Starter Pack: Why and how you should invest in Stock Market?

In India, for middle-class people, there are generally few sets of asset classes where one can invest – Fixed or Recurring Debits in Banks, Mutual Funds, Equity, LICs, PPFs, Money-back-guarantee plan, ULIPs etc.

Out of these, have you ever thought of the ROI out of these investment instruments? I guess, yes! But you might have missed out on the inflation rate which grows over the years.

For example, say you have invested 100 Rs in your Fixed Deposit Account which gives you a return of 5 Percent after a year. So, your total takeaway is Rs. 105. However, if you put a 4.5 % inflation rate into consideration, your actual takeaway would be Rs. 105 – (4.5% of Rs 105) which equals Rs. 100.3. So basically, you have earned 30 paise as profit over a year with Rs. 100 investments in Bank’s fixed deposit.

Quite shocking right. Unfortunately, yes. Many people do not consider inflation while calculating the return on investment.

Now, you must be asking what inflation is. In a very layman’s term – it is the decline of purchasing power of a given currency over time. For example, 5 years back in 2016, to buy 1 litre of Petrol, you had to pay Rs. 65/66 whereas now, in 2021, you need to spend Rs. 95 – 105 to buy the same quantity of petrol. This phenomenon is known as Inflation. Hence, the purchasing power of Rs. 100 notes have reduced over time since the price of the commodity has gone up. See the below graph to understand how the prices of petrol have gone up over the years in metro cities like Delhi and Mumbai. The same goes for Diesel and other gases too. 

Now, let us not get into the debate of why the price of petrol is rising. That is a geopolitical debate mixed with macro and microeconomics. So, why I have explained the inflation here. It is to make you realize that are we really increasing our money corpus? Or inflation is eroding the corpus over the years.

In that case, what we should do? Basically, we should invest in something where the returns will beat the inflation. But how? The answer is an investment in Stock Market. And why I am specifically mentioning the Stock market.

I will try to explain this into two parts – Why and How.

The response related to Why:

#1: The stock market is such an asset class where a retail investor like us can invest directly into it through a broker without too much hassle or interdependency on any bank. This is an extremely easy task to do. All you need is to have an account with any of the stock market brokers. There is minimal paperwork and due to digitization, creating an account can be done within 1 or 2 days and need a very nominal fee for account opening or account maintenance charges.

List of Brokers to chose from: https://www.chittorgarh.com/report/top_20_share_brokers_in_india_by_clients_at_nse/1/?year=2021

#2: Buying good stocks and holding them for years can fetch you a 10 – 15 per cent return over the year which can easily beat inflation.

#3: Stock market investment is a journey that makes a man wiser about the money they are investing upon. Because this stock market will give you lots of shock waves, you may initially lose money by investing in bad stocks without doing proper research. Even it can make you greedy for more profits and then suddenly out of luck you get some profit from the investment but immediately lose the next day. So with all these, the stock market can give you a very good lesson on how wisely you should pick up stocks and what you need to do (research and information gathering) before buying the stock at fair value.

#4: The stock market will help you to learn what type of companies and industries run in our country, what is their revenue model, modus operandi of doing business, how to read annual reports, balance sheet, P&L Report, understand the fundamentals of the company. Basically, it will enlighten you with the business running around you that you have never heard before. For example, have you heard of a company called Motherson Sumi (https://www.motherson.com/)? They manufacture the electrical components of vehicles, and their clientele is BMW. Volkswagen, Daimler. Ford etc.

Note: The list is non-exhaustive, but these are the top 4 things that come to my mind

The response related to How:

So, let us assume that you have understood the importance of investment in the stock market and have also registered yourself in one of the brokers I have mentioned in the list. Now, the question arises of what stocks to buy, in what quantity and when to buy. I will answer one by one.

Generally, you must have been working in a corporate or run a business. Your company or business must be associated with a particular industry say FMCG. Now, think in your day to day like what are the FMCG products that you consume like Toothpaste, staples, cosmetics, body care products etc. If you think close, few companies manufacture these products. The biggest one is Hindustan Unilever Limited (HUL). If you see the current share price of HUL as of 11th June 2021 (Friday) it is Rs. 2366. 

However, if I show you the chart of the share price movement over 5 years, it has grown from Rs. 874 to Rs. 2366. A whopping 170% Return.

Image source: Tickertape

Consider, you work in an IT firm, say, Infosys. I have been working in this industry as a Software Developer or as a consultant for around 4-5 years. You have got a basic level understanding of how an IT/Software company functions. And you are confident that in long run IT companies like Infosys will do more business, generating more revenue considering the need for digitization and on-prem-to-cloud for different business to function.

Now, if you see the Infosys share price over the years, you will be astonished to see that this company has given a whopping 1,459 Percentage of return to those investors who have bought the IPO of this company in February 1993. The equity share price was Rs. 5 and now it has moved to Rs. 1446.90 as of 11th June 2021 (Friday) touching its all-time high.

 So now you have understood that how would you pick and chose companies where you want to invest. However, HUL and Infosys is a known popular company, and everyone knows how great these organizations are. You really do not have to doubt the fundamentals of their businesses. But does it imply that you should not need to know learn how to analyze the fundamentals of a company, even if the company is great? The answer is No. You need to learn to analyze the fundamentals of a company.

And I will explain to you the easy steps to analyze it.

1.     Go to Screener (https://www.screener.in/)

2. Type the name of the company in the company search tab (in this case – Infosys) and select the name of the company in the dropdown list and click.

3. The page will load like this –

4.     Then scroll down and see the Peer Comparison. Check on the P/E Ration and Market Cap. In this below image you will see Tata Consultant Services (TCS) has the highest Market Capitalization and Tech Mahindra has the lowest PE Ration.

For a layman, the P/E ratio is a valuation measure, which can be used to know whether the stock is overvalued or undervalued concerning its earnings growth. The ratio can be calculated by dividing the current market price by earnings per share. Basically, the price-to-earnings ratio shows what the market or an investor is willing to pay for a stock based on its current earnings. An industry PE ratio can be calculated by dividing its market capitalization by its total net profit. 

5. Check on the quarterly Results. Observe if the Sales and Net Profit is the positive trend over the years. Also, the OPM% (Operating Profit Margin) is positive or consistent over the year. This shows the financial health of the company.

Learn more about OPM: https://www.investopedia.com/terms/o/operatingmargin.asp

6. Check on the Profit and Loss (P&L) statement. If the net profit over the Financial Year ending – March is on positive trend then it indicates that company has good financial health. 

7. Now the most important part of the Fundamental analysis of a company is the Balance Sheet. Check on the reserves and borrowings of the company. If the reserves are high and borrowings are less, then it shows a good sign of the financial stability of the company.

To give you a perspective, let me show you the balance sheet of Reliance Communication (RCOM), owned by Anil Ambani. If you observe the reserves are negative and borrowings are huge. This indicates the company's financial stability is in a poor state and does not advocate buying the stock of this company.

However, do not get misinterpreted by the balance sheet of BFSI company. For example, if you see the Balance sheet of HDFC, you will feel that HDFC is in a poor financial state. But in this case, it is not. Because their business model is based on lending and borrowing. Hence more number of borrowings doesn’t indicate that the bank is in financially weak condition. 

To analyze a Banking firm, also check the CASA Ratio of the company.

To learn more about CASA: https://www.investopedia.com/terms/c/current-account-savings-account.asp

8. Do some technical analysis of the stock. For example, what are the 52 Weeks high and low of the stock price in respect to the current date’s stock price? What is the 100 Day moving average of the stock price? The volume of the stock traded over the last few days. What is the support and resistance of the stock price over a period?

Now, these terminologies may sound confusing to you, and it sure does make you feel uncomfortable. But do not worry, periodic research on this will help you to learn all these things gradually. However, in the interest of time, you can visit this below site to do a technical analysis of a stock. 

Go to this link: https://in.tradingview.com/ and type the company name in the search bar. 

And then the page will be navigated to the trend charts of the stock price movement of Infosys which is depicted through candlesticks. PFB the snapshot:

By going through these candlestick charts, you can understand how the moving trend of the company is share prices.

However, I would advise you no to dig much into the technical analysis as it is mostly required when you do intraday trading or Future & Options (F&O) Trading.

To learn more about Technical Analysis: https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/technical-analysis/

So to summarize below are the few key points you should take note of.

1. You must invest at least 5 to 10 per cent of your monthly income in equity/stocks
2. You must do thorough research on the company fundamentals before buying any stocks. You should know what business the company does, what is their CXO members, past quarter results, whether the company is debt-free or not and do competitor analysis of the company before finalizing the purchase of stock of the company
3. In addition to point no. 2, do prefer to buy good fundamentally strong stocks or Blue chip stocks. Refer to this link: https://www.moneyworks4me.com/best-index/nse-stocks/top-nse100-companies-list/
4. You should try to hold the stocks for 4 to 5 years minimum to gain maximum return
5. You should avoid penny stocks or fundamentally weak stocks. Must avoid buying stocks on speculations or tips or media reports
6. You should not be tempted to sell off any stocks if the prices shoot up within a few days. It may be due to the media coverage of the company or due to good quarter results. The longer you hold, the maximum is your return.
7. Try to buy your favourite company's stock at a fair valuation or when you see the price has dipped down a bit. Utilize the buying opportunity regularly. The market will give you such incidents where you should buy more of that stocks.
8. If you want to get rid of buying stocks regularly, you can opt for SIP on Equity Mutual Funds like that of Nippon Mutual Funds, Parag PareikhMutual Funds, ICICI Prudential Technology Funds, Axis/SBI Blue chip or Mutlicap mutual funds.
9. You can also buy ETF (Exchange Traded Funds) or Nifty BeES (Benchmark Exchange Traded Scheme) to get a basket of stocks in one go.
10. Can also prefer investing Small case (https://smallcase.zerodha.com/) to invest in a diversified Equity portfolio

11. Should create a strong Equity Portfolio and learn to hedge. Your equity portfolio must have at least 13-15 company stocks of different Industry segments like IT, Pharma, BFSI, PSU, Auto, FMCG, etc. Do not concentrate on stocks particular to one industry.

Now, you must be asking what is Hedging. In simple terms, the best way to understand hedging is to think of it as a form of insurance. When people decide to hedge, they are insuring themselves against a negative event's impact on their finances. This doesn't prevent all negative events from happening. However, if a negative event does happen and you're properly hedged, the impact of the event is reduced.

So suppose, you anticipate that a particular stock will experience a downfall in price due to some negative news in the market or underperformance. You should sell off the stock without keeping it for a long time and park the money into your reserves. And then you will find the next opportunity to buy the same stock when negative news subsides and the performance of the company is improving or the stock price has gained a bull run. This way it will reduce the chances of capital loss.

12. Also should know what is Bull, Bear Run in Stock Market: https://www.investopedia.com/insights/digging-deeper-bull-and-bear-markets

Wish you all the best in your successful investment journey. Thanks for taking out time to read this article.