How can equity products create long-term wealth?

With a logical, conservative, and long-term investment approach, equity markets can generate the corpus to beat inflation. Understanding the value investing philosophy followed by Warren Buffett and his guru Benjamin Graham helps. In simple words, this philosophy means buying Re. 1 for 50 paise. Thus, this means buying a stock or an asset worth Re. 1 for a 50% discount is beneficial. The discount need not 50%, it can also be around 30% to provide a good safety margin.

 

That said, the above philosophy by no means suggests that if a stock price falls by 30%, we can assume that it is undervalued. It is important to note that a stock’s value is based on its fundamentals. As an investor, you must use fundamentals such as sales, earnings, and book value to estimate a company’s intrinsic value. Estimating intrinsic value of any company helps you build long-term wealth through the equity markets. Take direct equities as a major component of your portfolio. Build a portfolio by buying when stocks are available at a significant discount to intrinsic value. Thus, selling them once they reach their intrinsic value or replacing them with other stocks, which are at a discount helps build a strong portfolio. Such a portfolio is one of the best ways of building long-term wealth.

 

Before creating such a portfolio, please ensure that you don’t buy company’s stocks:

With unstable businesses

With high leverage

Which misallocate capital

Which are overvalued

 

Do not buy stocks with PE ratio above 30. Further, do not buy stocks of financial companies or banks with Price-to-Book Value above 3. Another effective way of investing profitably is through IPOs. Companies float an IPO for raising equity capital for growth. Investors need to note that in certain circumstances when raising capital becomes highly critical for a company, pricing of an IPO can become highly favorable to the investor. As an investor, you should focus on genuine IPOs priced at a discount to intrinsic value. Other IPOs are not unjustified, but are the ones should be more careful about. Never invest in a company during an IPO if it is overvalued at the IPO price. Generally, you can invest in them a year or so later when they might be available at a discount to intrinsic value.

 

OFS or Offer for Sale is an exercise similar to the IPO and another good investment avenue. However, the chances of it being a genuine capital raising mechanism for growth are higher. That said, never participate in an OFS unless the pricing is at a discount to intrinsic value.

 

Other routes such as buybacks can also be evaluated similarly. If the company is doing a buyback at a price, which is at a premium to intrinsic value, you should participate because you are selling to the company. However, if the buyback and the market price are both at a discount to intrinsic value, then you should participate in the buyback and simultaneously buy the shares from the market. This is similar to receiving a dividend from the company and is more tax-efficient for the company.

 

By Dr. Vikas Gupta

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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