Buy only what you understand

Topics Covered

• 1. Buy only what you understand
• 2. know what you are buying
• 3. THE 3 STEPS TO YOUR BUY DECISION
• 4. FIVE CASES WHERE THE TREND WAS CLEARLY VISIBLE
• 5. HOW TO SELL WHAT YOU DO NOT UNDERSTAND
• TAKEAWAYS FROM THE "BUY WHAT YOUR UNDERSTAND" DEBATE

1. Buy only what you understand

Forget about hot tips and peer pressure. Buy the stock of a company, whose products you or your family members understand. This familiarity could stem from your jobs, purchases or usage. These ideas are available all around if you care to observe. Don’t ever hold on to a stock which does not pass the litmus test of your conviction! It is actually quite simple.

2. know what you are buying

The Legendary Peter Lynch once said that he always made money on stocks that he understood in-depth. This brings us to an interesting rule of markets, i.e. “Buy what you understand; sell what you don’t”. Simple as it sounds, it calls for a lot of keen observation at your work-place, at competition, at supermarkets, at grapevine talks, at cocktail parties etc. They are everywhere.

Here is a sample of such data points. Your colleagues may be raving about a new product that has come into town. Your marketing team is talking about a new positioning strategy that the competition is working on. Your wife’s supermarket is seeing a Notepad line sell like hot cakes. In the drawing room you realize that your entire family is going crazy over one particular soap opera on prime time television. Your kids and their friends are going crazy about a brand of pizza. And the list can go on!

The entire reverse situation could signal a sell on a stock. We’ll discuss about the sell part later. The moral of the story is; keep your eyes and ears open, look out for cues, pick up silent trend shifts that are happening in the market and then do your own bit of research. That is a much more credible way of trading and investing than relying on some half-baked trading tips.

THE 3 STEPS TO YOUR BUY DECISION

It is just a starting point

These data points like; a greater number of a particular vehicle on the road, or improved off-take of a particular toothpaste brand from supermarket shelves, or strong product recommendations from your family and friends are just a starting point?

Do you second level pivot checks

There are many ways to do this. You can talk to competitors and employees to ratify your findings. Walk down to the nearest supermarket and check for yourself the shelf off-take. And of course talk to your broker too and check what other investors are buying.

And finally, check if it is practical

Check that the idea is profitable and sustainable. That is the acid test. With this clarity you can go ahead and look at buying the stock after checking with your broker for the right price level for entry.

"If you think it is a great stock idea, try drawing it with a piece of chalk. That is how simple it should be" – Warren Buffett

4. FIVE CASES WHERE THE TREND WAS CLEARLY VISIBLE

1. Hero Honda was the most famous case. In the mid-80s, it was the first motorbike to focus on fuel efficiency. The story was everywhere in all city and town roads. And the stock, needless to say, was a super performer in the next 10 years. You just had to look around and observe.

2. Bharti Airtel was another company that was redefining telecom in 2002. But the demand was growing in leaps and bounds. It was visible that, as more people logged into the network, it became more valuable and hence more people logged in. Stock moved from Rs.18 to Rs.1000 in 3 years flat.

3. Globally, one can never forget Apple. When the I-Phone was launched in 2007, there were queues the world over. Nobody had seen a smart phone of this calibre. It was all over the place and supported the growth of social media and vice versa. It became a multi-bagger in the midst of a crumbling market.

4. Contrast that with Nokia, till then a world leader in mobile hardware. Its phones were losing shelf space, its Symbian O/S was outdated and internet fanatics hated Nokia. Nokia’s prices went into a free fall, profits crumbled before it finally had to sell out to Microsoft. Was that not an obvious case?

5. Finally remember, a good idea is pointless if you get the timing wrong. Since the early eighties, software companies were riding the wave of low costs, outsourcing and cheap rupee. It was a full 18 years before they could translate the economies of scale into sustainable value. Look at Dish TV. Everyone will tell you that with digitization of media, this stock will be a super performer.

There are risks. Firstly, competition is driving prices down. Secondly the sector has to restructure. A great idea whose time has not yet come!

5. HOW TO SELL WHAT YOU DO NOT UNDERSTAND

Selling what you don’t understand is quite a tricky concept but let me give you some pointers. If the stock you bought has not moved for 3 years and you are losing other opportunities, just sell. Remember, no stock is greater than the opportunities you are missing. If the stock is crashing without reason, just run for the exit. Perhaps, the market knows something you don’t know. If stop loss is triggered, just go ahead and exit without a second thought.

But what if you are profitable? Well there are two pointers here. You have bought a stock and it has reached your profit target. Answer: just book out or hold with a stop-profit. Your investment in Reliance Capital is up 70% in one month. Just exit. Don't mistake your good fortune to be your stock picking skill. If something is too good to be true, it probably isn't.

6. TAKEAWAYS FROM THE “BUY WHAT YOUR UNDERSTAND” DEBATE

There are 4 questions you need to ask yourself for a buy decision. Is this product making a silent impact in the market? Do I understand its industry and the market it operates in? Is its model profitable, scalable and sustainable? And lastly, does the company make a product that is simple, boring and yet creates entry barriers? If so, just go for it.

Recommended Read: How and Why to Continuously Monitor Your Financial Goals?

The key lies in selling out. The best of buy ideas can only make money when you sell out. There is a world of a difference between book profits and booked profits. A smart player never rues over lost rallies or missed bottoms. That is, unless you have a really long term Buffetian view of stocks. Then you can look beyond profit taking; and ride the wave with the storm.