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Stockmarkets: Investors beware

Mar 16, 2005

Things have seemingly turned around for the stock markets (as yet) in the current year as compared to the euphoria seen on the bourses during the last couple of years. After breaching their all-time highs in recent times and after having come within striking distance (6,955 on the BSE-Sensex) of the so-called 'magical' 7,000 mark, selling pressure has been witnessed at these higher levels. Amidst the alternate bouts of buying and selling witnessed in the last 11-weeks or so, the Indian indices have gained a net of about 3% so far. One-key reason for the stagnation on the bourses seems to be the fact that at the current juncture i.e. almost 17x Sensex valuations on a 12-month trailing earnings basis (14x-15x FY06 basis), the markets have seemingly factored in much of the expected earnings growth of India Inc. next fiscal. However, while the indices have not moved much in the current fiscal, stocks, which 'do not' form a part of the indices, have been flying around. These are generally mid-cap and small-cap stocks, which are largely un-researched and 'primarily news based'.

This is typical of any bull-run when investors tend to get attracted towards mid-cap stocks because valuations of these look relatively cheaper as compared to index heavyweights. More often than not, the main reason for which a small stock comes in the reckoning is "It is a turnaround story!" And, again, most of the times, the argument provided by the so-called 'stockmarket opportunists' to small investors in order to convince them to buy the stock would be the stupendous rise the particular stock would have 'already' witnessed on the bourses. And it is such kind of selling by 'opportunists' that often makes investors overlook fundamentals for a quick buck.

However, while we continue to remain positive of the Indian growth story over the longer-term, we feel, from hereon, the story on the Indian bourses would be different in the sense that it would now be more stock specific. We feel, more so now, that investors need to take a balanced approach towards investing. While we have always maintained that investors must invest only with a long-term frame of mind, a sound approach would be to follow the Systematic Investment Plan (SIP), wherein an investor needs to invest a particular sum of money at regular intervals. This would help the investor arrest the fear of a stock market crash, as by following this approach, it would provide the investor with an opportunity to invest at lower levels also, thus effectively leading to an averaging out of his portfolio.

Further, during times of such uncertainties when there are various apprehensions regarding sectoral trends, it is advisable to adopt a bottom-up approach to investing. While the stock market per se could remain volatile, we feel that from hereon, the Indian stock market is a bottom-up story. There are companies that could (and would) outperform benchmark indices as well as index heavyweights in the future. It is not necessary that the index has to move up for investors to make money in equities. Even during the so-called 'bear phase' in the three years prior to 2003, a number of stocks did outperform the indices hands down. Stock selection is critical. Further, for investors who are relatively risk-averse and for whom capital protection is of prime importance, it is safer to stick with liquid and fundamentally sound companies instead of investing in 'emerging mid-caps'. Larger companies, with their financial muscle and balance sheet, are always in a better position to capitalise on any upturn and ward off dangers much more successfully in the event of a downturn.

Among other things to be kept in mind are those of return expectations and investment horizon. The return expectations have to be rationally driven, as super normal profits are not always possible. We believe returns in the region of 15% per annum over the next few years from equity investments is a reasonable expectation. Investors must remember that the additional returns (relative to the risk free rate of return on government bonds) on equities come bundled with the high risk involved in them. Apart from expectations, investment horizon also plays an important role because timing the market and trying to catch the troughs and peaks is a very difficult task. However, over a longer period of time, one can be reasonably sure of the returns that one can get from a good investment.

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