Investing in equities

Equities are a risky asset class and, therefore, one needs to be more cautious while investing in equities. So, how does one exercise caution while investing in equity stocks? Broadly speaking, there are three parameters that every investor needs to check while investing in equities:

Stock selection: With thousands of stocks to choose from, selecting the right stock is the most difficult part of equity investing. Also, the stock has to be at the right price and the investment has to be done at the right time. Here, some basic (fundamental) homework is necessary, such as finding out the number of years that the company is operating in the business and the nature of its business, financial performance of the company during the past three-five years, market share of the company, competitive environment, reputation of the promoters and the management, etc. Then some technical research would be necessary to determine the right price to buy the stock. This would entail studying the price movement of the stock over the past couple of years, the current trend in the price movement of the stock, the valuation of the stock vis-à-vis valuations of its peers and the industry, etc. So, the right stock at the right price and the right time is the key to successful investing in equities.

Level of exposure: The amount to be allocated to each stock is also as important as picking the right stock to invest. The amount to be invested in a single stock will depend on the risk appetite of the investor as higher the exposure to a single stock, higher will be the risk. The total amount of equity exposure will depend on the level of income of the investor, current financial liabilities, etc.

Return expectations: The expectation of returns determines the level of risk an investor is willing to take. So, if the expectations of returns are high, then the investors will have to take higher risk, and vice versa. Investors who expect higher returns should choose small-cap and mid-cap stocks that provide higher returns, whereas investors whose expectations are modest and have low risk appetite should go for large-cap stocks that provide decent returns and are less volatile and, therefore, less risky.