5 Simple Steps to Start Value Investing in India

If you start value investing in India, there is one big problem you face.

No matter how enthusiastic you are, and how hard you’re willing to work, sooner or later, you realize:

THERE ARE TOO MANY STOCKS!

You see, there are 4,751 stocks on BSE.

And 1,955 stocks on the NSE.

So, how do you find a good stock, out of so many?

Here’s How Warren Buffett Does It:

The world’s greatest investor, wrote in his 1996 letter to shareholders:

“What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.”

And, those are the 3 magic words:

“Circle of Competence.”

That is the key to value investing in India.

As you’ll see, this concept solves many problems at once:

  • You can handle the overload of choices, when it comes to picking stocks
  • You will invest much faster, and
  • Your stock picks will be much safer!

“Fine,” you say.

“But, show me how.”

Alrighty then. Here we go:

Step 1. Judge Your Work Load + Risk Appetite

Before you begin, ask yourself two questions:

A. How Much Work Can You Handle?

Are you pressed for time, and can’t handle much?

Then, start with the BSE Sensex (30 stocks).

Or, can you handle a mild workload?

Pick the BSE 100 instead.

But, if you can go full steam, then start with the BSE 500.

You get the idea.

And the second question is:

B. What is Your Hunger for Risk?

Do you wish to stick only to the prominent Indian companies?

Then stick to the BSE Sensex, or the BSE 100.

But, if you’re game for some adventure, and want to hunt for hidden gems, then you can pick up the BSE mid cap index as your starting point.

Or, maybe the BSE small cap index.

Your choice.

Step 2. Create An Initial Shortlist

Now, let’s say you start with the BSE Sensex.

These are the stocks you’ll have:

  1. Asian Paints
  2. Axis Bank
  3. Bajaj Auto
  4. Bajaj Finance
  5. Bharti Airtel
  6. HCL Tech
  7. HDFC Bank
  8. Hero MotoCorp
  9. HUL
  10. HDFC
  11. ICICI Bank
  12. IndusInd Bank
  13. Infosys
  14. ITC
  15. Kotak Mahindra
  16. L&T
  17. M&M
  18. Maruti Suzuki
  19. Nestle
  20. NTPC
  21. ONGC
  22. Power Grid
  23. Reliance Industries
  24. SBI
  25. Sun Pharma
  26. TCS
  27. Tata Steel
  28. Tech Mahindra
  29. Titan
  30. UltraTech

So, with this list of 30 stocks, here’s what to do next:

Step 3. Identify How You’ll Reject Stocks

Create a set of filters, on which you’ll reject the stocks…

1. Complex Business Models

For any stock you pick up, can you explain:

  • What does the company do?
  • How does it make money?

Example: I once read the annual report of a stock, called Cyient.

Had no clue.

My fault, of course. Not the company’s.

Similarly, I struggle with pharma stocks.

2. Changing Technology

Confession: I have difficulty in understanding technology.

Much less, predict it.

Artificial Intelligence? Geek and Latin.

Electric vehicles. Can only scratch my head!

Of course, you’re probably much better at it, than I am.

But do factor in, this point.

3. Crazy Competitors

Classic case: Telecom.

In 2007, Bharti Airtel used to be a hot stock.

Yet, competition was intense.

It was very difficult to predict how it was going to play out.

As you know, it only got worse.

4. Twisted Accounting

Some balance sheets are just too complicated.

Complicated entries. Too many subsidiaries. Too many notes.

Time and energy is better spent elsewhere.

So, to summarize:

Step 3. Reject Stocks, One by One

It’s now time to look at your initial shortlist, and reject the stocks which are wrong for you.

Here goes:

Rejected:
We might find the financial statements of these stocks to be complex and difficult to understand.

  1. Axis Bank,
  2. Bajaj Finance,
  3. HDFC Bank,
  4. HDFC,
  5. ICICI Bank,
  6. IndusInd Bank,
  7. Kotak Mahindra, and
  8. SBI

Rejected: The business of these companies suffer from rapidly changing technology and industry conditions. There is a chance, we’ll be caught unawares.

  1. Bharti Airtel, and
  2. Tata Steel

Rejected: The business model of these firms is highly technical and will go over our head.

  1. ONGC, and
  2. Sun Pharma

Rejected: The business model of these companies can perhaps be understood by others, but we just can’t seem to get a feel for it.

  1. HCL Tech,
  2. Infosys,
  3. TCS, and
  4. Tech Mahindra

Rejected: The corporate structure seems complicated. We will have to do a lot of analysis of government policies and political intrigue. We don’t want to struggle with it.

  1. Reliance Industries

Step 4. Arrive at Your Final Shortlist

Selected: Looks like we can understand the business if we study the company’s documents thoroughly and research the sector.

Financial statements will also perhaps be relatively simple.

  1. Asian Paints
  2. Bajaj Auto
  3. Hero MotoCorp
  4. HUL
  5. ITC
  6. L&T
  7. M&M
  8. Maruti Suzuki
  9. Nestle
  10. NTPC
  11. Power Grid
  12. Titan
  13. UltraTech

So there you are.

17 stocks – which is 57% of the total – have been rejected, outright.

That saves you 57% of the time you’d devote to researching and picking out value stocks.

Now you can focus on the selected 43% of the stocks and devote time to study them in detail.

Important: Please note that you need not necessarily agree with this classification. You may want to define your circle of competence using your own different filters.

And that’s fine.

In fact, that’s exactly what you should do.

Just make sure you are comfortable with the criteria you set.

What to Do Next?

If you want to do this exercise with a larger number of stocks, you can use the BSE 100 or the BSE 500.

The process is the same.

I have kept two templates for you in the Value Investing Library.

Disclaimer: Examples of Indian stocks here, are educational in purpose. Kindly, don’t use them as research recommendation.

Disclosure: I own Axis Bank and Tata Steel. My SEBI research analyst registration no. is: INH300005130.

30 thoughts on “5 Simple Steps to Start Value Investing in India”

  1. Good article sir. I want to do this exercise with a larger set of stocks like small cap 100 shares. So can u help me do this?

  2. Amit Singh Rahul

    Thanks for your very easy and illustrated example. It will be help me for sorting Companies name for Investment purpose.

  3. I think WB used to go through each and every company in the Moody’s or S&P manual and start from A down to Z. When asked how a normal person would do this, he said start with the companies with names beginning from A. I think he build his circle of competence by reading and filtering out…

    1. “I went through the Moody’s Manuals page by page. Ten thousand pages in the Moody’s Industrial, Transportation, Banks and Finance Manuals—twice. I actually looked at every business—although I didn’t look very hard at some.”

      1. Hi Bhaskar,

        Very valid observation.

        Correct me if I’m wrong – the ‘A-to-Z’ quote is from a TV program Warren Buffett did with the author ‘Adam Smith’, in 1993.

        At first glance, there seems to be a contradiction between the Adam Smith quote and the quote from the Berkshire letters. A deeper analysis shows otherwise.

        The context in which Buffett has said them holds the key.

        Warren Buffett began his value investing career as a quantitative (Grahamite) type of investor, chasing cigar butt stocks. He later developed more qualitative leanings, and now waits for economic franchises.

        The former requires that you intensely turn over every little rock to find the undervalued cigar butt. The latter requires that you be selective and patient for the easy-to-understand franchise to hit you on the head.

        Does Warren Buffett’s years of hard work with cigar butts inform his selections today?

        Of course.

        But, if you are new to value investing, do you necessarily have to exhaust all the 4,000+ stocks available on the BSE & NSE?

        Nope.

        Your circle of competence comes to your rescue.

        Does a truly dedicated value investor have to pick one approach over the other?

        Nope.

        He should use both the ‘circle of competence’ approach as well as the ‘A-to-Z’ approach. Though, the latter will require time and much intensity.

        1. Good points sir. I was just adding my thoughts that for a lay investor knowing his circle of competence itself is a blindspot. So reading broadly and widely is the way to go. If you already have a well defined circle of competence then having laser like focus makes more sense. There is no right or wrong approach in investing as we all know. For me reading widely has helped.

          On sidenote, you are doing a awesome work here. Please continue publishing more thought provoking articles on value investing. All the best !!

          1. Excellent point about circle of competence being a blind spot. 🙂

            The thing about this exercise, Bhaskar, is that it is iterative. A beginner to value investing can take the following steps:

            1. Start with your present state of knowledge. Be very honest (bravado proves to be costly here) and stick to an extremely narrow circle, if need be.

            Step 2. Gain experience and build upon your knowledge base.

            Step 3. Revisit your circle of competence often and see if it has expanded.

            After all, Warren Buffett himself has expanded his circle of competence over the years – his purchase of IBM being a great case in point.

            Thus, the blind spot can be managed if we are completely honest to ourselves.

            Should a beginner to value investing focus on reading instead? Is reading a great idea for value investors?

            As you know, in value investing, we are big fans of reading ‘everything in sight’ (to use one many Buffettisms). The only issue is, studying will take time. So, it is a long term solution. Albeit a mighty effective solution!

            Thus, the realistic approach is to think of our tiny little circle of competence as a starting place. And to keep expanding on it by diligent study.

  4. K Praveen Kumar

    Hi Satyajeet,

    Amazing article, very useful for starters like me.

    Filters/areas of selection i believe could start from circle of competence, but can include few beliefs/metrics like zero debt stock, honest management, ethical business areas. This to an extent will reduce the workable universe.

    I would like to point out that the downloadable material is very nice. Thanks for this initiative, and I hope you continue doing this going forward.

    All the best!

    1. Hi Praveen,

      Always nice to hear from you! You’ve been highly supportive from the start – despite my many bumbling efforts.

      Hope you’re doing good. 🙂

      Honest management, ethical business etc. can definitely be included as criteria in ‘circle of competence’.

      Debt-equity ratio (or zero debt for that matter), however, belongs to an entirely separately topic – ‘stock screening’.

      While both are closely related, ‘circle of competence’ is a Warren Buffett invention with a slightly more qualitative flavor to it. It embraces our limitations, foibles and idiosyncrasies and takes it from there. Behavioral finance guys would approve!

      ‘Stock screening’ is a more quantitative thing and its spirit can be traced back to the great Benjamin Graham. Of course, Warren Buffett did a lot of that in the 1950s and 1960s, when he began his value investing career.

      I’ll devote a separate article to the topic.

      Many thanks again!

  5. Hi,

    I chanced upon your blog and must say that it struck to me as a very sincere effort in educating the novice investor, myself included. Thanks very much.

    I think it would help to include a “share this” option in your articles and website to make it more popular and widen its reach through FB, Twitter etc.

    Looking forward to a rewarding relationship with your work/website. 🙂

  6. Thanks for the wonderful article as well as the PDF file illustrating WB guide to investing.

    However I have one question though. While WB rightly mentioned that we should look at Cigar Butt companies to diversify our investment in the initial period, don’t you think that we should look at the very definition of Cigar Butt companies with relation to the current times.

    As you rightly mentioned in the article – Buffetts First Million; during those times there were asset heavy companies however in the current times, the composition of asset heavy companies is shrinking and there are more business which are asset light.

    If you permit me, my opinion would be to look at the very definition of a Cigar Butt company ( a stock which has a last puff remaining – a puff for free). If we apply this definition then there are stocks in market which are asset light but also are under valued since they are hit by the broader issue of Capital outflow, Economy issues etc. I woud list a penny worth suggestion that we should look at stocks which has greater liquidity, stock which has leadership in the category – Number one or two and it’s current stock value is low because of broad issues affecting.

    One such stock I can point out is Sun Pharma (disclaimer : I own stocks of Sun pharma) which is a market leader in its category, has given stellar performance over a period of time, has done some strategic acquisitions but the value is beaten down due to broader issues affecting the stock market, economy as well as the major investor selling stock. However the future of the company is well placed and I think this stock qualifies as a Cigar Butt company although the stock price seems high.
    Other stocks would be software stocks e.g. TCS, Wipro (Disclaimer : I hold these stocks in my portfolio) which are asset light but they are available cheap today due to suspected lower income in the future.

    I believe we need to look at the very definition of Cigar Butt companies in light of the current times and availability. This of course is my opinion.

    Thanks

    Regards
    Waman

    1. Hi Waman,

      Thanks for writing in!

      I understand your concern.

      Buffett did indeed look at the definition again. But the definition that he looked at again was ‘good investment’ in general and not ‘cigar butt’ specifically.

      In other words, he moved beyond cigar butts and started looking at better quality companies with economic moats around them. They tend be light on tangible assets and have a lot of intangible assets/goodwill. This happened from the late 1960s onwards.

      So, your point is well taken. The definition of a good investment has indeed changed with time. And that is the genius of Warren Buffett!

      The definition of ‘cigar butt’, however, is what it always was. And there’s no harm done.

  7. Nice one !!!

    Rejecting stocks basis complexity may be good for people who do not have adequate time but still wish to do their own research. However the value is always found when the complexity gets simplified through restructuring.

  8. Snerhal Vankudre

    Dear Satyajeet.

    Discovered the blog today.

    Really fantastic effort put in by you. i went through your all articles in single day. Loved so much cant resist to continue reading. Thanks my vision of value investing has been polished.

  9. vaidy thirunavu

    Dear friend i am new to this blog, learnt about the art of value investing.

    Totally i failed in share investment. your article taught me to understand the mistake what i have done and what i should not do.

    I will buy the stock with the aim of value investing and i will not loose money further. I will get success.

    Thanks for giving essential information for the value investor.

  10. I came across your site through Google search yesterday. I appreciate your efforts to make novice people like us the fundamentals of value investing. I am enjoying the articles presented by your site.

  11. Great article. The concept of rejecting and focusing on few is well illustrated. I personally will try this as it’s very practical. Looking forward for more case studies.

  12. I prefer Techno Funda approach because all information can never be gathered but everything is in the price. Price and volume gives the first hand information as to what is playing out. Liked your approach as well but on a individual level it is very difficult to scuttle butt.

  13. Leslie Menezes

    Dear Sir,

    You have provided a very simple approach to a newbie value investor. I plan to apply this approach and in the worst downside I expect this approach should reward me by saving my capital.

    1. Thank you, Leslie!

      Indeed, downside protection is of utmost importance in value investing. In fact, that’s what this oft-mentioned Warren Buffett quote means:

      “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”

      Although, frankly, I’ve never been able to track back to where he actually said that! 🙂

  14. HEMANTHA KUMAR

    Dear Satya ji,

    Namaste. The article is very good. Warren buffett invested large sums in few companies. How can we allocate funds whatever we have. Requested for an article from you on this subject. I know that fans will always burden their stars.

    Thank you and best of luck.

    Hemanth

    1. Dear Hemanth,

      Namaste. And thank you for your kind words!

      Will definitely keep your suggestion in mind. But let me quickly share this for now:

      1. Portfolio allocation is entirely dependent on how you generate your investing ideas, what kind of research you do, and as a result, how much conviction you develop about the idea. That is to say, Hemanth, the work involved in value investing is front-loaded.

      2. Portfolio allocation is independent of portfolio size. You are absolutely right – we are obviously not in the league of Warren Buffett. Almost no one is! But that doesn’t mean we can’t emulate his “focused” style of portfolio allocation.

      In fact, the Oracle of Omaha himself is on record suggesting that we’d do well to stick to only 20 stock picks in an investing lifetime. Simply because it will ensure we think about each of them thoroughly and that will improve the quality of our decisions! 🙂

      Warm regards,
      Satya

  15. Very well explained the practical tenets of Value Investing without going into technicalities.

    An excellent starting point for the uninitiated, but even a good refresher for those who try to practise Value Investing, but at times lose the track.

    1. I’m so glad you liked it, Chirag!

      All of need to hark back to the basics from time to time. I certainly need to. 🙂

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