How to Invest Smarter?

Angel investors and venture capitalists provide funds to early stage or emerging startups in exchange for equity and aiming to make huge profits. The trend of such investments has been increasing and there are a number of startups that became successful as a result of such investments, including WhatsApp, Uber, and Facebook.

It is very important to invest in a promising startup that has a potential to attain a unicorn status, yet, it is not easy to be an investor. Choosing the right start up is as important for an angel investor as it is for an entrepreneur, but does it determine an investor’s success? To understand how one can invest smarter, let’s look at a few tips by different investors.

Focus on Team and Market

The investor in Famo.us, TouchOfModern, and Airseed, Siqi Chen, said that when you make an investment in a startup, it is usually a very early product. Therefore, it is crucial for an investor to calculate and assess the opportunities accordingly and should keep the focus on the team and the overall market.

Ask Yourself – “Would I Join this Start-up?”

Another angel investor, Mike Greenfield, who invested in Hullabalu and Pocket shared some important insights on taking an investment decision. He said that in the beginning, he used to ask himself if the startup would yield a positive outcome on an investment, but it changed over time, and now he usually asks if he could see himself joining that company when he was 24? If the answer to the latter is affirmative, it shows that the founder of a particular start-up is working a problem that isn’t structurally flawed and has a good chance of winning big.

He further said that such companies have a potential to convince a geeky person like him as they work on something that is important and also ace the integrity test. He added that if a startup satisfies all those things, it makes him feel like he’s doing something right as an investor, regardless of whether he makes money out of it or not.

Read the Herd Correctly

There is this common phenomenon in a stock market, whereby, investors can make a lot of money simply by reading the herd correctly. The same was observed by Christopher Schroeder, investor in Vox Media and Skift, when he began angel investing a few years ago. He said that when he presented a deal to bright and successful friends, the first question they asked was “who is in?” even before the question about a team and its concept popped up. Therefore, one has to read his herd correctly before taking any decision.

Identify the Scale of Assistance Required by a Startup

Jeff Miller, another investor in the world of angel investing, said that when an angel provides a feedback on a product, founder usually appreciate it. But the clutch actions are quite rare than anticipated by him. Such actions can affect a company’s future. However, if you look at it from the perspective of successful companies, they look for a minimal assistance from their investors. So, it is important to identify the scale of assistance required by a startup for its future growth.

Choose a Company with a Good Working Product

It is of vital importance to invest in a company that has a good working product. Having a good team of individuals in any startup is not enough if they don’t have a product that solves a problem. A product has to show a “product-market fit.”

Double Down the Investment Once a Potential Unicorn is Spotted

Once you identify a potential winner, you should “double down”, as it represents almost 20 percent of the initial pool of investment.

However, patience is the key, and individuals in early stage startups usually have to wait for 3 to 10 years before they start earning profits from their investment.

Although, there is a lot of risks involved in investing in a new startup, yet the trend for angel investing is rapidly increasing. In order to invest smarter, an investor has to always welcome different ideas, because great ideas are born every day.

But only a few of them, with the right investor (and investment) turns out to be a complete success.

Women & Angel Investing

Angel investing is a known term in the world of investments. Startups and early stage companies in need of funds usually try to approach these angels who make investments in exchange for stocks of the company. A number of popular names, such as WhatsApp, Uber, and Facebook have encouraged the angel investors to come forward and invest in startups with an aim of making huge returns.

The Shift in Focus Toward Female Entrepreneurs?

So, what do angel investors really look for? It is mostly the commitment, quality, integrity, and passion of the brains behind those startups that these investors care about. Last year, an angel investor and CEO of photo editing software PicMonkey, Jonathan Sposato, made an announcement that he’ll only invest in startups that have one or more female founders in it. He said that female entrepreneurs face a tough time getting traction, whether it’s about raising money, sharing their ideas, or even recruiting. He further said that you cannot just ignore these issues; you have to act as a catalyst if you are passionate about it. Sposato was of the opinion that this problem arises, because investors tend to back those startups that are similar to other successful firms they funded before, and most of those companies are led by men.

Male Entrepreneurs Securing More Investments

According to a recent research by the Women’s Business Council and Deloitte, it was identified that the proportion of women entrepreneur fell in 2014 despite a large number of registrations by new companies. Lack of female angel investors is also a contributing factor as most of the angel investments are still controlled by men. In a study of 220 UK startups by Startup DNA, it was revealed that male founders are 59 percent more likely to secure investments than females.

Angel Investing – Tides are Changing

However, the tides are changing. In a report issued by the UK Business Angels Association and the Center for Entrepreneurs, women now represent one in seven angel investors in the UK, which is twice as much as it was observed in 2008. Similarly, in the U.S., the number of female investors has increased from 20,000 in 2005 to around 60,000 in 2014.

More opportunities are being created for women and its source is the ever growing awareness among angel investors about the fact that startups with female founders are good investments. Moreover, women are also becoming aware of their potential to be a successful entrepreneur, whereby, they no more have to clean other people’s mess and can instead focus on materializing their own goals. Jeffery E. Sohl, director of the Center for Venture Research, said that while a percentage is still low, a large number of women-led organizations are getting angel funds. He is hopeful that this trend will continue to grow, as more women are getting degrees in engineering, technology, and science.

A senior fellow at the Kauffman Foundation and Founder of Next Wave Ventures, Alicia Robb, gave credit to the women entrepreneur role models who are paving a way for other women and showing how they overcame the obstacles despite the challenges. In 2015, 29 percent of the entrepreneurs, who sought funding, were women and 24 percent of the angel backed companies had female founders. According to a report by the BMO Wealth Institute, 51 percent of the personal wealth, U$S 14 trillion, in the United States are currently controlled by women and the amount is expected to rise up to $22 trillion by 2020.

Although, angel investing has always been dominated by male investors, the media has begun to play its part. For example, TV shows, such as Shark Tank, are familiarizing women with angel investing. Robb also said that angel groups have put in a lot of effort to reach and engage women. One example is Astia and Golden Seeds. They are focused on connecting investors to invest in startups with female founders. During the last five years, different organizations, including Pipeline Angels, 37 Angels and Female Funders have also joined them, and it has expanded from 21 cities in 2015 to 33 cities in 2016.

Emotions and Smart Investments Decisions

How Emotions Keep You from Taking Smart Investment Decisions

Being an investor in a financial market, a person must be able to control his or her emotions, because buying low and selling high may not be possible if emotions get in the way and adversely affect the investment decision. Most people tend to underrate the effects of emotions, whereas, market downturn is one of the factors that increase hospitalization rates when emotions run high.

Getting emotional in a financial world distorts even the best planned strategies. This is the reason why investors are advised to use reason and not emotions when making a financial decision. According to 2013 Dalbar Quantitative Analysis of Investor Behavior, emotions and the behaviors triggered by those emotions were partly the cause why investors underperformed the S&P 500 by almost 4 points over the last 20 years. This was because the element of desire to grab a hot investment and to sell losers for the avoidance of further losses tends to create a pattern of buying high and selling low.

Investors are most vulnerable when there is high volatility in the markets. That’s where emotions trigger panic, depression, capitulation and fear. However, by taking control, investors can prevent their emotions from affecting their decisions.

How many times you regretted the investment decision that you made? If you come to think of it, there would probably be quite a few that come to mind.
What caused it?
Was it lack of knowledge about the market, bad timings, or did your emotions play the part?

Following are some of the behavioral finance concepts that reflect how emotions can have a real impact on an investor’s ability to a sound financial decision:

Having a Short-term Thinking Process

People tend to disregard and ignore future benefits as compared to the more immediate ones. So, oftentimes, it becomes harder to make long term financial plans a priority in everyday life decisions. For example, everyone understands the value of saving for retirement or college education of a child, yet, find it difficult not to spend lavishly on buying a new car or a vacation.

Fearing Losses more than Valuing Rewards

Considering the aspect of behavioral finance, i.e., fearing losses more than valuing rewards, which is mainly triggered by short term thinking, it can become very problematic for an investor to take the right decision. This phenomenon is normally called loss aversion, as it leads to a risk averse behavior that eventually exposes the investment to a greater risk. For example, although, investors rationally understand that the markets will bounce back from a downturn, yet, the emotions instigate them to overreact.

As the behavioral economist, Richard Thaler, said, “We think we will be smart enough to take the long view, but when markets actually drop we lose our courage and sell at the bottom.”

Being Overconfident

Studies have shown that a large majority of investors consider themselves above average despite the fact that not everyone can be above average. According to the findings of a study conducted by Glaser and Weber (2007), investors overestimated their investment performance by 11.5 percent per year. Thaler said that people think they are better than everyone else, regardless of the evidence that most people fail to beat the market.

For example, in a rising market, investors might believe that it is their own performance that is causing them to succeed, which might cause them to ignore warning signals or the need to caution, eventually leading to unavoidable losses.

There are so many other emotional factors that can jeopardize the investing behavior and a well devised long-term financial plan of an investor, and these are as follows:

Hyperactivity

If an investor gets overwhelmed by a heavy stream of real-time information, he or she would start reacting to every twist and turn in the market, which might expose them to risky situations.

Greed

In any market, the greed to make more may tempt an investor to seek more growth in the value of his investment, but what they do not realize is that higher returns also mean higher risk.

Euphoria

The enchantment to see the stock going up day by day makes an investor falls into a trap of believing that success is self-perpetuating. He can easily get caught up in a bubble mentality.

So, even if we think we are being rational and analytical while making a move, deep down under the surface, emotions are always working in ways we cannot escape and may never entirely understand, which can keep us from taking smart investment decisions.

No undefeated fighter (like Floyd Mayweather Jr.) in Investments

Floyd Mayweather Jr. is not only considered the best boxer of all times, but also one of the highest paid athletes of 2012 and 2013 in the Forbes list. Known to be an invincible boxer, Mayweather won 12 world titles and was six-time winner of the Best Fighter ESPY Award, two-time winner of The Ring Magazine’s Fighter of the year, and three-time winner of the BWAA. This year, he has been ranked by ESPN as the greatest pound-to-pound boxer of the last twenty-five years.

But can there be a Mayweather among Venture Capitalists or Investments in general? When it comes to Venture Capital investments, there is no undefeated Fighter; nothing like Floyd Mayweather Jr. in boxing. A venture capitalist has to face the risk of losing his investment at some point in time. Just because they think they have taken all the right decisions, doesn’t mean they will always generate higher profits. There are a number of external factors that play a vital part in making a venture capital (VC) investment successful or unsuccessful, and none of these are avoidable.

Every investment has its ups and down, and venture capital investments are no exception. Being an investor, it is very important to have a realistic mindset; one cannot simply rule out the risk associated with that investment. However, what he can do is manage the risk. Same is the case with venture capital investment; a venture capitalist can always minimize the risk and increase the chances of success by working hard and continuously analyzing the market. If not all, it will allow him to succeed in most of them. Like Mayweather said, “To be the best, you have to work overtime.” And that is the key; a key to success.

In every sport, an athlete can improve the likelihood of success if only he trains hard for it. The loss is unavoidable, yet, it can be managed and minimized so as to reduce its overall impact. So, how can a venture capitalist minimize the risk of loss? What attributes must he possess to make a venture capital investment a success?

Understand the Market – One of the crucial elements of VC investment is to have a good understanding of the market. The markets are continually evolving and venture capitalists must have a good understanding of rapidly changing market trends in order to make the best out of their investment.

Be Optimistic about the Change – A key factor to adapt to a change is to stay positive. A co-founder of the Polaris Ventures and Emeritus Chairman of National Venture Capital Association, Terry McGuire, said, “You have to believe that the world can change; be optimistic and at the same time, be realistic and guarded, not romantic”.

Situational Awareness – A founder of Accel Partners, James R. Swartz said that a good venture capitalist possesses a trait of situational awareness, meaning he can walk into any meeting and identify the issues in just a few minutes; he can sort of cut through it and figure out what’s going on.

The CEO and fund manager of Renaissance Venture Fund, Christopher L. Rizik, has identified three qualities of a good venture capitalist. According to him, a good VC has a good sense of the world around him, and how it changes. Another quality is patience – a smart venture capitalist would never lose control or panic when the going gets tough, in fact, they make profits and eventually succeed as opposed to those who freak out and give up at an early stage. Lastly, a VC has to be fair to everyone as individuals want to work with those venture capitalists who are fair, smart and treat everyone well, and not with the ones who just think about themselves.

It is all about practicing, bringing precision and polishing your skills in order to learn and grow. Like Mayweather once said,

“Everybody is blessed with a certain talent, you have to know what your talent is; you have to maximize it and push it to the limit.”

Value Investment Strategy in Venture Capital

Why succeed in every investment (or the majority of them) is more important than depending on the statistical model of “Spray and Pray”.

Starting a business is not easy. One has to invest a lot of effort, time, and brain in order to introduce an idea that can stand out and is of value to others. Every individual is naturally inclined toward investing in a startup with better prospects than a start-up that would not generate any value and likely to fail in the future. Every investor would want to see his investment a complete success, whether it be an investment in a single stock or a bucket full of stocks. Same is the case with Venture Capitalists; they wish every investment to be successful, and for the same reason, prefer to use value investment strategy over the statistical model of spray and pray.

Although, spray and pray has got a lot of media attention in the past few years, and the face behind it is none other than Dave McClure, the founder of 500 startups, yet, you cannot deny the fact that it is important to reasonably manage your risk.

Nurturing the Idea is as Important as Making Money Out of it

Nurturing the idea is as important as making money out of it and this is exactly what value investors believe in, because you won’t be able to make money out of it if it doesn’t grow well. Manu Kumar, the founder of K9 Ventures, said that most companies do not turn out to be a failure because of their investors, but despite their investors. This is why he doesn’t want the startups, he has invested in, to fail, and wants a reasonable success rate in his investments. He keeps an average of four or five companies in his portfolio and he wants each one of them to be a success. This is why he is very selective and prefer to go for the one with good prospects. He keeps his investment between $100k and $200k and screen companies down while expecting a much higher rate of success. He looks for appropriately priced deals and doesn’t touch anything that is five or higher.

Value Investing Strategy – Bridging the Gap between Investors’ Mindset and Founders’ Perception

Another famous name among the Venture Capitalists, Thomas Korte, said that they do everything in a scaled way, because the majority of the founders tend to take the funds they are offered in the seed stage. There are very few in the market who believe that their investors would take them through Series B and Series C, and their apprehensions are true to a certain extent. At one point, McClure said, “it is not that their portfolio has a high death rate, it’s just that there is a higher death rate out there.” Instead of aligning himself with the founder and an acquirer, he prefers to align with an investor and acquirer. So, if a company has a scalable impact, he makes a deal as soon as possible. It is not easy to bridge the gap between investors’ mindset and this commonly held belief of startups. However, Value investing strategy can contribute towards changing this mindset and bringing harmonization to achieve common goals.

Benefits of Value Investing

Potential to Make High Profits – As opposed to spray and pray strategy, value investing has a potential to make high profits, because value investors tend to invest in companies that are being offered at a discount price and sell them well above their intrinsic value by bringing their true value to light through solid research on a value stock, its peers, and the sector.

Avoid Exposure to High Risk – Investing in a few companies with good future prospects will not only enable the investor to focus on materializing the potential value, but also keep the overall cost to a minimum. The investor will not be dependent to succeed on that only company that make the revenue beside all the others have already failed.

Yes, there might be a lot of effort and hard work involved the value investment strategy to be implemented while choosing the startups for investments, but it is important to note that short term price fluctuations are not always a true depiction of the true value of an asset.

As Benjamin Graham, the founder of value investing and mentor of Warren Buffet, once said, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

Value Investing or Spray and Pray

In my last article I wrote about the value investment strategy, now I will compare it with the “Spray and Pray” method.

Value investing and Spray and Pray are two of the widely talked about strategies in the world of venture capital. Some of them view value investing as a reasonable approach, because it is concentrated toward investing in companies that are undervalued and have a strong business model with good future prospects. While others consider spray and pray method to be a wise approach as they believe it gives rise to diversification and enables investors to generate maximum return out of a few startups that reach a unicorn status. Before going into detail about which strategy is better, let’s take a look at what value investing and spray and pray strategies actually are.

Value Investing

It is a commonly used venture capital strategy, where investors seek the companies that have a potential to produce large profits for an extended period of time. It is a concentrated investment approach that allows VCs to identify good startups after keeping in mind certain factors, including the cash flow position of a company, profit generation from its key operations, and its potential to grow in future.

Spray and Pray Method

Spray and pray method is a more diversified approach and is considered aggressive by some investors. A well-known name in the world of venture capital, Dave McClure, founder of 500 start-ups, is usually known as a spray and pray venture capitalist. However, he detests the idea of being characterized as such. A few years ago, he participated in a panel discussion of angel investors, where he said that he puts a lot of thought into his investment strategies, so it is not fair to call it spray and pray method; it is diversification with a thorough working behind it.

More Concentrated Approach or Diversified Approach – Which is Better?

When it comes to choosing between value investing and spray-and-pray strategies, mixed reviews are received from the market. For example, in an interview with McClure, he argued that a high volume and diversified investment strategies, like spray and pray, provide consistently stronger cash on cash returns than in the case of more concentrated scenario. He supported the idea by explaining his portfolio of 500 startups that around 60 to 80 percent of his investments do not reach any return less than 1x invested, whereas, 15 to 20 percent do provide 3 to 5 times the original investment. Moreover, 5 to 10 percent reach exceed the value of $100 million, but the actual return is generated from 1 to 2 percent of the startups that reach a unicorn status and provide 50 times or more of the originally invested funds.

When we talk about multi-party seed round, investors are compelled to earn their right to participate in the next phase due to the increased level of competition. It not only provides greater value to venture capitalists, but also turns out to be beneficial for entrepreneurs. According to McClure, using spray and pray at the seed level, collecting insight and optionality on early stage startups, and then doubling the bet on the successful investments, can actually break the perception of considering the concentrated portfolio strategy as industry best practice.

Flagship ventures, on the other hand, carefully select later stage value investments. They actively evaluate and fund the companies that are at an advanced stage in a product development, yet, these firms require additional funds and strategic involvement to reach their full potential. In a panel discussion of angel investors, Jed Katz from Javelin Ventures said that they invest as little as a few hundred grands to $2.5 million in the companies and dedicatedly invest the time and energy to expand their scalability. Another venture capitalist, Manu Kumar from K9 Ventures, said that he prefers all his companies to be a success, and this is the reason why he is very cautious about where he should invest. He further said that there are various strategies at a seed level, however, it doesn’t mean that one strategy is right and the other is wrong; they are just suitable at different levels.

Value Investment

Value investment strategy is one of the strategies used in the stock market, where investors look for the companies that have the ability to generate returns at a reasonable level during a sustained holding period. In other words, a value investor tries to find a company that is undervalued by the market, but it has a potential to show an increase in its share value once the market rectifies the error of valuing that firm. So, it allows an investor to buy a well performing share at a cheaper price.

How to Screen for a Value Stock?

Value investors are not concerned with the factors that usually cause price fluctuation in the market. For them, the factors that would impact a stock price are oil prices, inflation reports, wars, and hikes in the Federal rates. This is the reason why they look for stocks with strong dividends, earnings, cash flow, and book value, because value investing is not just about purchasing an undervalued stock, it is about purchasing a good stock that is undervalued. However, just having the strong fundamentals doesn’t necessarily mean it will be a value stock investment opportunity, because a company with strong and consistent earnings growth, attractive cash-flows, decent dividends, and a minimal amount of debt might represent a growth investment, and so, value investors won’t be interested in it.

An investor must keep three questions in mind when he seeks a high value stock:

How is the cash-flow position of a company?
If the company is generating profit from its key operations?
What are the future prospects in terms of growth potential?

Quantitative Aspects

How to assess a good value stock? (Just some RATIOS)

High Dividend Yield – The stock with an ability to generate high dividend yield, is considered a good value stock. However, a comparison should be made in the same industry.
Low P/E Ratio – It is a comparison between a share price and the earnings generated by each share. Paying less for more profit will be a good indication of a good value stock.
Low Price to Book Ratio – The lower this ratio is, the better it would be, as it shows how much will be left after the liquidation.
PEG Ratio – Value investing doesn’t simply means investing in low Price to earning stocks. Another largely accepted metric for finding out the intrinsic value of a company is PEG ratio, which is calculated by dividing the P/E ratio of a stock with its projected earnings growth rate over the years. It measures how cheap a stock can be while keeping in mind the growth of its earnings. Therefore, a PEG ratio of less than 1 means a company is undervalued.
Net-Net Method – According to this method, if a company trades at 67 percent of its current assets, an investor doesn’t have to adopt any other measure of worth, because it depicts that a buyer is getting all the non-current and intangible assets free of cost. But, there are only a few companies that are trading this low.

Qualitative Aspects

Value stocks can be found in any industry, including finance, energy, and even TECHNOLOGY. Yet, they are mostly commonly located in industries that have recently been hit by a difficult time, for example, the cyclical nature of auto industry give rise to a period of undervaluation of companies like General Motors and Ford.

Warren Buffett, one of the most astute investors of all time, learned the art of trading from Benjamin Graham, who was the father of value investing. Buffett has always emphasized that buying a good company at a fair price is far better than buying a fair company at a good price, which is true. Value investing is not about purchasing stocks at a bargain price and hoping for the best, nor is it about making quick money on a market trend. The main idea behind it is to invest in companies with strong business models.

It is important to have a long term strategy with value investing. The investors shouldn’t get faltered by short term market features, such as volatility or daily price fluctuations, because a good firm will not lose its worth even on a bad day. Although, value investment strategy is dependent on a stern screening process, yet, it has a potential to generate reasonable returns in the long run.

Basic Investment Strategies

Deciding on a suitable strategy to fuel your investment plan is based on various factors, including the risk appetite, the time span of an investment, and financial goals. Some investors stick to one particular strategy, while others use several strategies over a period of time. Although, investors usually have their own style that forms the basis of their decisions, yet, there are some basic investment strategies that can be employed to achieve your financial objectives.

Define Your Goals – Defining a goal is the first thing every investor should do. You cannot go about investing in the market haphazardly without having any plan in mind, or else you would end up losing all your money. Always devise a sound trading plan and define your financial goals. It allows you to identify which financial instrument is most suitable for you and enables you to take timely decisions.

Diversify – Investing is a broad term that can be intimidating for newbies as it involves a wide variety of investment vehicles and hundreds of strategies. However, it can be managed if you devise a flexible and effective plan. Today, investors have more investment options than were available to an average investor ten years ago. Having a few stocks in your portfolio might cost you more in the beginning, but it will be beneficial in the long run, because one of your investments might only generate 5 percent profit, while the other one gives you a 100 percent return five years later.

Monitor Your Investments – Investing in the same stock forever is never a wise option. Even the blue chip companies can turn out to be a failure, because the old perception of buying and holding the stock forever doesn’t work in today’s world with such an effervescent economy. Therefore, monitor your investments and take timely decisions to avoid losses.

Start Investing Early – The sooner you start, the better. This is certainly true when it comes to investing in the financial market. If you keep your money invested for a longer period of time, it will have more potential to grow. Patience is the key! If only you learn to practice patience and adhere to a long term investing strategy, you would definitely experience financial success and secure reasonable returns.

Turn Discretionary Income into Your Investment – It is important for you to not confuse your needs with wants. The president of the U.S. Retirement Strategy for Transamerica Retirement Solutions, Stig Nybo, once said that phone bills, cable TV packages, and other automatic services eventually become necessities, which doesn’t let the would-be investor jump out of it. He further said that you should question the things that have become the norm, but they might not be necessities.

Adhere to a Cash-flow Plan – It is an essential element that should become a part of your investment plan. Reinvest your money every month during your employment years and stick to a strict cash-flow plan, while making reevaluations as life progresses. This will definitely help you go a long way and enable you to achieve your financial goals.

Separate Emotions from Financial Decisions – Emotions play a major role in your investment decisions. But, it is very important to separate emotions from your short as well as long term financial objectives. Emotional involvement tampers with your judgment and performance. Just because everyone is talking about hot stocks, doesn’t necessarily mean it is going to be a good investment. Always analyze the trends and pay close attention to market news and events, as it allows you to take rational decisions in the long run.

Assess Your Tolerance for Risk – Whenever you invest in the market, ask yourself one simple question, “How much can I take and sleep at night if the value of my investment drops by 10 percent or 50 percent?” If a huge decline is going to hit you hard, you should consider investing the major portion of your funds in safe investments, such as, bonds or utilities.

However, bear in mind that it takes some time to be able to understand the gist of these strategies. Being a newbie, you might initially experience a high risk of loss if you follow one of these strategies. Therefore, observe patience and perseverance, because you will eventually get there.