Long Term Investment in Equity – Most important Checklist

“Compound interest is the eighth wonder of the world. He who understands it earns it … One who doesn’t pay it.”

– Albert Einstein.

Hi,

Hope you are well aware of the magic of compounding and the return that compounding can bring to you. And since you land on this page I assume that you also want to become one of the beneficiaries of compounding. As we know compounding works in the long term and one of the best ways to avail its monetary benefit is to have a long-term investment in equity.

We have a lot of examples of people making fortune in long-term investment and many more people losing huge in long-term investment. Yes!  It’s true! Not all long-term investments will fortune makers, but the ones who are already successful in long-term investment have some common investing traits and strategies. It is that similar approach we are going to look at in this article too.

1 Introduction to long term investment.

There are many ways to define long-term investment. It can be either time-wise long-term investment or gaining hefty profit. Either way, the main Motto of long-term investment is to give ample time to your investment and book multifold profit.

As you can compare image(a) VS image(b). An investor has to stay 3 to 4 years or just 1 year to see returns on investment. Therefore, the long term investment time frame could be anywhere from one year and above. What really matters is how well is your stock selection and when you have invested in it.

As you are cleared with the time frame, now it’s up to you how much position or investment you can hold for such a time period. Remember long term investment asks for patience, handling market volatility, managing frequent news impacting your investment, evaluation of company report regularly. Simply buy and hold is probably not the case anymore. Long term investment needs the well-evaluated stock to invest in and at the right point or levels. So stay with us, further, we are going to discuss the same.

2 Stocks to buy for long-term investment.

A very basic question you must ask yourself is- What is your motto behind the investment?

It can be for growth / regular income/retirement fund or simply to beat the inflation. Depending on your Moto you should invest accordingly.

Eg. For growth you would require stock with high growth potential in the upcoming year. Like emerging sectors or industries going to profit from government policies etc.

Regular income can be achieved through stocks that are well established, having a brilliant history of dividend payout, etc.

Investing in companies of sectors dealing with regular and ever-increasing consumption in the economy can help to beat inflation.

Since equity investment is risky; pension funds or retirement funds are advised to be invested with more safe instruments like an index fund, bonds, or fixed deposit directly.

With a clear Motto for long-term investment, you can focus on the theme and idea you want to invest in. Let’s understand the different type of themes and ideas involved,

There can be a single theme with an N number of ideas. Depending on your view you can choose a company that is dealing in your ideas and can further evaluate them on basis of different parameters discussed below:-

I) Understanding business:-

 With a clear Motto and idea to invest in, you would have sorted some companies. Now it’s time to understand

a) Company work:-

 In which sector and Products Company deals? What is the business model of the company? Analyzing economy in which company deals. You can understand it better by knowing more about company products, services, and business models.

b) Future demand:-

Understand the products and services of companies and matching them with your idea you can analyze whether the demand for this product will increase, decrease or remain stable in the future.

c) Competitive edge:-

For any company to remain long in business it must have a competitive edge over other competitors. Find out what is such an advantage of the company. Eg. Pidilite – has a business monopoly in adhesive manufacturing.

d) Consumer feedback:-

It can give you a very well idea of the company’s products. More the consumer is satisfied more the chance that business will sustain and perform in long run.

e) Past record:-

Analyzing records gives you a clear picture of the company’s performance in the past and companies with good past performance are likely to perform well in the future too.

f) Management:-

“A key to achieving success is to assemble a strong and stable management team.” – Vivek wadhwa

The most important part of any company is its management. You can see how well the company is managed by the CEO, promoters, and stakeholders in past.

II) Understanding risk:-

Every investment comes with a risk. It can be either systematic or non systematic.

  The systematic risk:-

It includes factors that can affect the overall market. eg. global recession, Interest rates, etc.

Non systematic risk:-

Such types of risk are only related to a particular industry or sector. This can be from a peer group, expansion risk, fall of demand, increase in the price of raw material or HR required, changes in government policies, etc.

While evaluating a stock, the risk involved with a particular company has to be taken into consideration.

III) Analysing stock:-

Till now we have tried to understand the basics of business in the qualitative term. But as an investor, we should quantify our knowledge. And for this you must learn or understand some basic skills required for analysis:-

a) Basic of profit and loss statement:-

The profit and loss statement gives you an overall picture of the revenue and expense of the company. It helps to analyze the income and expenditure of the company. You need to learn various terms like EBIT, EBITDA, PBT, PAT, etc.

b) Understanding balance sheet:-

It contains data related to the assets and liabilities of the company which helps to analyze the financial health of the company. The company’s net worth, debts, etc. are available on the balance sheet.

c) Cash flow:-

Having income and cash flow are two different things. The company shows its income when sales occurred but cash flow is registered when payment is done. So companies having steady cash flow can invest in real-time or pay dividends and debts, but if it is hard for the company to get back payment regularly (eg. loans provided by banks) then it can affect the financial health of the company in long run.

d) Shareholding pattern:-

Generally, companies where promoter increases their stake create positive sentiments regarding stock. As promoters know much more about industries and their future plans, their increase in stake can directly connect with companies’ growth.

But selling by promoter does not simply mean the company is going in turmoil. The promoter can sell stakes for various reasons like the need for cash, disinvestment, diversification of investment, book profit, personal use, etc.

e) Corporate action:-

If the company has a good track record of giving dividends and bonuses it indicates that the company is in a healthy financial position.

f) Industry analysis:-

The point discusses above are some key observations that can help you to filter out stocks. But to follow a more systematic approach in analyzing stock one can learn analyzing strategy like:-

Political economic social cultural technological legal and environmental analysis (PESTLE)

Boston Consulting Group analysis (BCG)

Structure conduct performance analysis(SCP)

Michael Porter 5 force model

Filtering the stocks you have selected, from the above-mentioned criteria; will give you few high-quality stocks to watch out for. Now you have answered to -What to buy for long term investment? but still, it’s the half work. The other half is to decide when to buy for long term investment that we will discuss further.

3) When to invest for long term investment.

Hope, you have successfully evaluated some stock to invest for long term. But the main point of action is at what level or price you should buy it to maintain good risk reward ratio. In general, you can follow two method for long term investment:-

1. value investing
2. Technical analysis for investing

I) Value investing

Such type of investment strategy focuses on buying undervalued stock compared to its intrinsic value. Value investors like Warren Buffett, Rakesh Jhunjhunwala, Michael lee-chin, etc.

a) Finding intrinsic value:-

The best way to find out or evaluate the intrinsic value of the company is through statistical calculation by fundamental analysis. Various tools such as

price to earning ratio (P/E)

return on equity (ROE)

price to book value (P/BV)

earning per share (EPS)

dividend per share(DPS), etc. are used to analyze intrinsic value.

You can also refer to “The little book of value investing by Christopher brown” to learn more about value investing.

b) Timing for investment:-

The most widely used practiced to invest is to enter when stock prices are half or two-third of the intrinsic value. An important factor in investment is- you have to wait for the right opportunity. It can even take several years to give you the right opportunity’s to invest.

II) Technical analysis for investing:-

The technical analysis mainly focuses on finding support and resistance. The tools of technical analysis are applied directly on charts, hence they can give you very reliable support points to buy. Some various tools that you can use for deciding entry are:-

200 day moving average

Trend line

Relative strength index

Bollinger Band

Fibonacci retracement

The timing for investment in technical analysis is generally based on 60% to 80% retracement from the top for long-term investment. You can also refer to the Fibonacci treatment level to find it below the value zone.

4) Money management for long term investment:-

Our capital has limitations. We cannot invest all the time and in every opportunity that comes to us. So we have to manage our capital accordingly.

I) Capital Allotment:-

You can manage your capital as per requirements shown below:-

II) Diversifying portfolio:-

Diversification is key to reduce risk. Try to diversify your investment in different themes/sectors/index and ideas (companies) as much as possible.

5) Final word:-

In the world of investment what to buy is easily available. You can have your own research or get an idea from friends, news, investment advisor, financial analyst, etc but trade execution and Capital Management is the most important thing that you need to do yourself.

The information provided here is completely for educational purposes. Before taking any investment-related decision please consult your financial advisor.

Happy trading and investing !