How not to lose money in the stock market

Aditya Alkaloids, Ajanta Soya Ltd, Akar Laminators, Amison Foods, Jaysynth Dyechem. . . These are just some companies where thousands of shareholders lost tons of money.

The promoters, CEOs, people who floated these companies' initial public offerings became rich at the cost of shareholders. By the way, most of these stocks are not trading or trading well below their IPO price.

My dad bought these stocks in early 1990s with his hard earned money. I remember these stocks were touted as really good or excellent in major newspapers and business magazines. or how markets work.

At that time, when my Dad bought these stocks he really did not understand what these companies are actually doing or how the markets work. He used to read a couple of paragraphs in a magazine or newspaper saw the rating (A/A+) and bought these companies' stocks.

He just speculated as he never had a very good understanding of how not to lose money in the stock market.

Let's learn a few things from his experience. As there are many IPOs that are coming to the market these days and the stock prices going through the roof, one needs to be very careful while investing one's hard earned money.

A time-honored cliché proclaims, with almost mystic authority: 'History repeats itself, and those who do not learn it are doomed to relive it.'

Stocks are real businesses and long-term success depends upon the success of these businesses. So think 'stocks' as 'businesses' before investing.

Here are four key areas you must look at while investing in the stock market:

1. Invest in stocks like you invest in businesses

• Will the business be there after 10 years? If you are not sure, you need to move on. If you talk about a 'hot' biotech company, I will not be sure whether the company will be there or not. Let's take Hero Honda, for example. There is a good chance that it will be there after 10 years.
• Does this company have a sustainable business advantage? It could be a share of mind or cost advantage. Share of mind like -- Thums Up.
• You must think about long-term advantage, because you need to make sure that these companies will survive after 10 years and make profits. There are very few companies that have long-term sustainable advantage, typically because of the brand or business model or exclusive access to low cost raw materials. Almost 50 per cent of the companies that floated IPOs in early 1990s -- that my dad invested in -- are now out of business. Almost 25 per cent are trading at under 5 per cent return. Most of the businesses that fell into this category did not have any sustainable business advantage.

Buy at stocks at the 'right price'

A good business does not necessarily mean it is good for investing. Let's say, you want to buy a new Maruti Zen where the market rate is around Rs 3.5 lakh. You would definitely buy it if someone were to sell a brand new one for around Rs 1.75 lakh. At the same time, if someone demands 5 lakh for it, you would not even look at it. You would wait until you the find the right deal.

That is what you must do with stocks too. The key is valuation here. Whenever people see growth, people/analysts get excited and forget to think that if there is a business that is growing too fast many competitors starts coming in and if it is a commodity product, there will be a huge margin pressure.

You don't need to look too many years back to understand what I mean. I am sure many of you remember the tech bubble bust. But guess what, many analysts will forget these lessons and see the last few quarters/years earnings and do a straight-line average! And that is because humans are hardwired to find patterns.

Integrity of the management

Invest only in businesses you trust. You do not want to partner with thieves. If you find a promoter or a CEO who does not care about the shareholder, just take your money and run. The key is a shareholder-friendly manager. You need to be really wary if the promoter has a lot of stake in the company because he will act in his own interests rather than the interest of minority shareholders.

Stock tips using SMS messages / broker tips / hot tip from insiders:

Whenever you see any of these, please run with your money and do not trust these people.

I am sure many investors have heard about pump and dump. They buy the stock ahead of everybody, tout the stock as the next Infosys (or say it will double in three or six months) and dump it when everybody else is buying.

The important question you need to ask him is if he is so sure why does he not sell his house and put the money in to that stock.

The crux of the matter is that there is no easy way to make big money quickly. It is well nigh impossible for many companies to predict what the future will be like for them over the next few years. In many cases, company CEOs cannot even predict the next few quarters.

I know of many people, other than my father, who lost their hard-earned money having fallen prey to greed, lack of research, and 'hot tips.'

Most of these time-tested principles are from great investors like Benjamin Graham and Warren Buffet. Follow them and you will not lose money in the stock market.