4-step guide for wealth creation in stock market: Learn how to find quality stocks

The pertinent question is: how to look for a quality stock? The devil is always in the detail.

By Manish Jain

Investing in equities has always been a tricky business for an average investor. We often find ourselves at a loss as to how to pick the right stock. What approach is the best one? The fear of missing out on returns in a bull cycle and loss in a bear market is topmost on everyone’s mind. Actually, it’s much simpler than what most people believe – to create significant wealth using equities as an asset class, one needs to do four fairly simple things:

a) Build your research capabilities: read up on the industry and the company. The past and the future growth path should be clear in your mind.

b) Have a long term approach: the best way to make returns is to aim for steady returns over a long period of time. This way we disregard the business cycles and benefit out of the power of compounding.

c) Keep the churn low: determine if the issue at hand is cyclical or structural. If the problem is a short term business cycle (which is normal and to be expected intermittently in any industry) then stay put and don’t panic.

d) Invest for steady, long term growth: a portfolio should typically be able to deliver steady returns over long periods disregarding the business cycles and macroeconomic situations.

Do these four things in a disciplined manner and see your wealth compound steadily.

However, the most important factor, which is most often underrated is Corporate Governance (CG). Quality comes at a price and is often perceived to be unduly expensive, but in the long run it always pays off. When you buy a stock where the promoter reputation is impeccable and the CG track record has been unblemished, you can be rest assured that you will have a good night’s sleep. The company will work to ensure that the interest of all stakeholders is taken care of. The information flow shall be completely transparent and you can be sure that your investment is in safe hands.

Sometimes, the short term appears fairly alluring and we are often tempted to ride the momentum, but believe me getting on a tiger is easy, getting off is almost impossible. Timing the market is an art that is yet to be perfected. Hence, it would be like playing Russian roulette with your hard-earned money. A quality stock, on the other hand, is like the proverbial hare, always winning the race in the long run.

The pertinent question being – how to look for a quality stock? The devil is always in the detail. Look for publicly available information. At least the last 10 annual reports need to be read and analyzed, cover to cover. The receivables, inter-corporate deposits, related party transactions, accounting policies, revenue recognition etc. are just some indicators. Meet as many competitors as you can, they will always have a tale to tell. Look at mid and senior management and their backgrounds. This will tell you about the “Good and Clean” companies from the lot.

Data from the last couple of decades indicates that quality stocks have always yielded higher and more sustainable returns as compared even to the broader markets. Thus being rewarded with higher multiples, which has often been termed as polarization. What is often perceived as Flight to safety, is actually Flight to quality! These industry-leading companies, which meet the “Coffee Can philosophy” are always a better choice.

So in short, don’t get swayed by the market momentum and look at the bigger picture and the long term. Often, when the world is selling is when it is time to buy the best of the businesses, making it imperative to break the cycle to greed and fear. So buy quality stocks, as they always deliver superior and sustainable returns.

As they say – quality never goes out of fashion!

(Manish Jain is a fund manager at Ambit Asset Management. Views expressed are the author’s own)