MONEY WISE
For the amnesiac investor
SHYAM P.
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The stock market is surging again. Tips for the over-exuberant...
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With the stock-market surge having erased all memories of the recent crash, the best prescription for amnesiac investors is an oath to not make the “same” mistakes this time.
It’s hardly been a few months since the market hit rock bottom. But now that the UPA is back, Voila! Our economy is going to instantly recover with the tap of a magic wand. Just that instead of a fairy godmother, we are counting on “politicians” this time.
The market crash of 2008 has already faded into a distant haze and so have the lessons learnt. Chartists are rife with predictions about Sensex hitting 18,000 this year.
Here is an oath for over-exuberant investors who have already forgotten the pain caused by mistakes of the past:
I will reduce my exposure to equities when the numbers point to a bubble.
It is dangerous to remain fully invested in an expensive market. One can easily verify how expensive the market is by checking the P/E (price to earnings ratio) of the Index at: http://www.nseindia.com/content/indices/ind_pepbyield.htm
. History has shown that whenever the P/E of the Index rises over 22, we are in for trouble.
I will not be seduced by trends.
It’s tempting for our brains to observe a high growth rate and then simply extrapolate this trend into the future, like what we did with real estate stocks. This has proved to be fatal, time and again. A fine example is the stock price of Infosys in year 2000, when it was trading at a price equivalent to 350 times the annual earnings per share, with high hopes that the company will continue to grow its earnings at nearly 100 per cent p.a. But we all know what happened, earnings did grow but not as high as expectations and today this excellent company is available at pretty much the same price as it was nine years back.
I will not salivate over companies making mega-acquisitions.
Acquisitions take many years to work and many of them fail. Buying a stock just because the company has made an acquisition is foolish. What one must stay away from are companies acquiring firms larger than themselves, by paying ‘cash’ and that too borrowed from the bank!
I will depend on “margin of safety” to protect myself.
The case for investment in a stock is based on the future performance of the company. But it’s hard to predict future performance. So the ways to hedge your bet are: A) never invest 100% of your cash reserve in stocks; B) buy stocks at minimum 30 per cent discount to the conservatively estimated intrinsic value.
I will not borrow to invest in stocks or invest in companies that have too much borrowing.
Investors and promoters who borrowed too much are either forced to liquidate their assets at dirt-cheap prices or stuck with loans worth much more than the value of underlying investments.
I will not take advice from salesmen.
Most people hesitate to pay for independent financial advice and as a result settle for advice from brokers without realising that there is an inherent conflict of interest because brokers earn a commission based on how much one invests, irrespective of the performance of one’s investment.
I will not speculate in IPOs.
Companies offer shares for sale in the public-market only when people are willing to pay extraordinary prices. That is why you witness maximum IPO activity during bull market frenzy and not in bear markets. There are many opportunities to buy stocks cheap; the IPO is not one among them.
I will not blindly follow FIIs.
During the heydays of 2007, private placement of shares by a company to FIIs would immediately take its share price to stratospheric levels. Today, many of the same stocks are available for a fraction of the price. Surely FII investment could be a vote of confidence for owning a stock, but not a reason to own it at any price.
I will learn some fundamentals before investing.
All of us work hard to earn our pay. But when it comes to investing the money we have earned, we choose not to spend even a fraction of the time. If you think your money is valuable, it is your moral responsibility to acquire at least the basic knowledge required for making and monitoring investments.
The writer, a research alumnus of the London School of Economics, is a finance expert. He can be reached at shyamscolumn@gmail.com or www.shyamscolumn.com
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