I have a slightly different take on course to become an investor. It does not involve reading books although I came to this conclusion after reading a ton of books 
. I used to read a lot thinking that all the smartness that comes from reading books is a shortcut to the hard work needed to research a company. So I read a lot of books. But even after that something in the back of my mind wasn’t giving me the mental signal that I can build my own portfolio (and earn a decent return on it to make all the efforts worthwhile). Especially books written by western authors were not relevant to Indian scene and there are not many books written about Indian markets. Because of this, I was a typical diversified investor investing in 20-30 stocks (sometimes even more) with no more than 3-5% of portfolio in each stock. Traditional investment books stresses on diversification so I was under the impression that I am following this advice. However after few years, I realized that my small allocation to a stock was a result of lack of confidence than any thoughtful diversification strategy as professed in books.
I realized that no amount of books will help me build confidence in a stock. For that, I needed to study the company and that means I have to read annual reports, collect data about company and its competitors, and even study customers and suppliers of the company. Once I started collecting such data about companies, I was able to build enough confidence to risk 10-15% of my net worth in a single company. As it turned out, it wasn’t such a big effort after all. In fact, process of collecting the data itself is half the work. Only after this change in strategy, I was able to boost returns, reduce churn, reduce anxiety, and actually started enjoying investing activity. Prior to that I was only able to earn as much as a good mutual fund ( and that means my efforts were not paying off as I could have earned whatever I was earning simply by buying a mutual fund and spare myself of all the efforts).
So, here is my version of the 2-year plan
- Throw away all the investment books
- Buy 5 companies from Nifty 50 whose business you are already familiar with. Who doesn’t know Maruti, HUL, HDFC Bank? You can use the money to buy the stocks instead of buying books.
- Familiarize yourself with the activities of the company by visiting their website. This will give you an idea about what the company does. Not everything listed on the website is important from an investor’s point of view as for most companies only a small subset of products or services contribute bulk of the revenue and profits.
- For each company, download last 10 years annual reports. These are available on BSE or on respective company website. Download any investor presentations. I generally look only the Q4 presentations as it has information for the whole year.
- Starting with the oldest, read annual reports (Director’s report, management discussion and analysis and any glossy pages) where company talks about its products, results of operation, future strategy, expansion plans, risks, why the profits went up or down in a year etc.
- For each company, find out the main sources of revenue. This is available in break up of revenue in notes to profit and loss statement, schedule MGT-9, segment information etc. Sometimes it is available in director’s report, chairman’s letter etc. Make a spreadsheet and record this information for each year especially the production volume data (e.g. number of cars made by Maruti, or number of loans disbursed by Bajaj Finance etc).
- You need to be able to build a mental picture (or spreadsheet) of where the growth has come from until now and likely to come from in future. New factory, new products, new geography, acquisitions etc. Once you have this mental picture, you will know the risk to revenue i.e. under what circumstances will company’s revenue stagnate or fall? This could be disruption, competition, product obsolescence, changes in laws etc.
- Similarly, build a mental picture (or spreadsheet) of main expenses and risk to expenses. Once you do that, you will know how the company earns profits and more importantly sources of growth and risk to profits. Conference call transcripts will give an idea about what analyst are worried about and pain points of investors.
- Next step would be to look at the debt and try to find out why company is unable to pay it off. Most common reason is poor cashflow, and other one is low margins. Not all debt is bad but if you are unable to figure out why company is not able to pay it off then stay away from the company.
- You don’t have to an expert in statement analysis but you can take a look at the cashflow statement to see where all the profit is going and why the company has to borrow money that it cannot pay off. This is something you will get better at over time and reading more statements is the way to go. Don’t take a shortcut by directly reading analysts reports.
- Next step is valuation. Some people use elaborate spreadsheets and some people just use hunch. You only need to be able to find out if company is trading at an exorbitantly high valuation and you don’t need complex spreadsheets for that but at the same time don’t use hunch as a strategy. You need to find something in between that you will have confidence on.
- Look at the price chart and try to find why the stock has gone up or down in the last 2-3 years. If you have done your homework, you should be able to answer this question. If you cannot answer this question to your own satisfaction, you haven’t understood the company enough. Ask yourself if you agree or disagree with the market. Most profits come from cases when you disagree and you are more right than the market.
- Finally, think from the POV of the person who is taking the other side of the trade. i.e. if you are a buyer ask yourself why the seller is willing to give up the profits and if you are a seller then ask yourself why the buyer could be buying. Believe me, I have reversed my decisions in the past when I saw from other person’s POV.
- Recheck the story every quarter. All you need to figure out is if the story has gotten better or worse and if valuations are moving along with the fundamentals. for large companies, price generally move in the same direction as fundamentals but market tend to overreact one way or the other.
- Make predictions for next 2-3 quarters. Short term predictions are not very important to the long term investor but ability to make short predictions will help you realize if you have understood the company and the environment it operates in. Ask yourself how will you react if profits drops in the short term especially when it is likely to drop. Sometimes, market will be shocked while you can be calm and profit from market’s reaction while other times you will be the one that is shocked. You don’t want to be in that situation very often.
- Have a feedback loop. Check what has worked and what hasn’t and adjust your strategy accordingly. Unfortunately, stock market is not a science lab where you can perform controlled experiments whenever you want. I have had many crash courses during bear markets and corrections. That’s just how it works.
An amateur makes decisions based on changes in sentiments and a professional makes a decision based on changes in information. You will know you have graduated once your decisions are driven more by the latter than former. This process gets better with time. Always try to find out what your edge is and try to improve that. You will also get an idea of what is your hedge when your edge doesn’t work. For me it is being extra conservative when valuing a company.
Starting with Nifty 50 companies will ensure that your mistakes won’t set you back a lot. I wish I had followed this advice myself . These companies also have more material available for you to chew on. Once you get comfortable, you can expand your horizon to smaller companies which are likely to be less understood and whose prices vary widely giving you an edge and more opportunities to profit.
This is just my take. It may or may not work for you but it has definitely helped me. I hope someone may find this approach useful.