Tejinder Singh Rawal

ONE OF the key principles of value investing is to understand the business you are buying. If you don't, it is better to stay away from it. An investor should take a commonsense approach in buying shares. He should ask himself if he would buy the business at the prevailing market rate of the share multiplied by the number of issued shares of the company. If yes, he can go ahead and invest.

The concept of circle of competence waspresented by Phillip Fisher, in his book, Common Stocks and Uncommon Profits. Mr Warren Buffett was inspired by this idea and always stayed within his own circle of competence.

He never ventured into buying a business he did not understand, preferring simple businesses over complex ones, however exciting the latter might have looked.

He said, "We try to stick with businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we're not smart enough to predict future cash flows."

Thus, while Mr Buffett always admired Mr Bill Gates, and though Mr Gates is director in his investment vehicle — Berkshire Hathaway — he never invested a dime in Microsoft, as it has a business model that Mr Buffett does not understand. He prefers to invest in companies such as, Coca Cola, American Express, Gillette and The Washington Post, whose business models he understands.

One difficulty individual investors face is that of getting information. Thanks to the Internet, information now is not very difficult to locate. A visit to the company's website should give you a great deal of information about it. Financial dailies carry information about various companies, and that could be a good starting point for your research. To succeed in long-term investing, you must have the ability to read the balance sheet and other financial statements. Understanding the annual accounts is easier than it seems to most of us, and buying an inexpensive book on how to understand financial statements could be one of the best investments you ever made. A visit to the supermarket, or a look at your wife's shopping preferences could give you clues about changing preferences, much before any analyst can capture the data. If you spend just a fraction of the time that you spend on buying a TV, on buying a long-term investment, you would be rich many times over. A value investor does not get carried away by terms such as `biotech' or `info-tech' in the name of a company.

Unless you understand biotechnology, or the area of information technology that a particular company is working in, your investment would be no better than a bet. It does not mean that all companies with such description are not worth investing in, it only means that they may be out of your circle of competence.

As a value investor you should work hard to increase your circle of competence. It could be an industry you have worked in, a product that you have been patronising for years, a company that you know inside out, or an industry that you can understand easily. Every investment idea you evaluate is a great chance to widen your circle of confidence, the knowledge will stay with you and can be put to use when there is an opportunity in that particular industry.If during a visit to the doctor, he expresses enthusiasm about Cipla or Dr Reddy's, it is worth further investigation. But to take the doctor's advise on Jet Airways would be as good as getting tips from the nearest panwallah!

(The author is a practising chartered accountant.)

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