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A few good questions... - Views on News from Equitymaster
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  • Aug 18, 2005

    A few good questions...

    We are currently in the midst of a bull-run that is showing no signs whatsoever of stopping. Reports are abound about the attractiveness of the 'India story', the strong growth expected by the Indian economy as a whole and India Inc in particular, the sustainability of this growth, the upcoming Indian middle class with huge purchasing power and so on.

    Quite clearly, the FIIs have been the pump primers of this surge in the indices. The US, Japan, Singapore, Mauritius, you name it, Foreign Institutional Investors (FIIs) from that country are here. Further there are justifications doing the rounds of the market that these (and more to come) would continue to remain invested here for a plethora of reasons including the fact that returns here are more attractive than in other investment destinations. So much is the effect of this belief that FIIs would continue to pour money into Indian equities, that Indian investors have gone all out and have been investing at the current levels. However, investors must note that, quite often, these FIIs are fair weather friends and at the slightest sign of danger, they and their money can fly out of sight!

    Repeating our oft-mentioned stance, we maintain that we are 'not' bearish on the Indian markets. We do believe that the 'India story' is a long-term positive play and as such, long-term investors do have good things to look forward to in terms of long-term returns. But at this point in time, with markets repeatedly making new highs every week, it is becoming increasingly difficult to find an investment worthy of note at the current high levels.

    Considering all of the above, in this write-up, we attempt to list down a few pointers and questions for investors to get them to think about their equity investments.

    So, what is your answer?

    Are you a first-time investor?: Well, if your answer is 'yes', then, to be honest, it is very difficult to buy too many stocks at these levels. Finding value at such heights is a very difficult task indeed and if you are planning to put your hard-earned money in the markets now, you have to be prepared to take high risks, as, at present, the risk-return ratio is clearly skewed towards risk. We have been proved wrong for some time now (along with many others), as the correction expected has just not materialized. The massive liquidity surge has astonished even the most seasoned of market watchers.

    Then, what can a new investor in equities do to take advantage of this bull market? Well, if seasoned pros are finding it difficult to judge the market at these levels, what chance does a new investor have? The point here is that, even if we take a longer-term perspective, valuations of many stocks are not really 'attractive'. Several stocks have already factored in FY07 earnings and chances of an upside in such stocks are slim, while the downside risk is very high. Therefore, the bottomline is, at these levels, a fresh investor would need to wait for a much longer period to earn decent return on his/her investments and this is coupled with the additional risk that comes at investing at higher levels.

    Do you invest on the basis of 'tips' or on advice based on research?: In such bull markets, 'everyone' becomes an 'expert' on the markets! Your neighbour, 'Patelbhai', says invest in stock XYZ, it will double in one week, or so he has heard. Everyone wants to get in on the action and excitement and appear to be 'knowledgeable' on the markets. Why, even your neighbourhood 'paanwala' will have heard of companies like Infosys and Reliance and even have an opinion on them!

    Therefore, it becomes pertinent to ask oneself if one is investing based on such 'tips' or based on solid research. If it is the former, then be prepared to burn your fingers if any adverse event affects the markets, as often, stocks that are touted as 'tips' are the ones that fall in a big way when the markets correct. We would always advise investors (current and potential) to invest based on research about the company and knowing it better, as, to that extent, the risk gets reduced considerably as you are now aware of what you are putting your money into, be it a cyclical industry like steel or a high-growth industry like software.

    Do you invest because FIIs are investing?: Are you the type of investor who puts his or her money into a stock just because the FIIs are putting their money in that stock? If 'yes', then you could end up being badly bruised! It is not easy to understand the kind of money (short-term or long-term) that FIIs put into a particular stock. If this money flies out at the slightest hint of trouble, then you could lose a lot of money. 'Piggyback investing' can be dangerous and puts at great risk, your hard-earned money.

    Do you understand the business of the company?: Warren Buffet, investment guru and the world's second-richest man, has not just risen to this stature by chance. He thoroughly understands the businesses of whichever stocks he invests in and has reaped rich rewards for this quality of his. Why not attempt to cultivate a little bit of Warren Buffet in ourselves and reap similar rich dividends? It is important to understand the dynamics of the industry in which the company operates and the company's position in the industry. This will reduce substantially, the risk associated with investing. It is rightly said that 'risk means not knowing what you are doing'. Thus, when you study the company and its business in detail and take pains to understand the finer points, you reduce the risk that you take.


    We have given a few pointers above as to the kind of hard questions one must ask oneself in these markets. You work hard to earn, why not make sure you work similarly hard to invest your hard-earned money? Given the fact that the time value of money gets eroded due to inflation, it is extremely vital to ensure that you do not lose your money just because of some 'tip' a friend or relative gave you. There are adequate negatives in the global economy at present, such as high crude prices, the possibility of a China slowdown, bursting of the housing bubble in the US, rising US interest rates and so on. Because this is a seemingly unstoppable bull market, these factors have been discounted. But, as an investor, one must make sure that one does not 'discount' researching the stock and investing based upon fundamentals!



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