Short term 'tips' Vs long-term investing! - Views on News from Equitymaster

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Short term 'tips' Vs long-term investing!

Jun 9, 2005

"Stock XYZ is trading at Rs 20 now. It will go up to Rs 50 in 3 months time, GUARANTEE!" "MNC Technologies is Rs 10 now, it will touch Rs 35 in 6 months time, SURELY!" No, these are not our recommendations on any particular stocks for investment, so don't get too excited! We are just summarising some of the 'so-called tips' that many 'so-called knowledgeable market players' dish out to their customers. Some of these are quite simply nonsensical and put at great risk, the money of the investor - YOU!

Most of the short-term tips, which could range from 3 or 4 weeks to 6 months or thereabouts, are news-driven, largely removed from fundamentals. These could be due to the company receiving a large order, due to which sentiment on that stock has improved and it is likely to move up rapidly in the near future. Or it could simply be due to operators taking positions in the scrip, in which case, buying it would be fraught with risks, since, as and when these operators offload their positions, the scrip would plunge rapidly. Such scrips may be entirely stripped of fundamentals and be highly speculative and it is often in such scrips where small investors get their fingers burnt. An example is 'Z' group scrips, which are generally illiquid and operator-driven.

While we are not necessarily saying that investing in all such stocks will be speculative in nature, we do believe that if one is investing in the stock markets, one should do so with a long-term view of the company's business and accordingly take a call. The logic is simple - stock markets have the potential to deliver the highest returns among most asset classes and accordingly, the risk of investing in them is considerably higher than, say, bank fixed deposits, or PPF.

This risk is very high in the short term, which ranges for periods around one year. This is because, in the short term, stocks are driven largely by news flow, which can be classified as macro and micro-related. An example of macro-related news is news regarding long-term prospects of the industry or economy, such as that relating to the recent softening of steel prices and cutback of imports from China. On the other hand, micro-news could be stock-specific developments such as new order wins, or even disappointing quarterly results. A clear case in point is TCS, which declared disappointing results for 4QFY05. The stock got a battering after that, plunging by as much as 16% in just two trading sessions!

Therefore, stocks tend to be more volatile in the short term. As an investor, one must always look for ways to minimize this risk while investing. One of the best and time-tested ways of doing this is investing for the longer term. While punters and speculators can probably afford to take on the risks of trading on a daily or weekly basis, small investors might not have such a risk appetite. Therefore, the best bet for such investors is to invest in fundamentally sound companies, having strong growth prospects and a visionary management team.

If we take a look at the Sensex over a one-year period, it has gained by a strong 36.2%. However, one must also note that this was mainly due in part, to the spectacular fall that it had witnessed on 'Black Monday' May 17, 2004. The Sensex was, thus, still recovering from the shock it had suffered and as a result, to that extent, the returns picture gets skewed. This is yet another example of sentiment affecting the markets in the short term.

However, if we take a longer time frame of four years, the picture gets evened out. We have not taken a three-year time frame, since the markets have been on a sustained bull run since 2003 and returns will obviously be good. Therefore, to smoothen out the impact of the bull markets, we take an additional one-year to assess returns. The picture is quite clear. The Sensex has managed to clock a CAGR of around 18% in this period. And a point to be noted is, that in this four-year period, there have been numerous ups and downs - what we would call 'short term blips' - witnessed by the markets - 9/11, oil price shocks, increasing interest rates in the US, 'Black Monday' and so on. Despite so many 'crests and troughs' during this period, the eventual result is favourable for the investor.

Therefore, as we have seen in the above examples, it pays to be patient and hold on to your investments for a longer period of time. Of course, you have to follow a sound investment strategy of putting your money in fundamentally sound companies with a reputed management team and good growth prospects. And, needless to add, investing at the right price. If you had bought Infosys, a solid company with an excellent management team, but you bought it during the peak of the 'IT bubble' in 2000 at maybe Rs 16,000, then you would not have made any great returns. Therefore, one must be very sensible while taking such decisions, as one is investing one's hard-earned money! And be disciplined - book profits as soon as the stock hits your target price. Keeping greed under control is a very difficult thing to do, but one that can earn fabulous dividends for any investor. Just ask Warren Buffet!


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