Warren Buffett's Complete CNBC "One Year Later" Interview - Transcript and Video - Warren Buffett Watch - CNBC.com
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10 years ago
Wednesday, September 16, 2009
Sunday, September 6, 2009
Evaluating a company's stock price
When we are talking of the price of a company's stock we are normally referring to the price at which the stock is traded at the exchanges. This is the market price. That stock prices fluctuate wildly is a common knowledge. To be sure, such fluctuations, which we call volatility, attract a certain type of people who attempt to profit from rapidly fluctuating prices. Whether they are able to make a profit is a different matter though. For most, however, taking a decision on what price to buy a stock at, is truly vexing . A company may have a great business and its future is likely to hold tremendous profit potential but if its price has already run up substantially, investing at that price is not likely to be a good investment. What then is the right price to buy a stock. For that let's get familiar with what are the different ways we ascribe a price to a company's stock.
The first is the face value or the par value. This is linked with how the company raises its capital which is the money for starting and running the company. Apart from the promoters of the company putting their own money companies also raise money from the public by selling certain number of stocks . The money thus raised is the equity capital . Companies also borrow capital. The proportion of such borrowed capital to the total and also its relation with the equity capital is a matter of choice of the financial planners of the company. The equity capital divided by the number of stocks offered gives the face value. In practice though this is a convenient round number and the number of stocks is calculated on the basis of the face value so fixed to arrive at the required equity capital.
So is it that the face value or par value is what the stock price ought to be. No, actually the face value has nothing to do with the market price. This is because as the company carries on with its business over time it accumulates profits which go into it's reserves and so the stock of the company has a greater value than the face value which the market aptly recognizes by paying a higher price. Another example would be of a company distributing dividend twice the face value. Dividend yield in such a case would be enormous if one pays the face value to acquire the stock. The market price therefore assumes a higher value to bring the dividend yield to comparable levels. The reverse could also happen . The company could be making losses year after year. Instead of accumulating reserves it could be eroding its net worth. Markets then would not pay even the face value of the stock and the stock would quote below par value.
If the face value is not at all a correct indicator of price because of subsequent changes in the company's worth, what if the reserves are added to the equity capital to arrive at a workable value. Such a value is the 'Book Value' which is obtained by dividing the sum of the equity capital and the reserves by the total number of stocks subscribed. But relying on the book value has its own limitations. As mentioned, book value takes into account the reserves accumulated over the years in the past and can be of little use in forecasting future profits. Book value being balance sheet based does not reflect any appreciation of assets which continues to maintain original valuations inspite of the market price of the assets having gone up. It has been seen that prices of good companies invariably quote higher than the book value. Another criterion namely the ratio of price to book value (P/V ratio) is a little more useful. An important characteristic of this ratio is that it remains more or less constant and remains close to the average value over a period of time. This is a valuable tool in the hands of the investor. Any increase in the ratio would indicate that the stock is overpriced and vice versa.
If there is any criteria that has the most dominating influence on the price of a company's stock is its earnings, so much so that markets start paying higher prices merely on anticipation of higher earnings. This is the Price to earnings ratio (P/E ratio) where the earnings are taken to be earning per share (EPS). Like the P/BV ratio it also tends to remain around it's average value over a period of time and any deviation from the mean would indicate whether the stock is overpriced or underpriced. But it scores over the P/BV ratio because it is able to capture the opinion of the market as regards the earning potential of the company. Such is the halo of the P/E ratio that it sometimes runs into several hundred signifying an inordinate price in relation to its present earnings which may not have started coming in. Companies in gestation period fall in this category. But here also there are limitations. Accepting a high P/E multiple enhances risk. Further when earnings start coming in for a company which was in gestation, the P/E multiple can actually fall to comparable levels. It therefore follows that buying a high P/E stock does not necessarily give high returns on investment . It can be a bad investment also.
It therefore is difficult to ascertain whether the market price of a stock is appropriate for investing by using any single approach mentioned above. But inspite of their limitations these criteria when taken together nevertheless offer a reliable way to answer the question "Is the price right". The right price has to reflect not only the present but also the future. For that both the P/BV ratio and the P/E ratio when taken together becomes more powerful than any single approach for evaluating the price at which investment can be made in a company. This is done by calculating the mean of the average P/BV and the average P/E. This is the 'Intrinsic Value'. Buying at a price close to or less than the intrinsic value will give the investor a maximum return. Average for both can be over any number of years depending on the time frame of the investor keeping in mind that the greater the period, longer will be the time frame of the investor which in turn should give better return.
One final point though. It is to be kept in mind that the intrinsic value should reflect future earning potential of the company. It means that by estimating the intrinsic value we are trying to forecast the possible price appreciation in future. This also encompasses the objectives and expectations of the investor. Towards that end using other forecasting techniques to project a company's future earnings alongwith investor's own judgement greatly enhances the accuracy in finding out if the stock is reasonably priced.
Till my next then
Happy investing
The first is the face value or the par value. This is linked with how the company raises its capital which is the money for starting and running the company. Apart from the promoters of the company putting their own money companies also raise money from the public by selling certain number of stocks . The money thus raised is the equity capital . Companies also borrow capital. The proportion of such borrowed capital to the total and also its relation with the equity capital is a matter of choice of the financial planners of the company. The equity capital divided by the number of stocks offered gives the face value. In practice though this is a convenient round number and the number of stocks is calculated on the basis of the face value so fixed to arrive at the required equity capital.
So is it that the face value or par value is what the stock price ought to be. No, actually the face value has nothing to do with the market price. This is because as the company carries on with its business over time it accumulates profits which go into it's reserves and so the stock of the company has a greater value than the face value which the market aptly recognizes by paying a higher price. Another example would be of a company distributing dividend twice the face value. Dividend yield in such a case would be enormous if one pays the face value to acquire the stock. The market price therefore assumes a higher value to bring the dividend yield to comparable levels. The reverse could also happen . The company could be making losses year after year. Instead of accumulating reserves it could be eroding its net worth. Markets then would not pay even the face value of the stock and the stock would quote below par value.
If the face value is not at all a correct indicator of price because of subsequent changes in the company's worth, what if the reserves are added to the equity capital to arrive at a workable value. Such a value is the 'Book Value' which is obtained by dividing the sum of the equity capital and the reserves by the total number of stocks subscribed. But relying on the book value has its own limitations. As mentioned, book value takes into account the reserves accumulated over the years in the past and can be of little use in forecasting future profits. Book value being balance sheet based does not reflect any appreciation of assets which continues to maintain original valuations inspite of the market price of the assets having gone up. It has been seen that prices of good companies invariably quote higher than the book value. Another criterion namely the ratio of price to book value (P/V ratio) is a little more useful. An important characteristic of this ratio is that it remains more or less constant and remains close to the average value over a period of time. This is a valuable tool in the hands of the investor. Any increase in the ratio would indicate that the stock is overpriced and vice versa.
If there is any criteria that has the most dominating influence on the price of a company's stock is its earnings, so much so that markets start paying higher prices merely on anticipation of higher earnings. This is the Price to earnings ratio (P/E ratio) where the earnings are taken to be earning per share (EPS). Like the P/BV ratio it also tends to remain around it's average value over a period of time and any deviation from the mean would indicate whether the stock is overpriced or underpriced. But it scores over the P/BV ratio because it is able to capture the opinion of the market as regards the earning potential of the company. Such is the halo of the P/E ratio that it sometimes runs into several hundred signifying an inordinate price in relation to its present earnings which may not have started coming in. Companies in gestation period fall in this category. But here also there are limitations. Accepting a high P/E multiple enhances risk. Further when earnings start coming in for a company which was in gestation, the P/E multiple can actually fall to comparable levels. It therefore follows that buying a high P/E stock does not necessarily give high returns on investment . It can be a bad investment also.
It therefore is difficult to ascertain whether the market price of a stock is appropriate for investing by using any single approach mentioned above. But inspite of their limitations these criteria when taken together nevertheless offer a reliable way to answer the question "Is the price right". The right price has to reflect not only the present but also the future. For that both the P/BV ratio and the P/E ratio when taken together becomes more powerful than any single approach for evaluating the price at which investment can be made in a company. This is done by calculating the mean of the average P/BV and the average P/E. This is the 'Intrinsic Value'. Buying at a price close to or less than the intrinsic value will give the investor a maximum return. Average for both can be over any number of years depending on the time frame of the investor keeping in mind that the greater the period, longer will be the time frame of the investor which in turn should give better return.
One final point though. It is to be kept in mind that the intrinsic value should reflect future earning potential of the company. It means that by estimating the intrinsic value we are trying to forecast the possible price appreciation in future. This also encompasses the objectives and expectations of the investor. Towards that end using other forecasting techniques to project a company's future earnings alongwith investor's own judgement greatly enhances the accuracy in finding out if the stock is reasonably priced.
Till my next then
Happy investing
Sunday, August 9, 2009
Minimizing investment risks
The objective of any investment is to bring in returns through profits generated on the money deployed . In the case of stocks this can be by way of dividends received or appreciation in the value of the stocks or both. If none of the above is realized the investment turns to loss and is no longer an investment. This is equally applicable even if the invested amount remains the same numerically because of the erosion of the purchasing power due to inflation. In the case of investment in stocks the chances of the investment giving profits may at times be jeopardized by numerous factors. There is no guarantee that dividends will keep coming in and market value of the investments will keep soaring in a linear fashion. What is true is that company's fortunes don’t always remain the same. It is dependent on a host of environmental and internal factors. Investing in stocks therefore involves exposure to a possible loss. That is, there is a risk element to it. In fact there is nothing as a risk free investment. Taking risk is an integral part of investing in stocks. Yet investing in stocks have been known to be giving superior returns despite the risk involved.
One other aspect of risk is that it is directly related to return. This means the higher the risk involved with the investment the higher is the return. Put in other words if one wants high returns one has to contend with high risk. How does it happen that way. Let's see. Suppose one decides to put in a certain amount on money in buying stocks of a certain company in an initial public offer. The investment is made on the basis of the assessment of the company's ability to set up the project and start earning profits at the end of a specified period. The uncertainty lies in the gestation period and how successfully the company gets its business running and hence the risk. The greater the amount of money that is committed at the start, and hence a greater risk, the higher is the return if the company delivers as per the investors expectations. If however things go wrong and the company struggles with its business the investor's capital may as well, in the worst situation, be written off. A higher investment is this case would result in higher loss. A low risk low return investment brings safety to capital.
The question then arises as to how do we go about dealing with the risks. The answer is to minimize the risks since it cannot be got rid of completely. In the paragraphs that follow an attempt is made to understand various important risk areas and how to deal with these.
At the individual level the first and probably the most important is to have a clear idea of how much risk one is capable of taking. Not knowing one's limits is an invitation to disaster. This requires clear headed decision, free from greed or any other emotion. Decision required to be taken are on the level of expected return and the extent of loss that can be tolerated. This again is influenced by age, income level, financial commitments, mental makeup and personality traits. It is the individual investor who has to decide for himself what his goals are and set it clearly.
The other aspects are quite general. For example a decision on whether the stock of a given company can be bought, if based on a complete study of the company is likely to be far less painful if at all. Questions that need to be asked are what environment is the company operating in with respect to the economy, political and social situations. In other words how are these factors likely to impact the business prospects of the company going forward. Is the company's management capable of delivering on its stated profit targets. Has the intrinsic value of the company's stock been determined. The intrinsic value in most cases is different from the market value . Intrinsic value is arrived at by calculating what the stock price ought to be taking into account its sales, profits, profit margin equity capital etc. Market value is the price at which the stock is trading at the stock exchange. The extent of any gap between the two gives valuable indication of any risk involved in buying the stock at the prevailing market price. This is possible because stock prices always tend to adjust so as to close the gap between the two. If the market price is higher than the intrinsic value then there exists a certain degree of risk in buying at the market price. Of course in many instances market gives a higher price to a stock on the basis of its perception of profitability and expects the intrinsic price to move up to close the gap. Again if market's perception of future profits is low any rosy estimation of intrinsic value will hardly be of any use. Nevertheless examining the intrinsic value can go a long way in reducing risk. It is the answer to the question "Is the price right". This is an example of fundamental analysis that is an analysis based on study of aspects fundamental to a company's business.
Fundamental analysis has its limitation. In that it cannot come to terms with market behavior. This is because not all people will arrive at similar intrinsic value estimates and differences here can be wide indeed. Another type of analysis known as technical analysis attempts to capture just this. Trends in price movements. Both fundamental and technical analysis when used in conjunction can help minimize risk by allowing us to properly choose a company and to fairly assess its right price for investment.
Diversification in investment is another strategy to minimize risk. Broadly speaking diversification would mean spreading one's capital in different asset classes. One could for instance allocate varying amounts of the total fund in different areas such as gold, real estate,
equities, commodities, bonds etc. These days people even invest in paintings, works of art that is. But here we are dealing essentially with investing in stocks. This form of investment nowadays is by far the most convenient in terms of ease of management and also has the ability to deliver superior return. So if one is investing only in stocks then the golden rule is the proverbial "never put all your eggs in one basket" as every one knows what happens when the basket drops. You loose all your eggs. A basket of 5 to 10 stocks would be more than adequate for most. And if one has the inclination and time to track more stocks one can add more. But then again just as diversification limits losses and thereby the risks also, it at the same time caps profits also. Betting on a few potential winners at times offer fabulous returns. But that would depend on the investor's risk appetite .
In order to keep investment risks low one has to ensure that the investments are liquid at all times. This is as important as any other approach to minimize risk, if not the most. This means one should be able to exit the stock if the need arises on account of any requirement. Getting stuck with a dud stock is the worst nightmare for an investor. Here also, it has been seen that the most liquid stocks give moderate returns whereas less liquid ones give high returns. As before it's the investors risk appetite which is of prime concern.
Finally it needs to be mentioned that there is no single approach to investment analysis. Proper tax planning without doubt can maximize returns which therefore offsets a great deal of risk. An investor needs to work out his own methods to suit his requirement. Here the role of personal judgment of the investor cannot be overemphasized. Investor's own judgment based on his experience and also gut feeling plays a very important role in successful investment.
One other aspect of risk is that it is directly related to return. This means the higher the risk involved with the investment the higher is the return. Put in other words if one wants high returns one has to contend with high risk. How does it happen that way. Let's see. Suppose one decides to put in a certain amount on money in buying stocks of a certain company in an initial public offer. The investment is made on the basis of the assessment of the company's ability to set up the project and start earning profits at the end of a specified period. The uncertainty lies in the gestation period and how successfully the company gets its business running and hence the risk. The greater the amount of money that is committed at the start, and hence a greater risk, the higher is the return if the company delivers as per the investors expectations. If however things go wrong and the company struggles with its business the investor's capital may as well, in the worst situation, be written off. A higher investment is this case would result in higher loss. A low risk low return investment brings safety to capital.
The question then arises as to how do we go about dealing with the risks. The answer is to minimize the risks since it cannot be got rid of completely. In the paragraphs that follow an attempt is made to understand various important risk areas and how to deal with these.
At the individual level the first and probably the most important is to have a clear idea of how much risk one is capable of taking. Not knowing one's limits is an invitation to disaster. This requires clear headed decision, free from greed or any other emotion. Decision required to be taken are on the level of expected return and the extent of loss that can be tolerated. This again is influenced by age, income level, financial commitments, mental makeup and personality traits. It is the individual investor who has to decide for himself what his goals are and set it clearly.
The other aspects are quite general. For example a decision on whether the stock of a given company can be bought, if based on a complete study of the company is likely to be far less painful if at all. Questions that need to be asked are what environment is the company operating in with respect to the economy, political and social situations. In other words how are these factors likely to impact the business prospects of the company going forward. Is the company's management capable of delivering on its stated profit targets. Has the intrinsic value of the company's stock been determined. The intrinsic value in most cases is different from the market value . Intrinsic value is arrived at by calculating what the stock price ought to be taking into account its sales, profits, profit margin equity capital etc. Market value is the price at which the stock is trading at the stock exchange. The extent of any gap between the two gives valuable indication of any risk involved in buying the stock at the prevailing market price. This is possible because stock prices always tend to adjust so as to close the gap between the two. If the market price is higher than the intrinsic value then there exists a certain degree of risk in buying at the market price. Of course in many instances market gives a higher price to a stock on the basis of its perception of profitability and expects the intrinsic price to move up to close the gap. Again if market's perception of future profits is low any rosy estimation of intrinsic value will hardly be of any use. Nevertheless examining the intrinsic value can go a long way in reducing risk. It is the answer to the question "Is the price right". This is an example of fundamental analysis that is an analysis based on study of aspects fundamental to a company's business.
Fundamental analysis has its limitation. In that it cannot come to terms with market behavior. This is because not all people will arrive at similar intrinsic value estimates and differences here can be wide indeed. Another type of analysis known as technical analysis attempts to capture just this. Trends in price movements. Both fundamental and technical analysis when used in conjunction can help minimize risk by allowing us to properly choose a company and to fairly assess its right price for investment.
Diversification in investment is another strategy to minimize risk. Broadly speaking diversification would mean spreading one's capital in different asset classes. One could for instance allocate varying amounts of the total fund in different areas such as gold, real estate,
equities, commodities, bonds etc. These days people even invest in paintings, works of art that is. But here we are dealing essentially with investing in stocks. This form of investment nowadays is by far the most convenient in terms of ease of management and also has the ability to deliver superior return. So if one is investing only in stocks then the golden rule is the proverbial "never put all your eggs in one basket" as every one knows what happens when the basket drops. You loose all your eggs. A basket of 5 to 10 stocks would be more than adequate for most. And if one has the inclination and time to track more stocks one can add more. But then again just as diversification limits losses and thereby the risks also, it at the same time caps profits also. Betting on a few potential winners at times offer fabulous returns. But that would depend on the investor's risk appetite .
In order to keep investment risks low one has to ensure that the investments are liquid at all times. This is as important as any other approach to minimize risk, if not the most. This means one should be able to exit the stock if the need arises on account of any requirement. Getting stuck with a dud stock is the worst nightmare for an investor. Here also, it has been seen that the most liquid stocks give moderate returns whereas less liquid ones give high returns. As before it's the investors risk appetite which is of prime concern.
Finally it needs to be mentioned that there is no single approach to investment analysis. Proper tax planning without doubt can maximize returns which therefore offsets a great deal of risk. An investor needs to work out his own methods to suit his requirement. Here the role of personal judgment of the investor cannot be overemphasized. Investor's own judgment based on his experience and also gut feeling plays a very important role in successful investment.
Saturday, August 1, 2009
Warren Buffett to CNBC: Invest in Stocks Even At Dow 9000 - Warren Buffett Watch - CNBC.com
Warren Buffett to CNBC: Invest in Stocks Even At Dow 9000 - Warren Buffett Watch - CNBC.com
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My notes: Not many would be comfortable with Mr Buffet's time horizon of investments. The important takeaway however is that stocks will outperform any other asset class . Also for anyone not concerned with immediate or near term prospects, which may not be favorable, its about time one can start looking at stocks albeit keeping the buy till a dip occurs in the current run.
Sunday, July 26, 2009
Of budgets and market direction
In my previous post while discussing Indian stock markets I had mentioned that the annual budget was likely to influence the market direction. Much expectation was built around it. Market's immediate reaction however was negative and the indices corrected significantly post the budget announcement. Some felt that since a great deal was expected from the budget which was not met, the markets gave it a thumbs down. It was clear however that the Finance minister missed a great opportunity to reverse India's image of being slow in bringing in reforms. With the kind of support it received in forming the Government particularly absence of the left parties, Government could have gone ahead and announced big ticket reforms to make India attractive for greater foreign investment. There are host of financial sector reforms that could have found merit. Dilution of Government ownership in companies through a process of stake sale has been pending for a very long time. A clear road map on this is very much needed as this country cannot go on paying for inefficiency. Subsidies is another area which has no place in a country which thinks of becoming an economic power. Government spending on private fuel consumption is unheard of any developed country. Labor sector reforms is vital to free the corporate sector which could then churn more growth.
The resounding crash of the stock markets prompted the Government to hastily offer clarifications which helped arrest the fall. Markets had however recorded a highest ever budget day fall. But the extent of the fall was sort of a knee jerk reaction as there was nothing in the budget to warrant such a fall. To be sure there is a cause for worry in the fiscal deficit number which is pegged at 6.8% of GDP. This no doubt is high for comfort. But the finance minister has clearly indicated that this was deliberately kept so in a scenario of slow growth and will be progressively brought down in the following years. This is to be seen as it is not clear how this will be done.
Other than this there are quite a few positives. Government has provided for a 36% increase in expenditure for 2009-10. This is fantastic inspite of the payout in connection with pay revision of Government employees. The economy couldn't ask for a better stimulus. There is an overwhelming emphasis on infrastructure spend . A staggering 9% of GDP of the country is targeted to flow in by way of investment by 2014. Add to this a hefty increase of direct spend on both rural and urban development projects of the Government. This will result in a very enviable order book for the core sector industries. On the taxation front Government appears to be quite serious about bringing in reforms. Rolling out unified Goods and Services Tax is high on the agenda. Since indirect taxes are high in India this is expected to make India a more competitive manufacturer in comparison to other countries.
As for the corporate results for Q1, the numbers so far are very encouraging indeed. Core sector industries comprising of coal, cement, steel, power and oil have grown at 4.8% as against 3.8% during the corresponding period last year. Month on month it has grown at 6.5%. Car maker Maruti posted an increase of 25% in it's net profits for Q1 as compared to same period last year. Telecom company Bharti reported a rise of 22% rise and a record 8.5 million subscriber addition. diversified company ITC reported a jump of 17.4% in Q1 net profits. Power equipment maker BHEL's net profit is higher by 22%. India's largest private sector bank ICICI and second largest lender recorded a 21% rise in net profits. These are the who's who of India's corporate sector. And they have done a commendable job.
Markets in the meantime have recovered from the budget day lows and is hovering around its resistance zone. As mentioned in my previous post this is very strong resistance area. Charts are indicating short term strength albeit approaching overbought conditions. Even if the current momentum takes it past the resistance zone market will be at overbought levels. Markets can continue to rise even being in overbought levels for long time. whether that will happen or not will depend on factors such as global markets, FII inflows and monsoons. As per the latest indications monsoons are not expected to deviate much from it's long term average though major parts of North India are already in draught or near draught conditions. Stop loss level now stands at 13700-14000 for the sensex
On the international front Dow has been holding over 9000 for 2 consecutive days. This is an encouraging development. At any rate US markets were vastly oversold when they reached the bottom and a good recovery cannot be ruled out. In the meantime more American banks are reported to have fallen. It is a known fact that markets recover before the economy does. If the US economy has reached the bottom then probably its time the markets start recovering.
Until my next then,
Happy investing
The resounding crash of the stock markets prompted the Government to hastily offer clarifications which helped arrest the fall. Markets had however recorded a highest ever budget day fall. But the extent of the fall was sort of a knee jerk reaction as there was nothing in the budget to warrant such a fall. To be sure there is a cause for worry in the fiscal deficit number which is pegged at 6.8% of GDP. This no doubt is high for comfort. But the finance minister has clearly indicated that this was deliberately kept so in a scenario of slow growth and will be progressively brought down in the following years. This is to be seen as it is not clear how this will be done.
Other than this there are quite a few positives. Government has provided for a 36% increase in expenditure for 2009-10. This is fantastic inspite of the payout in connection with pay revision of Government employees. The economy couldn't ask for a better stimulus. There is an overwhelming emphasis on infrastructure spend . A staggering 9% of GDP of the country is targeted to flow in by way of investment by 2014. Add to this a hefty increase of direct spend on both rural and urban development projects of the Government. This will result in a very enviable order book for the core sector industries. On the taxation front Government appears to be quite serious about bringing in reforms. Rolling out unified Goods and Services Tax is high on the agenda. Since indirect taxes are high in India this is expected to make India a more competitive manufacturer in comparison to other countries.
As for the corporate results for Q1, the numbers so far are very encouraging indeed. Core sector industries comprising of coal, cement, steel, power and oil have grown at 4.8% as against 3.8% during the corresponding period last year. Month on month it has grown at 6.5%. Car maker Maruti posted an increase of 25% in it's net profits for Q1 as compared to same period last year. Telecom company Bharti reported a rise of 22% rise and a record 8.5 million subscriber addition. diversified company ITC reported a jump of 17.4% in Q1 net profits. Power equipment maker BHEL's net profit is higher by 22%. India's largest private sector bank ICICI and second largest lender recorded a 21% rise in net profits. These are the who's who of India's corporate sector. And they have done a commendable job.
Markets in the meantime have recovered from the budget day lows and is hovering around its resistance zone. As mentioned in my previous post this is very strong resistance area. Charts are indicating short term strength albeit approaching overbought conditions. Even if the current momentum takes it past the resistance zone market will be at overbought levels. Markets can continue to rise even being in overbought levels for long time. whether that will happen or not will depend on factors such as global markets, FII inflows and monsoons. As per the latest indications monsoons are not expected to deviate much from it's long term average though major parts of North India are already in draught or near draught conditions. Stop loss level now stands at 13700-14000 for the sensex
On the international front Dow has been holding over 9000 for 2 consecutive days. This is an encouraging development. At any rate US markets were vastly oversold when they reached the bottom and a good recovery cannot be ruled out. In the meantime more American banks are reported to have fallen. It is a known fact that markets recover before the economy does. If the US economy has reached the bottom then probably its time the markets start recovering.
Until my next then,
Happy investing
Sunday, June 28, 2009
Indian Stock Markets at formidable resistance
Levels of around 15600 for the sensex and 4600 for the nifty turned out to be formidable resistance levels for the markets. Markets corrected from that level to 14000 for the sensex and 4150 for the nifty. This is a very important zone. For, from around these levels the market reversed trend in the past on a number of occasions during the past year and a half. Sometimes this level served as resistance and on some occasions it served as support to a previous fall. It is worthwhile to mention that there is nothing sacrosanct about these levels, or for that matter, any levels that we keep hearing about all the time. Yet we keep referring to index levels and feel comfortable with our preference to follow these in our buy sell decisions. That is because the support resistance levels are points which represent the collective decision of the market participants in the past. What is meant is that say at a given level in a rising market a majority of the participants decide to sell. The result of such an action is a market correction and if the correction continues we say the markets faced resistance at that level. Likewise if at a given level in a falling market a majority of market participants decide to buy and market continues to rise we say market found support at that level. Though however markets often make attempts to recover from a correction and even pierce the earlier resistance levels. Such a situation indicates further rise while likewise a breach of support indicates further fall.
What has been mentioned above falls in the realm of 'technical analysis' in stock market parlance. Technical analysis relies on the patterns of previous price movements to predict the future. It believes that if selling was seen at a given level in the past people will sell again whenever the same level is reached at a later date. Many people use it as an aid either alone or in conjunction with other methods to formulate their buy sell decisions. Resistance support levels work if the basis on which buy sell decisions in the past were taken remain unaltered . That is if there were reasons to sell at say 15600 level in the past and the same reasons hold at a subsequent attempt to reach 15600 selling will again be seen. And vise versa, if a support is established, buying will emerge whenever that support is reached in a market fall, as long as market situation don’t change. In such a scenario following technical analysis can be highly rewarding. That however is not always the case, because the world around us is constantly changing and a host of new factors come into play which are quickly taken in by the market. The collective wisdom of the market then decides on whether to stick to the levels or ignore it and continue with the journey.
One could of course say that the markets had gone up substantially and in double quick time that too, and had to pause anyway. True, but at what point? Between 2003 and end 2007 Indian markets witnessed a very strong up trend interspersed with minor corrections . The key indices appreciated to the tune of 700% in a span of 5 years. Only the diehard buy and hold investors who sat through the entire period have handsome multibagers in their hands even now with the massive correction.
So where does it all leave us. How do we figure out whether to stick to the levels indicated by technical analysis or continue to hold on with the position in the light of fresh data points which these days are getting to be enormously complex. Fact is no single approach is going to be sufficient. We have to scalp every bit of information, technical levels being one of these, and attempt to analyze its impact on the market. I shall attempt to deal with these issues in subsequent posts picking up issues prompted by current market situation. This is what I intended to do in this post. Markets reaching significant resistance prompted me to dwell on resistances supports in technical analysis.
Getting back to the market, next week is going to be important for Indian stock markets. Following the expiry of the derivative settlement last thursday market players are expected to take up positions ahead of the presentation of the budget. Annual budgets in India are more than income expenditure statements. They also carry announcements on policy initiatives, thrust areas, priorities of the Government on a host of areas ranging from taxation , fund allocation to social sector initiatives such as education. health, employment generation etc. And as such this annual exercise is looked forward to with extreme eagerness. A great deal of expectation starts to build up. Cross section of interested parties build up wish lists and are presented to the Finance minister.
And this single event is likely to influence market behavior in the near term. Then the 1st quarter results would start coming in. If Government declares its intentions to open up the economy, rationalize taxes, reduce fiscal deficit and make commitments on growth then market sentiment will get another boost. Corporate performance as will be evident from the quarterly numbers will determine whether market deserves another leg up. Otherwise the markets are poised for a period of consolidation or even a correction in the mid term. But from the pre budget noises it seems hopes are high on the Government delivering on its agenda.
Finally monsoon is getting to be a cause for concern. Any anomaly in its progress will have its impact on agriculture which will mean a tempered down growth projection.
Until my next then,
Happy investing
What has been mentioned above falls in the realm of 'technical analysis' in stock market parlance. Technical analysis relies on the patterns of previous price movements to predict the future. It believes that if selling was seen at a given level in the past people will sell again whenever the same level is reached at a later date. Many people use it as an aid either alone or in conjunction with other methods to formulate their buy sell decisions. Resistance support levels work if the basis on which buy sell decisions in the past were taken remain unaltered . That is if there were reasons to sell at say 15600 level in the past and the same reasons hold at a subsequent attempt to reach 15600 selling will again be seen. And vise versa, if a support is established, buying will emerge whenever that support is reached in a market fall, as long as market situation don’t change. In such a scenario following technical analysis can be highly rewarding. That however is not always the case, because the world around us is constantly changing and a host of new factors come into play which are quickly taken in by the market. The collective wisdom of the market then decides on whether to stick to the levels or ignore it and continue with the journey.
One could of course say that the markets had gone up substantially and in double quick time that too, and had to pause anyway. True, but at what point? Between 2003 and end 2007 Indian markets witnessed a very strong up trend interspersed with minor corrections . The key indices appreciated to the tune of 700% in a span of 5 years. Only the diehard buy and hold investors who sat through the entire period have handsome multibagers in their hands even now with the massive correction.
So where does it all leave us. How do we figure out whether to stick to the levels indicated by technical analysis or continue to hold on with the position in the light of fresh data points which these days are getting to be enormously complex. Fact is no single approach is going to be sufficient. We have to scalp every bit of information, technical levels being one of these, and attempt to analyze its impact on the market. I shall attempt to deal with these issues in subsequent posts picking up issues prompted by current market situation. This is what I intended to do in this post. Markets reaching significant resistance prompted me to dwell on resistances supports in technical analysis.
Getting back to the market, next week is going to be important for Indian stock markets. Following the expiry of the derivative settlement last thursday market players are expected to take up positions ahead of the presentation of the budget. Annual budgets in India are more than income expenditure statements. They also carry announcements on policy initiatives, thrust areas, priorities of the Government on a host of areas ranging from taxation , fund allocation to social sector initiatives such as education. health, employment generation etc. And as such this annual exercise is looked forward to with extreme eagerness. A great deal of expectation starts to build up. Cross section of interested parties build up wish lists and are presented to the Finance minister.
And this single event is likely to influence market behavior in the near term. Then the 1st quarter results would start coming in. If Government declares its intentions to open up the economy, rationalize taxes, reduce fiscal deficit and make commitments on growth then market sentiment will get another boost. Corporate performance as will be evident from the quarterly numbers will determine whether market deserves another leg up. Otherwise the markets are poised for a period of consolidation or even a correction in the mid term. But from the pre budget noises it seems hopes are high on the Government delivering on its agenda.
Finally monsoon is getting to be a cause for concern. Any anomaly in its progress will have its impact on agriculture which will mean a tempered down growth projection.
Until my next then,
Happy investing
Friday, June 5, 2009
Stunning rally in the Indian stock markets
The results of the recently concluded elections to the Indian parliament produced a stunning impact on its stock markets. The sensex recorded a 17.3 % rise on the first trading day after the results, the highest single day rise ever by any index in the world. The month of May recorded the highest monthly gain of 2893 pts in 17 years. On the day of writing this post the sensex closed above 15000 for the first time since Septrmber 08 after touching a low of 8047 in Mar 09. This is nothing short of a spectacle. Market participants were plainly astonished as the indices soared. No one expected such a dramatic improvement in the market sentiments . Clearly Indian markets have been re rated on the back of a clear mandate given by the voters. The congress party with its allies have been able to form a government without the support of parties with divergent views on economic reforms notably the left parties, read my recent post here. The present Govt is therefore expected to go ahead and carry on with the reforms it always wanted to but could not. Markets are giving this the thumbs up.
The question now on everyone’s mind is how far can this rally go. Clearly momentum of the market is very strong and gives the illusion of being unstoppable. But that cant be, it has to stop somewhere. For the time being it is better to go with the rally till the general budget which is slated to be presented on 3rd July . There are strong indications that this time around Govt is clear headed in its intentions. Expectations are that a good measure of reforms will be initiated. Even if the actual measures taken may not be as per expectations of the market, at least there will be roadmaps of actions to be taken in in its 5 year term. And that would keep the markets happy. Then around that time results for the 2nd quarter should start coming in. Indications are that rural demand is strong as evident from the sales numbers of cars, 2 wheelers, mobile connections etc. The direction of the budget and the performance of Indian companies should make it possible for us to take a call on the markets.
While it is too premature to say we have decoupled from the developed markets the true situation could be that our very own consumption story is likely to get a stimulus with the new Govt in place. This will ensure a respectable growth number . It is already close to 7 and any increment will be viewed very positively. This by itself will ensure inflow of further capital into the economy which will drive valuations up. This will be only up to a point and beyond that it will be the global factors again. In any case the small decoupling that will occur will mean that we will not fall as much as the developed markets. Presently of course the global markets are assisting us.
In my previous post I had mentioned of resistance at around 14700 on the sensex. The sensex refused to go beyond 15000 and has been consolidating between 13500-15000 ever since it broke out from the 12200 levels. As of now 12200 should be taken as the stop loss level in case the market takes a turn which is unlikely at the moment. In case it breaks out of the 13500-15000 range which is very likely given the current momentum, the next targets will be very aggressive indeed. Valuations however might go ahead of fundamentals in the near term. For those wanting to put in fresh money it is better to wait for a correction. Those who are already invested just ride the rally with strict stoplosses. Taking a trailing stoploss view this would be every 1000 points beyond 15000.
Till my next then,
Happy investing
The question now on everyone’s mind is how far can this rally go. Clearly momentum of the market is very strong and gives the illusion of being unstoppable. But that cant be, it has to stop somewhere. For the time being it is better to go with the rally till the general budget which is slated to be presented on 3rd July . There are strong indications that this time around Govt is clear headed in its intentions. Expectations are that a good measure of reforms will be initiated. Even if the actual measures taken may not be as per expectations of the market, at least there will be roadmaps of actions to be taken in in its 5 year term. And that would keep the markets happy. Then around that time results for the 2nd quarter should start coming in. Indications are that rural demand is strong as evident from the sales numbers of cars, 2 wheelers, mobile connections etc. The direction of the budget and the performance of Indian companies should make it possible for us to take a call on the markets.
While it is too premature to say we have decoupled from the developed markets the true situation could be that our very own consumption story is likely to get a stimulus with the new Govt in place. This will ensure a respectable growth number . It is already close to 7 and any increment will be viewed very positively. This by itself will ensure inflow of further capital into the economy which will drive valuations up. This will be only up to a point and beyond that it will be the global factors again. In any case the small decoupling that will occur will mean that we will not fall as much as the developed markets. Presently of course the global markets are assisting us.
In my previous post I had mentioned of resistance at around 14700 on the sensex. The sensex refused to go beyond 15000 and has been consolidating between 13500-15000 ever since it broke out from the 12200 levels. As of now 12200 should be taken as the stop loss level in case the market takes a turn which is unlikely at the moment. In case it breaks out of the 13500-15000 range which is very likely given the current momentum, the next targets will be very aggressive indeed. Valuations however might go ahead of fundamentals in the near term. For those wanting to put in fresh money it is better to wait for a correction. Those who are already invested just ride the rally with strict stoplosses. Taking a trailing stoploss view this would be every 1000 points beyond 15000.
Till my next then,
Happy investing
Wednesday, May 6, 2009
Stocks have rallied and now what
I occasionally write comments on blogs that I read. A comment on "Time to buy" posted by Sudershan Sukhani on his blogsite read here goes like this :
"Exactly, now seems to be the time to start accumulating for the medium to long term. Prices of stocks of good companies i.e. companies with proven management and ability to sustain growth have fallen to abysmally low levels. Prices of such company’s stocks appear to be competing with scam hit Satyam’s price in as much as the race to the bottom is concerned. While it is true that the stratospheric valuations of most stocks reached at the height of the last bull market had to be corrected , and true to its form the market made excesses here also, the extent of the present decline is not in sync with valuations. These are precisely the indicators which one should not miss or else one would loose the opportunity. Also, it now appears India is comparatively better placed and therefore there will be lesser risk aversion and money is expected to start flowing into the market sooner than later. We will however have to wait till the elections are over".
This was posted on 11 Mar 2009. The sensex had closed at 8160 the previous trading session, started moving up from the next session after making an island reversal.As on date the sensex has gained by 50% and individual stocks by as much as 100%. While there were enough indications of an imminent trend reversal , the extent and ferocity of the reversal has taken everyone by surprise. World markets have also shown similar rallies. Happily for us, FIIs since mid Mar have pumped in (net purchases) over $2 billion.
The question on everyone's mind is where to go from here. Has a new bull market started or are markets ripe for a correction. Making predictions on stock markets is a mug's game. It will be prudent however to start getting cautious at this stage. For one , bear markets don’t go in a hurry and as a corollary bull markets too don’t start in a hurry . One should expect the markets to test the bottom it has formed earlier before a new high can be seen. Economic data on the global front is far from being rosy. The damge has been colossal and it will take some more time for recovery to set in. India though can be better placed in view of its domestic demand but unlikely to have an impact the markets if global sentiments don’t support.
So far as the markets are concerned, technical indicators point to an overstretched condition for the short to medium term. Long term charts however indicate continuation of the rally for some more time and that too with vigour. The inference is that markets may take a pause and then continue with the uptrend for some more time. For how long is difficult to say. We have an event ahead of us. Any nasty surprise on this front and we will be hurtling down as fast as we had climbed up. Any surge in the indices in the ensuing period leading to the election results should be utilized to book profits. Immediate resistance of sensex is around 12500 levels. In case it is able to cross this resistance the next resistance is around 14000-14700. For those who are holding cash and have not been able to buy earlier, no harm in waiting for a while more till the election verdicts are out when the situation can be reviewed.
Till my next then
Happy investing
"Exactly, now seems to be the time to start accumulating for the medium to long term. Prices of stocks of good companies i.e. companies with proven management and ability to sustain growth have fallen to abysmally low levels. Prices of such company’s stocks appear to be competing with scam hit Satyam’s price in as much as the race to the bottom is concerned. While it is true that the stratospheric valuations of most stocks reached at the height of the last bull market had to be corrected , and true to its form the market made excesses here also, the extent of the present decline is not in sync with valuations. These are precisely the indicators which one should not miss or else one would loose the opportunity. Also, it now appears India is comparatively better placed and therefore there will be lesser risk aversion and money is expected to start flowing into the market sooner than later. We will however have to wait till the elections are over".
This was posted on 11 Mar 2009. The sensex had closed at 8160 the previous trading session, started moving up from the next session after making an island reversal.As on date the sensex has gained by 50% and individual stocks by as much as 100%. While there were enough indications of an imminent trend reversal , the extent and ferocity of the reversal has taken everyone by surprise. World markets have also shown similar rallies. Happily for us, FIIs since mid Mar have pumped in (net purchases) over $2 billion.
The question on everyone's mind is where to go from here. Has a new bull market started or are markets ripe for a correction. Making predictions on stock markets is a mug's game. It will be prudent however to start getting cautious at this stage. For one , bear markets don’t go in a hurry and as a corollary bull markets too don’t start in a hurry . One should expect the markets to test the bottom it has formed earlier before a new high can be seen. Economic data on the global front is far from being rosy. The damge has been colossal and it will take some more time for recovery to set in. India though can be better placed in view of its domestic demand but unlikely to have an impact the markets if global sentiments don’t support.
So far as the markets are concerned, technical indicators point to an overstretched condition for the short to medium term. Long term charts however indicate continuation of the rally for some more time and that too with vigour. The inference is that markets may take a pause and then continue with the uptrend for some more time. For how long is difficult to say. We have an event ahead of us. Any nasty surprise on this front and we will be hurtling down as fast as we had climbed up. Any surge in the indices in the ensuing period leading to the election results should be utilized to book profits. Immediate resistance of sensex is around 12500 levels. In case it is able to cross this resistance the next resistance is around 14000-14700. For those who are holding cash and have not been able to buy earlier, no harm in waiting for a while more till the election verdicts are out when the situation can be reviewed.
Till my next then
Happy investing
Thursday, April 23, 2009
Derivatives trading - removal of stocks
The decision of National Stock Exchange to remove 50 stocks from F&O trading is a very welcome step for ordinary retail investors. This will particularly benefit traders who like to trade in futures contracts but do not quite know which stocks to select . Streamlining the list of F&O stocks by removing the weed will ensure that ordinary traders don’t get trapped in unsuitable stocks. Modification of the criteria for inclusion in the F&O list such as market cap etc will ensure that dud stocks don’t find a place in the list. This is very important because through the derivatives products one is able to take a far greater exposure in the market than the cash available with him. Such exposure can be 3,4 or 5 times the cash deployed. If the market goes in his favor the trader makes high profits in relation to the cash deployed. But more often ,as is the case , if the trade goes against him he incurs 3,4 or 5 times more losses than he would otherwise have incurred due to his leveraged position.
Having seen how leveraged trading as in the case of futures trading has a multiplying effect on profits or losses lets see how this is converted into a domino effect if such trading is undertaken in shallow stocks. By shallow stocks what is meant is that these are stocks having low market cap and with low liquidity. These stocks are subjected to wide price fluctuations. Which means these stocks have high impact costs that is any buy sell order results in large price changes. For these stocks therefore gains are comparatively large when prices are rising and losses are also large when prices are falling. Trading in such stocks in the futures segment is therefore fraught with a great deal of risk.
To contain the risks though one can put a system of 'stop loss' in which the losses are cut short when the trade turns unfavorable while the profits are allowed to run. But these are techniques for disciplined traders, which very few of us are. Many may correctly be able to cut the losses but cannot figure out when to re-enter the stock thereby missing out on the opportunity when markets turn.
When derivatives trading was introduced in the Indian stock market the lot size was made such that the contract value had to be a minimum of Rs. 2 lakhs. With an average margin of around 25% a trader had to pay about Rs 50000 upfront as margin money with more kept ready for margin call requirement. This served as a good deterrent for ordinary retail traders to dabble in stock futures. However as the bear market was setting in and prices were taking the plunge the cash required to buy or sell a stock futures contract also came down to mouthwatering levels. A single stock futures contract of most blue chip companies were available for around Rs 10000 to Rs 12000. In the bear market that was prevailing the bears were having a field day while the traders on the buy side lost heavily with very few among them being able to catch the recent up move .
In contrast, what about the investor who buys only as much as he is capable of paying for. This is delivery trade where stocks are held till they are sold and when sold, delivery of the stock is given. Since he doesn’t have to sell out as soon as prices dip for any reason and as a response to a stop loss trigger price, he is free from the worry of timing his re-entry . And if he has bought in a market which is trending up he can wait out the temporary dips and can be successful in making a profit. This is not to say that he will never sell . He will of course sell when he is required to, out of a decision taken on various other factors that he has set for himself. In a derivative trade he is required to square up his trade on the expiry day bearing whatever losses he has made. He may however roll over to the next series but there is no certainty at all whether he will be able to recoup his losses. And for all you know the following month series might add to his losses. Having experienced consecutive losses he soon gives up and is worse off. In a delivery based trade on the other hand a patient wait can see him make profits as markets invariably get better after a beating
There are other ways though in which derivatives can be used .For example derivatives can be used for hedging a portfolio via the options route. But those techniques may be useful for protecting a portfolio for the short term. In a raging bear market its utility is doubtful.
In the short term, one has to be very adept at using derivatives since the risks are many fold. Ordinary retail traders should therefore resort to a more sedate approach of delivery based trading where there may not be spectacular and quick profits, which in any case may be a mirage, but there can be steady profits. Generating profits few times in a year may not be such a bad idea after all.
Happy investing.
Having seen how leveraged trading as in the case of futures trading has a multiplying effect on profits or losses lets see how this is converted into a domino effect if such trading is undertaken in shallow stocks. By shallow stocks what is meant is that these are stocks having low market cap and with low liquidity. These stocks are subjected to wide price fluctuations. Which means these stocks have high impact costs that is any buy sell order results in large price changes. For these stocks therefore gains are comparatively large when prices are rising and losses are also large when prices are falling. Trading in such stocks in the futures segment is therefore fraught with a great deal of risk.
To contain the risks though one can put a system of 'stop loss' in which the losses are cut short when the trade turns unfavorable while the profits are allowed to run. But these are techniques for disciplined traders, which very few of us are. Many may correctly be able to cut the losses but cannot figure out when to re-enter the stock thereby missing out on the opportunity when markets turn.
When derivatives trading was introduced in the Indian stock market the lot size was made such that the contract value had to be a minimum of Rs. 2 lakhs. With an average margin of around 25% a trader had to pay about Rs 50000 upfront as margin money with more kept ready for margin call requirement. This served as a good deterrent for ordinary retail traders to dabble in stock futures. However as the bear market was setting in and prices were taking the plunge the cash required to buy or sell a stock futures contract also came down to mouthwatering levels. A single stock futures contract of most blue chip companies were available for around Rs 10000 to Rs 12000. In the bear market that was prevailing the bears were having a field day while the traders on the buy side lost heavily with very few among them being able to catch the recent up move .
In contrast, what about the investor who buys only as much as he is capable of paying for. This is delivery trade where stocks are held till they are sold and when sold, delivery of the stock is given. Since he doesn’t have to sell out as soon as prices dip for any reason and as a response to a stop loss trigger price, he is free from the worry of timing his re-entry . And if he has bought in a market which is trending up he can wait out the temporary dips and can be successful in making a profit. This is not to say that he will never sell . He will of course sell when he is required to, out of a decision taken on various other factors that he has set for himself. In a derivative trade he is required to square up his trade on the expiry day bearing whatever losses he has made. He may however roll over to the next series but there is no certainty at all whether he will be able to recoup his losses. And for all you know the following month series might add to his losses. Having experienced consecutive losses he soon gives up and is worse off. In a delivery based trade on the other hand a patient wait can see him make profits as markets invariably get better after a beating
There are other ways though in which derivatives can be used .For example derivatives can be used for hedging a portfolio via the options route. But those techniques may be useful for protecting a portfolio for the short term. In a raging bear market its utility is doubtful.
In the short term, one has to be very adept at using derivatives since the risks are many fold. Ordinary retail traders should therefore resort to a more sedate approach of delivery based trading where there may not be spectacular and quick profits, which in any case may be a mirage, but there can be steady profits. Generating profits few times in a year may not be such a bad idea after all.
Happy investing.
Thursday, April 2, 2009
The contrarian approach
What is the contrarian approach. In a contrarian approach we do exactly the opposite of what the majority is doing. To understand that lets see first what is crowd behaviour
in the stock market. Crowd psychology in the stock market is no different from that seen anywhere else. Crowd behaviour is the mentality of following the herd. It is going with the majority opinion. This means when the market is trending i.e. continues in its direction whether up or down , everybody is eager to join the bandwagon so to say. In the early stages of the trend though this gives the desired result and more people join in giving further boost to the already developed trend. But all trends reverse at some point. The trouble with the crowd is that it does not know when and where to get off the bandwagon. That is because crowd behaviour essentially precludes any logical or rational thought process and all actions are dictated by following what everybody else is doing.
Now everybody cannot be right at any given point of time. This should be very simple to comprehend. For if every body is right and is able to make profits where are the losers going to come from. In any transaction both the buyer and the seller cannot be right . Either the buyer is right or the seller is right. If the buyer is right he stands to make profit on his investment and vice versa. In fact a buy sell takes place as a result of opposing views of the buyer and the seller. Since there are as many buyers as there are sellers simple arithmatic tells us that at least 50% of people are loosers. This without any further mistake on the part of the investor. If investors make further mistakes, which they invariably do, the number of loosers far surpasses the winners in the stock market. This is a very important aspect of investing in stock markets and has to be kept in mind. Winners in the stock market are few. So following the majority does not pay.
This is the contrarian approach. You sell when others are buying and buy when others are selling. That is buy in an atmosphere of gloom and doom and sell amidst euphoria. Buy into companies which have been neglected by the market, if the fundamentals are right and wait patiently because markets will eventually catch up with the fundamentals and reward you. But here is a caveat . This approach works when a majority opinion has indeed been formed among the participants in the market. But if one takes the approach before that , i.e. when the majority opinion is under formation one will miss out on the opportunity thrown by a trending market that is a rising or a falling market.
But how does one go about figuring out whether a majority opinion has indeed been formed. Tracking the P/E multiple can be a very useful method. The P/E ratio is obtained by dividing the price of the stock with it's earnings per share. Obviously it indicates how far the price has gone in relation to the company's earnings. P/E multiples are very high or low at around the time when the trend is maturing that is when a reversal is imminent as the trend does not seem to have any more legs to go on whether up or down. In such a situation the P/E ratio has strayed very far from the value it normally commands. Following the P/E ratio therefore gives us a reasonable idea as to the extent of the price rise or decline. But one has to be careful here, as sometimes, price of a company's stock rise or fall dramatically following some unexpected news on the company and so does the P/E multiple. In such a situation it is helpful to compare with other companies in the sector. Sometimes also unexpected events take their toll on the markets which then stands rerated or derated depending on whether higher or lower P/E multiples are paid. But that is a different thing. These days P/E ratios are given with stock quotes of most newspapers and it is very good practice if one makes it a point to keep tab on the P/E multiple.
Happy investing.
in the stock market. Crowd psychology in the stock market is no different from that seen anywhere else. Crowd behaviour is the mentality of following the herd. It is going with the majority opinion. This means when the market is trending i.e. continues in its direction whether up or down , everybody is eager to join the bandwagon so to say. In the early stages of the trend though this gives the desired result and more people join in giving further boost to the already developed trend. But all trends reverse at some point. The trouble with the crowd is that it does not know when and where to get off the bandwagon. That is because crowd behaviour essentially precludes any logical or rational thought process and all actions are dictated by following what everybody else is doing.
Now everybody cannot be right at any given point of time. This should be very simple to comprehend. For if every body is right and is able to make profits where are the losers going to come from. In any transaction both the buyer and the seller cannot be right . Either the buyer is right or the seller is right. If the buyer is right he stands to make profit on his investment and vice versa. In fact a buy sell takes place as a result of opposing views of the buyer and the seller. Since there are as many buyers as there are sellers simple arithmatic tells us that at least 50% of people are loosers. This without any further mistake on the part of the investor. If investors make further mistakes, which they invariably do, the number of loosers far surpasses the winners in the stock market. This is a very important aspect of investing in stock markets and has to be kept in mind. Winners in the stock market are few. So following the majority does not pay.
This is the contrarian approach. You sell when others are buying and buy when others are selling. That is buy in an atmosphere of gloom and doom and sell amidst euphoria. Buy into companies which have been neglected by the market, if the fundamentals are right and wait patiently because markets will eventually catch up with the fundamentals and reward you. But here is a caveat . This approach works when a majority opinion has indeed been formed among the participants in the market. But if one takes the approach before that , i.e. when the majority opinion is under formation one will miss out on the opportunity thrown by a trending market that is a rising or a falling market.
But how does one go about figuring out whether a majority opinion has indeed been formed. Tracking the P/E multiple can be a very useful method. The P/E ratio is obtained by dividing the price of the stock with it's earnings per share. Obviously it indicates how far the price has gone in relation to the company's earnings. P/E multiples are very high or low at around the time when the trend is maturing that is when a reversal is imminent as the trend does not seem to have any more legs to go on whether up or down. In such a situation the P/E ratio has strayed very far from the value it normally commands. Following the P/E ratio therefore gives us a reasonable idea as to the extent of the price rise or decline. But one has to be careful here, as sometimes, price of a company's stock rise or fall dramatically following some unexpected news on the company and so does the P/E multiple. In such a situation it is helpful to compare with other companies in the sector. Sometimes also unexpected events take their toll on the markets which then stands rerated or derated depending on whether higher or lower P/E multiples are paid. But that is a different thing. These days P/E ratios are given with stock quotes of most newspapers and it is very good practice if one makes it a point to keep tab on the P/E multiple.
Happy investing.
Tuesday, March 31, 2009
If only we could sell
On hindsight the previous bull market had given us a fantastic opportunitiy . If only we could sell . This is of course on the assumption that we had invested in stocks earlier. For it is only when sales are made that profits or losses are booked . Since the previous bull run was one spanning a multi year time span , one could end up with profits only. And now the clock has turned almost full circle , meaning prices are at levels last seen in most cases by as much as decade earlier. The Dow Jones Industrial Average , which is by far the most tracked index , fell from 14093 on oct , 08, 2007 to 6627 on Mar, 02, 2009. this later figure was last recorded around Dec, 1996.
Markets which have fallen to lower levels present an opportunity for acquiring the same or an equivalent basket of stocks and still leave money to spare or buy more. This is too simplistic a scenario though and used only as an illustration . For instance if resorted to at an early stage of the market decline which has been one of the most ferocious ever, there can be a genuine cause for heart burn. But the basic tenet remains firmly the same, that is, sell one must . Because by not selling one becomes a collector and will have to put in additional money to continue participating in the market. This may not be always possible. But more importantly one will not be able to profit from the cyclical market ups and downs and in the long run may end up with no profits as also loosing on the time value of the money.
Another very important reason to sell is that once stock prices reach heady levels it literally falls due to its own weight. It takes a great deal of buying pressure to elevate and maintain prices at high levels. Which means a buying climax will surely be followed by a withdrawal of such pressure as there can not be an endless presence of buyers and the market will be exhausted of buyers sooner or later. It is here that an opposite activity occurs. It is precisely at these times that some people start pressing speculative sales. These are people who assume prices will fall from that point on and put in sell orders without actually owning the stocks. In fact the derivative market has essentially such mechanisms. With absence of fresh buyers and addition of speculative sales the demand supply situation gets severely distorted and prices take a tumble. No wonder investors stare, in utter disbelief, at the disappearance of the wealth they thought were theirs. Its a different thing though , and not pertinent at this point of discussion, that these sellers will have to cover up their position by buying back what they had short sold. Such counter buy order reverses the downward spiral and prices recover, the extent of which again depend on several other factors. One such factor could be, interestingly, the reemergence of buyers who believe prices will go up. Their buying push up the prices again. And the game goes on.
It is thus seen that selling becomes a very important factor in the quest for profitable investments in stocks.. By selling we not only are able to buy back at lower prices without requiring additional money but also are favourably positioned for the next upmove.
Yet inspite of very strong reasons to sell, we fail to take that decision at the right time or when we do take, it usually is the most ill timed. Many people have had that agonising experience of seeing the prices of their most preciously held stocks start moving up after they have sold . While there can be several reasons why selling becomes a difficult proposition, one very common and important one emanates from our emotions , which essentially is that we are normally biased towards buying. We tend to associate buying with a sense of optimism in mind and having to take a sell decision appears to negate the optimism. To a certain extent most people are conditioned into a buy bias as buy advises around us far outweigh sell advises . There are numerous instances where the bias against selling is so strong that one is fiercely determined to hold on even when losses are staring at the face and mounting. And if the investment has appreciated we want it to appreciate more . This is the greed factor.
We therefore have to overcome our emotions, keep a clear head. It is not easy and we have to muster as much mental and emotional discipline as we can for that all important sell decision. How do we go about doing that . Here are a few indicators which if recognised will help us to take a rational view and proceed with our objective that is making a profit on our investment.
1. Sell if justification for fresh buying cannot be found . Meaning if you don't want to buy then sell it if are holding . By not selling one is holding the stock. Holding the stock is justified only if it is expected to rise. Its different if one is holding for dividend income .
2. Do not hold a stock unless it is worth a buy. A decision to hold is the same thing as to buy afresh. In a way it is the same thing as reinvesting sans the buy sell procedures and brokerage charges.
3. Sell when the fundamentals turn for the worse. Whether it pertains to the company or to the economy as a whole, monitoring developments by way of access to reliable news sources is very helpful .
4. Delete the cost price of the stock from mind. Remember, the rational to sell a stock is quite independent of the acquisition cost .As explained above one decides to sell because the price is not expected to go up any further and in all likelihood fall from there on. One is selling either to book profits or to prevent further losses if the investment has gone wrong. Its extremely difficult to maintain such a strict frame of mind but it is here essentially that a distinction can be made between an average and above average investor.
Markets which have fallen to lower levels present an opportunity for acquiring the same or an equivalent basket of stocks and still leave money to spare or buy more. This is too simplistic a scenario though and used only as an illustration . For instance if resorted to at an early stage of the market decline which has been one of the most ferocious ever, there can be a genuine cause for heart burn. But the basic tenet remains firmly the same, that is, sell one must . Because by not selling one becomes a collector and will have to put in additional money to continue participating in the market. This may not be always possible. But more importantly one will not be able to profit from the cyclical market ups and downs and in the long run may end up with no profits as also loosing on the time value of the money.
Another very important reason to sell is that once stock prices reach heady levels it literally falls due to its own weight. It takes a great deal of buying pressure to elevate and maintain prices at high levels. Which means a buying climax will surely be followed by a withdrawal of such pressure as there can not be an endless presence of buyers and the market will be exhausted of buyers sooner or later. It is here that an opposite activity occurs. It is precisely at these times that some people start pressing speculative sales. These are people who assume prices will fall from that point on and put in sell orders without actually owning the stocks. In fact the derivative market has essentially such mechanisms. With absence of fresh buyers and addition of speculative sales the demand supply situation gets severely distorted and prices take a tumble. No wonder investors stare, in utter disbelief, at the disappearance of the wealth they thought were theirs. Its a different thing though , and not pertinent at this point of discussion, that these sellers will have to cover up their position by buying back what they had short sold. Such counter buy order reverses the downward spiral and prices recover, the extent of which again depend on several other factors. One such factor could be, interestingly, the reemergence of buyers who believe prices will go up. Their buying push up the prices again. And the game goes on.
It is thus seen that selling becomes a very important factor in the quest for profitable investments in stocks.. By selling we not only are able to buy back at lower prices without requiring additional money but also are favourably positioned for the next upmove.
Yet inspite of very strong reasons to sell, we fail to take that decision at the right time or when we do take, it usually is the most ill timed. Many people have had that agonising experience of seeing the prices of their most preciously held stocks start moving up after they have sold . While there can be several reasons why selling becomes a difficult proposition, one very common and important one emanates from our emotions , which essentially is that we are normally biased towards buying. We tend to associate buying with a sense of optimism in mind and having to take a sell decision appears to negate the optimism. To a certain extent most people are conditioned into a buy bias as buy advises around us far outweigh sell advises . There are numerous instances where the bias against selling is so strong that one is fiercely determined to hold on even when losses are staring at the face and mounting. And if the investment has appreciated we want it to appreciate more . This is the greed factor.
We therefore have to overcome our emotions, keep a clear head. It is not easy and we have to muster as much mental and emotional discipline as we can for that all important sell decision. How do we go about doing that . Here are a few indicators which if recognised will help us to take a rational view and proceed with our objective that is making a profit on our investment.
1. Sell if justification for fresh buying cannot be found . Meaning if you don't want to buy then sell it if are holding . By not selling one is holding the stock. Holding the stock is justified only if it is expected to rise. Its different if one is holding for dividend income .
2. Do not hold a stock unless it is worth a buy. A decision to hold is the same thing as to buy afresh. In a way it is the same thing as reinvesting sans the buy sell procedures and brokerage charges.
3. Sell when the fundamentals turn for the worse. Whether it pertains to the company or to the economy as a whole, monitoring developments by way of access to reliable news sources is very helpful .
4. Delete the cost price of the stock from mind. Remember, the rational to sell a stock is quite independent of the acquisition cost .As explained above one decides to sell because the price is not expected to go up any further and in all likelihood fall from there on. One is selling either to book profits or to prevent further losses if the investment has gone wrong. Its extremely difficult to maintain such a strict frame of mind but it is here essentially that a distinction can be made between an average and above average investor.
Happy investing
Tuesday, March 17, 2009
Are stocks worth investing in
For anyone who has looked at the stock market during the last 1 to 1 1/2 years has probably turned aghast at the extent to which stock prices have fallen. Between Jan 08 and Oct 08 the BSE index has fallen by about 64% i.e. fallen to about 1/3rd of its peak value. Many high profile so called popular stocks have been reduced to as much as 1/10th to 1/20th of their peak value. For anyone who had put in money around this time it probably has been a shattering experience and the wealth so lost might not be recoverable easily. This therefore raises a very fundamental question . Is it worthwhile to invest in stocks or are stocks suitable only for gamblers. An important question at this point could equally be how many people asked this same very question at the peak of the bull market and exited the market. If they did, then they would be, like the proverb, laughing all the way to bank.
Lets face the facts . Stock markets are not gambling dens. Stock exchanges, where stocks are traded, are public institutions where millions of people engage in buying and selling of stocks and are regulated by government. As regards other avenues of investment i.e. the traditional real estate and gold etc, well real estate also had its share of fall too. There is a property glut at present as evident from large number of unsold properties and discounts of whopping 30-40 % . Besides property has with it an attendant maintenance expenditure as also the stamp duty etc. which basically boils down to reduced return on investment. Then, not long ago, we were grumbling on measly returns on FDs . Gold did not appreciate for a considerable period . Whereas anyone who has been able to catch the bull market which started in 2003 and remained invested has succeeded in making handsome gains in spite of the downturn. It therefore appears that stocks cannot be ignored for getting above normal returns. The question can then be, if stocks cannot be ignored, do people have to loose money buying stocks.
Not if we understand how the stock market behaves. Following should explain very briefly.
Stock prices continually change, in that it keeps going up and down. Our nature is such that we always want to wait for prices to go up still further before we sell and vice versa i.e. we go on postponing the buying decision expecting prices to fall further. But this never happens in reality however much we want. And at some point the trend reverses itself and in most situations leaving no time for people to grasp what happened. And before long, gains are wiped out and losses mount. This is the greed and fear factor. All of us are prone to it. He who has conquered it is already on way to profits. Whether profits will be made depends on a few other aspects.
One is, to get an indication of whether a top or bottom is close by , for it may never be possible to catch the exact top or bottom. It is best to keep an eye on previous year high. If the prices have reached a level where it has greatly exceeded previous years high, it is time to sell. And we shouldn’t bother if prices still go up further for it will invariably come down but profits will have been captured. Look out for the frenzy in buying where people start buying all sorts of junk stocks whose prices reach abnormal levels and IPOs start flooding the market . By all means sell at these times. Getting a clue on whether a bottom is at hand is more difficult and a little risky too. While in the case of a bull market one will have made lesser profit but in the case of a bear market one stands to loose if the buying decision goes wrong and prices correct further. However few generalistions appear to work . Look out for the absolute apathy where people just don’t like stocks. The market is dull and listless and doesn’t react to any kind of news. A large number of good quality stocks record new 52 week lows . In both the extremes markets gets detached from realities of economic fundamentals and represents an aberration . This signals an imminent trend reversal.
The above illustrates when major tops and bottoms are formed in long term bull and bear cycles. A long term investment strategy focused on these cycles is more likely to generate extraordinary returns when compared to short term strategy.
Happy investing
Lets face the facts . Stock markets are not gambling dens. Stock exchanges, where stocks are traded, are public institutions where millions of people engage in buying and selling of stocks and are regulated by government. As regards other avenues of investment i.e. the traditional real estate and gold etc, well real estate also had its share of fall too. There is a property glut at present as evident from large number of unsold properties and discounts of whopping 30-40 % . Besides property has with it an attendant maintenance expenditure as also the stamp duty etc. which basically boils down to reduced return on investment. Then, not long ago, we were grumbling on measly returns on FDs . Gold did not appreciate for a considerable period . Whereas anyone who has been able to catch the bull market which started in 2003 and remained invested has succeeded in making handsome gains in spite of the downturn. It therefore appears that stocks cannot be ignored for getting above normal returns. The question can then be, if stocks cannot be ignored, do people have to loose money buying stocks.
Not if we understand how the stock market behaves. Following should explain very briefly.
Stock prices continually change, in that it keeps going up and down. Our nature is such that we always want to wait for prices to go up still further before we sell and vice versa i.e. we go on postponing the buying decision expecting prices to fall further. But this never happens in reality however much we want. And at some point the trend reverses itself and in most situations leaving no time for people to grasp what happened. And before long, gains are wiped out and losses mount. This is the greed and fear factor. All of us are prone to it. He who has conquered it is already on way to profits. Whether profits will be made depends on a few other aspects.
One is, to get an indication of whether a top or bottom is close by , for it may never be possible to catch the exact top or bottom. It is best to keep an eye on previous year high. If the prices have reached a level where it has greatly exceeded previous years high, it is time to sell. And we shouldn’t bother if prices still go up further for it will invariably come down but profits will have been captured. Look out for the frenzy in buying where people start buying all sorts of junk stocks whose prices reach abnormal levels and IPOs start flooding the market . By all means sell at these times. Getting a clue on whether a bottom is at hand is more difficult and a little risky too. While in the case of a bull market one will have made lesser profit but in the case of a bear market one stands to loose if the buying decision goes wrong and prices correct further. However few generalistions appear to work . Look out for the absolute apathy where people just don’t like stocks. The market is dull and listless and doesn’t react to any kind of news. A large number of good quality stocks record new 52 week lows . In both the extremes markets gets detached from realities of economic fundamentals and represents an aberration . This signals an imminent trend reversal.
The above illustrates when major tops and bottoms are formed in long term bull and bear cycles. A long term investment strategy focused on these cycles is more likely to generate extraordinary returns when compared to short term strategy.
Happy investing
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