Being a low risk operator, your leitmotif in life is to avoid anything hot. Touching anything hot will not only scald you but could well burn a hole in your pocket. Rumor mills in our bourses will always provide grist to the mill, but we suggest you not to get pounded inside it. Here it would be pertinent to talk about 'momentum investing' or buying what is going up and thus, has the momentum. Simply put, it means 'join the gang'. If everybody thinks stock x is a good buy, then it has to go up because everybody will buy it. Yes, it works fine for a month or two. But the only problem is that you are likely to be one of the last people to join the herd and will not know when the momentum reverses. And then the herd becomes a stampede. So, stay away from 'hot stocks'.
Look at the management quality
Thou shall keep away from a company run by management with a track record of incessant wealth dilution or corporate mis-governance. It is all the more relevant in India as there have been numerous cases where fraudulent promoters have literally flown with cheap equity money. But how do you judge management quality? The best place of course is the annual report. A company's attitude towards minority shareholders is important. And this is not reflected in discount coupons or soft drinks at Annual General Meetings. Good indicators to consider are level of disclosures in the annual report, levels of investments in group/ associate companies, etc. However, the only exception to this commandment you can make if you have a reliable report that the management is changing for good.
Do not buy stocks of the same feather
Putting one's eggs in a single basket is naïve. So also keeping a large portfolio. This could turn unwieldy and is a sure recipe for below average returns. But how on earth would you chose stocks in a market with more than 6,000 scrips? Well, the choice will remain confined to those scrips, which are frequently traded. But then nowadays most IT and media stocks are well traded. So does that mean that one's portfolio should contain only IT and media companies? Nah… To limit risks it is important that you don't go gung-ho on some sectors as their fortunes change without taking your permission. You shall choose such scrips, which represent the broad spectrum of industries and confine your choice to those who are proven market leaders in their field of business. You buy businesses and companies. You do not buy the market or stock prices. An exception to the market leader rule can be made only if there is a big turnaround or restructuring story.
Next comes the allocation of weightage. Sectorwise weightages (how much to put in steel, how much in petrochemicals and how much in IT?) would be decided on the top down view of the sector's prospects. You should review this annually at least, unless there are major events demanding more frequent reviews. And for recent views on various sectors to aid your decision making, you can read the reports at 5paisa.com. As the Pope (Alexander Pope, I mean) had once stated that all human beings do err, it is best that you invest in stocks which give you an easy exit route.
Strong industry and company position
You are known by the company you keep. Similarly, a company is known by the industry it is in. A company's performance can be as good as the industry it is in. Look at what happened to a blue chip company like Telco in the last three years. It is the fifth largest manufacturer of commercial vehicles in the world. It is a market leader with 75% market share of the Indian commercial vehicles market. If just by looking at these figures, a fool had invested in the stock at Rs500 three years back, his capital would have eroded about 70-80%. What went wrong? The industry went into a recession. So even the best company in the sector turned in very poor performance. Hence, it is important to understand industry dynamics and industry prospects.
Positive cash flows
You shall invest only in companies that are expected to have a positive cash flow in the next 3 to 5 years. In other words, the companies that will have 'operating' cash flows higher than their requirements for capital expenditure and investments, only merit a look. The important phrase is of course 'operating cash flows'. Operating cash flow is the profit after taxes (net profit) plus depreciation (a non-cash expense). It represents the money left with the company after meeting all its regular expenses and therefore belongs to the shareholders -i.e. you.
But you have every right to ask why is cash flow so important when the company may be making bumper profits? Isn't that sufficient? No, we Fool's would say. Again take a simple example. Company A produces product X for total cost of production of Rs90. It sells it for Rs100 cash down payment (no credit sales). Company B produces the same product for Rs90 and sells it for Rs110 on credit of 6 months. Obviously Company B is more profitable. But if this cycle goes on a time will come very soon when Company B will run out of cash and will not be able to produce its products. Or for sometime it will borrow money at high rates of interest and ensure that its cost of production becomes Rs100. Either way you can now guess who the winner would be in the long term. No prizes for getting this right - yes, it is Company A. The point is that cash flow to a company is like the heart to a body - a perfectly healthy body can come to naught if the heart is weak. So it is with companies.
1. Gujarat Ambuja Ltd
This stock absolutely transcends time, unless we decide to go back to the caves. Impeccable management, strong earnings potential, omni-present demand for cement and a company which is miles ahead of other laggards (mind you, not competitors) in the industry. 5p could not get into the Kaun Banega.. sitcom. Therefore we decided that buying into GACL was easier. After all, we do not want our grandchildren to ask us - Kyon nahin bana karodpati?
2. HDFC Bank Ltd
A true blue 5p solid steady stock - Starting on a clean slate, low base and terrific management, this stock will lick the erstwhile masters (read SBI) in its own back-yard. Moreover, no frills, no nakhra, no fuss and an absolute chocolate mousse. No unnecessary tension of asset quality, manpower and technology. The Rock of Gibraltar of the 5p solid steady portfolio.
3. Hindustan Lever Ltd
HLL will flourish as long as humans inhabit the planet. Ok, alright, if not the planet, at least India. Top of the mind brands sold through a penetrative distribution network fueled by tons of cash and a thoroughbred management. Ooh! Don't we love this all-pervasive company? In fact, a lot of aspects of our life do hinge on this FMCG major. So we said, why not make HLL a part of our low risk - money making - rock steady 5p portfolio too? Another sheet anchor for the portfolio.
4. Hero Honda Ltd
This is one automobile company, which has remained on the top of charts of every mutual fund worth its NAV. With consumer preference having shifted to the motorcycle segment, it has just the right kind of models to lure the old and the young with a mix of power, style and fuel-efficiency. And what's more, the company has enough cash to take care of capex needs and is well on its way to become debt free by next year.
5. Infosys Technologies Ltd
It would be blasphemy if any portfolio overlooks this stock. What do you talk about ITL? - fantastic management, focussed vision, Industry leader, excellent manpower …or maybe we should just call it the proxy for the Indian Software Industry. Its potential for growth combined with little downside risk, makes ITL one of the sheet anchors of the 5p steady stock portfolio.
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