Monday, November 22, 2010

Investing in what you know

In a world dominated by lot of institutional investors what can an individual investor do to stand-out and take advantage of the opportunities that lie ahead of him/her?

Unlike institutional investors, individual investors need not remain invested all time.

The individual investors have inherent advantages over large institutions as large firms either wouldn't or couldn't invest in small-cap companies that have yet to receive big attention from analysts or mutual funds.
To take advantage of the opportunities, individual investor can invest in stocks of companies that he/she understands or knows, provided the valuations are attractive.

For example : As an individual, in your daily routine, you would use lot of products and services from various companies.

Here, let us examine the products & services that you may come across in your daily routine:

Once you wake up you might read a 'Deccan Chronicle' newspaper, thereafter use your 'Colgate' toothpaste/brush, shave with Gillette and use a shampoo made by P&G or HLL. For Breakfast, you might be having 'Britannia's' Cakes and Glaxo's 'Horlicks'. After wearing the dress from 'Zodiac', 'Titan' watch and 'Bata' shoes you might ride your 'Hero Honda' or drive a 'Maruti Suzuki' 4-wheeler to reach your destination. Through the day, you might call your friend from your 'Airtel' mobile and plan a movie in 'PVR' over the weekend.
In most of these cases, you have been using the products or services for quite some time and liked them, and knew that the company was doing well, but might not have taken advantage of the opportunities provided by the stock market to invest in these company's stocks and benefit from the
growth of these companies.

For example: X and Y purchased their 'Whirlpool' refrigerators last March, ahead of Summer, at Rs.20,000. Y, also an investor, investing in the stock market noticed that the company is performing well, and found the valuations were reasonable and purchased Rs.20,000 worth of whirlpool stock as well (800 shares @ Rs.25). After about an year, while 'X' is happy with the refrigerator, 'Y' is not only happy with his refrigerator, but also with his decision to invest in 'whirlpool', which worked wonders for him! You may wonder how? The 'Whirlpool' stock went up by nearly 10 times in the last one year and is currently trading at Rs.250 and value of Y's investment multiplied to Rs.2,00,000(ie.800 shares @ Rs. 250)

Here, we should add a caveat before you think investing is too easy and you want to buy shares of all the companies that you know. A good company is the starting point of investing; we should also study if it is available at reasonable valuations.

Going back to March last year when ‘Y invested in the stock, Whirlpool India, whose parent company was the largest consumer durable company in the world was quoting at around 6 times P/E. It was a debt free company where both sales and the profits were growing at a steady pace and the valuations were certainly attractive.

Buying the stock in a company, just on the basis of its attractiveness may not always be a correct decision. For example, if you would have purchased 'Titan' shares 7 years ago, along with your watch, the amount invested in that stock would have gone up by 40 times, however, if you had invested in 'Jet Airways' after flying with them nearly 5 years ago then you would have lost 60% of your investment.

Finally, identifying the growth potential of the company through positive experience of the company's product or services is not sufficient. One should take an investment decision based on the valuation of the company and future prospects through due diligence.

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