The Criteria to Choose Stocks for Long Term Investment
Market always goes for a correction once in a while. It provides an excellent opportunity for the investor to buy the stocks at a cheaper price and sell at a higher price. Such opportunities are rare, but if one stays invested for the long term, then he/she will reap a lot of benefits. Long term investment means accepting a certain amount of risk in the pursuit of high rewards. So, one of the obvious questions that come to mind is why one invests in the long term.
Reasons for investing in Long term:
One of the biggest concerns for an investor, who invests in the stock market is market volatility. Volatility measures the degree to which prices change of security. The greater and more frequently a security price moves, then higher is the volatility. Higher volatility is an indication of higher risk. Some stocks can be highly volatile in the short term but show patterns of growth and stability in the long run. So, if the short-term investment is all about capital preservation, then long term investment is about wealth creation. Let’s look at the advantage of investing in Long Term investing:
- Compounding effect: In compounding basically, interest is added to the principal after a year then onwards added interest is act as principal for another year. This addition of interest to the principle for subsequent years is known as Compounding. If an investor invests in the long term, then they can take advantage of compounding and the ability to reinvest the profit overtime to generate even greater profit potential.
- Tax Advantages: Investing in the long term provides tax advantages on capital gains. The long-term tax gains are taxed below your income bracket, while the short-term tax gains are often taxed as a regular income.
- Averse the loss due to emotions: One of the greatest advantages of investing in the long term is that, it averse the loss due to emotions. Sticking with stocks over the long term allows you to focus on the meat and potatoes of your investment rather than decision-based on emotions due to short term fluctuations.
- Investment risk drops: Investing in the long run drops one’s investment risk by removing lost opportunities as well as the volatility in the market.
The most obvious question that comes in an investor’s mind is how to choose stocks for long term investments.
- Shareholding: It is quite essential to understand how widely this stock is held. It will help in understanding whether there is going to be a lot of floating stock making it susceptible to volatile moves or is it going to be a steady stock. In case, if the promoter shareholding is more than fifty percent then it implies that they believe in their stock and its growth prospects.
- Historical Prices and Average Volume: Before buying any stocks, one should look upon the historical prices and average volume. It will help you understand the current trend compared to earlier time frames. Moving averages help you to understand the current price and in case if there is a correction, at what price stop loss trigger price is going to be?
- Price to Earnings Ratio (P/E): It is one of the most important ratios to check before picking any stock. High Price to Earning stocks shows how much stocks investors are paying for each rupee of earnings. It also indicates whether the company is undervalued or overvalued. The best way to know the ideal P/E ratio is by comparing the current P/E with the company’s historical P/E ratio, the average industry P/E and the market P/E. For example, a company stock with a P/E ratio of 15 seems expensive when compared to its historical P/E, but maybe a good buy if the average industry price to equity ratio is 18 and the average of the market is 20.
- Price to Book Value ratio: The price to book value ratio helps is used to comparing the price to book value. Book values indicate the amount the company will have in case if the company liquidates its assets and sells all its liabilities. A company with P/BV value less than one means, it is undervalued and more than one is overvalued.
Before investing in stock for the long term, it’s better one should analyze its risk and desired returns. There are many reasons for an investor to invest in the long term such as saving for retirement or college education for children and for a future house. Whatever be the reason, one should choose the stocks based upon their risk profile and time period.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing