Common Sense Investing

Series
-By: StockMarketCallsIndia
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 Common Sense Investing Part 1: Introduction

In this Series we will learn who one can pick multi bagger stocks. Here we will be keeping
aside all stock market theories analysing businesses through our common sense.

Here we will be going thorough 4 parameters for successful stock picking or lets term it as
the 4 rules for successful stock picking. Before going thought the 4 rules, these rules are
proposed based on an assumption as well as a fact.

The assumption made here is that the stock that is being bought is held forever and the fact is
one should keep in mind that the stock prices always retrace the growth in earnings of the
business.

The Assumption

Why should the stock be held for long?

Einstein called compound interest as the 8th wonder of the world. Time and compound
interest together are like magicians. The longer the assets in this case stock held the time and
compound interest together help to increase the value of the stock.

Here is a chart that shows how compound interest and time can appreciate your capital when
100 rupees is invested for different period at different rate of interest.

Time(Yrs.)
10 25 35 50
Rate(%)
5% 162.88 338.63 551.6 1146.73
15% 404.55 3291.89 13317.5 108365.7
25% 931.32 26469.7 246519.03 10947644.3
35% 2010.65 181277.77 3644868.78 328615788.00

The Fact

Stock prices usually retrace the growth in the company's earnings. For example, if the
earnings of company 'X' increases by 20% this year then the stock price is expected to rise by
20% over a period of a year.

Here is an example of Divi's Lab

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Based on these 2 statements here are the 4 rules for stock picking. In the upcoming tutorials
we will be going through these 4 rules in much detail.

Earnings Per Share

2011 2012 2013 2014 2015

32.41 40.19 45.58 58.26 69.49
Total (%) 214.409

Based on these 2 parameters (a) Stock is held for ever, (b) Stock Price retraces the growth in
earnings.

Here are the 4 rules:

Rule 1: Business must produce a product or a service for which the demand must grow with
time.

Rule 2: Business must produce good quality non durable goods or service.

Rule 3: Business must be durable competitive and should possess an economic moat.

Rule 4: Business Must have Good Financials.

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 Common Sense Investing Part 2: Rule 1 for
Successful Investing.

Rule 1: Business must produce product or service for which the demand must grow with
time.

If one expects to hold the stock forever, then one wants the business to produce a product or
offer a services for which the demand will be high and will continue to grow with time. If the
business produces a product for which the demand grows along with time, then one can
expect the business to report higher sales moving forward. Higher sales will generally turnout
into higher profits and growth in profits will lead to higher stock prices.

Now let’s consider example of Colgate and HP and try to analyse which among them is a
better investment.

In this example we are quite aware that Colgate sells oral products whereas HP sells laptops
and PC’s.

Considering Colgate, Colgate is selling toothpaste from 1873, The sales in year 1994 was 9
billion$ where as in 2015 the sales is 17 billion $. Colgate produces products for which the
demand grows over time. 50 years from now one can expect Colgate to be selling more oral
care products than what it is the selling today.

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Now considering HP in 1995 HP generated a revenue of 30 billion $ where as in 2014 HP has
managed to generate 111 billion dollars,

Going by the numbers HP looks to be a better investment as the sales have managed to grow
faster.

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But 50 years later the future of HP is uncertain, the product that HP would be making 50
years from now is unknown, Hence Colgate looks to have a better prospect as even after 50
years one can expect Colgate to be selling oral care products.

HP might enter a better business which can make it grow much faster than Colgate, but what
business HP will enter is uncertain, hence betting on something uncertain isn’t a good
investment.

To put in a nut shell one must buy business that is expected to produce a product or provide
service and demand for the product should increase along with time.

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 Common Sense Investing Part 3: Rule 2 for
Successful Investing.

Rule 2: The business must produce a good quality non-Durable Product or Service.

Rapidity of Turnover Refers to the number of times the stock of goods is sold and restocked
during a given period of time. Turnover has a great influence on the companies consistent
profitability.

To understand this let us consider examples of Coca Cola and LG

In case of coca cola, while buying coca cola people look for good quality and good taste and
people won’t look for durability of coca cola, if a bottle of coke is consumed then the same
person will buy one more irrespective of how long it lasts, here the rapidity of the turnover
will be very high and this will lead to consistent growth in sales over time. As a result,
growth in earnings and stock price will also be consistent.

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Considering LG, LG manufactures electronics. While buying electronics people look for
good quality and durability, therefore as an electronic brand if the company wants the
customer to come back then it has to produce a product which lasts long. Since Durability
plays a major role, the rapidity of the turnover for companies the company from a customer
will be very less. In this case the sales generally will be inconsistent and fails to follow a
trend over a period of time. As a result, it is hard to find these stocks grow consistently as the
earnings of these companies aren’t consistent.

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 Share Price Of Coca Cola

Share Price Of LG

Covering it in a nut shell, for businesses the rapidity of turnover is very important and
companies offering durable products generally will have lesser rapidity of turnover and
companies producing goods with faster turnover will have higher rapidity of turnover. Faster
turnover helps in consistent growth in the profits as well as consistency in the stock price
growth.

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 Common Sense Investing Part 4: Rule 3 for
Successful Investing.

Rule 3: Business must be Durable Competitive and should possess an Economic Moat

Durable Competitive Businesses and Price Competitive Business

Durable competitive businesses are businesses where the products offered by the company
are purchased based on the quality of the product and the price of the product is not given
much of importance.

Price competitive businesses are businesses where the products offered by the company are
purchased based on the price at which they are offered and quality is not given much of
importance.

Lets understand this by considering the examples for Cadbury and Jet Airways.

Cadbury is a durable competitive business, the product offered by Cadbury, chocolates are
bought for their quality and taste without price being a concern, therefore Cadbury is
a Durable Competitive Business.

Where as in case of Jet Air ways, Jet airways is an airline company and the people while
booking plane tickets always look for the best deal and opt the one which offering the service
for a lower cost. Here the service offered by the company is availed on the price at which it is

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being offered but not on the quality of the service, hence these businesses are Price
Competitive Businesses.

Economic Moat

The term Economic Moat, coined and popularized by Warren Buffett, refers to a business'
ability to maintain competitive advantages over its competitors.

Economic Moat is sustainable competitive advantage of the company by having a well-

known brand name, pricing power and a large portion of market share.

Examples:

Beverages: Coca Cola

Baby Care: Johnson and Johnson

Oral Care: Colgate

Animation & Entertainment: Walt Disney

These companies possess an economic moat through well-known brand names and high
market share
Importance of Company being Durable Competitive and having an Economic Moat

The most important advantage of the company being durable competitive and having a moat
is that the company will be able to maintain consistent profit margins. Due to inflation there
will be general rise in the prices, if the business is durable competitive and has an economic
moat it will be able to increase the prices of the goods offered without any significant effect
on its sales.

For Example, in case of Cadbury,

In 2012, Cadbury offered 12g Diary Milk for 5 rupees, but in 2015 Cadbury offers 6g diary
milk for 5 rupees, Cadbury has cut the cost of production significantly to maintain consistent

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margins instead of increasing the price. Since Cadbury is a durable competitive business it
won’t be having any effect on its sales.

In case of Airline Companies which is a price competitive sector, in 1995 the average Ticket
Cost was 475$ where as in 2015 the average ticket cost is 375$ inflation Adjusted, the airline
companies have to contract their margins due to high competition which leads to very low
profitability in spite of good sales.

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In a Nut Shell

 Businesses can be classified into Price Competitive and Durable

Competitive Businesses.

 Price Competitive Businesses offer goods or service which will be purchased based
on the price at which it is offered for.

 Durable Competitive Businesses offer goods or service which will be purchased

based on its quality and Price will be given Less Importance.

 Economic Moat is ability of the business to maintain Durable

Competitiveness through
Good Brand Names and Large Market Share.

 Only Durable Competitive Businesses possessing an Economic Moat can increase

their product price to adjust to inflation without sales being affected.

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 Common Sense Investing Part 5: Rule 4 for
Successful Investing.
Rule 4: Good Financials.

After selecting the business with long term prospects it is important to have a look through
the financials before investing in the business.

Here are the key financials one has to look for in financial statements:

 Growth in Sales
 Growth PAT or Net Profit
 Consistency or growth in Net Profit Margins
 Low Long Term Debt to Equity Ratio
 Consistency or Growth in Return on Equity.
Let’s understand it with example of Britannia Industries

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 Common Sense Investing Part 6: Case Study
Here we will be analysing Colgate Palmolive through each of the 4 parameters discussed
earlier.

Rule 1: Does Colgate Produce a Product which will have continued and rising demand?

Yes, Colgate Does Produce Oral Care products from 1873 and it is expected to produce the
same for many decades as technology cannot change the demand for toothpaste.

Rule 2: Does Colgate produce a product which is non-durable and rapidity of turnover
is high.

Colgate does produce oral care products which re non-durable and the durability comes down
when consumed more which increases the demand too.

Rule 3: Is Colgate a Durable competitive business with economic moat?

Colgate belongs to a sector of healthcare which is a durable competitive sector, the

consumers do buy the products based on the quality of the product offered by the company.

Colgate does have an economic moat, having more than 55% market share in India, colgate
has a good brand name, trust and goodwill which has developed a moat for colgate which
helps it to keep it away from the competition.

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Rule 4: Financials of Colgate:

Breaking down the financials of Colgate Palmolive India.

Sales: the sales of Colgate India in 2006 was 1072 crores, where as in 2015 Colgate manages
to sell products worth over 4000 crores. Over a period of 10 years colgate has managed to
increase its sales by 363%, This indicates that colgate has consistent demand for the product.

PAT: The profit grown from 140 crores in 2006 to over 550 crores in 2015, growing over
392%, The sales of colgate has gone by 360% whereas the PAT has gone up by 390%
indicating that the company has managed to either cut down the cost or improve its profit
margins.

Net Profit Margins: In 2006 the Net Profit Margins stood at 12.6% whereas in 2015 the
profit margins are at 14.5%, Colgate has managed to maintain an average margin of 15.7%
over the years. Therefore, when it comes to Margins, Colgate has able to maintain consistent
margins without any reasonable contraction.

Debt to Equity Ratio: Colgate is a company with zero debt on its balance sheet, Hence the
debt to equity ratio of the company 0, which is as low as it can get, with company having to
pay no interest on its debts, it does have its impact on the profitability of the company.

Return on Equity: ROE for Colgate in 2006 was 52.09% where in 2015 the ROE has
expanded to 89.5% this is a indication that the company has very good fundamentals.

All these aspects put together gets reflected in the stock price of Colgate which has
surged over 9700%

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