Lesson 11 – Investment decisions – Checklists, buy and sell decisions, and taxes

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Lesson 11 – Investment decisions – checklists, buy and sell decisions,  and taxes

Today, I will discuss the use of checklists and how they help an investor do a systematic analysis of a stock. I will also discuss thoughts behind the process of entering a stock and exiting it. Last, I will cover capital gains taxes on stocks.

Investing checklists

You have surely used checklists before at some point or the other. Why do we use them? To make a process foolproof. In Lesson 10, I covered investing biases. If we know that we can make mistakes, why not create a system of checks that reduce the effect of biases. A checklist for investing is used so that we cover all the points we ideally want to cover and don’t miss any aspect.

I have written in detail already about checklists at Capital Orbit. Please read through these two articles,

Checklist for investing – Capital Orbit

Stock investing checklist – Are you using one yet? – Capital Orbit


When should you buy?

First, it makes sense to follow your checklist. You can follow the one I have shared in the article above. You can add or delete a few points if you wish based on your investing style.

Whatever be your checklist, once you are satisfied on the various aspects covered in your checklist, you can make a decision to buy or avoid or wait for some more time for a better price.

There are different styles of investing. Value investors would suggest that you enter a stock when the market price is less than the intrinsic value by a margin. This margin is the margin of safety.

Growth investors would be alright with a lesser margin of safety. They pay more attention to future earnings which are inherently not predictable with certainty. They are fine with paying for future growth.

It is easy to go wrong with growth investing because what is forecast by you for future earnings may not materialise. On the other hand in value investing, one pays more attention to what has already happened. In essence, past financials and developments are given more importance.

While starting off investing, it will be relatively safer for you to pursue value investing. Good companies with understandable businesses, relatively steady earnings which are growing at a decent clip and a good management, should serve you well, if you buy at prices which give you a margin of safety.

As a thumb rule, if a business is growing at a decent clip with good profitability and good return ratios you typically will make less mistakes with a stock that has a P/E in single digits or around 10 than something that is trading at 20-25 times trailing earnings. This can never be an absolute rule. I am sharing my experience. Please remember to do your own checks.

If you consider P/E on future earnings like analysts on TV and media do, you have a greater chance of mistakes. Future earnings are tough to predict and get right.

Buying decisions can be made easy by easing in to a stock. Not all at one go.

You have heard of systematic investment plans for mutual funds. Think of the same logic for a stock. Phil Fisher, a famous fund manager, used to buy into a stock over a few years. Yes, buy in, over years. Today, people want quick returns in few weeks. He on the other hand had a patient outlook. It served him very well.


When should you sell?

Selling is a tough decision. You can easily get wedded to the stocks you hold because of biases as explained in earlier lessons.

Broadly, you should sell if,

  • Your homework was wrong – Have no shame in accepting if you made a mistake in your investing study. Better late than never. Get out if the correct version changes the investment outlook.
  • New facts emerge which materially change the outlook – We work with incomplete facts. Sometimes, facts emerge later once you have already invested. Again, like the first case, if these new facts change your perspective for the worse, sell and move on.
  • Price and value equation has changed – If you see that the stock is overvalued when compared to historical price to earnings ratios or price to book ratios, you may consider selling. You may also be doing a discounted cash flow analysis (DCF) which tells you the value of a stock. If price is significantly higher than value you may consider selling.
  • Switch into a better stock – This situation might arise. You may sell the weakest stock that you have in this case to raise money to invest in a better stock.

In the third case, pure value investors would sell the moment price rises upwards to meet value.

You may sell over a few weeks or months and not at one go if you are pragmatic. This is because overvaluation may persist for reasonably long periods of time. A more pragmatic investor would “ride” the wave. This has its own risks in that you might not get out on time.


How do taxes affect stock investments?

Short term capital gains as of the day of writing this lesson are 15%. Short term is defined as one year. Long-term capital gains taxes are zero.

Dividends are tax-free in your hands as an individual.

If you are buying and selling a stock within a year’s time, you will face short term capital gains. If you hold stocks for longer than a year and then sell them you will essentially not pay any tax on the gain.

Capital losses cannot be set off against other heads of income like Salaries, rent income, business income. Capital losses can be carried forward for eight assessment years and set off against future gains. Short-term capital losses can be used to set off against long-term and short-term capital gains. Long-term capital losses can be used to set off only against long-term capital gains, not short-term capital gains.


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