|
Equities: Eight investing tips!
The stock market 'meltdown' witnessed since the start of 2005
(notwithstanding the recent marginal recovery) has once again
brought to the forefront an inherent weakness existent in our
markets.
This is the fact that foreign institutional investors,
indisputably and almost entirely, dominate the Indian stock market
sentiments and consequently the market movements.
In this article, we make an attempt to list down a few points that
would aid an investor in mitigating the risks and curtailing the
losses during times of volatility as large investors (read FIIs)
enter and exit stocks.
Considering the Indian stock market behaviour over the previous
fortnight, it would not be entirely inappropriate to state that
the 600+ points (9%) correction witnessed in 10 trading sessions
was almost as bad (if not worse) as the single-day near 800-points
(16%) crash (!) seen on
May 17, 2004.
This is because, in either scenario, it is primarily the
retail/small investor community, which gets affected the worst as
they are generally among the late entrants to a bull run (i.e.
near the peak) and amongst the last to exit in a correction.
However, some amount of stock market prudence and a disciplined
approach could go a long-way in protecting one's capital. Listed
below are a few points.
1. Manage greed/fear: This is an important point, which every
investor must keep in mind owing to its great influencing ability
in equity investment decisions. This point simply means that in a
bull run control the greed factor, which could entice you, the
investor, to compromise with your investment principles.
By this we mean that while an investor could get lured into
investing in penny and small-cap stocks owing to their eye-popping
returns, it must be noted that these stocks have the potential to
wipe out almost the entire invested capital. Another way greed
affects investor behaviour is when they buy/hold stocks above the
price justified by its fundamentals.
Similarly, in a vice-versa scenario (bear market), investors must
control their fear when stock markets turn unfavourable and stock
prices collapse. Panic selling would serve no purpose and if the
company has strong fundamentals, the stock is more than likely to
bounce back.
It is apt to note here what Warren Buffet, the legendary investor,
had to say when he was asked about his abstinence from the
software sector during the tech boom: 'It means we miss a lot of
very big winners but it also means we have very few big losers.
We're perfectly willing to trade away a big payoff for a certain
payoff.'
2. Avoid trading/timing the market: This is one factor, which many
experts/investors claim to have understood but are more often
wrong than right. We believe that it is rather impossible to time
the market on a day-to-day basis and by adopting such an approach
an investor would most probably be at the losers' end at the end
of the day.
In fact, investors should take advantage of the huge volatility
that is witnessed in the markets time and again. In Benjamin
Graham's (pioneer of value investing and the person who influenced
Warren Buffet) words: 'Basically, price fluctuations have only one
significant meaning for the 'true' investor. They provide him an
opportunity to buy wisely when prices fall sharply and to sell
wisely when they advance a great deal. At other times, he will do
better if he forgets about the stock market.'
3. Avoid action based on rumours/sentiments: Rumours are a part
and parcel of stock markets, which do influence investor
sentiments to some extent. However, investing on the basis of this
could prove to be detrimental to an investors' portfolio, as these
largely originate from sources with vested interests, which more
often than not, turn out to be false.
This then leads to carnage in the related stock(s) leaving retail
investors in the lurch.
However, if we consider this from another point of view, when
sentiments turn sour but fundamentals remain intact, investors
could take the opportunity to build a fundamentally strong
portfolio.
This scenario is aptly described by Warren Buffet: 'Be fearful
when others are greedy and be greedy when others are fearful.'
4. Avoid emotional attachment/averaging: It is very much possible
that the company you have invested in fails to perform as per your
expectations. This consequently gets reflected on the stock price.
However, in such a scenario, it would not be wise to continue to
hold onto the stock/buy more at lower levels on the back of
expectations that the company's performance may improve for the
better and the stock would provide an opportunity to exit at
higher levels.
Here it is advisable to switch to some other stock, which has
promising prospects. In Warren Buffet's words: 'Should you find
yourself in a chronically-leaking boat, energy devoted to changing
vessels is likely to be more productive than energy devoted to
patching leaks.'
5. Avoid over-leveraging: This behaviour is typical in times of a
bull run when investors invest more than what they can manage with
the hope of making smart returns on the borrowed money. Though
this move may sound intelligent, it is smart only till the time
markets display a unidirectional move (i.e. northwards).
However, things take a scary turn when the markets reverse
direction or move sideways for a long time. This is because it
leads to additional margin calls by the lender, which might force
the investor to book losses in order to meet the margin
requirements.
In a graver situation, a stock market fall could severely distort
the asset allocation scenario of the investor putting his other
finances at risk.
6. Keep margin of safety: In Benjamin Graham's words: 'For
ordinary stocks, the margin of safety lies in an expected 'earning
power' considerably above the interest rates on debt instruments.'
However, having a stock with a high margin of safety is no
guarantee that the investor would not face losses in the future.
Businesses are subject to various internal and external risks,
which may affect the earnings growth prospects of a company over
the long-term. But if a portfolio of stocks is selected with
adequate margin of safety, the chances of losses over the long
term are minimised.
Graham further says: 'While losing some money is an inevitable
part of investing, to be an 'intelligent investor,' you must take
responsibility for ensuring that you never lose most or all of
your money.'
7. Follow research: The upswing in the stock markets attracts many
retail investors into investing into equities. However, picking
fundamentally strong stocks is not an easy task.
In fact, it is even more difficult to identify a stock in a
bullish market, when much of the positives are already factored
into the stock price, making them an expensive buy.
It is very important to understand here that owning a stock is in
effect, owning a part of the company.
Hence, a detailed and thorough research of the financial and
business prospects of the company is a must. Given the fact that
on most occasions, research is influenced by vested interests, the
need of the hour is unbiased research.
Information is power and investors need to understand that unless
impartially represented (in the form of research) it could be
misleading and detrimental in the long run.
8. Invest for the long term: Short-term stock price movements are
affected by various factors including rumours, sentiments, market
perception, liquidity, etc, however, in the long-term, stock price
tends to align themselves with its fundamentals.
Here it must be noted what Benjamin Graham once said: '. . . In
the short term, the market is a 'voting' machine (whereon
countless individuals register choices that are product partly of
reason and partly of emotion), however in the long-term, the
market is a 'weighing' machine (on which the value of each issue
(business) is recorded by an exact and impersonal mechanism).'
Of course, it must be noted that the above list is not exhaustive
and there may be many more points that an investor needs to
understand and follow in order to be a successful investor.
Further, the above points are not just a read but needs to be
practiced on a consistent basis. While making wealth in the stock
markets was never an effortless exercise, it becomes all the more
difficult when stock markets/stock prices are at newer highs.
Compiled by Eisen Picardo |
