The Investor Mindset

When the word 'Investor' rings in your head, what is the very first thing which comes in your mind?

I picture a charming man wearing a dark shaded tux with a bow instead of tie, has confident eyes, and smiles just to smile and not really smile, leans forward, and looks at the ground which makes an illusion at something deep is going on in his head (he might really be thinking about something)!

Psst... I'm definitely not describing Leonardo Dicaprio!💖


Ahhhhh! there a gigantic coincidence you see!

Investor

But in a generic sense, an investor is someone who invests resources into ventures that will provide a positive return.

But more often this term is likely getting associated with markets and money.

Moving ahead let's proceed for some mental exercises as an investor,

What is your relationship with money?

Do you simply work to earn it then spend it?

Or, do you work and save and hope that one day you’ll have enough to retire in comfort?

Or, do you understand how to make money, control it and use it to build the world you want for yourself and your family?

I have been through each of these stages. From the worker to the saver, to now the investor. And I have to say, since becoming an investor, I’ve got a whole new outlook on life. 


Being an investor is a whole different mindset, it’s one of growth and strength. It’s a mindset that leads to positive aspirations and living.

Before proceeding with the actual terminologies, when we consider the stock market as a whole there are traders also.

What are Traders?

What do traders do?

How are traders associated with the markets and investors?

Trader






A trader is a person who buys and sells goods, in stock market terms a trader simply buys and sells shares or stocks. 

Their primary goal is to purchase and sell shares in different companies and try to profit off short-term gains from stock price fluctuations for themselves or for their clients.

Traders play an important role in the market because they provide much-needed liquidity, which helps both investors and other traders.

Liquidity means there's enough volume of trades as well as buyers and sellers in the market so that stocks can be bought or sold easily.

Stock traders and stock investors are a different cluster of people. Stock traders use their money or the firm's money and typically focus on short-term trades. 

Stock investors use their own money to buy securities and are long-term traders.

Now that we understand the trader and investor understand Compounding!

Compounding Effect

what is compounding?

Why compounding?

How compounding?



For now, these questions will suffice our needs.

Compounding in simple terms is the ability of money to grow when the gains of previous reinvested for the coming year.

For example, consider you invest Rs.100 which is expected to grow at 20% year on year (also called CAGR - detailed article very soon). At the end of the first year, the money is expected to grow to Rs.120. At the end of year 1 you have two options:
Let Rs.20 in profits remain invested along with the original principal of Rs.100 or
Withdraw the profits of Rs.20.

You decide not to withdraw Rs.20 profit; instead, you decide to reinvest the money for the 2nd year. At the end of the 2nd year, Rs.120 grows to Rs.144. At the end of 3rd year, Rs.144 grows to Rs.173. So on and so forth.

Compare this with withdrawing Rs.20 profits every year. Had you opted to withdraw Rs.20 every year then at the end of 3rd year the profits would have been just Rs. 60.

However since you decided to stay invested, the profits at the end of 3 years is Rs.173. A good Rs.13 or 21.7% over Rs.60 is generated just because you opted to do nothing and decided to stay invested. This is called the compounding effect. 


Let us take this analysis a little further, have a look at the chart below:




The chart above shows how Rs.100 invested at 20% grows over a 10 year period. If you notice, it took almost 6 years for the money to grow from Rs.100 to Rs.300. However, the next Rs.300 was generated in only 4 years i.e from the 6th to 10th year.

This is in fact the most interesting property of the compounding effect. The longer you stay invested, the harder (and faster) the money works for you. 


All investments made based on fundamental analysis require the investors to stay committed for the long term. The investor has to develop this mindset while he chooses to invest.


Now that we have been praising an investor more than a trader, does investing work?


Investing is more like watching a plant grow. 

Think about it, if you give it the right amount of water, manure, and care would it not grow?

Of course, it will. Likewise, think about a flourishing business with healthy gains, great margins, innovative products, and ethical management.

Is it not obvious that the share price of such companies would appreciate  

In some situations, the price appreciation may delay (recall the SBI chart from the previous chapter), but it certainly will always appreciate. 

An investment in a good company defined by investable grade attributes will always yield results. However, one has to develop an appetite to digest short term market volatility.

Did I just say investable grade attributes? Now, what on earth are they?

These are few distinguishable characteristics of a company that can be classified under two heads namely the ‘Qualitative aspect’ and the ‘Quantitative aspects’

The process of evaluating a fundamentally strong company includes a study of both these aspects. In fact, in my personal investment practice, I give the qualitative aspects a little more importance over the quantitative aspects.

The Qualitative aspect mainly involves understanding the edgy scenario aspects of the business. 

This includes many factors such as:

1. Management’s background – Who are they, their background, experience, education, do they have the merit to run the business, any criminal cases against the promoters etc

2. Business ethics – is the management involved in scams, bribery, unfair business practices

3. Corporate governance – Appointment of directors, organization structure, transparency etc

4. Minority shareholders – How does the management treat minority shareholders, do they consider their interest while taking corporate actions

5. Share transactions – Is the management buying/selling shares of the company through clandestine promoter groups

6. Related party transactions – Is the company tendering financial favors to known entities such as promoter’s relatives, friends, vendors, etc at the cost of the shareholder's funds?

7. Salaries paid to promoters – Is the management paying themselves a hefty salary, usually a percentage of profits

8. Operator activity in stocks – Does the stock price display unusual price behavior especially at a time when the promoter is transacting in the shares

9. Shareholders – Who are the significant shareholders in the firm, who are the people with above 1% of the outstanding shares of the company

10. Political affiliation – Is the company or its promoters too close to a political party? Does the business require constant political support?

11. Promoter lifestyle – Are the promoters too flamboyant and loud about their lifestyle? Do they like to display their wealth?

A red alert is raised when any of the factors mentioned above do not fall in the right place. 

Qualitative aspects are not easy to uncover because these are very subtle matters.

However, a diligent investor can easily figure this out by paying attention to the annual reports, management interviews, news reports etc. As we proceed through this module we will highlight various qualitative aspects.

The quantitative aspects are matters related to financial numbers. Some of the quantitative aspects are straightforward while some of them are not. 

For example, cash held in inventory is straight forward however ‘inventory number of days’ is not. This is a metric that needs to be calculated. The stock markets pay a lot of attention to quantitative aspects.

Quantitative aspects include many things, to name a few:

1. Profitability and its growth
2. Margins and its growth
3. Earnings and its growth
4. Matters related to expenses
5. Operating efficiency
6. Pricing power
7. Matters related to taxes
8. Dividends payout
9. Cash flow from various activities
10. Debt – both short term and long term
11. Working capital management
12. Asset growth
13. Investments
14. Financial Ratios

This list is never-ending and varies sector-wise.
Over the next few chapters, we will understand how to read the basic financial statements, as published in the annual report. As you may know, the financial statement is the source for all the number crunching as required in the analysis of quantitative aspects.




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