My First Principles of Equity Investment

Posted on April 26, 2011

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The Value Investing approach has thoroughly influenced my investment decisions for the past 8 years that I have been actively managing my investments in the Indian equity market. I have earlier written a two-part blog post on how the value investment approach to pick my portfolio allowed me to ride rather successfully through the 2008-09 stock market meltdown. (You can read the two blog posts here and here). In these previous posts, I had alluded to what I look for when selecting a stock, namely

  • a strong track record, in the recent past, of delivering positive earnings and a consistent growth in earnings,
  • a strong balance sheet with minimal leverage demonstrated by their debt and working capital requirements,
  • and importantly, were available at prices that represented significant discounts to what I considered their fair values.

In this post I want to expand on those ideas and present what I call my first principles of equity investment.

My thinking has been greatly influenced by the writing of Benjamin Graham, the founder of the school of value investing approach, and Warren Buffet, arguably the most successful and certainly the most well-known practitioner of the value investment approach. If you have either read the book The Intelligent Investor by Benjamin Graham or read Warren Buffett’s letters to the Berkshire Hathaway shareholders, let me do you a favour and tell you to stop reading any further; there is very little new in my post that is already not covered in detail by Graham or Buffett. However, if you have not read either then hopefully you will find this interesting.

Firstly, there is a difference between trading and investing. I am absolutely certain that I am an Investor and do not have the skills, capabilities and mindset to make a good Trader. My first principles therefore are for equity investment and not equity trading.

So here are my first principles of equity investment:

  1. Investing is no different from owning a business. If you have invested in a good business at a reasonable price, stick with it.
  2. Be willing to pay the fair price for a good business. You would rather own a good business at a fair price rather than an average business at a good price.
  3. Look at the past to estimate the future performance but beware of the recency effect.
  4. Err on the side of caution and employ a margin of error
  5. A good business is easy to sell and difficult to buy; sell only if you can’t afford to hold.

In subsequent posts I intend to expand on each of these principles in greater detail.

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