. On the other extreme are the big bullies, the grizzlies. The ones that have been mauling the stock markets of late are definitely one of those big ones. You can’t tame a grizzly, it’s difficult to run from it, and there are no safe havens.

Look around and there are signs of bear market wounds. The technology stocks are all down by 80 per cent (and more) from their peaks. The Sensex is at the same level it was 10 years back. There are large scams all around. The US and Japanese economies are in a recessionary state. There are hardly any stockmarkets that have actually increased investors’ wealth in recent times. Even the consumer product companies have started showing signs of trouble (for instance, HLL’s growth rate has slowed down). The MNC companies that people thought would treat the minority shareholder well have started misbehaving (Gillette’s share swap deal is a case in point). The ‘old economy’ stocks
never seem to announce any good numbers.

The most common question asked today is how to escape from the bear and at the same time position yourself well for the bull ride whenever it happens (and I sure hope it happens!). In times of trouble, get back to the basics. Limit your downside risk and position yourself to cash in on a turnaround as and when it happens. As I see it, there are broadly four categories of stocks. The defensives, the technology stocks, the old economy stocks and the next wave stocks. And there are different issues to deal with in each of these categories.

Defensives, as they are most commonly referred to nowadays, are the consumer and pharmaceutical companies. Most of these stocks are down a good 30-50 per cent from their peaks. The only concern here is that, why should you buy a stock at PERs in excess of 30, for growth rates less than 15-20 per cent when you have other kinds of stocks available at either much lower PER levels or much better growth rates?

The reason, quite simply, is that they are defensives. Your downside is limited and if you are positioned in the right companies, you could make in excess of 50 per cent over the next year. For instance, HLL has averaged a PER of about 40 in each one of the past 10 years, and average growth in excess of 20 per cent despite a stagnant market.

Technology stocks. Most techs are down more than 80 per cent from their peaks. The PERs of most stocks are less than their annual percentage growth rates. There are three issues to remember with technology stocks. Firstly, the chances of these stocks getting back their old valuations (like PERs in excess of 100) are quite remote. Secondly, growth rates in excess of 80 per cent that many companies averaged over the past 3-5 years, would be difficult to repeat. Thirdly, not every company will survive these turbulent times.

Old economy stocks. These are the likes of auto, cement, and capital goods companies. Most of these stocks have seen their average PERs drop from highs of 25X-plus about six years back to single-digit levels now. Not all stocks are going to turn around together, some are going to fall by the wayside. Watch out for debt traps. As long as you are with cash-rich companies earning decent return on their investments, and buy them cheap, you could make some extremely satisfying investments. Management quality, dividend yields, debt levels are key issues to watch out for in this arena.

New wave stocks. The stock market is like the sea. There will always be waves. Over the last decade, we have seen the NBFC wave (1994), the auto sector wave (1995) and the cement sector wave. And remember the aquaculture wave of 1995. The most recent waves were in technology and media stocks. There will always be waves and that is the way the markets are supposed to behave. Never think for a moment that it will turn to a ripple-free pond. Simply get your surfing kit ready, and prepare yourself for the next wave, wherever it comes from.

Identifying where the new wave will strike is one of the most interesting fields of study within the stock markets. Watch out for high marginal rates of incremental returns, reasonable valuations (not necessarily cheap), good growth rates and some element of skepticism from investors (you know, people saying, “This can’t continue for long”).

In these turbulent times, being in the stock market is like being in the high sea with a violent storm around you. If you are already committed to the equity markets, it is difficult to quit now. It is time to prepare yourself in times of these storms. Drop anchor, wear your life jackets, tie yourself if need be. But remember — like all storms, this one too shall pass.

Wish you happy sailing in sunny times, whenever they come.

You’re keeping the right company if you stick with those that are on a growth path.

HOW DO you identify great companies to invest in?

To find an answer, let’s look at the factors that influence purchase decisions in other spheres. A farmer is more likely to buy a plot that yields 200 kg per acre than another that gives 100 kg: that way, his chances of doing well even during a drought are considerably better. Again, a cow that yields 20 litres of milk is a better buy than one that gives just 10 litres. Of course, the high-yield plot–and the high-yield cow–will also cost more, but right now we’re discussing great buys, not the best price. That’s a different story in itself.

Much the same logic applies to equity investments. As we saw in an earlier column (Keep an eye on the RoE), the higher the return on equity (RoE), the better the company’s earning power. The RoE is also a measure of how the company will fare during downturns, so look for consistency of RoE over a period of time–not just a year.

Now, there are many companies that post great RoE, yet don’t do very well in the stock market. Experienced investors look at the growth factor–a measure of whether the company has managed to grow in its business.

Here are some ways in which a company can grow.

Increasing market share. This is perhaps the quickest way to grow. Take the example of Hero Honda vs Bajaj Auto. Both are in the two-wheeler industry, but over the past 10 years, Hero Honda has consistently increased its market share at Bajaj Auto’s expense. This is a classic case of one player taking share away from the market leader. Not surprisingly, Hero Honda has rewarded investors with a compounded annual appreciation of 45 per cent over the past five years, while Bajaj Auto has dipped at a compounded 9 per cent over the same period.

Punjab Tractors’ story is different. Over the past decade, the company gained market share quite evenly, and was one of the best performing stocks (with returns in excess of 50 per cent a year for over 10 years). But when growth flattened, the stock plummeted 60 per cent from its peak.

Then there’s the case of Hindustan Lever. In recent years, it gave Colgate a run for its money: over the past five years, the market share of Colgate’s core toothpaste brand has fallen from about 60 per cent to about 42 per cent. Most of this was taken by Lever, which was also made gains in other areas of business. But over the past two years, Lever’s sales growth has slackened–and its stock has went down nearly 30 per cent from its peak.

This leads us to an inescapable conclusion: the market detests a slowdown in sales growth. As long as you stick with a company that’s gaining market share, and stay away from one that’s losing it, you’re on a good wicket. But you have to be careful in playing this game. That’s because the moment the market senses that a company is no longer gaining market share, and that sales growth (and, consequently, profitability) is dipping, valuations will take a beating and there’s likely to be a sharp correction in the share price.

Efficient businesses.

A company also records quick growth when it moves into more profitable and efficient businesses. Take the case of Container Corporation, which moved away from traditional means of transporting freight to more efficient means–using containers. (But in this case, I haven’t been able to figure out why the stock hasn’t performed in tandem. Any ideas from those of our readers with an analytical bent of mind? Do write in to me.) Reliance’s petro-based products have taken market share away from alternative materials such as steel and aluminium. These offer good growth opportunities as they normally last for a long period. And competition, when it does come, will be from a less-efficient business model, which will not be able to compete with the new models.

Market growth. Asian Paints is a good example of a market growth play. Its market share within the industry has remained more or less stable at about 44 per cent (and it has returned 10 per cent annually over the past five years). Growing with the market is a stable way to do business, and although only rarely will you find extraordinary growth here, there are many companies–particularly in FMCG, pharma and finance–that log 12-15 per cent growth rates for long periods. As long as you are ready to play the volatilities in such stocks, you can rake in regular returns.

When you have a stock that offers a decent RoE and the company is growing at a fair clip, you can be sure it will give you fairly good returns. There’s also a high chance of getting extraordinary returns. But, then, the story doesn’t end here. There are many stocks that have registered good growth and offer attractive RoE, yet have not performed–Marico, Balrampur Chini, Zodiac Clothing, to name a few. Where did they falter? We’ll explore that in my next column.

The record of return on equity of a stock is a great first-cut method to weed out the laggards from the multi-baggers . Here’s how the best investors do it.
I HAVE an extremely interesting friend — call him Mr Knowledgeable. He is a fund of information and I have often benefited immensely from the depth and breadth of his knowledge. Like the time I wanted to buy a car, I simply called him up. He knew the exact power difference between a Lancer and a Honda City, the difference between the engines of the Accent and the Ikon, and the mileage of a Zen or a Santro. Nor was he the repository of wisdom on automative matters alone. You could ask him about anything – a TV or a DVD player — and he would take centrestage and talk confidently, and knowledgeably, on the pros and cons of different models. And rarely have I gone away not knowing more about the product. His ability to collect information and zero in on the key factors to look for in a product is simply wonderful.

But such a knowledgeable man becomes a completely different being when it comes to investing. I have often had the opportunity to see him in action as he makes his investment decisions. His personality undergoes a marked transformation. Gone is the suave, sophisticated man who can enliven hangers-on with his incisive analyses. First,
he looks around furtively and ensures that nobody is within earshot. He then picks up the phone and in a hushed voice asks someone in the finance field for a tip. He adopts this popular investing philosophy called ‘tips-based’ investing. And since I’ve spent a good bit of my time being a ‘tips-based investor’, I empathise with him.

I confronted him one day and asked him why he does not do the same thing he does while buying a car or a DVD player: simply find out the features of different stocks, compare them and make a decision on what stock to buy. His problem was simply that he knew that horsepower, engine capacity, mileage, maintenance cost, resale value and the like were important parameters for cars. But when it came to stocks, he could not figure out what to ask after someone told him that a company is great.

Truth to tell, Mr K is not unique in facing such a quandary. So I decided to speak with some experienced investors and ask them what they looked for when they went out to make stock investments. The following is a list of some of the key parameters that good investors look for. And surprisingly, the methodology is much the same as buying a car.

Return on equity.

The first and foremost question to ask is what is the return on equity (RoE) on the stock. RoE is the total profit divided by the net worth — or earnings per share divided by book value. Ideally, when you’ve got a company in your sights, try to find out the RoE for the past five years. It’s quite easy to ferret out this information — the interactive tool we’ve provided right here will let you do it in a jiffy. Else, you can check the annual report of the company — most companies have started giving out the financials for the last five years. Or you could simply ask your broker to provide you the information — make him earn the brokerage.

If the RoE has been below 14-15 per cent for all five years, it’s like buying a car that gives you a mileage of 5 km per litre. The company is definitely not worth investing in, especially if you want to stay invested for more than a year. On the other hand, if the RoE is more than the 15 per cent benchmark for all five years, then you can be sure it’s a good company, well worth your investment.

The reason why you should look for at least 15 per cent is that even AAA-rated company bonds give you about 12 per cent returns; some really good companies give you even 13 per cent on their bonds. When investing in equity, it is reasonable to expect an additional 2-3 percentage points in returns. If a company has been earning RoE of less than 10 per cent for five years, one is better off investing in AA bonds. Some of the best examples of stocks that have high RoE are Hero Honda or Infosys.

Is RoE increasing every year? Have you ever had the experience of going to the market, picking up a dozen mangoes and finding one so juicy it is far superior to all the others you’ve bought? The stock with the increasing RoE is like that. These are the stocks that make a 20- or 50-bagger. (For more clues on sniffing out a multi-bagger, read my earlier column: Stalking the 100-bagger.) Look at HLL’s track record. It shows that the company is not only a great company but is also improving its relative position within the industry.

The market valuation of such stocks keeps on improving as long as the RoE continues to increase.

Decreasing RoE. The market hates nothing like a stock with a ‘decreasing RoE’. It is even worse than the low RoE stock. It simply means that the company is losing its relative competitiveness within the industry. The company continuously disappoints investor expectations — there is no limit to the losses one can make in such stocks. For examples in this category, you need look no farther than Shiram Honda, Carrier Aircon, MTNL and Colgate. All these companies had extremely high RoE at some point in their history and saw their profitability drop over the next three-four years. You’d do well to avoid these stocks; as a new investor, get in only after it is firmly established that RoE has turned. There is no reason to worry that you’ll miss the run on the stock. The stock will not turn around in a hurry, as there will be several investors stuck with the stock at various levels waiting to get rid of the stock the moment it reaches their buy price.

Avoid companies that promise high RoE. Over the past few years, many companies have caught on to this emphasis on RoE. As a result, many state upfront that their targeted RoE is about 20 per cent: but they never really reach that magic figure. Beware of such companies until they actually prove their credentials. This is one of the greatest traps the market can set for you and if you can avoid this diligently, half the journey is done.

And finally, you may ask about those companies with high RoE but with stocks that have not performed. That takes us to the second criteria that investors look for: growth in sales. But more on that later.

The key to a good stock-pick is to look for a catalyst that will drive it to a higher orbit.

THE WORD catalyst (cat.a.lyst: one that precipitates a process or event) tries to take one directly to the beginning of an event. It could be that little spark that caused a forest fire. Or the role of the matchmaker in a marriage. Some attempts at catalysing a process might fail (I am not sure whether Vajpayee’s bus trip to Pakistan did anything to catalyse the peace process). Some can trigger a wave of change.

With this brief prelude, let’s drive straight ahead to the highway we are supposed to be on — the investment highway. Most people who have got into the world of equity investment have had the experience of either investing in, or being left holding, a stock that looks cheap but does not move for years. I recently read that Jammu & Kashmir Bank (whose financials look pretty okayish) trades at a PE of less than 2 with a dividend yield of 11 per cent. Some others have also written about reasonably profitable MNC stocks that are quoting at ridiculously low prices. There are quite a number of other stocks in this category — Shriram Honda trades at a PE of 3, IDBI at a PE of less than 2 and Cholamandalam Finance offers a dividend yield of 17 per cent. This list even includes consumer products such as Timex and Phil Corporation.

My own experience with such stocks has been quite bizarre. About three years ago, I was doing some diligent work on how to pick up value stocks and I had made a list of some of them. At that point, Gramophone Company was flushed with the success of ’1942 – A Love Story’ and ‘Hum Apke Hain Kaun’ and yet the stock was trading in the mid-30s. I bought it then, sure that these movies which boasted of several musical hits would have the music major’s cash registers ringing for some time to come. But imagine my consternation when, immediately after I bought in, the stock went into the sub-20s.
Completely dejected, I exited the stock. Within two years, thanks to the media boom and Zee Telefilms taking off, it reached dizzy heights of Rs 2,300.

Worse still, on exiting Gramophone, I bought into Premier Auto Electric, which was quoting at one-fifth its book value, a dividend yield of almost 20 per cent and a PE ratio of less than 2. Over the next two years, the company, which had a 25-year track record of paying dividends, decided to cut dividends and the stock promptly halved! How’s that for luck!

Three orbits. The funny thing about the stock market is that it might not be as efficient as the pundits claim. Stocks can quote in three categories — or to borrow a term from science, three different orbits. The lowest orbit is the bearish phase, when stocks (despite being moderately profitable) are quoted at silly valuations (a PE ration of less than 4 or so). The next orbit is the acceptable orbit (PE of 10-18 or so) and the third is the really bullish orbit (with a PE far in excess of 30).

Take the case of Wipro. In 1997 (by which time Infosys was quite popular with the market), Wipro was trading at a PE of less than 8. Within six months, when the market realised that Wipro was also in the software business, the stock was re-rated upwards to a PE of about 20. Over the next 18 months, it went on to touch a PE of 800-plus.

Stocks need a catalyst to change orbits, and it’s a good idea for investors to keep an eye on potential catalysts. Take, for instance, HDFC, which was quoting at a PE of 6-8 for almost two years. Many people claimed that the stock was expensive at even those levels. Then HDFC launched its mutual fund and the government announced concessions to the housing finance sector, and the stock today trades at a PE of over 15.

The need to have a catalyst in sight could simply direct you to the right choice of stock among all the sub-3 PE stocks or all stocks with a dividend yield of over 12 per cent. If you list all the penny stocks in the market, you will easily line up more than 200. Now, instead of buying the first stock you see at a PE of 3 or a dividend yield of more than 12 per cent, choose a stock where you see a catalyst that could kick the stock to a higher orbit. This could potentially give you a 100-bagger, for these stocks come not from earnings growth but from a dramatic change in PE ratios.

Once you can identify the underlying trends that make or break companies, it’s easy enough to spot the winners.

Watching children grow is quite a delightful experience. Among the many facets of a child’s growth, I find the way they observe and identify patterns a beautiful thing to watch. It’s fascinating to watch the first time they start to observe patterns and digest them — like noticing that the sun rises and sets every day. Or a few years later, when the child starts
to notice that the phases of the moon repeat themselves. Or that stars too rise and set like the sun.

There is, in fact, a school of thought that believes that knowledge is all about recognising patterns that happen around us, and using them to predict future happenings. But this column attempts not so much to discuss the meaning of knowledge as to sharpen your skills as investors.

And what of corporate pattens? As you watch companies over a period of time, you will slowly start to notice that they have an underlying pattern. Every profit-making company normally has an underlying larger macro pattern that it is riding on. The importance of an investor understanding the macro trend underlying a company’s fortunes cannot be
overstated.

Take the current software boom for example. In simple terms, a typical engineer sitting in the US gets paid $80 per hour and over the past five years, companies have found a way of getting the same work done in India and charging customers $22 per hour and still managing to make super normal profits. Does it sound simple enough?

No wonder the Indian software industry is growing at 60 per cent. In this case, would you invest with the Indian software industry or with a similar company in the US doing the same job? The No. 1 company riding this trend has gone up 2,000 times since it went public 10 years back!

Or take the case of the readymade garments industry. Ten years back, I was able to get a pair of trousers stitched for about Rs 100, whereas today, I can’t dream of getting it done for anything less than Rs 250. Tailoring is more expensive today (including the cost of two trips to the tailor and the possible risk of the tailor making a mess of it occasionally) than buying readymade trousers. No wonder some readymade garment businesses are growing at above 25 per cent. So, will you invest in a tailor or in a readymade garments company?

The same thing happened in the steel and plastics industry. About 15 years ago, plastic entered India in a major way. The advantages of plastic over steel are numerous – plastics are lighter, they don’t rust, they look better and sometimes last longer. Most important, plastics started getting cheaper. In the same period, the stock price of Reliance went up 10 times and that of Tisco dropped to 10 per cent of its original value.

Take the case of the pharmaceuticals industry. Over the past 50 years, the average life expectancy in India has gone up from less than 40 to over 65. Over the next 50 years, this trend is expected to continue. And it’s a chicken-and-egg story whether the people have benefited from the pharmaceutical companies or the other way around. Wouldn’t you find a high level of comfort investing in pharmaceutical companies?

The home and the world. Or take an interesting social trend. The joint family structure has been dissolving into the nuclear structure over the last 20 years. Even this trend will affect the investment climate. Without getting into a discussion on the moral or social issues that the trend reflects, what you can notice is that packaged foods companies
have benefited a lot. What pickles do you have at home? Your grandmother’s or one of those branded pickles?

The point is simply this. When you go about choosing a stock to invest in, it might be useful to understand the underlying trend the company is riding on. It’s like boarding a bus — you can’t just check how good the driver is; you also need to know in which direction the bus is heading.

If you can trace the trend for a single unit of the product the company is dealing in – such as the cost of readymade trousers vs tailor-made ones — it would help you understand the true story and keep track of any developing trend.

At the least, it will tell you whether it is an exciting story or not.

Invest only in companies that have been growing at a consistent pace for long periods, and you won’t have reason to regret.

Stock markets have been around for almost 1,000 years. The earliest I have heard of shares of companies being traded is around 1050 AD. But it could well date further back, as the history of the stock market has not been chronicled well enough. But there’s one thing I am reasonably certain of: no company, however good, has lasted as long.

If we look at the Indian stock market, there are very few companies that are over 50 years old and are still growing at a consistent pace. As an investment policy, I feel that the companies I invest in must generate a growth rate in excess of the GDP rate of growth.

Few and far between. Looking at the 6,000-odd listed companies, I find very few worth writing about — or writing home about. Most of them came into existence during IPO booms; the 1991-94 boom must have spawned over 1,000 listed companies. But fewer than 200 of these are likely to be active today. By active, I mean a$ growth rate in excess of the GDP rate of growth on a consistent basis.

There are many reasons why companies are unable to grow consistently over long periods. Perhaps cheaper and better substitutes have been found for a company’s products — as when plastic chairs replace steel ones. Or maybe the management is wrangling for control of the company, or is simply incompetent or greedy.

On the other hand are the companies that have been chugging along at a steady pace, such as Hindustan Lever, Nestle and Wipro, which have seen growth rates in excess of 15 per cent for a long time. These are the Gavaskars of the corporate world — they play for the country for many years and make significant contributions. Others such as Asian Paints or L&T are like Mohinder Amarnath — slower but still making a regular contribution.

Play it safe. If you want to protect your capital, stick to investing in companies that have been growing at a consistent pace for long periods. Leave the turnaround stories, the cyclical plays and the IPOs from unknown promoters to investors who are closer to the story and know the company far better than you do. Stick to the ‘steady performers’ and
you’ll be happy.

If you want to play it safe, pick up these stocks at an attractive price. If you can get them at a PE ratio less than 8, it would be great. Or you could follow this rule, which an experienced investor once revealed… He had a list of 20 stocks that he believed were truly great and would stand the test of time. He waited till they were available at half their previous highs and then picked them up.

Nestle was quoting at 40 per cent of its previous high about three months ago. HDFC was available at a PE less than 7 for the past three years despite growing at 15 per cent consistently. In today’s market, such opportunities abound. Asian Paints and Marico are available at a PE of about 8 while chugging along at a steady 10 per cent. And the best bit is that much of this information is readily available — you don’t have to expend time and energy digging it out.

With this approach, you might not multiply your returns manifold in a single year, but you have a good chance of a 30 per cent return every year. You also have very low chances of losing money.

One final piece of information that just might convince you: Peter Lynch, George Soros and Warren Buffett have all averaged less than 40 per cent a year in their investing career. Surely, you wouldn’t mind being in that league.

A stock that grows 100 times after you buy it? Now, that’s a real winner.

ONE OF the terms commonly used by regular stock market players is the 100-bagger. Which means that the stock price goes up a 100 times after you’ve bought it. To land a 100-bagger is the dream of every investor (and my name tops that list!), and if you do land one, you won’t have to worry about your money matters for a long time. Imagine investing Rs 1 lakh in a 100-bagger and harvesting Rs 1 crore. Of course, we’re talking of this happening within a reasonable period of, say, three or five years, not a lifetime.

Every three or five years, along come a few of these ‘baggers’. A quick look at the past 10-20 years indicates that for any such period there are about 10-20 such baggers. Stalking the 100-bagger is something of an art form, and one I would definitely like to learn while I am in the investing game.

There are over 6,000 stocks in the market today and locating potential ‘bagger’ candidates can be a difficult proposition. Even if you tell me they are well-managed companies, with good growth, etc, how on earth am I supposed to find just those few that will zoom up a 100 times over the next five years?

Taking on a sleeping giant. Look at some of the multi-baggers of the past — Hero Honda, Zee Telefilms or Castrol. One common feature among many of these companies is that they were faced with a large competitor who was not overly bothered with providing what customers wanted.

Take Zee Telefilms. All it did was take on the might of Doordarshan, and about 10 years ago, there were not too many people who were happy with DD. Remember the three-hour programming a day? Or the all-too-frequent ‘Sorry for the Interruption’ sign on TV?

Or take the case of Hero Honda. Before it vroomed into the Indian two-wheeler industry, customers had to be content with the two-stroke scooters from Bajaj. A scooter that you had to tilt 45 degrees before starting and which gave a miserable 40 km per litre. What did Hero Honda do? It came out with a bike that gave 80 km per litre and a much smoother riding experience.

There are several such cases of the ‘big and mighty’ being tamed. I’m sure the Maruti stock would have performed wonders if it had been listed. Why? Simply because it gave a product far better than the Ambassador or Fiat that had ruled the market for over 30 years. There are many such examples: Titan vs HMT, Jet vs Indian Airlines or Castrol vs Indian Oil.

How do you spot it? Anyway, the point I am trying to make is that, in stalking a multi-bagger, there’s one simple ploy. It is easier to identify a big company that makes products you are deeply disgruntled with, and then look for its smaller competitors. It’s far easier to spot a seven-foot sloppy man in a crowd than a 5 ft, 6 inch agile man! Try to locate an efficient high-growth company, something most people will advise.

Take the case of HDFC Bank vs State Bank of India. It takes about 15 minutes to draw money at most branches of SBI and less than a minute at HDFC Bank. To open an account with SBI is a nightmare. With HDFC, just call them and they send a man to your house. Why, you can even order a draft over the phone! Clearly, the days of customers being taken for granted by those huge banks are coming to an end. On the other hand, SBI is a Rs 1,00,000-crore bank and HDFC a Rs 6,000-crore one. Which simply means that the latter has a long way to go!

The point is that HDFC Bank will most likely grow rapidly for a long time. Simply because it is better at providing what customers want. If that does happen, the chances that the stock will turn out to be a 100-bagger are quite high.

Or take insurance companies such as LIC and GIC. These monoliths will find it difficult to move ahead, and I assume here that you aren’t too happy, as countless others are not, with the service you get from the present crop of insurance players.

If you come across any such large corporation — one that makes products you dislike but are almost forced to use — do let me know. I am sure we can track down the ‘David’ who will knock down that ‘Goliath’.

It is tempting to buy into the market when you know that long-term investing can be one of the easiest ways to make money. Is there any way to ensure you don’t burn your fingers?

I distinctly remember when I was first drawn to the stock market. I heard a story of enormous wealth created by doing almost nothing, which went: “My grandfather bought Hindustan Lever stock 25 year ago. Today, it is worth much more than what the entire family saves in a year.”

I want to make money from the stock market — it is clear that long-term investing with a ’high quality’ company is one of the simplest ways to wealth. It is simple as it does not require you to be in touch with the market all the time, but it is also tough because it requires discipline and patience, both of which you’ll need to resist the temptation to book profits and spend the money.

The first step towards creating wealth is to find out how much money the stock market can make for you in 10-20 years. Let’s assume your father invested Rs 1 lakh 25 years ago in blue-chip stocks. Assuming this collection of stocks grew at about 22 per cent – roughly the rate of growth in the Sensex since inception -– the initial investment will be worth about Rs 1.2 crore now. If the investment had been made in stocks that generated 30 per cent returns, the initial investment will be worth more than Rs 5 crore. Now, if the Rs 1 lakh had been invested in fixed deposits offering 12 per cent interest, it would be worth about Rs 15 lakh today.

With the right choice of stocks, lay investors can expect returns of about 20 per cent. But making that right choice is tricky. The first stock I invested in has not seen any trading in the past year. The sad part is that I can’t even take a tax loss on it. How do I choose stocks that will give me decent appreciation over the next 10-20 years? I asked several experts what the trick behind choosing the right stock was; and summed up their advice into these three rules:

Rule 1: Choose an industry where growth opportunities and profitability of all the players are good. Probably the best examples of this are Colgate and HLL over the past 30 years in India, during which time the market for toothpaste and soaps opened up dramatically. This is a good time to invest in sectors such as pharmaceuticals and organised retailing (did you know that four out of the top six stock performers in the U.S. over the past 20 years are retailing companies?).

Rule 2: Check for outstanding managers/promoters. Though this seems difficult to judge, a great investor has an easy way out. He says your best bet is to choose a manager you would be happy to have as your son-in-law or daughter-in-law!

Rule 3: The stock should be available cheap. This offers the margin of safety to exit, in case you figure out that you have committed some mistake in Rules 1 and 2.

There are 40-odd companies that will give you returns of over 35 per cent a year over the next 10 years. (Relevant data for Indian companies is not available, but in the U.S., 26 companies gave returns of over 20 per cent a year over the past 20 years, and 84 companies gave returns of over 20 per cent a year over the past 10 years.