Four pillars of stock investing

Four pillars of stock investing

“Is it the right time to gain equity exposure ?” The answer depends upon the investment portfolio you want to structure.

For a diversified portfolio (mutual funds and ETFs), you need to wait till the euphoric sentiments cool down. For a concentrated pool of equity, there is no right or wrong time to invest in equity market.

Investing and making a return in direct stock investing is an exercise that combines finance and behavioural skill.

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. You only find out who is swimming naked when the tide goes out – Warren Buffet.

With respect to direct equity investment, there are four pillars of value creation:

  1. The core-of-value principle establishes that value creation is a function of returns on capital and growth.

  2. The conservation-of-value principle says that it doesn’t matter how you slice the financial pie with financial engineering, share repurchases, or acquisitions; only improving cash flows will create value.

  3. The expectations treadmill principle explains how movements in a company’s share price reflect changes in the stock market’s expectations about performance, not just the company’s actual performance (in terms of growth and returns on invested capital). The higher those expectations, the better that company must perform just to keep up.

  4. The best-owner principle states that no business has an inherent value in and of itself. It has a different value to different owners or potential owners. A value based on how they manage it and what strategy they pursue.

Ignoring these cornerstones can lead to poor decisions that erode the value of companies.

An intelligent investor will do his analysis, find out the true value of the business and then decide whether the asking price is justified. Anyone who does not follow this process is just speculating in the stock market.

Do not get caught up in the euphoria of a rising or declining stock market. Do your own due diligence or consult an investment firm that can perform the analysis on your behalf. 

Do not try to answer “is it the right time to invest in the stock market” but rather “is it right for me to invest in the stock market”.

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