Riding Out Volatility
As the indices have grown over the years, the psychological impact of the dips and highs has become larger. India vix is one indicator of how volatility swings happen in a short time frame. A 1000 point change today is the same as a 300 point change a few years ago, as it works out to roughly the same in percentage terms. Though we live in volatile times, a 1000 point fall makes one feel that something is drastically wrong. Headlines such as “10 lakh crores of investor wealth lost in 2 days” can have a deep impact on investors. To keep their peace of mind and the portfolio in one piece, investors can check the following when investing in stocks:
- Ensure stocks they invest in have strong ROOTS, ie robust balance sheets with low debt. Volatile times might cause fragile companies to collapse. Having low debt helps tide over bad times.
- Ensure promoters are aligned to the company with significant shareholding and low pledging.
- Ensure companies have consistently high return on equity, which proves that the company’s cash engine is ploughing money back to grow the company and not into promoters’ pockets.
- Ensure adequate ‘margin of safety’ so that they do not end up buying an expensive company in a bull cycle just because the price is seen as going up. Weak ROOTS can cause such stocks to implode.
- Check if companies are leaders in implementing technology for process automation. In an era where software is seen as eating the world, companies can quickly become irrelevant if they ignore technology.
- Check for pricing power because companies that are able to hold or increase prices in recessionary periods have been proven to compound well over time. We call companies that are able to grow relentlessly as having WINGS. Combination of ROOTS & WINGS leads to a stable portfolio over time.
The ROOTS & WINGS investment philosophy is a handy framework for picking stocks. Companies with strong ROOTS, i.e. robust balance sheets, aligned promoters and consistently high Return on Equity and with growing sales, cashflows, operating income and profits on the wings side will do well
In addition to this, we look for companies which excel in ABCDE, which is an acronym for Advocacy by customers, Brand power, Cost leadership & Pricing power, Distribution, and Engineering & Technology.
While ROOTS & WINGS is a numbers driven approach, ABCDE adds a qualitative flavour to the portfolio selection. A combination of quantitative and qualitative approaches can help an investor construct a high quality portfolio that reduces emotional bias and makes for better decisions.