Few decades ago, legendary banker J P Morgan was asked how he lent money. His reply is worth its weight in gold for every investor. “I lent money against character, character and only character,” he answered. What is true in banking is also true in equity.
Investing in equity is akin to entering into a partnership with a promoter. This partnership should be evaluated like marriage. The basis of such partnership should be strong fundamentals and reasonable price.
Will you enter into a partnership with someone who does not have a character? Will you give money to someone whom you can’t trust? When we have to give money to a near and dear one to start a business, we ask him/her many questions, putting him/her through a grilling. Most of the time, money is given in instalments and not at one go. The same criteria should apply for investing in an equity partnership.
When you consider investing in equity, evaluate the character of the promoter or manager. What is his/her background? How has he/she grown the business? How much commitment does he/she have? What kind of vision does he/she have? Does he/she have the ability to execute his/her vision into a business reality? Most important, check track record in treatment of the minority shareholders in the past. All this information is easily available today through the internet. Sites such as Watchoutinvestor.com, the news archive on google.com, etc, can help you take a good call on the promoter. Don’t compromise on choosing your partner and half of your job is done.
Warren Buffet mentioned that when a good manager meets a bad business, it is usually the business that wins. So, the next job after finding a promoter of sound character is to ensure that he/she is in a good business. Legendary US fund manager Peter Lynch mentions in his book about an incident where seasoned fund managers were pitched against kids to pick up stocks. To every one’s surprise, kids won against fund managers by a handsome margin. This essentially happened as students picked up those stocks whose products they were using. One can make a pretty good call about business based on sheer common sense and good observation power. There is no harm in missing opportunity in businesses that one doesn’t understand. A legendary investor such as Buffet has not invested in technology stocks, although his friendship with technology czar Bill gates is well-known. Observing day-to-day life’s consumption can give a good view about business. A change in the pattern of consumption like from a scooter to a motor bike, if picked up early enough can help you make big money. Many a times talking to channels engaged in the business can help you validate your views. For instance, a chemist can easily tell you about the pharma company’s products. A grocer can tell you about the FMCG products. Besides, surfing the net can provide good quality of information about a business. It is important to know about the business and the cycle. A combination of knowledge of business and promoter helps you identify good stocks (or lagdi stocks), which can compound your wealth.
It may look difficult to find answers to so many questions about business and promoter, but in essence, you are answering just two simple questions — Will this company be in existence after 10 years? And, will it make more profit after 10 years than what it is making today?
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If the answer to these two questions is positive, past experience does suggest you have found a winner. If you don’t believe this, run this test on your portfolios of the mid-90s and get an idea for yourself.
The writer is president, corporate banking, Axis Bank