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Markets: Sense(x) and sensibility!

May 4, 2006

The Indian stock markets continue to be on a roll. Fathom this, over the last 3 years, since April 28, 2003, the BSE-Sensex has delivered a return of 325%, considering the new lifetime high it achieved during yesterday's trade. This makes for a compounded average return of 106% during this period! Not many investors would have managed to beat the index in this bull-run. However, the moot point is not this and is rather, now what? While we would refrain from hazarding a guess as to what levels could be achieved by the Sensex over the next quarter or year, we would rather look at the long-term (3 to 5 years) wherein there is an almost surety of positive returns. We would like to put this in the words of Mr. Ajit Dayal, CEO and CIO of Quantum Advisors Pvt. Ltd., Director of Quantum Asset Management Company and Chairman of Quantum Information Services Ltd - "In the last 4 years we have seen the market increase by over 350%. Over the long haul, Indian stocks will give 15% per annum returns, so an Index of 150,000 is possible, but in 20 years!"

He further states, "Now, before you get excited and sell your houses to buy stocks remember the risks of being in equities and also recall the journey from 400 to 10,000 - there were years when the Index lost money. So there will be NO straight line to the sky but many bumps along the way although, as much research has shown, equities tend to outperform other assets like debentures/bonds and property over long periods of time. And they should because you take more "risk" by being in equities."

As such, during this period, there are certain very important points that investors must remember in order to survive in the stockmarkets and enjoy the returns.

Thus, amongst some of the things that an investor must do are:

Read that Annual Report: The sole means of communication and contact from the company to the shareholder (read retail investor) is the Annual Report. This should be the investment bible for any stock market investor. The Annual Report would provide you a fair insight into the company's business model, its markets, its competitors, its financial position and its future course of action.

Get your asset allocation right: The allocation of surplus money between equities and other investment avenues like debt, property and gold should not be different in a bull market and a bear market. That is, there is no real need to increase the percentage of investment in equities just because the markets are going up. The risk appetite of a person remains the same, depending upon the age bracket and his financial requirements. This is one of the important disciplines of investing in stockmarkets.

Research harder: This is one trouble that comes bundled with a bull-run, as valuations of stocks rise beyond any possible justification. And this over-valuation could continue till the bull-run lasts, as market intermediaries come out with the most awkward reasons to justify their stance. However, this should not deter an investor, who would now have to research harder in order to find a stock that still holds value.

Invest in fundamentals: Don't budge from this principle under any circumstances, as fundamentals of a company would stay with it irrespective of the (bull/bear) phase of the markets. Invest in fundamentally sound companies with viable business models and an impeccable management track record to protect your portfolio value from getting eroded.

Have patience: We are a firm believer of investing for the long-term. In fact, the possibility of you making money is much higher in the long-term vis--vis the short-term. It is important to note here that over the long-term, equities have outperformed all other asset investment classes.

Now, let us consider some things that an investor must avoid doing.

Avoid rumours: During any bull run, this is the first thing that gets activated. Since everything and anything goes up in a bull run, markets are always full of 'tips' and 'rumours'. Noises like 'turnaround story', 'bonus/split in the offing' and 'large order' are some of the garbs under which rumours thrive. Retail investors need to exercise strict caution here and avoid such calls.

Avoid herd mentality: Do not buy a stock just because the whole market is talking about it. Generally, when the markets start talking about a stock, it would already have had a handsome run on the bourses. It is precisely when the stock has given huge returns within the shortest time span possible that the stock will come into the limelight. And God forbid, it is quite likely that after you have bought the stock, the only direction it heads to is down, as it would generally be devoid of any fundamentals.

Avoid greed: This is an important investment practice one should abide by strictly. Keep strict targets for yourself and do not hesitate to sell a stock when its price target is achieved, beyond which, it is just over-expectations and market momentum that takes over the stock. Similarly, to look at the other side of this, do not get emotionally attached to a stock. If fundamentals of a company change due to any unforeseen and unpredictable development (like a government policy), get rid of the stock. There is no dearth of investment opportunities in the market.

Do not borrow and invest: Borrowing and investing in the stockmarkets is not a good strategy to follow. In this case, your stock market profits will first be used to service the debt taken and after that the left over will be your profits. In fact, it is quite possible, in order to increase the returns, since a major chunk goes towards interest payments, the investor might be forced to take higher risk (for higher returns), which could be well over his/her risk appetite. Moreover, it would serve as double whammy if the stockmarkets were to go into a correction mode.

We must again reiterate the fact here that the above is not an exhaustive list of 'to do/not to do things' while investing in stock markets and neither are they a foolproof method of guaranteed returns. However, they will go a long way in mitigating the risk factors considerably. All the above factors play a collective important role in determining the success of an investor's portfolio.

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