The 3 Golden Words of Profitable Stock Picking - The 5 Minute WrapUp by Equitymaster
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The 3 Golden Words of Profitable Stock Picking

Sep 10, 2015

In this issue:
» Market corrections - A buying opportunity?
» Gold - not an idle asset anymore!
» ....and more!


Most people in the investment business have a horrible habit. I've been in the industry for far too long, and I can tell you this-it's a habit that costs them a lot of money. Investment results suffer, both their own and of those that they advise. It even leads to a lot of embarrassment every now and then. But they keep doing it. As they say, old habits die hard.

Just what is this habit? It's not knowing how to say the three simple words, 'I don't know'.

The few smart ones out there have learned to say these words. They see no ignominy in saying them often. And as a result, their performances and stock picking skills have gone through the roof.

One person I've seen use these words perhaps the most often is the famous (and very rich) investor Warren Buffett. He uses these words at the drop of a hat, especially when it comes to stock picking. And just look at the fortune he's racked up doing this!

Take a recent interview for example. The interviewer was anxious to know why Buffett is not buying Facebook's stock... Is it because he thinks it will go down? Or does he feel that this is a bubble scenario for tech stocks (such as Facebook, Apple, Google, etc) right now? Buffett's answer was quick and instinctive:

    I would never short those stocks. I'm not saying they have anything but brilliant futures. But, I just don't know! It's just harder to figure. It's fascinating to watch, but I don't have to draw a conclusion on even 10s of stocks. I just have to look at one and two, and feel that I have a reasonable fix on what those companies will look like in five or ten years.

And therein lies the difference.

You cannot arrive at a reasonable conclusion on every situation. You cannot value every stock.

Seems obvious, but I see the financial industry consistently trample over this very logical principle day in and day out. Most analysts see their job as putting a precise number on every stock. And the sole purpose of higher education in finance is seen as giving them the tools to do just that. In fact, in the industry, the stocks that they need to analyze are often predefined and handed out to them by others. They have no say. Their job is only to crunch the numbers and come to a conclusion. Do they dare say 'I don't know' or 'this is too difficult'? They'd probably be jobless the very next day.

Throw them a Facebook, Flipkart, or anything else of the sort; you'll never hear them say the words Buffett did.

Stock picking is habitually looked at as a process where you find the stocks that can multiply your money the most. In the process, an even more important aspect of stock picking is ignored-avoiding the stocks that have the potential to lose you the most money.

So the message is loud and clear. If you want to take your skills of picking the right stocks to the next level, learn to master this latter aspect of stock picking. Be humble about your analytical abilities. Be honest about situations where you feel a reliable conclusion just cannot be reached. Avoid such situations. Learn how to say 'I don't know'. And say it often.

Do you think the secret of successful stock picking lies in mastering the 3 golden words? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Greed and fear - these are the two strongest and most defining emotions driving the stock markets and fortunes of investors. The ones, who have mastered the emotions and herd mentality and stood by their conviction, have often been at the winning end. It is often the sudden changes in the market moods when these qualities are tested. And over long term periods that they are rewarded.

The market crash on 24th August was one such event. While a lot of investors panicked, some viewed this correction as a buying opportunity. As suggested in an article in Economic Times, these include promoters and insiders of more than a hundred companies. The latter have bought shares on price erosion as concerns on China economy spooked foreign investors leading to large scale sell offs.

While this does not mean that retail investors should blindly buy shares on such information, it does remind us that corrections in stock price which are influenced by macro economic developments could be an opportunity to invest in fundamentally strong stocks at reasonable prices.

Promoters consolidate holdings on stock price correction
*As a % of total no. of shares on June 30, 2015

We are all aware of Mr Warren Buffett's aversion to gold. Mr Munger has even gone to the extent of calling any gold hoarder a jerk. As per these gentlemen, since gold does not generate any economic value, it makes little sense to be invested in gold. While this has been a limitation with gold so far, we have always differed in our view on gold and believe that it is the soundest money around.

With Government deciding to monetize gold, we believe that the case for investing in gold becomes even stronger. The new scheme will allow investors to earn interest on gold. And with this, gold will not be an idle and totally unproductive asset.

Apart from gold monetization scheme, the Government has announced a sovereign gold bond scheme that is likely to convert investment demand for physical gold into paper demand. A minimum of 5 to 7 years of tenure is likely to protect investors from vagaries in gold price. Both the schemes will not just reduce costly imports, but will help to boost forex reserves as deposited gold could be auctioned. While the intent seems to be good, with interest rate yet to be determined and given India's emotional bond with gold, only time will tell whether the scheme will be a success or not.

In the meanwhile, the Indian markets continued to trade below the dotted line with the BSE-Sensex trading lower by about 252 points or 1.0% at the time of writing. Sectoral indices were trading in the red with those from the realty and consumer durables segment leading the losses.

 Today's investing mantra
"Risk comes from not knowing what you're doing." - Warren Buffett

Publisher's Note: Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate prices are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst) and Richa Agarwal (Research Analyst).

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2 Responses to "The 3 Golden Words of Profitable Stock Picking"

Naval Anklesaria

Sep 10, 2015

The secret of successful stock picking not only lies in this 3 words only but also use your common sense of picking the stock at the right time - when there are very few buyers in the market. Combining this two will not only make your stock grow but it will touch the sky. Finally it is only with experience one can learn and also with failures in life, one learns the art of picking up gems from a hay stock. Lastly, your luck should never fail you in life. All the best.


Virender Kumar

Sep 10, 2015

How do you compare Indian oil with HPCL and BPCL?

Like (1)
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