When we start investing - no matter what kind - the first thing to do is to classify them into the bad and the rest and not look at the bad again. So far, so good. Everyone does that. No, actually, that's not true. Everyone does NOT do that. Most of us are concerned solely with looking at investments and selecting the good ones and maybe the great ones. Practically, the whole of the investing discourse - books, videos, magazines, websites - is laser-focused on choosing good investments. It feels like the most logical, the most obvious thing to do. Good investments make money, so let's identify the good ones and make that money.
That's self-evidently true, but that does not mean we should start with that. Over the years, I have observed that many of the best investors actually start with a negative attitude. That is, their greater concern is to eliminate the bad rather than choose the good. It's a very fundamental point and one that is independent of whether you are investing in stocks or mutual funds or bonds or real estate, or anything at all. In fact, it's generally true of many things other than investing also.
I recently interviewed Samir Arora, who has just launched Helios Mutual Fund in his second innings in the Indian mutual fund industry. In the 1990s, at the dawn of India's contemporary, post-liberalisation mutual fund sector, Arora was the Chief Investment Officer at Alliance Mutual Funds in India. His equity funds' remarkable performance significantly bolstered the appeal of Indian equities for a fresh cohort of investors. Later, Alliance sold off its Indian operations to what became Birla Sun Life AMC. Arora then relocated to Singapore, founding his hedge fund venture, Helios, focusing on Indian stocks.
Arora says that over the years, he has settled down on eight factors that are the starting point for evaluating a stock. They are all fairly obvious factors like management quality, profitability, growth, valuation, etc. However, the important thing is that these are initially used not as indicators of whether a stock is to be invested in but whether it is to be avoided. That's actually not the same thing. These factors are go/no-go indicators. The crucial thing about the methodology Arora espouses is that if a company falls short in even one of these factors, its stock is off the table, regardless of how exceptional the other aspects might be. To take the obvious example, consider valuation. Plenty of great companies are wonderful investments in every way, except that their stocks are overpriced, i.e., the valuation is too high. This means that they cannot be touched.
This disciplined strategy ensures that investors avoid potential pitfalls, even if they seem alluring at first. Instead of getting swayed by a majority of positive indicators, they are taught to be cautious and discerning, understanding that one weak link can jeopardise an entire investment. In the volatile world of equity investing, where emotions often cloud judgement, having such clear-cut criteria can serve as an invaluable anchor. Furthermore, by trimming down the vast ocean of choices to a more manageable pond, investors can focus their energy and resources on genuinely promising opportunities, leading to potentially more informed and wiser decisions. This approach drastically lowers the research load by eliminating large parts of the markets and narrows the universe that we have to consider.
This entire concept is both intriguing and practical. When picking a stock, certainty about its worth is always elusive, even after purchasing. Yet, with rejected stocks, it's different. Once you spot an issue, the decision becomes clear-cut, instilling full confidence that this stock isn't the right choice. Thus, approach stock suggestions with a sceptical lens. Begin by seeking reasons why it might not be a wise investment. This sounds like a caution-first approach, but it's actually not. It directly leads to better investment choices, more confidence, fewer nasty surprises and higher investment returns.
Also read: Choosing stocks and spouses
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