Sunday, April 26, 2009

Stock Market: Act like Poor to Become Rich

The world as a whole has to be thankful that we have witnessed one of the worst crises (Crisis) in history without which, the act of unjustified greediness by investors would have continued for more years. The situation was not different with general population either. People spent money on luxury things far more than what they were capable of while the situation warranted economical prudence. I wondered who all survived this crisis and the answer is relative rather than specific as most of us survived except few suicides. But, some people managed the situation better than the rest and I would like to draw a parallel between this general life and stock market.



India has managed this recession better than most of the countries purely because of the saving mindset cultivated from childhood and also the conservative strategy followed by corporate world. But in US, a person with even $35,000 income went for 3 bedroom single home property and even worse is on the part of the banks that financed him charging higher interest rates without dwelling much on the repayment capability. Any man with a common sense would tell that the lower income people should be provided loans with lower interest rates but I still fail to understand the logic behind the US banks charging higher interest rates from low income group. I of course know that charging higher interest rates to low income people would prevent them to approach a bank for financing. But if it is not working, then there should be some alternate strategy which US banks lacked and still they do. As you know, getting a loan in India is not that easy and definitely not as easy as in US. The result is there for everyone to see that Banks survived and people survived too.

People who continuously saved some money and lived decent but economical life, have not only managed to survive but managed to live as normal as ever. Those who went for luxury beyond their financial capability failed miserably and no wonder all those who committed suicide have lived in 5 bedroom luxury villas. But what is the parallel here? Why I am talking about all these in a stock market blog?
We give so much importance to quality and the price in almost all the things we buy whether it is buying a home or car or vegetables or anything for that matter. But do we give the same importance while buying stocks? I do not think so if the recent rally is taken as an example. I am not saying that buying now would be a mistake as prices are still lesser than what it was one and half years back. But I am just asking why we did not buy when the prices of the stocks were lesser than what it is now? It seems people are ready to buy even a cup of garbage if there is a rumor that it would turn as gold in few years.

Buying stocks at lower prices not only gives you better returns but also protects you from capital loss. SENSEX was around 8000 in the First week of March and I was compelled to buy stocks because of the valuation and was even compelled to post an article with best stocks. I posted “Best Indian stocks for Long term investments” on March 14, 2009 and here is the link for that.

http://www.stockanalysisonline.com/2009/03/best-indian-stocks-for-longterm.html

Majority of the stocks have returned more than 30 % returns and some of them giving more than 50 % returns. I also posted another post with “Best Small cap stocks” on March 18, 2009 and the link is given below.

http://www.stockanalysisonline.com/2009/03/best-small-cap-stocks-india-2009.html

Majority of the stocks listed in the above link has given more than 100 % returns and it is unbelievable. The mid and small cap stocks have given extraordinary returns in this rally in such a short time. How many people bought stocks when the SENSEX was around 8000? If you ask me, Yes, I bought some but not enough to tell you that I have achieved something in stock market. But I am happy that I bought something at least. So, my point here is, why people show due diligence in price while buying household and other articles but do not show same kind of prudence in buying stocks? When people go out for shopping, they try to reduce the price as much as they can but not in case of stocks. I do not know if people would have avoided buying if there was a furniture or cloth sale with 1/8 of the price. Stocks were so cheap and many small and mid caps were available at 1/8 or 1/10 th of the price a year ago and most of the retail investors avoided it. People can ask if there was no buying then how the market went up. Market went up not because of retail investors but because of Mutual Funds, Insurance companies and Institutional Investors. May be the retail investors who bought mutual funds exactly in the first week of March, 2009 would have benefited to an extent but definitely not to an extent of what they would have got if they had bought stocks during the same period.

So, here is my rule number one.
Rule 1: Buy stocks (Of course good companies) without any hesitation whenever market is unjustifiably low. If you are in doubt, just ask yourself if you would buy cloths or furniture or laptop or house if the price is lowered 1/8 th or 1/10 th of the original price. If the answer is yes, then you should go ahead and buy stocks whenever it is available at extremely low prices. In essence retail investors should act like poor while buying stocks. If you act like poor and buy stocks, only when it is available at extremely low prices, then I do not think there is any need for analyst advice or recommendation. You just need the guts to do that.

Reason:
1. Extraordinary profit when the market is up.
2. Limited downside potential.
3. Some protection even if you have bought bad stocks.


Recent Rally

It is true that SENSEX has moved 40 % higher than what it was 6 weeks back. I feel that’s more to do with abundance of cash with fund houses and institutional investors rather than any fundamental difference in the economy. We are still getting bad news around and companies are still posting average quarterly returns with poor future guidance. Unemployment is still raising and housing market is still getting worse. Credit card default is mounting. But why the heck stocks markets moved up so fast? Of course some companies have exceeded market expectations but those are exceptions rather than rule.
I have a feeling that the market has gone up so fast and it is not a healthy sign. If the market has gone up in a measured way, then we can be sure of its upside. May be a 20 % upside in such a short time would have been appropriate given the future economic growth expectations. But 40 % in such a short time does not offer any clue to retail investors about upside or downside. Moreover it gives false hope to people and retails investors start buying after mutual funds and institutional investors create almost an artificial upside in the market and eventually they stand to lose money when the market pulls back to healthy numbers. I might be wrong here and markets might move up continuously from here on and I even wish so. But over heating market always destined to get cooled off and investors have to be at least cautious if they can’t resist buying at the peak of a rally like this. So, here comes my rule number two.

Rule 2: Do not buy stocks if the market goes up (Rally) too quickly in too short time. If you can’t resist buying in the rally, at least be cautious and safeguard your investments by investing in good stocks that has not over heated. Buying at the peak of rally might minimize the net returns over the long term.

Reason:

1. To safeguard the investments from a potential fall
2. To Maximize the net returns in the long term
3. Some protection from buying artificially inflated stocks

Earnings and Economic Outlook - March 2009

Many companies have announced the quarterly results and overall the results have been mixed. Some companies have posted very good returns and some companies have announced average returns. But when compared to other countries, Indian companies have done really well and the economic outlook with respect to India looks good.
Had Infosys, TCS, ICICI and Reliance announced the similar kind of numbers just for sake two months back, SENSEX would have gone even to 7000 level. Since the market sentiment has improved, average and even bad results do not have much impact on stock prices. Stocks are moving higher and higher even with poor guidance and thats what happens when the sentiment is positive. But considering what the corporate world is experiencing around the world, Indian companies have done remarkably well. Overall economic outlook for India looks positive and any significant downside in the market from current levels (11300) should be a buying opportunity.
Kumaran Seenivasan

5 comments:

jamesvaikom April 26, 2009 at 12:20 PM  

Sir,
Great article. My view is most of the fearful investors who sold their holdings during october crash have returned to the market during current rally. When market start falling these investors will sell their holdings at through away prices. Most retail investors trade by watching technicals and they don't look at fundamentals. These people don't know the fare value of the stocks or identify false breakouts.

Shabu's April 27, 2009 at 2:25 AM  

Dear Kumaran,

Nice and worthy article again. Investors still learn to buy while others are in fear. Current buyers, especially short term traders will the worst victims, if another crash occured. Long term investors can still accumulate gradually in every major dips.
regards

Anonymous,  January 17, 2010 at 4:30 PM  

This is a celebrated article as they all are. I bring into the world been wondering nearly this for some beat now. Its notable to note down this info. You are fete and balanced.

Anonymous,  August 19, 2010 at 6:30 PM  

i'm new... hope to despatch round more often!

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