How to make money in the stock market? This is a classic question that most investors ask. And the answer to this question depends upon whom you are asking. There are a number of styles of stock investing and their adherents vouch for the efficacy of their respective styles. How do you know then which style is good? Here is some quick help.
Broadly, all styles of stock investing can be categorised into two: fundamental investing and technical investing. While a fundamental investor studies financial details and other company-related information to pick his stocks, a technical investor studies price patterns, trends, mathematical models and other graphical data to pick stocks.
Which of these two is better? We profess fundamental investing. The technical style of investing is mostly used by traders to make a quick buck in the market. It is not just complex but also not suited to most investors. Neither is its wealth-creation track record impressive.
The fundamental style of investing can itself be divided into many sub-styles. Since it entails studying a company's financial data and other company- or sector- or economy-related information, a fundamental investor can use a combination of these to formulate his 'own' stock-investing style. For instance, an investor may give more weightage to certain financial parameters and club them with his subjective judgement of the sector dynamics to pick a stock.
Though the styles of fundamental investing are many, the more popular ones are growth investing and value investing. Growth investing seeks to invest in those companies that have ample room to grow and expand. Such companies tend to belong to booming industries. Think of the information-technology sector in the last decade. Indian IT companies were growing at a feverish pace. They were the most sought-after by investors. Given their 'privileged' status, growth stocks command a premium and are available at high valuations.
Value investing, on the other hand, is about spotting companies which are available at a 'bargain'. What's a bargain? Value companies are available at less than their intrinsic worth. An analogy for this is how people shop for vegetables. You check many stalls, locate the freshest veggies, ask the price, and if the price looks high, tell the vendor how much you are ready to pay.
Value investing is the real form of investing. It requires you to find good companies available at a bargain. Why are they at a bargain if they are really good? The stock market chases the fashion of the day. Those stocks that get 'out of fashion' are ignored by the market. And that's exactly why you should pick the best among them. Such stocks are available at a bargain. Later when the market recognises their potential, they get rerated and deliver gains.
Value investing is not just a logical way of investing in businesses, it's also comparatively 'safer'. You buy stocks at low valuations and this acts as a safety net if the market itself falls. In market declines, expensively valued growth stocks tend to correct heavily and can give investors sleepless nights.
Value investing is essentially long-term investing as the realisation of value happens over the long term. This is why you should have a time horizon of at least five years when you invest in stocks.