Apr 23, 2009|
Value investing: Best company to invest
It is most common for investors to get lured into buying the stock of a company that is very popular, is being recommended by a lot of people, and is said to be certain to do fabulously well in future. Its stock is on business channels all the time, its prospects are mouthwatering, its profits are set to grow exponentially, and its products are seeing demand like never before. It seems almost obvious that there could be no better company to invest in.
However, if that's how you feel, be sure that value investing guru Benjamin Graham would definitely not agree with you. More specifically, he sees two problems imminent for someone making investing decision based on such a strategy.
For one, placing all the emphasis on choosing and investing in such a company can often lead one to get tempted into paying too high a price for such a 'great' stock. The buying price is as important, if not more, as choosing a company to invest in.
The second is problem is that the company itself may be chosen imprudently. It would be instinctive to choose a company that is large and well managed, has a good record, and is expected to show increasing earnings in the future. But such expectations are highly vulnerable to subjective interpretation, and so is putting a price on such qualitative factors. Thus, wherever such factors come into the picture, prices are frequently overdone.
Also, optimistic expectations, even though they may seem justifiable at the time, very often fail to be realised. Look around you; many of the leading companies of yesterday are today languishing at less than one tenth their peak prices as they have very few takers. Not long back, people just couldn't get enough of these very same companies.
Take the stock of Unitech for example.
Unitech is one such company that was a darling of the real estate story. The housing boom, burgeoning middle class demand, high margins, the rising long term trend of real estate prices etc. were some of the reasons put forth to justify paying any price for the stock of Unitech - a company said to be extremely well positioned to take advantage of the favorable industry characteristics.
Look at where it is now. From a high of about Rs 538 that it touched in January 2008, it fell to a low of about Rs 23 in November 2008. That's a fall of about 96%, that too within the same year. It has so far been able to recover to Rs 44, still 92% lower than its all time high.
While history is full of innumerable such examples, the future is likely to have still many more. As Graham said "The standing of an enterprise is in part a matter of fact and in part a matter of opinion. During recent years investment opinion has proved extraordinarily volatile and undependable". He said this in 1940, but it is as true today as it was during his time.
Disclaimer: The case of Unitech has just been used as an example and does not amount to any recommendation of the stock from Equitymaster
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