Peter Lynch’s much-acclaimed book ‘One Up on Wall Street’ is a wonderful book for investors who are serious about wealth creation from stock markets. A great book which unlocks more and more value every time you read it.
For those who are not aware, Peter Lynch was the manager of Fidelity Investment's Magellan Fund from 1977 to 1990 and managed to generate an average annual return of 29.2%, growing $18 million in assets to $14 billion.
The most admirable thing about Peter Lynch is his uncomplicated and straightforward approach to investing. He is a firm believer that anyone can be successful in the stock market with little research, patience and resilience.
The book offers many valuable lessons for investors with the most prominent one being “Behind every stock is a company. Find out what it is doing”.
Unfortunately, this is something most investors today are lacking big time. And even if they try to understand the company, it is only when their investments don’t work, or their portfolio has crashed badly.
We often come across investors who buy stocks just because they are in the news or 'current hot favourites' without understanding the nature of their business. Some prime examples of such companies include Reliance Power, Reliance Naval, Suzlon and Unitech.
Investors panic when they see the stock prices of such companies tumbling down. The result: They impulsively sell these stocks, and unfortunately, most of the time in losses.
When you are investing in stocks of a company, it essentially means you are buying part of the ownership of a company. Hence it is of utmost importance to know few important things about the company you are investing in.
Few questions which every investor should ask before investing in a business:
What are the company’s core products/services?
By looking at a company's core products or services, one can get know whether there is a regular demand for its products or services and whether the demand is likely to exist or cease in future. Some companies have simple products which are easy to understand, like soaps, toothpaste and detergents. On the other side, there are companies which work on sophisticated technologies like artificial intelligence. For a novice investor, it is challenging to anticipate the future demand for products of such companies as the business model is very complicated.
Can you guess what’s common among Coca-Cola, Gillette, Bosch, MRF, TTK Prestige, Hawkins, and Nestle India? All these are strong brands with products that have a loyal and humongous customer base. Such companies are not only likely to get repeat business from existing customers but also new business from new customers based on recommendations of existing customers.
What is its market share and how much competition does it have?
Any company with a significant market share or operating in a sector with colossal entry barriers enjoys an advantage over new entrants. For example, the telecom sector in India is a sector where high initial setup costs are a significant deterrent for new businesses who wish to enter the industry.
Is the company’s business model scalable over time?
A company operating in an industry with tremendous growth potential offers a huge investment opportunity. The growth potential, coupled with the scalability of operations and sustainability of the company, can take its share prices to great heights.
Does the company have visionary and transparent management?
A management which is visionary, transparent and follows ethical business practices can catapult the business to the next level, thus making it a multibagger stock. On the other hand, inefficient and unethical management that is not transparent can ruin an established business. Infosys, Wipro and Maruti are few of the well-managed companies in India that have created fortunes for their shareholders.Discover why management pedigree matters a lot by clicking here.
Are the earnings of the company consistent and recurring?
Any company with consistent and recurring earnings has a definite advantage. Many businesses are dependent on bagging new contracts for revenue. As business cycles change, there may be some slack periods when new deals may be difficult to come. This can affect the income of companies severely. However, companies with a recurring revenue stream won’t be affected much. Wipro, TCS and Infosys are some prime examples of companies in India with recurring earnings in India.
What are the debt levels of the company?
Debt-free companies have adequate cash which they can use for expansion of business or rewarding the shareholders with dividends. Whereas debt-laden companies are forced to use part of their profits for paying off interest, thus compromising on capital expenditure for buying, maintaining, or improving their capacity utilization.Read more about debt trap here.
To become a successful investor, knowing these things about the business in which you are investing is very important. Remember: You’re buying a company, not just stock. So unlike a lottery where you can play a blind-game, investing in companies require research and the determination to stay calm when the stock price falls. Needless to say, stay calm only if the fundamentals of the company have remained intact.Learn more about best way to invest money in equity markets here.