The first 2 books that I read about investing were written by a mutual fund manager. I will try to summarize below what I learnt about investing from these 2 books.
He said that we should invest in stocks that we know about. So a software professional should invest in IT stocks, doctors in pharmaceuticals and so on. The advantage of investing in such a manner is that if there are any changes in a particular industry the people involved with that industry are the first to know about it long before the markets realize it and factor it in the prices. For example, if there is a slowdown in the IT industry the employees are probably the first ones to realize it when the companies start cost cutting measures like firing people, reducing onsite travel, etc. So it’s an advantage for a software professional to invest in an IT company since he/she can experience first hand the changes that are taking place in the industry.
Similarly a doctor knows which medicines sell the most and which pharmaceutical companies make these medicines. So it would be an advantage for a doctor to invest in such pharmaceutical companies rather than investing in IT stocks about which he knows little/nothing about.
He also suggested that we should categorize stocks into various categories like
1.Cyclical - Companies which have a boom and bust cycle every few years like real estate,cement,steel companies,etc.
2. Turn arounds - Companies currently showing a loss but which have good future prospects and likely to show a profit soon.
3. Slow growers - Companies growing at a slow rate of 8-10% each year.
4. Fast growers - Companies growing at a fast rate of 20-25% each year.
5. Stalwarts - Companies with a long history who grow at a rate of 10-20% each year and which pay a regular dividend.
By categorizing stocks in this way we know the return that we can expect from the companies that we have invested in. He preferred to invest in fast growers and stalwarts.
He suggested that we should buy stocks which have P/E less than the Growth in EPS. For example if a stock had a P/E of 20 and its growth in EPS was 25%, we should invest in it.
He also suggested that we should track the company every 6 months and sell the stock only if its future prospects looked bad or of there was a better investment opportunity.
He also suggested that we should hold a stock for at least 2-3 years.
I invested using the above method but the mistake I made was that I concentrated on companies which had a P/E less than the Growth based on the latest quarterly results. These companies had very high P/E ratios and the growth rate was even larger (for a very short time!). But the most important lesson that I forgot was that the mutual fund manager had also mentioned that maintaining rates of growth greater than 25% is very difficult for a company to do on a regular basis and surely the prices of the companies that I had invested in came crashing down!
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