The lure of the bourse


Director, Banyan Tree Advisors

December 20, 2011

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.