Peter Lynch’s much-acclaimed book ‘One Up on Wall Street is a wonderful book for investors serious about wealth creation from stock markets. A great book unlocks more value every time you read it.
For those unaware, Peter Lynch was the manager of Fidelity Investment’s Magellan Fund from 1977 to 1990 and generated an average annual return of 29.2%, growing $18 million in assets to $14 billion.
The most admirable thing about Peter Lynch is his uncomplicated and straightforward approach to investing. He firmly believes that anyone can be successful in the stock market with little research, patience and resilience. The book offers many valuable lessons for investors, the most prominent one being “Behind every stock is a company. Find out what it is doing”.
Unfortunately, it is something most investors today are lacking big time. And even if they try to understand the company, it is only when their investments don’t work or their portfolio has crashed badly. As a result, we often come across investors who buy stocks just because they are in the news or \’ current hot favourites\’ without understanding the nature of their business. Some prime examples of such companies include Reliance Power, Reliance Naval, Suzlon and Unitech.
Investors panic when they see the stock prices of such companies tumbling down. The result: They impulsively sell these stocks, most of the time in losses. When you are investing in a company’s stocks, it means you are buying part of the ownership of a company. Hence it is of utmost importance to know a few essential things about the company you are investing in.
Few questions which every investor should ask before investing in a business
What are the company’s core products/services?
By looking at a company \’s core products or services, one can know whether there is a steady demand for its products or services and whether the market is likely to exist or cease in future. For example, some companies have simple products which are easy to understand, like soaps, toothpaste and detergents. On the other side, companies work on sophisticated technologies like artificial intelligence. For a novice investor, it is challenging to anticipate the future demand for products of such companies as the business model is very complicated.
Can you guess what’s common among Coca-Cola, Gillette, Bosch, MRF, TTK Prestige, Hawkins, and Nestle India? All these are strong brands with products that have a loyal and humongous customer base. As a result, such companies are not only likely to get repeat business from existing customers but also new business from new customers based on recommendations of existing customers.
What is its market share, and how much competition does it have?
Any company with a significant market share or operating in a sector with colossal entry barriers enjoys an advantage over new entrants. For example, the telecom sector in India is where high initial setup costs are a significant deterrent for new businesses wishing to enter the industry.
Is the company’s business model scalable over time?
A company operating in an industry with tremendous growth potential offers a huge investment opportunity. The growth potential, operations scalability, and the company’s sustainability can take its share prices to great heights.
Does the company have proactive and transparent management?
Visionary, transparent management, and following ethical business practices can catapult the business to the next level, thus making it a multibagger stock. On the other hand, inefficient and unethical management that is not transparent can ruin an established business. Infosys, Wipro and Maruti are a few of the well-managed companies in India that have created fortunes for their shareholders. Discover why management pedigree matters a lot by clicking here.
Are the earnings of the company consistent and recurring?
Any company with consistent and recurring earnings has a definite advantage. Many businesses are dependent on bagging new revenue contracts. As business cycles change, there may be some slack periods when new deals may be challenging. This can affect the income of companies severely. However, companies with a recurring revenue stream won’t be affected much. Wipro, TCS and Infosys are some prime examples of companies in India with recurring earnings in India.
What are the debt levels of the company?
Debt-free companies have adequate cash that they can use to expand business or reward shareholders with dividends. Whereas debt-laden companies are forced to use part of their profits for paying off interest, thus compromising on capital expenditure for buying, maintaining, or improving their capacity utilization. Read more about the debt trap here.
To become a successful investor, knowing these things about the business you are investing in is very important. Remember: You’re buying a company, not just stock. So unlike a lottery where you can play a blind game, investing in companies requires research and the determination to stay calm when the stock price falls. Needless to say, stay calm only if the fundamentals of the company have remained intact. Learn more about the best way to invest money in equity markets here.