How Investors Can Avoid Wealth Destroyers
It's quite easy for an investor to make mistakes out of exuberance, impatience, or even ignorance
Did you know 95 per cent of retail investors lose money in the stock market! Instead of picking stocks that can help them create wealth, majority invest in wealth destructors. Over 70 per cent stocks don’t even end up beating FD returns and only 17 per cent companies beat the 15 per cent return on equity threshold.
These are shocking stats which an investor realises when he has already lost money, which eventually makes him quit the markets.
It's quite easy for an investor to make mistakes out of exuberance, impatience, or even ignorance. But these mistakes can be costly, therefore you should know them and avoid them to completely reap the fruits of investment.
Let’s take a deep dive into a few such ‘wealth-destructive’ traits.
Catching a falling knife
Investors exhibit herd mentality and inadvertently get into stocks which have been in a secular downtrend just to average out their costs, waiting for a turnaround. For example, Vakrangee had touched highs of INR 515 in January 2018, but post that it has fallen down and has been trading in a range of INR 18-66 levels. So an investor would have lost money in this stock as it never reclaimed its highs. The opportunity costs are higher in such cases and you can make extreme losses.
Divergence in retail shareholders
Source: Samco Stock Ratings
Hindustan Unilever is owned by 7.4 lakh retail shareholders whereas Colgate-Palmolive and Dabur are owned by merely over 2 lakh retail shareholders. While such quality resilient businesses have within 10 lakh shareholders, businesses which are weighed down by massive debt and have difficulty in repaying their creditors such as Reliance Power has over 30 lakh shareholders, Suzlon 11 lakh and Vodafone Idea over 15 lakh. This proves that wealth destructors comprise of a much larger public shareholder pie, mostly filled by speculators who will run away at the first signs of trouble causing the stock to crash. It is comparatively safer to invest in secular stocks with quality investors rather than punters.
Confuse a cheap stock for an inexpensive one
Most retail investors base their stock selection criteria on the basis of stock price. As tempting as it may be to invest in the lowest-priced stocks hoping that they’ll shoot up one day, most of the times the cheapest stock does not actually provide the best value or any value. A below INR 10 stock like Vodafone Idea, South India Bank, Suzlon Energy, Reliance Power, etc., might appear a bargain at first glance, but they are actually fundamentally weak or debt-laden businesses. These stocks might never move in your favour especially in market downcycles.
Trusting unsolicited sources
Many new investors put too much faith in hot stock tips offered by a friend or colleague or unsolicited sources. Now, anyone can recommend a stock but one rarely knows the track record of the one recommending. Therefore, doing your own research is extremely essential to test the water of equity markets.
Knowing the brand but seldom knowing the business
Investors often fail to notice that they can burn their hands even in popular brand stocks. For instance, an investor in Exide Industries would not have made any profits from 2015-till date. An investment in Fortis Healthcare in 2017 would have lost wealth for investors since there has not been any material improvement in its stock price. These brands when compared to strong businesses such as IEX, Dr. Lal PathLabs, OFSS have been able to deliver around 2.5 times returns in merely 2-3 years. Therefore, investors should weed out the ‘so called famous brands’ that are wealth destructors from their portfolio.
There are a number of other wealth destructor traits that will lead investors down the same road.
Tips to avoid losing capital and multiply your returns
- Identify and invest regularly in strong businesses.
- Don’t make too many changes to your portfolio often.
- Avoid buying too many stocks.
- Diversify your capital and allocate only as per your risk.
- Maintain a healthy mix of high-risk, medium-risk and low-risk stocks.
- Avoid ‘expert’ tips. Do your own research.
- Filter stocks using The FIVE factor check – Eliminate businesses with
- o low ROE,
o moderate ROE but poor free cash flows,
o lumpy or unpredictable cash flows,
o large discretionary products or commoditized businesses, &
o overpriced businesses..
- o low ROE,
Since only 2 per cent of stocks actually create 99 per cent wealth for investors, it is essential to pick the right stocks and be updated about any significant changes in them. Stock selection is a tricky art with a success rate of less than 20 per cent and investors are at a serious disadvantage most of the times. Therefore, don’t fall prey to wealth destructors and invest your hard earned money in the right manner to create wealth for your retirement.