Are you still in denial? - Views on News from Equitymaster

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Are you still in denial?

Dec 15, 2008

The BSE-Sensex is down almost 55% from its all time high of January 2008. Your stock portfolio must have not done well either during this period. You might be in a stage of denial that stocks can’t lose further. If yes, you are just at the second stage of the Kübler-Ross Grief Cycle. Feeling of shock is what you must have already experienced as the first stage. And we already empathise with you for the next stages that you might enter/have entered - those of anger, and then depression. In this article, we show why you should get rid of denial and get ahead in your investing endeavours.

Kubler-Ross Grief Cycle

A 'flight into reason' is what your need at this moment. The key to avoiding uncomfortable emotions is by focusing on facts and logic. And both facts and logic state that, based on historical standards, stocks are trading cheap currently.

But before making any investment decision you need to be convinced of your action. "The Indian stock market requires great conviction, as surely as it victimises the unconvinced," said the renowned investor Peter Lynch. You will know that you are convinced when you buy outstanding businesses when they are available cheap.

The easier part is to identify outstanding businesses. India has lots of them, like HDFC, Tata Steel, and Infosys. The tricky part is to identify if these businesses are available cheap.

The most important step to generating wealth from stocks over the long term is to buy when they are cheap. Here are few factors that make the business/stock attractive to be bought:

  • Price to earnings of less than 10;

  • Price to book value of less than 1;

  • Negligible debt on balance sheet;

  • Fast and sustainable free cash generation; and

  • Strong competitive advantages (like management vision, market leadership and technological edge).

We are not sure which way the markets will move in the short run. In fact, given that the issues will still take time to resolve, do not be surprised if stocks continue to slide from their current levels.

However, the fact is that shares of companies with solid businesses and visionary managements have been punished as those with doubtful credentials. And if you decide to buy quality stocks today, we believe you will be more than pleased in a few years that you pulled the trigger.

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