TEN GOLDEN RULES FOR INVESTING IN STOCK MARKET - PART-2

TEN GOLDEN RULES

FOR INVESTING IN

STOCK MARKET

PART.2

This (Part-2) is a continuation of the Golden  Rules for Investing. You can find the first Part by clicking on the URL Below :

http://wiseinvestmentideas.blogspot.in/2012/12/ten-golden-rules-for-investing-in-stock.html

Now- we will continue the rules 4 to 10 -

4.    SELECT THE PERIOD & PRICE FOR INVESTMENT :

There are certain periods which are better for Investment than other periods.

GO AGAINST POPULAR ACTION – is one cautious but wise Rule for Investors. When all others are selling and a share price is falling, it may be a good time for a long term investor to make his purchases of GOOD STOCKS  for the future.

CATCH THEM LOW – But never Wait for the lowest price to BUY.  The daily traders’ activities affect the daily prices in regular investors’ market too ; and not only the options and futures markets.

Likewise, foreign investors make BUYs and SELLS on more varied factors than local investors.

Therefore, a particular stock may rise or fall on a day to day basis within a certain range – unconnected with the company’s past performance or expected future performance. If a company is performing badly, consistently over last 3 years, still, its stock price may rise due to such factors on some days. Likewise, an excellent company’s stock may go down also, on certain days – due to such factors. If price of a Good stock goes down due to such factors – it is not time to get depressed – but time to buy it more if you can.

Do not bother about Bad stocks – whether their prices rise or fall.

Never buy any stock without reasonable Analysis – merely because others are Buying. Stock Buys should not be based on capricious, lightning decisions. It must always be based on analysis and informed opinion.

In certain periods, stock prices go to  VERY LOW  levels – not because of bad company performances, but because of other National and international factors. Most Investors don’t BUY then. The MOOD  is to sell. But, Investors who buy at such times make a GOOD KILLING later, when prices rise again.

Economies like India can never be down for all time to come. The economy moves up and market sentiment also invariably moves up. Then, company performances only will count. The CYCLICAL NATURE of GOOD TIMES vs BAD TIMES is most often forgotten by most investors during BAD TIMES. The Intelligent Investor moves for BUYING at that time – when prices are very LOW.

Between a GOOD TIME and BAD TIME, the price difference of the same company with same growth trend can be very huge – as much as 300% or even more.

While we do not forecast BAD TIMES for Indian Market, the general dictum BUY LOW always applies. It also means that, when market is at its HIGHS, you can relax and watch the market. If you have kept certain stocks for more than 10 years – may be, you can think of en-cashing them at such Highs partially.

Right now – in December,2012 - has the market hit its HIGHs? No. Not yet. This is the popular opinion. Since company performances are improving and are expected to improve further, and since Government performance is also expected to improve from now on – Good gains are predicted in 2013. Now, will this, or will this not materialize in 2013? This is where the RISK vs REWARD theory comes into picture.

The downward Risks are definitely LOW for 2013.

With a Pro-market Government in action, upward potential is reasonably bright. If the APPLE CART is not swung by CORRUPTION SCANDALS,  2013 can be a BIG YEAR OF LUCK for all medium / long term investors. The other factor awaited is RBI action  in 2013, in reducing the HIGH INTEREST RATES that are prevailing now. This will be a BIG PLUS for Market sentiment. The Assembly election slated for 2013 are not expected to throw up any major surprises. Either Congress of BJP will bag each state. Their Economic philosophies being same, Stock Market is not expected to react much whichever way, the results swing.

However, even within 2013, there will be periods of small LOWs in stock prices, and BIG HIGHS. These may occur at around the times of Assembly Election results and other permutations and combinations among Political Parties. The general graph is expected to be a steadily rising trend, with occasional, minor  corrections. Choose the period of small LOWs (or corrections) to make further purchases.

It is no doubt difficult to predict the small LOWs and Highs accurately. So, many experts, advise  monthly Investment Plans. Invest fixed amounts out of your income -  every month – in the stocks selected by you – and you will be averaging out your INVESTMENT COST thereby. This plan is based on the premise that you can never accurately predict the MOST IDEAL time to BUY. But, you can definitely select a GOOD STOCK  to buy. Combining the 2 premises, buy your selected stock, every month – and invariably when the prices are LOW. Even so, if your gut feeling says, prices are HIGH and likely to fall a little, WAIT for a while. If your GUT feeling says, the prices have fallen well, BUY immediately.

Over a period of time, Your GUT FEELING will become so good and accurate, that it proves right a lot of time. It arises from solid reasoning, even if you do not elaborately rationalize it.

Do not be in HASTE to sell a GOOD STOCK, when prices have risen. You must assess its future Potential – before you ever decide to SELL A GOOD STOCK.

Some people do BUY and SELL operations like trading operations. BUY today as prices have fallen, sell today as prices have risen, Buy again tomorrow as prices have fallen. You must factor into these BUYs and SELLS, the Brokerage costs and  the capital Gains tax on short term capital Gains that you have to pay – before you can credit yourself with precise TIMING OF THE MARKET.

If you are not yet an INCOMETAX PAYER, you can attempt this. But, if you are a Tax payer, especially in a higher tax bracket, better avoid such frequent operations. It is not worth it for you. Your small profits would be cancelled by the Big Tax you will need to pay.

5.    VALUE INVESTING vs GROWTH INVESTING:

These are two famous techniques of INVESTING for the long time. Good stocks can be broadly differentiated into VALUE STOCKS and GROWTH STOCKS.

VALUE STOCKS : These are stocks of GOOD companies whose current  Market price is less than its current true worth. How do we measure whether the price of a Good stock is below its true current worth?

Two often used metrics for this are -  Price to Earnings ratio and Price to Book Value Ratio.

These can be calculated easily. But, to start with, you can adopt the ratios calculated by Experts, which are available in many reputed web sites and Economic News Papers. If these two ratios are significantly below the INDUSTRY average – you can say it is a VALUE STOCK.

But, you still need to examine and determine, if this value stock is a GOOD STOCK for YOU to invest.

Price is usually LOWER  because, managements are not good enough, company’s past growth was not good enough, company’s future potential is not good enough and so many such valid reasons. Many a time, market has not assessed the FULL POTENTIAL of a stock’s future – and if you locate a good value stock of that type, you can invest in it.  Try to find such diamonds before the others do.

In developing markets like India, there are several such value stocks for value investing. You need to make your analysis well for the past 3-5 years to be satisfied that it is a GOOD, VALUE STOCK to invest. In each Industry, you can find a few such value stocks.

GROWTH STOCKS :  These are stocks whose PE ratio and PB Ratio may not be LOW, but whose growth curve over past 3-5 years and expected growth in future is much better than Industry average.

For instance, in Banking sector,  HDFC BANK is one such company. Its price is not LOW, but its growth curve in the past has always been far superior to the others in the sector.

In Pharma sector, traditionally PE and PB ratios have been very High, compared to other sectors. Growth Investors choose many companies in Pharma  sector since - diseases, drugs and drug companies are all expected to Grow very FAST in future. Pharma sector invariably caters to the whole world market – while most other sectors cater to limited markets within India or a little more outside. Therefore, you can find many value stocks in such sectors.

BLUE CHIP STOCKS :These are stocks of companies which have great resilience in weathering any storm and come out of it strong again. Generally, these companies have been in business for several decades, have seen several ups and downs, and have displayed extraordinary resilience in times of Ups and downs both. They command High PE and PB ratios for this reason.

Blue chip Companies also grow fast in their Industry – and their share price also is therefore expected to grow fast. Some Blue chips are MNCs with operations in many countries – like TATA STEEL, TATA Motors and so on. Their fortunes therefore depend on the combined operations of all their Plants in the world. In other words, their operations depend on international costs, international prices, international market environment and Political environment. TATA steel has been facing some heat in its international operations whereas TATA Motors has been a big beneficiary from its international Operations. TATA STEEL has always been a Blue chip, known for its efficient Indian operations. But, for investing in the company now – we need to assess the International steel scenario for the future. In respect of TATA Motors, both Indian and International operations have been good but international operations have been much better.

In general, all NIFTY 50  companies can be considered as BLUE CHIP companies.

There is no Guarantee that the price of Blue chip stocks will rise faster / higher than Growth stocks / Value stocks. Each has its own trajectory.

6.    PORTFOLIO THEORY OF INVESTING :

Should we invest in a single good stock or should we invest in a number of good Stocks? Should we put all of our Eggs (Money) in one Basket (one Company stock); or should we put our Eggs in many Baskets? If so, in how many baskets?

This is a crucial factor for every stock investor to understand. There are several RISK-REWARD theories – most of which advice that  we must not put all of our eggs in one Basket.

Do not invest all of your money in one single company – however good, the company may be.

Identify about 10 Good companies – one or two from each growth sector. This will spread your risks across several companies and several sectors  – and the downward risk will become very limited. If you have identified the Growth sectors correctly and the growth/value stocks in each sector correctly – no matter the errors you may have committed in such selection -  you are still insured to a good extent in respect of downward risk.

On the other hand, even if you have selected an excellent stock – if you invest all your money in it – you are subject to the likely exposure to many risks unknown to you.

Be aware – that there are always RISKS unknown to you. Such risks are classified into many varieties – and many risks are not in our knowledge and control. They can hit us at most unexpected times. Therefore, it is better to invest in about 5 -7 Growth sectors – and around 10 companies, with one or two from each sector. This is called Portfolio Investing. For example, Mining sector was a darling of all Investors for a long time – but, look where it stands today ! Scandals have hit the Industry hard – and it will take some time for it to recover from them. Steel, Aviation and Telecom sectors are all sufferers because of unexpected risks. They will take time to recover.

Therefore, it is strongly advised –not to put all your money in one single company stocks – but spread it across  5 to 10 in due course.

Why not more than 10? If you can watch many sectors and many companies effortlessly and simultaneously – you can invest in more companies too.

Mutual Funds do it generally. With their quantum of funds and the limitations on them not to invest huge funds in any single company – there is a compulsion on them to look for more companies to invest in. But, watch, which are the TOP COMPANIES  the Mutual funds invest in. You will know this from the percentage of their corpus that they have invested in various companies. This is usually available  in their web sites and some times published in the Economic News papers and by top MF analysts. These give you an idea on where the experts are investing.

Even if you identify 15-20 Great companies – it is still better to further make a final selection from out of your favorite stocks – and limit your final Investment to around 10 stocks, which you consider as the Best. This means, you are trying to maximize your returns – while at the same time, minimizing your risks.

7.    PENNY STOCKS :

Penny stocks are stocks available at low prices. They may be languishing at such low prices for several years. But, some Penny stocks, with the induction of a Good CEO or Chairman, may turn their fortunes to the better suddenly. Or, the introduction of a new product, a new marketing practice or some such event can trigger a  turn-around in their fortunes.

In a NORMAL, STABLE market, if their prices are rising, one needs to find out the cause for such rise.

But, in a Bull market, many Penny stocks also rise along with other GOOD stocks, in tune with the market, only to fall later to their deserved lower levels.

Penny stocks are especially fascinating for first time, smaller retail Investors. They invest in it – usually, without the much-needed  mental preparedness to lose the money also.

There are several Good reasons – not to invest in Penny stocks.

(i)           The floating stock in the market is so low that is very difficult to find BUYERS for your Penny stocks. You may not be able sell it when you want to .You can BUY; but you can’t sell!

(ii)          Information available on Penny stocks is very low

(iii)         Available info may not be reliable

(iv)         Demand for its products, the efficiency of its marketing etc – are uncertain

(v)          Many times, the reputation of its Management is so LOW, that any improvement in its product sales does not move the stock price upwards.

(vi)         The company may be facing many local disputes or Political rough weather.

All these are difficult for a retail Investor to know and understand. Therefore, it is better to avoid PENNY STOCKS – for retail investors.

When there are any numbers of GOOD VALUE/GROWTH stocks to choose from, why go in for stocks of uncertain reputation?

8.    HOLDING ON TO DUD STOCKS :

However scientifically you may choose, all circumstances and all risks are not in our knowledge or control. Change is the very essence of life – whether of Individuals or of companies. Some Great companies of yesterday – can also turn into DUD stocks today. This may happen due to various reasons. Telecom sector in India was a great investment 5 years ago. Today, it is facing an uncertain future. Many Policy decisions are either Bad for the Industry or leading to uncertain future. Aviation Industry may look glamorous to others; but is in deep troubles as far as stock Investors are concerned. Mining Industry was a darling of the Past, but, presently facing uncertainties. Steel Industry is also facing problems worldwide. Auto Industry is in good health right now ; but is at a crucial stage – where it needs momentous technology, marketing and expansion decisions. Textile Industry needs re-orientation. So, every Industry has some factors knocking heavily at its door.

Companies not recognizing their future challenges and not preparing for them turn into DUD STOCKS. Satyam Computers turned into a DUD stock at one time, thanks to its own management. But a changed Management has succeeded in bringing it out of the problems albeit slowly. Global Trust Bank became a DUD stock – and got merged into another Bigger Bank.

 We have said earlier that you must select 10 good companies of 5 – 7 good sectors – with promise of future growth. But, having done that, you must periodically watch – what is happening to the sector itself and within the sector, to your specific company.

This periodical review, at least once in a month, is essential for all of your stocks. If you have time, review it as often as you can. If at any point of time, you feel, a particular stock is likely to face rough weather in future, and its sales / profits are likely to suffer very adversely, take the TOUGH DECISION of reviewing whether to SELL IT.

 You are not in the business of stock investing, out of compassion or sympathy for the companies. You are in it – for your PROFIT. No other motive. If you do not foresee any Profits in future or, you foresee losses in a particular company – it is time to get yourself out of your investment in it. It is likely that you are not the first to have spotted the trouble. The share price may already be hurtling down fast. This downward trend is not to be confused with the periodical Highs and Lows in a normal market.

Suppose, the market is normal. But your stock is not normal. And, you know it.  When you do – do not any more hope that it will some time later, come out of the problem and go up again. It may or may not. Satyam has never climbed to its past peaks even after the new management has taken over. It is no more a Dud stock. But, it was one, before the new Management took it over. Original Investors should have got out of it – in time. The incurring of loss on your investment – must be seen actually as  CUTTING DOWN YOUR LOSSES at current levels. Sell the DUD stock and go for the stock of another value / Growth Stock.

In stock Market especially, Lord Krishna’s Gitopadesam comes in very much handy. Do not rejoice too much in your  profits of today. Do not also despair in losses. In Gita, Krishna calls it the mindset of a Sthitha Prajna.

Take all precautions, but be prepared for occasional losses. You can always recoup all such losses in future Profits. There is always another, Brighter Day – for a long term Investor. Over all,  days of depression are much less and days of brightness are much more. That is how, life in stock market runs. Therefore, do not despair the losses in a dud scrip. Get rid of it; and go for tomorrow’s stars once again. The only rule in respect of DUD scrips is – Get rid of them as fast as you can – after identifying them as DUD Scrips.

Likewise, sometimes, you may identify an excellent scrip with fantastic future potentials, at a low cost today.  Out of the 10 scrips already in your portfolio (all of which are good scrips), identify the one with least Potential. Compare it with your new find. How do they compare? If the New scrip you have discovered is far superior than the one in the Portfolio, sell that one in the Portfolio and with those funds, acquire the one with better Potential. At some point of time, your Portfolio will stabilize with 10 scrips – you like most.

9.    INVESTING IN LIFE vs INVESTING IN STOCK :

Stock investment is intended to enrich the quality of your life and not to downgrade it.

Therefore, never invest more funds in stocks than you can afford.

Never take loans to invest in stocks.

Never use your credit card to get money to invest in shares.

Always keep sufficient money aside for some unforeseen financial Emergencies.

There is always a Dilemma on how much cash is sufficient for such emergencies.

You can encash your good scrips within 4 days flat when a need arises. So, provide for at least 4 days emergency requirements.

Always lead a Good Quality of life – free from financial stress.

Beyond that -  invest your surplus money in stock market.

Should you first go for an Insurance Policy; or a House; and then, invest in stocks?

This question also haunts many investors. This depends on your RISK PERCEPTION – Plus your dependents and their needs.

Too much Insurance is – providing for too large risk, which rarely exists. A reasonable amount of insurance –especially health and accident insurance is handy.

If you are unlikely to reside in the house in the foreseeable future, investment in house property is not the best option. Guarding the house, periodical repairs, paying taxes, finding good tenants and dealing with them are all botheration you can avoid. There is no doubt that house value appreciates. You must always compare the appreciation in value with the amount you are spending on maintenance, repairs etc plus, the botheration of dealing with tenants’ demands. Also, do you have enough money on hand to make your house purchase, or, do you go for Bank loans for it? In such a case, the interest costs and the resultant lesser Income for the period of recovery of the principle and interest must also be considered.

Invest in a plot of land where you are likely to need a house and keep it secured.

But, if your surplus income is small and your saved wealth is not enough -  Go in for stock Market investing as a good, steady investor. Many times, you will find yourself accumulating sufficient surpluses from sock Market for buying a plot of land or even a flat after a few years of Investing.

Stocks, Insurance, Land or Building, wherever you are putting your money in – ensure that your quality of life today is satisfying to you after the investment.

Do not BUY a better TOMORROW at too much sacrifice in the present.

Tomorrow’s Life’s worth is much less than that of your today’s Life’s worth.

More money tomorrow may not be able to compensate for Today’s loss of life’s comfort and pleasures.

Yet, tomorrow also has a great worth in our life. A person who secures his future can and does enjoy his present with much greater confidence and hope. In other words, Life is a TRADE-OFF between present and future. Strike a balance between the two.

It simply means – do not buy shares by selling your LAST SHIRT. It is not worth it.

Invest only the amount that is really surplus for you – or by postponing expenditures that are worthy of postponing.

Every day of your investing Life – question yourself – ARE YOU HAPPY?

Stock prices keep on changing – every Minute. They go up and go down. If you can see constant change anywhere – it is in stock market prices. These changes are of not much consequence to you – as long as your company is performing well in its product introductions, sales and Profits.

A stock investor must be willing to remain happy – when stocks go down for even prolonged periods of time – because, at the end of the tunnel, THERE – IS – LIGHT. All these good stocks will again go up. Life is like that in the stock market.

10.    WHEN TO GET OUT OF THE MARKETS FINALLY :

Never. Till the last breath, remain in the market. It is a great, hilarious game of gains and losses. A Tendulkar may have to retire in his thirties. A CAG may have to retire at 60. A ManMohan Singh may have to retire in his seventies. But, you don’t have to retire  till the last day of your life.  If you want to know, this one game keeps you mentally agile and healthy till the very end of your life. Even on the last day, you can still click BUY on a GOOD stock, tell your spouse / children, chat with them, and tell them Good BYE. They will be happily sorrowful. Is this an addiction? No. It is a healthy habit and a hobby. You can pursue all of your other life’s ambitions and goals – you can even be spiritual or artistic or indulge in politics or social service – or spend great time with family and friends periodically. Stock Investing enhances your life’s possibilities and does not reduce it in any way.

So – let us all welcome 2013 – as the best ever year for the stock Investor.

Happy New Year to all readers.

=Yours

(V.Vijayamohan)