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See, what long-term can do! - Views on News from Equitymaster
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  • Oct 18, 2004

    See, what long-term can do!

    "In the long-term, we are all dead," quipped the legendary economist, John Maynard Keynes, to American housewives, asking them to give up the thrifty habit of generations. In modern times, proponents of the short-term practice of trading (or speculating) in stock markets use this quote to renounce the practice of long-term investing.

    For the speculating community, 'long-term' can be used to denote a period anything from a couple of days to a couple of weeks! As such, the chart below might lead to 'indigestion' for these very (speculative) people.

    Note: Returns are calculated on Rs 100 invested in November 1994

    As is indicated by the chart above, a long-term holding in any of the companies (Infosys or Wipro) might have led to humungous gains for investors. Note that we have used the word 'investors' in this case. While one might wonder that a long-term holding in Sensex companies might have led to miniscule gains during this period (Rs 135 on Rs 100 invested), this brings into the forefront the need to pick and choose from within a boutique of stocks.

    Now, there arises a bigger question - what companies to choose for long-term holding? As we have reiterated a number of times, there are certain key parameters that investors can use. Some of these are -

    1. The vision: Infosys' 1993 balance sheet says, "Infosys strategy is to be a solutions provider in the global market and to complete on quality and productivity rather than just on cost". The management at that time said that it is important to not to focus too much on cost competitiveness but also services competitiveness. Investors are talking about BPO now! While one could argue that Infosys is a rare company, it is not so difficult to identify visionary companies, if one reads the balance sheet.

    2. Earnings growth sustainability: Just looking at one-year performance of a company and taking an investment decision may not be a good strategy. Investors need to understand what it takes to grow on a sustainable basis i.e. moving up the value chain, leveraging on technology, diversifying revenue and geographical mix and so on. While it is easier said that done it is a crucial factor.

    3. Sufficiently strong financial condition:Cash flow should be given preference over book profits, as the net profit may not adequately reflect the quality of the earnings. What if bulk of the sales were achieved through higher credit to customers (debtors).

    4. Dividend growth: While high growth companies can defer or make lower dividend payments for some years, grave inconsistencies are to be carefully looked into.

    5. Moderate P/E ratio: There is always a price above which any stock is expensive, even if for long-term investment. P/Es need to be compared within the industry. Also, a stock with excessively volatile P/E history calls for additional research. At times, even P/E may be misleading (say for commodity stocks). Understand more about the P/E ratio.

    While we have listed above some key rules to be adhered to before selecting a company for investment, there is one bigger rule that applies to stock market investing - discipline. The legendary investor, Warren Buffett once said, "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."



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