Guide for Investors

Golden investment rules!


As the Indian stock markets move into uncharted waters, and stock prices move under a cloud of volatility, it is time for small investors to step back and take note of some of the key rules for safe and defensive investing.
In these times, the rules spelt out by the legendary investor, Benjamin Graham, should come in handy for 'defensive' investors, or those who are risk-averse in their investing habits.
A defensive investor is one who generally places high emphasis on the safety of his capital through avoiding serious mistakes while making investment decisions.
Also, a defensive investor is one who aims at freedom from effort and the need for making frequent decisions.
In these volatile times, thus, such an investor should keep some benchmarks for himself while selecting his portfolio of stocks. Only this would be of help in his need for making less frequent decisions.
These are some of the characteristics that a defensive investor should look at in a company, or the potential investment target(s).
1. Adequate size of the enterprise: This is one of the most important factors while selecting a company for investment. Investors should note that small companies or those that are in the nascent stages of their development are more likely to have a volatile future than bigger corporations.
While an aggressive investor would have interests in such small yet growing companies, this should not be a defensive investor's cup of tea. He should be content in having large and strong companies in his portfolio.
2. Sufficiently strong and stable financial condition: A sufficiently strong financial condition of a company should be another top priority for defensive investors.
They should make sure that their investment target (company) has a strong balance sheet and profit and loss account, and a very strong cash flow statement. This is because, more than book profits, it is the strong cash position that is of help for the company in times of pressure and uncertainty.
Also, for a company to be a sound investment target, not only should it have a history of decent earnings growth, but also stability in the same. A company with a volatile earnings growth history is more likely to be a risky proposition.
3. Dividend growth: A consistent dividend payment record is another indicator of the sound financial position of the company. While there might be instances when a growing company is ploughing back earnings towards future growth rather than paying large dividends, investors must see that there are no grave inconsistencies in dividend payments.
4. Moderate P/E ratio: A moderate price-to-earnings ratio is a very useful indicator for a defensive investor. This is because a relatively lower P/E would save investors from paying a very high price that does not justify the value of an investment.
Also, a history of moderate or less-volatile P/E's also helps the investors' cause. This is because a company that has had volatile P/E's in the past is a case of investors building up 'irrational expectations' of its growth.
5. Management quality: Apart from these performance parameters, investors should also take note of the 'management quality', its vision and the past track record.
6. Do your homework: All said and done, while the rules mentioned above are benchmarks that every defensive investor needs to apply before making any investment decision, the fact that he should do his homework carefully should not lose relevance.
This means that he should research well about the company's history, its business model and factors that are likely to affect its future performance.
7. Long-term view: Also, the investor should have a long-term (more than 3 years) investment horizon for this maximizes the chance of garnering adequate return on investments







The golden rules of investing



The Sensex is on fire, notwithstanding Wednesday's dip. It's a bull run like no other witnessed by Indian investors. And investment gurus -- like Marc Faber -- say this bull run could last for a decade or more!
While it is time to rejoice at the booming Indian economy and the historical journey of the Sensex, the foremost question in the minds of all small investors -- like us -- is whether it is the right time to buy or sell stocks now.
So what does the layman do in times of a roaring bull market? Are there any rules for you and me to follow while dealing in the stock market? What should you avoid doing? And, more importantly, what should you do?
Of course, there are some golden rules that you must follow. And these have been culled from a variety of sources: writings by investment gurus, articles in newspapers like Business Standard and Web sites like Equitymaster.com, opinions of brokers and analysts and a whole lot of others who have learnt the art of investing the hard way.

So here are some golden rules of investing to follow, especially in a bull market:
1. Don't be greedy: Do keep in mind that it is not always that you would be able to buy a stock when it is as its lowest price and sell it when it is at its highest. Do not be greedy. Invest smartly, with some professional help and some study on your own.
2. Avoid 'hot tips': Stay away from 'experts'. There are a large number of so-called experts floating all around. Stay away from them. Your broker, neighbors, cousin or business journalist friend may suggest surefire picks. Success may not come as fast, as we are in unchartered territory. Use your own judgement.
3. Avoid trading/timing the market: Like in the previous point, don't try to time the market by betting on when the stock price will be highest or lowest. In most cases, such 'timing' leads to huge monetary losses and mental tension.
4. Avoid actions based on sentiments: Don't be emotionally attached to stocks: Some people -- for sentimental reasons -- tend to stick with certain stocks even though they might not bring them good value. Sentiment can be for a variety of reasons: your late father had bought the scrip and you wish to keep it; you had yourself betted on a company's stock thinking it will do good but are now too egotistic to accept your mistake can retreat, etc.
5. Don't panic if the market drops: Be patient and hold on to the scrip until some semblance of sanity prevails in the market. Don't rush to sell the stock. Hold onto your winners and sell your losers. Consult a professional and then act accordingly. Don't let a drop in the stock market alter your long-term investment plans.
6. Stay invested, possibly continue to invest more: It is natural to book profits with the markets at higher levels. This should be done, but we suggest people should also stay invested in the equity markets. Indian stocks do not appear overstretched at present, considering that average price/earnings ratios -- a common measure of value -- were around 15-16 times.
7. Buy stocks if there is a 5-8 per cent drop in the market: In this bull market, a 5-8 per cent drop in prices offers you a good opportunity to buy scrips.
8. Avoid checking the price of stocks or mutual funds after you've sold them: The grass on the other side will always seem greener and can rarely bring you happiness.
9. Try to avoid penny stocks: While doing your research, attempt to understand which the company is and what it does. Value picking may score above growth picking at this stage. Do not be tempted to buy penny or mid-sized stocks at this stage, envisaging a huge windfall.
10. Diversify: At these record levels, there will be certain amount of risks. We suggest you diversify a bit, looking at stocks, mutual funds, commodities and gold (for a longer-term). If equities are your favorite, we expect you would be able to pick up some of these stocks again.
11. Don't commit large amounts of money: Even if you have a strong risk-bearing capacity, we suggest you do not commit large sums of money at this stage. A sharper correction would just leave you bleeding more.
12. Don't trade for short-term: In line with the stay-invested mantra, do not be completely target oriented. 8,000 or 9,000 are not sacrosanct levels. It is more important to be stock-specific, keeping an internal value for the stock.
13. Don't expect to be a millionaire overnight. Patience pays, so be realistic.
14. Stick to the desired asset allocation: What's asset allocation? Well, the combination of the types of investments you have made within your portfolio is your portfolio's asset allocation. A diversified portfolio consists of equities, mutual funds, real estate, bonds, etc.
Asset allocation is the key to successful investing, say experts. Even though equities may outperform debt substantially, it will not be wise to put all your investments in equities.
Investors should allocate assets among various asset classes - primarily equities and debt - based on their risk appetite. Being overweight by about 10-20 per cent in equities may be justifiable, say fund managers.
In other words, if you are advised to allocate 20 per cent of your investments into equities based on your risk profile, you could consider a maximum exposure of 40 per cent currently given that equities are poised to surge ahead.
14. Distinguish between stocks for keeps and trading: When you buy a stock, be clear about your objective behind the purchase - whether you have bought the stock as an investment or a trading bet. Trading stocks are not bad as such. But they require you to work harder and act quicker.
Buy with adequate margin of safety: That's where attractive purchase prices can help. As a matter of fact, selling stocks is no different from buying them. Keep a sufficient margin of safety when buying a stock and don't rely on making a good sale ever.
15. Sell when value is realized: Some stocks may rise sooner than you may have anticipated. In a frenzied bull run, investors may see their target prices being met in a matter of days. Here time should not be of any consequence.
If you feel that your investments are adequately valued, you should exit regardless of how long you have held them. There are times when stocks begin to quote at extraordinarily high levels within a short period after you have invested in them.
Although investors are often advised to invest for the long term in equities, if you get extraordinarily high returns within a short span, it is wiser to get out, say experts.
16. Keep a watch on relative valuations: The real cost of a stock is not the price you pay for it, but the opportunity cost of not putting your money in another stock with a greater potential to rise. Let's say you hold a smaller pharma company and find that a larger one is also available at the same multiple. It may make good sense to switch. A larger company, with more liquidity and visibility, will be preferable.
While buying a stock most investors look to buy the cheapest of the lot. Indeed, that is the right approach. However, it may not be a good idea to buy a stock just because it is cheap in relative valuation terms.
When stocks become overvalued there is little logic in holding on to them just because they appear cheaper than others.
17. If you realize a mistake, exit: Even while we are talking about selling stocks in a bull market, experts emphasize that if investors make mistakes, they should exit immediately even at a loss.
If you realize your analysis was flawed or that you got carried away for any reason, it's good to get rid of a stock as soon as possible. Waiting for a better price at such instances may prove to be quite dangerous.
18. Start investing early.
19. Try to invest in things you know.
20. Try to adopt a long-term perspective with regard to investing.
21. Know your risk: It is critical to understand where you stand and where you want to be. What level and amount of investment are you comfortable with, regardless of what market experts tell you? Therefore, take some time to evaluate your risk-bearing capacity. This is a golden rule that should be applied at almost all times.
22. Play safe, invest in a mutual fund: For those who are still not sure about their research, we suggest you invest through a mutual fund. The advantages would be the risks would be minimized and you would stay invested for a longer-term in equities.
23. Encash when stock prices dip: We reiterate it is important to bring some money home, when you have made profits in earlier times. We expect a correction to take place, which could be in the range of 300-500 points. Considering that you would stay invested in equities, we advise that you encash at each dip of the Sensex. The short-term trend will be stock specific.
24. Don't blindly follow media reports on corporate developments, as they could be misleading.
25. Don't blindly imitate investment decisions of others who may have profited from their investment decisions.
26. Don't fall prey to promises of guaranteed returns.


Golden rules for investment in equity

INVESTING in shares and debentures is risky business and requires continuous monitoring of one’s investments. This monitoring not only takes time, but also requires a fair bit of knowledge of financial terms and understanding of the changing economic environment within which the companies operate. Equity market investments typically yield high returns, particularly if invested over longer periods of time, although such investments are characterized by a high degree of price volatility in the short term. The returns generated by holding a diversified portfolio in India — such as the BSE Sensex — from 1985 to 2000 is a CAGR of over 17.5 per cent. But the BSE Sensex index has been very volatile during this period, going through many cycles of peaks and troughs that investment in equities has dismayed many in the short term, but if executed in the framework of the 10 golden rules outline below, may help in better choices.
Identify objective
Identify your objective, given your needs, life stage and resources. If you want to increase the value of your investment in order to have a larger sum to spend at a later date, your main priority will be capital growth.
Identify your risk tolerance
Young people at the start of their working lives will have a greater appetite for taking financial risk as compared to people at the end of their career who are looking forward to stable income and preservation of capital. These two extremes will exemplify the ability to take equity exposure. The young person is likely to be largely in equities for he can afford to take short-term capital loss in anticipation of higher rates of return from equities. The elderly will be unable to take the risk of capital loss even in the short term as their ability to make back any losses will be limited by time and ability to earn.
Middle-aged people will balance their investments between capital growth and some capital preservation to take care of near needs such as children’s education and consumption.
Categorize stocks
Investing in cyclical stocks, such as those in the cement or steel sector, requires an understanding of the economic scenario, both national and global. An active involvement in the investment is required in order to reap the maximum benefits of swings in economic cycles over time. The stock prices are likely to move through extreme highs and lows, and the ability to time entry and exist will be necessary. Growth investing refers to stocks in sectors where the future direction is clear for the medium term-such as technology. However even here, timing is key, for the stock may do nothing for a long time as momentum builds up and then move sharply thereafter. Defensive investing is that which is done from a long-term viewpoint, where a stock is held on the premise that it will grow consistently and on a sustainable basis over time, such as those in the fast moving consumer goods sector. While the appreciation may, at times, not be as dramatic as cyclical or growth stocks, stocks that constitute defensive investments grow steadily over longer time periods.
Check out technical position
Can you actually sell your investment when you want to? The liquidity of a stock is very important in taking an investment decision, for if there is very little free stock available in the market, buying and selling may well impact the stock price in an adverse manner. It is interesting to see what the price volume relationship is for a stock. So if a stock price is moving up or down on high trading volume, it is more likely that there is real interest in that price movement than if there is very little volume supporting the price move.
Know what the company does
The fate of each stock is tied inextricably to the fortune of the underlying business, and the market’s perception of the future prospects for that business. The industry’s future potential in terms of projected demand-supply is key as is the company’s competitive position in the industry. The business model of the company should be considered, as well as possible future changes, and the ability of the company to sustain growth and momentum well into the future.
Who runs the company?
To my mind the capability and integrity of management is even more important in determining the future viability of your investment. A strong, credible, experienced and shareholder responsive management team is critical for operating and growing a successful company. In the newer areas of our economy, management vision is also of significant importance.
Company’s performance
The price earnings (P/E) ratio is the often-quoted measure of a company’s value. This ratio divides the stock price by the year’s earnings, and is useful in arriving at comparative valuation. But the tool that is quite prevalent in professional evaluations is the return on equity (ROE), which is the year’s earnings divided by the net worth of the company. This when compared to the cost of capital for the company allows the investor to gauge the company’s wealth creating ability. Apart from the ratios the investor must also focus on the sustainability of earnings growth.
Company’s valuation?
Two stocks may have the same ESP but different PE’s. This is because ROE may be different and its sustainability may be different. Broadly speaking, the higher the sustainable ROE, the higher the P/E rating. A high P/E does not therefore necessarily imply an overvalued stock. Stocks with high sustainable ROE’s are likely to trade at high P/E multiples.
Know the price target?
Having completed rule 1 to 8 above, and having selected stocks and built a portfolio, it is now imperative to track these investments loosely. One method of doing so is to set expectations, by identifying a target price, and to re-evaluate the stock when this target is reached. Here, it is important to consider opportunity costs. If there is a loss on a stock, should one realize that loss and invest in another stock, which has a greater potential, or should one wait for the loss to turn into a profit. By not selling out of low return stocks to get into higher return stocks, investors miss out on opportunities.
Do you want a professional manager?
Many investors mistakenly assume that they can purchase one or two stocks and they will do well. In the absence of good luck, this can be a dangerous strategy since there is always a risk of a stock declining in value or the business facing company specific problems. The more diversified the portfolio; lower is the risk of one poorly performing stock affecting overall performance of the portfolio. However, a good way of diversifying the portfolio is to invest through mutual funds where the professional fund manager and the rigorous investment process is likely to limit risk while maximizing profit, depending on the risk profile of the fund invested in.