Monday, November 08, 2004

Setting a Goal

One of the most memorable things I learnt from reading about Buffet is that your returns are not determined by the price at which is you sell but instead at the purchase price of a share. In other words, every share (even a blue chip) has a ceiling price above which it is no longer a good investment.

A good investor must learn to determine the price at which to buy a share in order to make the kind of returns which he / she expects.

There's more to this sentence than meets the eye. Look at the implications - to make money, an investor:

  • must have a well defined target percentage return in mind. The higher the target, the smaller the universe of stocks (or, for that matter, the universe of investments in general)
  • must identify promising candidates and research them to get an idea of their long term prospects. The time horizon must necessarily be long (5 years or more) because short term fluctuations in price are difficult, if not impossible, to predict
  • must be willing to wait for share prices to reach a level at which buying them makes it possible to achieve the target returns
Of these, the first is the one which people are likely to gloss over. Much has been said and written about research and the importance of patience in value investing but little is ever said about setting a target. But then, what use is all the research if you don't even know what your goal is?

Your goal should be a function of your own requirements and circumstances. Some people might expect 50% returns from their investments year after year whereas others would be happy with 15%. Most mutual funds in India would struggle to generate more than 15-17% on a consistent basis, desipite the high level of inflation and market volatility; Buffet apparently has a track record of growing money at a blistering rate of 23% per annum. (Note that Indian mutual fund returns seem to be usually stated in 'simple interest' terms whereas what we're looking for is compounded growth rate). Hence the purchase price ceiling for the same share would vary between individuals depending on what they're looking for.

I personally would like to see returns of 22-23% on my investments. What this implies is doubling of my investments every three years or, in other words, retirement in 15 years!! ;-)

Ambitious? Maybe, but I have great hope on the Indian markets. We're powering forth in the 21st century - India Inc. as a whole is going great guns and markets have enough pep to keep the right stocks going at rates possibly even a lot better than this. The trick is to finding these growth stocks. And my search has just started...


zac said...

I completely dig into the philosophy of how a goal is the most important success parameter.

Given the science we have to analyze stocks, is there a recommended way for setting the goal? At least for validating whether the goal is indeed a sound one? not too low not too high


Amit said...

Your goal would basically be to accumulate a certain amount of money in a definite period. It could be for any purpose. You need to decide how much money is required (e.g. you may want to retirn in another 20 years with perhaps a corpus of 500,000 dollars) and also the amount you feel you can invest on a regular basis (say 10,000 dollars a year).

Using these two parameters it should be possible to come up with target returns you need. The higher the returns required, the riskier the investments you need to get into.

If you find you're looking at generating more than 25% returns on an annual basis, you might want to re-think your goals or at least the time in which you want them. It will be very difficult to find an asset class (even investing in emerging markets) that will help you generate such high returns over a long period of time. And I mean across the universe of investments, not just stocks.