Stocking up the right way

Crazy seems to be the only word to describe the movement of the stock markets over the past two years. Consider this: in 2008, the markets fell by more than 52 per cent, while in 2009, they rose by 77 per cent. That's a huge difference. So what does it mean for the investor? At the most elementary level, it means that it is futile to predict the market. Possibly the best way to make money in the stock market these days is to buy small portions of great businesses run by brilliant entrepreneurs. But how do you identify such stocks? Here are five different thought processes that could help you zero in on a company that can promise good returns.

1.Look at businesses that are very big today and are likely to be bigger in the next 10-15 years. For example, oil and gas is a large business sector now. As people buy more cars and the world relies more on fossil fuels, businesses in this sector are likely to become even bigger. Another sector that is sizeable and is set to grow is telecommunications.

2.Look for a consolidated business structure. The number of players should be limited, irrespective of the size. For instance, in the textiles sector, the opportunity is big, but there are hundreds of players. On the other hand, the automobiles business, where the opportunity is possibly larger, has only 7-8 players as final producers. So, fewer players will share the growing pie of profits.

3.Find a category where discretionary expenditure plays a big part. This expenditure is going to grow at a rapid pace as the economy takes off. So far, we have been busy consuming basic goods and services. But with better income levels, we will see the demand for discretionary items such as processed food, cars, value-added financial services, luxury items and durable goods increasing rapidly.

4.After having identified the business that you think will be worth investing in, be it wireless, automobiles or financial services, look for the company whose shares you would want to buy. Consider a company with high profitability, examine its sources of profit and the duration for which it can continue to churn high revenues. Does it have a capable management that can defend the current profitability and does it have scope to grow further? Usually, these qualities are found among the top players of the industry. This is why I suggest that investors stick with the best and the biggest.

5.Once you have zeroed in on the company, an important point is to understand whether the stock is available at a reasonable price or not. The stock need not be very cheap, but it should not be euphoric in valuation either. Remember the market adage: pessimism produces the best prices. Take advantage of temporary setbacks of the company or the market to buy at attractive prices, and then wait patiently. If you are a serious investor, don't churn your portfolio too often. As long as you are confident about the performance of the company, hold on to the stock for a few years. Patience can take care of a lot of uncertainties associated with the future and produce wonderful results.

Raamdeo Agrawal is the Director of Motilal Oswal Securities