Invest long term

The bloodbath at the Stock Markets yesterday would have made many of you investors vary of trading in Stocks. The trick in making profits in the Stock Market lies in following some sound principles rather than speculating. Speculations might yield you phenomenal returns once in a while, but in the long run it all evens out. Prudent long range planning in equity investments will yield you a return in the range of 20-25% and that should be your aim.

There are some basic principles on investing in the Stock Market. Stock investments should be looked at in the same way as buying a business. The stock investor is really buying a tiny share or partnership and should apply the same principles that they would in buying a business. Always buy companies that are managed well. The company should be soundly managed. The Company should be prudent in using its retained earnings. Contrary to what many think, those companies that stick to what they know are always a sounder investment proposition than the ones who diversify mindlessly.

A good company is one that has demonstrated its earning capacity over a period of time. This can be assessed through its revenue growth, net profits, capital expenditure and growth in brand equity. The company should also have shown consistently higher returns on equity and capital.

Not many do this, but an investor needs to evaluate the equity-debt structure of the company he proposes to invest. Higher debt should serve as a warning signal. Look for a equity:debt ratio of 1:2.5.

The cost of investment should be reasonable with a margin of safety. These are both subjective in nature and depends on the attitude of individual investors on risk-return trade-off. Price/Earnings ratio, Earnings per share and Book Value will serve as a guideline in this regard.

This may sound a bit tedious. But never invest in a company whose business you don't know. Put in some effort to understand the business. You wouldn't buy a business that you are totally ignorant off, will you? Then why should you invest in a business that is complex and you have no clue about?

Finally, plan for a longer term. Do not expect outstanding returns in the shorter term. Slow and steady wins the race. Prepare yourself mentally for the long haul.