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A better way of making money in stocks - Views on News from Equitymaster
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  • Oct 5, 2010

    A better way of making money in stocks

    If given a choice, what would you rather be? The purchaser of a full business or a part owner of a business. Well, what kind of a question is this you would ask? Almost anyone would want to be a full owner.

    Yes, we believe this is indeed the logical answer to an illogical question. If there is enough money and resources at disposal, then one would indeed want to buy a full business rather than have a fractional ownership of it.

    However, there is one place where this logic can virtually be turned on its head. And this place answers to the name of stock markets. You see, in stock markets, the person who buys a fractional ownership in a business can get in a much better position than someone who buys the whole firm.

    Buying a whole firm is a tricky affair. The transaction usually takes place between a very well informed buyer and an equally well informed seller. Furthermore, acquisition of a full company may not always be a one horse race. There could emerge several other players who would evince interest in the same company.

    Common sense tells us that such a scenario is never good from a purchase price point of view. There are some very strong chances that the firm that ends up buying the target company is paying a very steep price for the same. Thus, the possibility of the target company creating good long term value for the buyer gets diluted to that extent.

    Now contrast this with buying fractional ownership of a business from the stock markets. Sometimes, the stock markets are priced expensive and sometimes, they are priced very cheap like the environment that prevailed in late 2008 and early to mid 2009.

    This environment was a stock picker's dream come true. Even the best businesses were trading at a fraction of the price that they would have been sold at had it been a complete 100% acquisition. Thus, buying a fractional ownership in such an environment would have been indeed more profitable from a long term value creation point of view than buying the whole company.

    And this is the beauty of stock markets. A small part of some really fantastic businesses sometimes sell at a fraction of the price that it would command in a deal involving the entire company.

    It is this approach that would do an investor a world of good. Most investors view stocks as nothing but pieces of paper that have to be bought low and sold high. Very few people think of them as fractional ownership in businesses, one that has to be persisted with for a very long term.

    Firstly, only buy good businesses that are trading at a fraction of the price that they would command in a fully negotiated transaction involving the entire company. And once bought, never try coming out of it unless there is some real deterioration in the long term fundamentals of the company. Trust us, there are very few better ways of getting rich through stocks than the one just mentioned.



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