It is very difficult to have edge over investing. There is obviously no single way of making money in the stock market. There are short term traders,buy & hold Investors and all kinds of people in-between.By using different approaches one can create his own edge in investing, which can be used to beat the market.
There are three ways by which an edge can be created. These are informational edge, an analytical edge and a behavioral edge
What does Informational edge mean to me ? It is an abundance of knowledge on a particular stock or sector, which other do not have. It is created by having superior information such as ground level data or ongoing inputs given by the management.
All disclosure are mandate in publicly traded companies to be given to all investors at the same time. In such case how one can create informational edge?
There is a way by which informational edge gets created. That is to study a business that is not covered by any analyst. This can be mostly done in micro cap, small cap or start-ups. For such type of companies we won’t find lot of information even in their annual report so we have to do a deep research, also a scuttlebutt sometimes,or meeting Management of the company. If you follow the advice given below you will gain informational edge.
In short it is said “putting ourselves in their shoes”
Look at the matrix given for CERA SANITARY from 2010-2013 the company has shown growth in its sales and operating profit by 37% & 28%, respectively. The market did not recognize the stock even when the EPS was growing at 33% and thus valuing it at a P/E of 10x only. WHY WAS IT SO? Because there were no institutional investor and none of the investor was following the company. So lot of information was not available. The only way was to do a deep research by which an informational edge can be created and it can be advantage for any investor.
The price chart given below shows the advantage of having informational edge.
Analytical edge gets created when you rely on the same information as other but you process the information differently than someone to gain unique insights.Which enables you to arrive at different conclusion.
When you keep tracking data of a company on Quarter on Quarter basis, you can sense if any divergence in the report.
Here we can say your “PERSPECTIVE” is your edge.
Take a look at matrix given for Titan company from 2014-2017 the company has shown growth in sales at 6%. But operating profit and EPS has shown a growth of 0.3% only. Which we can say is a negligible growth from last 3 years. Whoever is having an analytical edge would raise a question, why the operating margin has decreased from 10% to 8%. On further analysis he would find that the company is spending on Advertisement purpose. If we see the expense on advertisement for last 3 years, it has grown at a CAGR of 7%. So we have to see normalize expense which has been increasing year on year. Rather than seeing single year expense.
At normalize operating profit margin of 10% the EPS in 2017 would have been around 8.6 At one point the stock was selling for Rs.589 which gave it a P/E ratio of around 46. I guess this is not cheap for a company whose sales growth of last 3 year is 6%. “The market is not bothered about valuation, as it was a quality stock”.
The price chart given below shows the advantage of having an analytical edge.
I considered it as the most important edge.
Having a behavioural edge means that you’re not exposed to an emotional shortcoming that proves to be a disadvantage for other investors.
Behavioural edge can be obtained by following a simple process and sticking to it.Each one of us is different and there is no single process that would applied for everyone.The one that can be followed to obtained behavioural edge are.
- In such market find approx 15 quality stock that you would be proud to own for a long term.
- Study them thoroughly(in-an-out deep research).
- Sit patiently and wait for the right pitchto buy.
As Buffett says- “Big opportunities come infrequently”.
Given below is the P/E chart of Maruti Suzuki Ltd. From 2011 to 2017, if we see the Sales and EPS growth it has grown at CAGR of 10.6% &20.2%, respectively. During 2013 the stock was available at a P/E of 13.
Suppose, in 2011, an investor bought a share at Rs 955.40 with a P/E of 13. The share went up to Rs 1741.85 in May 2013 and then again fell back to the Rs 1380 in few months. At this point, investor can chose between being patient and stick to his belief or he might even sell on the basis of not generating return in that time period. Again the stock is now trading Rs 9123 with a P/E of 36. Thus we can say it is all about ones temperament. If the investor would have stayed patiently the stock would have generated return thus giving him an behavioural edge over the one who preferred to exit at that point of time.
Anyone with a behavioural edge would have identified this opportunity and would have bought this company’s shares.
If you don’t have an informational edge, an analytical edge, or a behavioral edge when making an investment, the investment can still be successful. However, your success will be due to luck, not skill. And in the long run, luck cancels out. So in a long run luck doesn’t work, your “Edge over investing” works.
*Stocks discussed in this are just educational purpose only and not recommendations to buy or sell.
–Mr. Vebunaraya’s Blog