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The golden rules of stock investing

Nine rules to build a stock portfolio that will survive and thrive under all market conditions.

By Devangshu Datta | Print Edition: November 2, 2006

When the Sensex hits an all-time high, even people who have never seen a stock ticker want to invest in shares. When they pluck up their courage and enter, they are promptly overwhelmed by an information overload. How do they sift through all the numbers, abbreviations, jargon and conflicting advice to pick the right stocks?

The best way is to develop a rational strategy that works over the long-term. Share prices fluctuate--but a long-term investor who ignores those fluctuations actually has a better chance of being on the right side of price movements than a trader punting on tips.

Ultimately, stocks represent shares of businesses. By deciphering how businesses work to create value, investors can make money. But they need to take the time and trouble to learn this. Investors generally come to this realisation the hard way after they have lost money speculating on tips. Even when they make money, it is more by chance than by following a considered strategy.

Eventually, regular investors figure out some system. All the investors we spoke to lost money before developing their strategies but were not sure if those strategies would always work. There are different styles of equity investment. Market legends such as Warren Buffett, the world's most successful investor, and Peter Lynch, the man who made Fidelity, have markedly different approaches.

But all successful investors follow rules-even if some of those rules differ. Some rules tend to be common to all successful investors since these work through every market phase. By learning some basic rules and applying them in a disciplined fashion, you will become rich- but not overnight. You will find stocks that tend to consistently beat the market in all its manicdepressive moods. Your long-term equity returns will very likely help to make you rich. Just as important, you will not suffer a catastrophic loss of the type that befalls the unwary and ignorant investor.

The bull run sweeping through the markets has created unprecedented wealth over the past three years. But all-time highs also mean more hazards. In the following pages, MONEY TODAY presents nine golden rules that could shorten an investor's journey to riches.

Golden Rule 1: Higher sales is a mustlook for 30% growth per year.

Because everything flows from the topline.

Before a company can even think about profits, it has to sell its products or services. No amount of brainstorming or fancy management theories can save a company- and its shares-from fading if the demand for its products is on the decline.Sales sizzlers

Enron Corporation is one example. It ran on empty and fooled its shareholders-for some time. Google did exactly the opposite. Long before it went public, its flagship product-the ubiquitou  search engine-was dominant. TCS is an Indian example of a company that launched an IPO long after it had been a market leader.

Everything flows from the top line-that is so obvious, it is hardly an insight. Yet, even experienced investors under-rate high turnover growth. Surprisingly, none of the people we interviewed placed an emphasis on this fundamental aspect .

So what turnover growth rate would rate as excellent? The cut-off we recommend is 30% annual growth for the past three years. If that seems high, consider this: most profit-making companies have seen sales grow at 22-25% between 2003- 4 and 2005-6. The overall economy has grown by an average of 8% (post-inflation) during this period.

Given the boom, there is no dearth of companies that have produced far higher levels of turnover growth than our cut-off. Suzlon Energy topped the list with sales growth at 120%. Even the last company in our list, Thermax, saw a vigorous salesgrowth of 61% between 2003-4 and 2005-6.
Khagesh Patel

Khagesh Patel, 52, chartered accountant, Ahmedabad

My father was a friend of Dhirubhai Ambani and invested in the Reliance IPO (1970s). I started investing in 1993. When the 2001 crash came, I picked up blue chip shares at bargain prices. Here are MY RULES of stock investing...
1. Invest only in blue-chip stocks such as Reliance and Tata companies
2. Don't touch stocks of small unknown companies
3. Go for companies that pay good dividends
4. Invest 50% of the money for the long term and the balance for 3-4 months
5. Keep a keen eye on the FII investment cycle

There should be a steady rise in the top line rather than sudden bursts in sales volumes. Consistency and predictability are useful factors, if only because they reduce investor stress.

There may be a sudden surge in demand for a product or a company may have undergone capacity expansions that cause a bulge in volumes. The company may or may not be able to sustain a sudden burst in sales driven by a chance spurt in demand for a product.

A key element in sustainable sales growth is the existence of the innovative streak-be it a new product, a new service model or out-of-thebox marketing.

Think of all the BPO firms that pioneered the outsourcing revolution some five years ago. Or the launch of contract research services in the pharma industry. Or ICICI Bank's drive to attract retail cuscustomers. Each initiative has delivered handsome returns.

Is the rule of 30% sales growth eternal? High sales growth is a must but the percentage may vary. The Nifty is our benchmark. A stock pick must have the potential to beat the Nifty - or else, you could invest in an index fund. Right now, the Nifty has over 25% sales growth so we have set 30% as our cut-off. If the Nifty's growth rate changes, we would review the 30% cutoff.

The easiest free access to a company's financials is often its own website. There are also many free-to-use financial portals. But the best are the stock exchange websites, http://www.bseindia.com/ and http://www.nseindia.com/.

On Page 2
Golden Rule 2: Profits should have outspaced sales
 

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