Stock Exchange Basics - Part II
>> Tuesday, February 17, 2009
Stock Exchange Basics - Part II
| Chapter 2 Module 7 - Do it yourself - Basic investment strategies |
|
Chapter 2
Module 8 - The market Talks. Listen to Spot the best.
Market Direction.
Is the Market Heading South?
Check out the NSE Nifty and BSE Sensex charts on ICICIDirect every day. Observe the price and volume changes, there may be some selling on a rising day. The key is that volumes may increase on a day as the index closes lower or is range-bound. Studying the general market averages is not the only tool. There are other indicators to spot a topping market: A number of the market's leading stocks will show individual selling signals. In a falling market start selling your worst performing stocks first. If the market continues to do poorly, consider selling more of your stocks. You may need to sell all your stocks if the market doesn't turn around. If any stocks fall 8% below your purchase price, sell immediately. However, if you have tremendous confidence on the company stick to your pick.
Is theMarket Turning Upwards?
After a prolonged fall, the market will try to bounce back and try to rally from the low levels. However, you can't tell on the first or second day if the rally is going to last, so, as ICICI Direct’s Wise investor, you don't buy on the first or second day of a rally. You can afford to wait for a second confirmation that the market has really turned and a new uptrend or bull market has begun. A follow-through will occur if the market rallies for the second time, showing overwhelming strength by closing higher by one per cent with the volume higher than the day's volume. A strong rebound usually occurs between the fourth and seventh session of an attempted rally. Sometimes, it can be as late as the 10th or 15th day, but this usually shows the turn is not as powerful. Some rallies will fail even after a follow-through day. Confirmed rallies have a high success rate, but those that fail usually do so within a few days of the follow-through. Usually, the market turns lower on increasing volume within a few days.
When the market begins a new rally, stocks from all sectors don't rush out of the gates at the same time. The leading industry groups usually set the pace, while laggards trail behind. After a while, the top sprinters may slow down and pass the baton to other strong groups who lead the market still higher.
Investors improve their chances of success by homing in on these leading groups. Investors should be wary of stocks that are far beyond their initial base consolidated point/stage. After the market has corrected and then turns around, stocks will begin shooting out of bases. Count that as a first-stage of a breakout. Most investors are wary of jumping back into the market after a correction. Plus, the stock hasn't done much lately; so many investors won't even notice the breakout. But the fund managers would take buy positions at this stage.
After a stock has run up 25 per cent or more from its pivot point, it may begin to consolidate and form a second-stage base. A four-week or other brief pause doesn't count. A stock should form a healthy base, usually at least seven weeks before it qualifies. Also, when a stock consolidates after rising around 10 per cent, it's forming a base on top of a base. Don't count that it as a second stage.
When the stock breaks out of the second-stage base, a few more investors see this as a powerful move. But the average investor doesn't spot it. By the time the stock breaks out of the third-stage base, a lot of people see what's going on and start jumping in.
When a stock looks obvious to the investment community, it's usually a bad sign. The stock market tends to disappoint most investors. About 50-60% of third-stage bases fail.
But some stocks keep going and eventually form a fourth-stage base. At this point, everybody and their sisters know about this stock. The company's beaming CEO shows up on the cover of business publications. But while thousands of small investors rush into this "sure thing," the top mutual funds may quietly trim or liquidate their holdings.
Most fourth-stage breakouts fail, though not necessarily right way. Some will rise 10% or so before reversing. Fourth-stage failures usually undercut the lows of their old bases.
But a stock can be reborn and begin a new four-base life cycle all over again. All it takes is a sizable correction.
How Do You Define A Bear Market?
Typically, market averages falling 15% to 20% or more.
Top Buying Volatile Stocks.
Buying at the right moment is the best defense against a volatile market. When the stock of a top-class company rises out of a sound price base on heavy volume, don't chase it more than five per cent past its buy point. Great stocks can rise 20-25% in a few days or weeks. If you purchase at those extended levels, what may turn out to be a normal pullback could shake you out. That risk rises with a more volatile stock.
Top Caution Signals from the Market!!!
There are several signs in the stock market that suggest caution, even though they're all very bullish. Here are some of them and what they might mean, based on past experience. First, everybody's bullish. If everyone's bullish, that means they've already bought their stock and are hoping more people will follow their enthusiasm. Most individual investors are fully invested. And as long as large inflows are still going into equity mutual funds, everything's fine. Watch out when the flows turn into trickles. There won't be buying power to keep boosting stocks.
Second, fear of the Economy/Political scenario. This is an initial indicator, which would pull of sporadic selling that could eventually mount into an outright bear market.
Third, new records for the SEBI week after week. That’s exuberance and won't continue. The technology sector is leading this market, and there's plenty of growth ahead for the group, but the pricing for many of the tech stocks is way ahead of the earnings. Most of the tech stocks are priced to perfection, meaning that if they don't report earnings above the analysts' expectations, they'll be in for a bashing. Too much good is already priced into many of these stocks. Fourth, a record season for IPOs. While there's always been a push to get financing done when the market is upbeat, this last penultimate (second last) season had been one for the records. Records never last. That's not how the market works. The penultimate season saw IPOs such as Hughes Software, HCL Technologies being subscribed several times over, with premium listings as they opened. This was followed by dismal erosion of value for those IPOs. What followed is issues such as Ajanta Pharma, Cadilla etc, opened at deep discounts. Two emotions drive markets: fear and greed. Usually there is some fear and some greed. Markets usually do best when they climb a wall of fear, meaning that every one expresses fear of investing but stocks continue to go higher. When that sentiment changes to bullish, the market roars ahead. Because the market is depressed, the next psychological state will be fear, and there will be a pull back, nothing severe. This great economy isn't going to stop growing, but many stocks are too far ahead of their numbers and will be pulling back when the market has a bad day
Module 8 - The market Talks. Listen to Spot the best.
| Market Direction. Is the Market Heading South? Check out the NSE Nifty and BSE Sensex charts on ICICIDirect every day. Observe the price and volume changes, there may be some selling on a rising day. The key is that volumes may increase on a day as the index closes lower or is range-bound. Studying the general market averages is not the only tool. There are other indicators to spot a topping market: A number of the market's leading stocks will show individual selling signals. In a falling market start selling your worst performing stocks first. If the market continues to do poorly, consider selling more of your stocks. You may need to sell all your stocks if the market doesn't turn around. If any stocks fall 8% below your purchase price, sell immediately. However, if you have tremendous confidence on the company stick to your pick. Is theMarket Turning Upwards? After a prolonged fall, the market will try to bounce back and try to rally from the low levels. However, you can't tell on the first or second day if the rally is going to last, so, as ICICI Direct’s Wise investor, you don't buy on the first or second day of a rally. You can afford to wait for a second confirmation that the market has really turned and a new uptrend or bull market has begun. A follow-through will occur if the market rallies for the second time, showing overwhelming strength by closing higher by one per cent with the volume higher than the day's volume. A strong rebound usually occurs between the fourth and seventh session of an attempted rally. Sometimes, it can be as late as the 10th or 15th day, but this usually shows the turn is not as powerful. Some rallies will fail even after a follow-through day. Confirmed rallies have a high success rate, but those that fail usually do so within a few days of the follow-through. Usually, the market turns lower on increasing volume within a few days. When the market begins a new rally, stocks from all sectors don't rush out of the gates at the same time. The leading industry groups usually set the pace, while laggards trail behind. After a while, the top sprinters may slow down and pass the baton to other strong groups who lead the market still higher. Investors improve their chances of success by homing in on these leading groups. Investors should be wary of stocks that are far beyond their initial base consolidated point/stage. After the market has corrected and then turns around, stocks will begin shooting out of bases. Count that as a first-stage of a breakout. Most investors are wary of jumping back into the market after a correction. Plus, the stock hasn't done much lately; so many investors won't even notice the breakout. But the fund managers would take buy positions at this stage. After a stock has run up 25 per cent or more from its pivot point, it may begin to consolidate and form a second-stage base. A four-week or other brief pause doesn't count. A stock should form a healthy base, usually at least seven weeks before it qualifies. Also, when a stock consolidates after rising around 10 per cent, it's forming a base on top of a base. Don't count that it as a second stage. When the stock breaks out of the second-stage base, a few more investors see this as a powerful move. But the average investor doesn't spot it. By the time the stock breaks out of the third-stage base, a lot of people see what's going on and start jumping in.
When a stock looks obvious to the investment community, it's usually a bad sign. The stock market tends to disappoint most investors. About 50-60% of third-stage bases fail.
But some stocks keep going and eventually form a fourth-stage base. At this point, everybody and their sisters know about this stock. The company's beaming CEO shows up on the cover of business publications. But while thousands of small investors rush into this "sure thing," the top mutual funds may quietly trim or liquidate their holdings. Most fourth-stage breakouts fail, though not necessarily right way. Some will rise 10% or so before reversing. Fourth-stage failures usually undercut the lows of their old bases. But a stock can be reborn and begin a new four-base life cycle all over again. All it takes is a sizable correction. How Do You Define A Bear Market? Typically, market averages falling 15% to 20% or more. |
| Top |
Buying Volatile Stocks. Buying at the right moment is the best defense against a volatile market. When the stock of a top-class company rises out of a sound price base on heavy volume, don't chase it more than five per cent past its buy point. Great stocks can rise 20-25% in a few days or weeks. If you purchase at those extended levels, what may turn out to be a normal pullback could shake you out. That risk rises with a more volatile stock. |
| Top |
Caution Signals from the Market!!! There are several signs in the stock market that suggest caution, even though they're all very bullish. Here are some of them and what they might mean, based on past experience. First, everybody's bullish. If everyone's bullish, that means they've already bought their stock and are hoping more people will follow their enthusiasm. Most individual investors are fully invested. And as long as large inflows are still going into equity mutual funds, everything's fine. Watch out when the flows turn into trickles. There won't be buying power to keep boosting stocks. Second, fear of the Economy/Political scenario. This is an initial indicator, which would pull of sporadic selling that could eventually mount into an outright bear market. Third, new records for the SEBI week after week. That’s exuberance and won't continue. The technology sector is leading this market, and there's plenty of growth ahead for the group, but the pricing for many of the tech stocks is way ahead of the earnings. Most of the tech stocks are priced to perfection, meaning that if they don't report earnings above the analysts' expectations, they'll be in for a bashing. Too much good is already priced into many of these stocks. Fourth, a record season for IPOs. While there's always been a push to get financing done when the market is upbeat, this last penultimate (second last) season had been one for the records. Records never last. That's not how the market works. The penultimate season saw IPOs such as Hughes Software, HCL Technologies being subscribed several times over, with premium listings as they opened. This was followed by dismal erosion of value for those IPOs. What followed is issues such as Ajanta Pharma, Cadilla etc, opened at deep discounts. Two emotions drive markets: fear and greed. Usually there is some fear and some greed. Markets usually do best when they climb a wall of fear, meaning that every one expresses fear of investing but stocks continue to go higher. When that sentiment changes to bullish, the market roars ahead. Because the market is depressed, the next psychological state will be fear, and there will be a pull back, nothing severe. This great economy isn't going to stop growing, but many stocks are too far ahead of their numbers and will be pulling back when the market has a bad day |
Chapter 2
Module 9 - What To Buy? When To Sell?
Sky rocketing stocks -- What is the right price?
Discount sales in most sectors – Buy at a bargain.
Sky rocketing stocks -- What is the right price?
Investors' dilemma is that they want to participate in the tech rally but the numbers look too high. While many of these gravity-defying stocks aren't worth their current prices, a few are. Here's how to tell the difference and when to buy them.
First, when a stock has stratospheric valuations, there's a reason: extremely high expectations. Investors expect the company to perform in an exceptional way in two areas: growth in revenues and growth in earnings. The challenge for investors is to discern which of these high-flying stocks deserve their attention.
Look for a stock that is essential, better performing. Does that mean you just buy the stock and hope? Definitely not. It does mean you start to monitor it and when the stock misses an earnings report or doesn't grow revenues fast enough, you look to buy. That takes patience. There's also the risk that the company won't make a misstep, and you won't buy it. If it happens that way, it will be the first company in history to do so. Granted the level may be much higher than the current one when you finally buy it, but the value of the stock may be much better. In other words, the P/E would be lower than the current levels.
The characteristics of the stocks you want to focus on are:
Market leaders who dominate their niche. The big tend to get bigger, win more contracts and have the largest R&D budgets.
Earnings that are growing, at an increasing rate, every year.
Revenue growth that exceeds the industry average.
Strong management.
Competing in an high and long-term growth oriented industry sector.
When you find all of these factors in a stock, it won't be a cheap one. But if you want to own it, sometimes you have to pay more than you would like. Currently, that's the entry fee for owning the best stocks in the technology areas. If you are patient and wait for some time you can pick some scrips at a relatively good price.
Top Discount sales in most sectors – Buy at a bargain.
There are lot of good stocks available at bargain prices. There are ways of finding the stocks, which are currently out of favor.
First, look for stocks that are out of favor for a temporary reason.
Second, look for stocks within sectors that are currently out of favor.
Third, use the tight screening methods to bring stock into your “Watch List” Here are some of the parameters to use and benchmarks to begin your search:
P/E ratio: Use a minimum of 10 and a maximum of 30. With current P/E ratios closer to 30, stocks with low P/Es can sometimes signal out of favor stocks. When you find these, make sure you're reading all the latest news items and check the analysts' thinking at ICICIDirect.
Price-to-Sales Ratio: Also called PSR. This is a macro way of looking at a stock. Many investors like to find stocks with a PSR below 1. It's a good number to start with, so put in .5 as a maximum and leave the minimum open. Be careful though, because many stocks will always carry a low PSR. You're looking for the stocks that have historically been high and are temporarily low.
Earnings growth: Look for atleast 20 per cent. If you can find a stock that has its earnings growing at 20% and its P/E at 10, you've got something worth investigating further. This is known as the PEG or P/E-to-Growth ratio. Sharp investors are looking for a ratio well below 1. In this example, the stock would have had a PSR of .5 (10/20).
Return on Equity: Start at 20% as the minimum and see who qualifies. The return on equity tells you how much your invested rupee is earning from the company. The higher the number, the better your investment should do.
By using just this combination of variables, you can find some interesting stocks. Try to squeeze your search each time you screen by tightening your numbers on each variable. And when you do find a stock, make sure you read all the relevant information from all the stock resources on the Web.
Top Should you buy more if the stock you own keeps climbing?
Top Cracking Buying Points
Here are some buying points for your reference
1. Strong long-term and short-term earnings growth. Look for annual earnings growth for the last three years of 25% or greater and quarterly earnings growth of at least 25% in the most recent quarter.
2. Impressive sales growth, profit margins and return on equity. The latest three-quarters of sales growth should be a minimum of 25%, return on equity at least 15%, and profit margins should be increasing.
3. New products, services or leadership. If a company has a dynamic new product or service or is capitalizing on new conditions in the economy, this can have a dramatic impact on the price of a stock.
4. Leading stock in a leading industry group. Nearly 50% of a stock's price action is a result of its industry group's performance. Focus on the top industry groups and within those groups select stocks with the best price performance. Don't buy laggards just because they look cheaper.
5. High-rated institutional sponsorship. You want at least a few of the better performing mutual funds owning the stock. They're the ones who will drive the stock up on a sustained basis. 6. New Highs. Stocks that make new highs on increased volume tend to move higher. Outstanding stocks usually form a price consolidation pattern, and then go on to make their biggest gains when their price breaks above the pattern on unusually high volume.
Top Cracking Selling Point
The decision of when and how much to buy is a relatively easy task as against when and what to sell. But then here are some pointers, which will assist you in deciding when to sell. Keep in mind that these parameters are not independent pointers but when all of them scream together then its time to step in and sell.
1. When they no longer meet the needs of the investor or when you had bought a stock expecting a specific announcement and it didn't occur. Most Pharma stocks fall into this category. Sometimes when they are on the verge of medical breakthroughs as they so claim, in reality if doesn’t materialize into real medicines; the stock will go down because every one else is selling. It's then time to sell yours too immediately, as it didn’t meet your need.
2. When the price in the market for the securities is an historical high. It's done even better than you initially imagined, went up five or ten times what you paid for it. When you get such a spectacularly performing stock, the last thing you should do is to sell all of it. Don't be afraid of making big money. While you liquidate a part of your holding in the stock to get back your principal and some neat profit, hold on to the rest to get you more money; unless there is some fundamental shift necessitating to sell your whole position. To repeat do not sell your whole position.
3. When the future expectations no longer support the price of the stock or when yields fall below the satisfactory level. You need to constantly monitor the various ratios and data points over time, not just when you buy the stock but also when you sell. When most ratios suggest the stock is getting expensive, as determined by your initial evaluation, then you need to sell the stock. But don't sell if only one of your variables is out of track. There should be a number of them screaming that the stock is fully valued.
4. When other alternatives are more attractive than the stocks held, then liquidate your position in a stock which is least performing and reinvest the same in a new buy.
5. When there is tax advantage in the sale for the investor. If you have made a capital gain somewhere, you can safely buy a stock before dividend announcements i.e. at cum-interest prices and sell it after dividend pay out at ex-interest prices, which will be way below the price at which you had bought the stock. This way the capital loss that you make out of the buy and sell can be offset against the capital gain that you had made elsewhere and will hence cut your taxes on it.
6. Sell if there has been a dramatic change in the direction of the company. Its usually a messy problem when a company successful in one business decides to enter another unrelated venture. Such a decision even though would step up the price initially due to the exuberant announcements, it would begin to fall heavily after a short span. This is because the new venture usually squeezes the successful venture of its reserves and reinvesting capability, thus hurting its future earnings capability.
7. If the earnings and if they aren't improving over two to three quarters, chuck out the stock from your portfolio. To get a higher price on a stock, it needs to constantly improve earnings, not just match past quarters. However, as an investor, you need to read the earnings announcements carefully and determine if there are one-time charges that are hurting current earnings for the benefit of future earnings.
8. Cut losses at the right level. But do not sell on panic. The usual rule for retail investor is to sell if a stock falls 8% below the purchase price. If you don't cut losses quickly, sooner or later you'll suffer some very large losses. Cutting losses at 8% will always allow investors to survive to invest another day.
However, this is not exactly the right way to do it. Some investors have certain disciplines: take only a 10% or 20% loss, then get out. Cut your losses, let your winners ride, etc. The only problem with that is that you often get out just as the stock turns around and heads up to new highs. If you have done your homework on a stock, you will experience a great deal of volatility and a 5 to 8 % move in the stock is part of the trading day. To simply get out of a stock that you've worked hard to find because it goes down, especially without any news attached to it, only guarantees you'll get out and lose money. Stay with a good stock. Keep up with the news and the quarterly reports. Know your stock well, and the fluctuations every investor must endure won't trouble you as much as the uninformed investor. In fact, many of these downdrafts are great opportunities to buy more of a good stock at a great price, not a chance to sell at a loss and miss out on a winner.
Module 9 - What To Buy? When To Sell?
|
| Sky rocketing stocks -- What is the right price? Investors' dilemma is that they want to participate in the tech rally but the numbers look too high. While many of these gravity-defying stocks aren't worth their current prices, a few are. Here's how to tell the difference and when to buy them. First, when a stock has stratospheric valuations, there's a reason: extremely high expectations. Investors expect the company to perform in an exceptional way in two areas: growth in revenues and growth in earnings. The challenge for investors is to discern which of these high-flying stocks deserve their attention. Look for a stock that is essential, better performing. Does that mean you just buy the stock and hope? Definitely not. It does mean you start to monitor it and when the stock misses an earnings report or doesn't grow revenues fast enough, you look to buy. That takes patience. There's also the risk that the company won't make a misstep, and you won't buy it. If it happens that way, it will be the first company in history to do so. Granted the level may be much higher than the current one when you finally buy it, but the value of the stock may be much better. In other words, the P/E would be lower than the current levels. The characteristics of the stocks you want to focus on are:
When you find all of these factors in a stock, it won't be a cheap one. But if you want to own it, sometimes you have to pay more than you would like. Currently, that's the entry fee for owning the best stocks in the technology areas. If you are patient and wait for some time you can pick some scrips at a relatively good price. |
| Top |
Discount sales in most sectors – Buy at a bargain. There are lot of good stocks available at bargain prices. There are ways of finding the stocks, which are currently out of favor. First, look for stocks that are out of favor for a temporary reason. Second, look for stocks within sectors that are currently out of favor. Third, use the tight screening methods to bring stock into your “Watch List” Here are some of the parameters to use and benchmarks to begin your search: P/E ratio: Use a minimum of 10 and a maximum of 30. With current P/E ratios closer to 30, stocks with low P/Es can sometimes signal out of favor stocks. When you find these, make sure you're reading all the latest news items and check the analysts' thinking at ICICIDirect. Price-to-Sales Ratio: Also called PSR. This is a macro way of looking at a stock. Many investors like to find stocks with a PSR below 1. It's a good number to start with, so put in .5 as a maximum and leave the minimum open. Be careful though, because many stocks will always carry a low PSR. You're looking for the stocks that have historically been high and are temporarily low. Earnings growth: Look for atleast 20 per cent. If you can find a stock that has its earnings growing at 20% and its P/E at 10, you've got something worth investigating further. This is known as the PEG or P/E-to-Growth ratio. Sharp investors are looking for a ratio well below 1. In this example, the stock would have had a PSR of .5 (10/20). Return on Equity: Start at 20% as the minimum and see who qualifies. The return on equity tells you how much your invested rupee is earning from the company. The higher the number, the better your investment should do. By using just this combination of variables, you can find some interesting stocks. Try to squeeze your search each time you screen by tightening your numbers on each variable. And when you do find a stock, make sure you read all the relevant information from all the stock resources on the Web. |
| Top |
Should you buy more if the stock you own keeps climbing? |
| Top |
Cracking Buying Points Here are some buying points for your reference 1. Strong long-term and short-term earnings growth. Look for annual earnings growth for the last three years of 25% or greater and quarterly earnings growth of at least 25% in the most recent quarter. 2. Impressive sales growth, profit margins and return on equity. The latest three-quarters of sales growth should be a minimum of 25%, return on equity at least 15%, and profit margins should be increasing. 3. New products, services or leadership. If a company has a dynamic new product or service or is capitalizing on new conditions in the economy, this can have a dramatic impact on the price of a stock. 4. Leading stock in a leading industry group. Nearly 50% of a stock's price action is a result of its industry group's performance. Focus on the top industry groups and within those groups select stocks with the best price performance. Don't buy laggards just because they look cheaper. 5. High-rated institutional sponsorship. You want at least a few of the better performing mutual funds owning the stock. They're the ones who will drive the stock up on a sustained basis. 6. New Highs. Stocks that make new highs on increased volume tend to move higher. Outstanding stocks usually form a price consolidation pattern, and then go on to make their biggest gains when their price breaks above the pattern on unusually high volume. |
| Top |
Cracking Selling Point The decision of when and how much to buy is a relatively easy task as against when and what to sell. But then here are some pointers, which will assist you in deciding when to sell. Keep in mind that these parameters are not independent pointers but when all of them scream together then its time to step in and sell. 1. When they no longer meet the needs of the investor or when you had bought a stock expecting a specific announcement and it didn't occur. Most Pharma stocks fall into this category. Sometimes when they are on the verge of medical breakthroughs as they so claim, in reality if doesn’t materialize into real medicines; the stock will go down because every one else is selling. It's then time to sell yours too immediately, as it didn’t meet your need. 2. When the price in the market for the securities is an historical high. It's done even better than you initially imagined, went up five or ten times what you paid for it. When you get such a spectacularly performing stock, the last thing you should do is to sell all of it. Don't be afraid of making big money. While you liquidate a part of your holding in the stock to get back your principal and some neat profit, hold on to the rest to get you more money; unless there is some fundamental shift necessitating to sell your whole position. To repeat do not sell your whole position. 3. When the future expectations no longer support the price of the stock or when yields fall below the satisfactory level. You need to constantly monitor the various ratios and data points over time, not just when you buy the stock but also when you sell. When most ratios suggest the stock is getting expensive, as determined by your initial evaluation, then you need to sell the stock. But don't sell if only one of your variables is out of track. There should be a number of them screaming that the stock is fully valued. 4. When other alternatives are more attractive than the stocks held, then liquidate your position in a stock which is least performing and reinvest the same in a new buy. 5. When there is tax advantage in the sale for the investor. If you have made a capital gain somewhere, you can safely buy a stock before dividend announcements i.e. at cum-interest prices and sell it after dividend pay out at ex-interest prices, which will be way below the price at which you had bought the stock. This way the capital loss that you make out of the buy and sell can be offset against the capital gain that you had made elsewhere and will hence cut your taxes on it. 6. Sell if there has been a dramatic change in the direction of the company. Its usually a messy problem when a company successful in one business decides to enter another unrelated venture. Such a decision even though would step up the price initially due to the exuberant announcements, it would begin to fall heavily after a short span. This is because the new venture usually squeezes the successful venture of its reserves and reinvesting capability, thus hurting its future earnings capability. 7. If the earnings and if they aren't improving over two to three quarters, chuck out the stock from your portfolio. To get a higher price on a stock, it needs to constantly improve earnings, not just match past quarters. However, as an investor, you need to read the earnings announcements carefully and determine if there are one-time charges that are hurting current earnings for the benefit of future earnings. 8. Cut losses at the right level. But do not sell on panic. The usual rule for retail investor is to sell if a stock falls 8% below the purchase price. If you don't cut losses quickly, sooner or later you'll suffer some very large losses. Cutting losses at 8% will always allow investors to survive to invest another day. However, this is not exactly the right way to do it. Some investors have certain disciplines: take only a 10% or 20% loss, then get out. Cut your losses, let your winners ride, etc. The only problem with that is that you often get out just as the stock turns around and heads up to new highs. If you have done your homework on a stock, you will experience a great deal of volatility and a 5 to 8 % move in the stock is part of the trading day. To simply get out of a stock that you've worked hard to find because it goes down, especially without any news attached to it, only guarantees you'll get out and lose money. Stay with a good stock. Keep up with the news and the quarterly reports. Know your stock well, and the fluctuations every investor must endure won't trouble you as much as the uninformed investor. In fact, many of these downdrafts are great opportunities to buy more of a good stock at a great price, not a chance to sell at a loss and miss out on a winner. |
Chapter 2
Module 10 - Learn To Manage Your Portfolio.
Importance of diversification.
Importance of diversification.
Diversification helps you protect your investments from market fluctuations. Diversifying means allocating your money to different investments avenues and shields you from price risks. As you pick the best stocks from the hottest sectors, the fluctuation risk of the stock eroding your investment rises correspondingly. Since some stocks in the IT and media sectors are highly volatile, you need to protect your portfolio by investing in some defensive stocks or other industry groups. It would also be wise to diversify your investments into bonds or FDs as these are low risk - fixed income avenues.
The primary objectives of any Portfolio management are
Security of principal amount invested
Stability of income
Capital growth
Liquidity – nearness to money to take up any new buy opportunities thrown open by the market
Diversification
Diversifying means buying stocks belonging to different industries with very low correlation i.e to find securities that do not have tendencies to increase or decrease in price at the same time.
What you're working towards should be at least five industries for the stock portion of the portfolio with each stock being the best stock, in your opinion, in their respective industry group. There should still be money invested in a money market fund (the equivalent of cash) as well as some in fixed income.
Top Portfolio – Age relationship.
Your age will help you determine what is a good mix / portfolio is
Age Portfolio below 30 80% in stocks or mutual funds
10% in cash
10% in fixed income 30 t0 40 70% in stocks or mutual funds
10% in cash
20% in fixed income 40 to 50 60% in stocks or mutual funds
10% in cash
30% in fixed income 50 to 60 50% in stocks or mutual funds
10% in cash
40% in fixed income above 60 40% in stocks or mutual funds
10% in cash
50% in fixed income
These aren't hard and fast allocations, just guidelines to get you thinking about how your portfolio should look. Your risk profile will give you more equities or more fixed income depending on your aggressive or conservative bias. However, it's important to always have some equities in your portfolio (or equity funds) no matter what your age. If inflation roars back, this will be the portion of your investments that protects you from the damage, not your fixed income.
Also, the fixed income of your portfolio should be diversified. If you buy bonds and debentures directly or if you invest in FDs, then make sure you have at least five different maturities to spread out the interest rate risk.
Diversifying in equities and bonds means more than buying a number of positions. Each position needs to be scrutinized as to how it fits into the stocks or bonds that already are in your portfolio, and how they might be affected by the same event such as higher interest rates, lower fuel prices, etc. Put your portfolio together like a puzzle, adding a piece at a time, each one a little different from the other but achieving a uniform whole once the portfolio is complete.
Top Review of portfolio
Portfolio Management is an incomplete exercise without a periodic review. Every security should be subject to severe scrutiny and a case made out for its continuation or disposal. The frequency of review will depend on the size, amount involved and the kind of securities held in the portfolio. Spend a bit of time; you'll get a little bit of results. If you spend more time, your results should improve. We would suggest you spend a minimum of one hour a day during normal times while on the days of high volatility, its suggested that the investor monitor the situation closely.
Top Look analyze and do some adjusting
Look at your portfolio and do some adjustments. But don't just sell the losers (or the winners) randomly. There are several consequences of any action whether it's the taxes, the asset allocation, or the timing of the transaction. Here are a few things to consider.
If you liked a stock because of its earnings and it continues to deliver, hang on even if the price has not moved up. It will because earnings are the engine of any stock's price. As always, patience is heavily rewarded in the market because it is the rarest commodity.
As for selling a stock and then thinking you can buy it back after some days. There are two problems with that type of thinking. One, you generate two rounds of commissions (sell, then buy) and two, you may not get to buy the stock back at a decent price because the stock might have run dramatically in the month you did not own it. If you sell a stock, do it with finality and move on. Don't try to time the market. No one can do that with perfection.
Top Sector Rotation
You've probably noticed that tech stocks are hot, financials are not. Neither are the Consumer durables or some of the large-cap FMCG or Pharmaceuticals. If you're thinking about jumping onto tech stocks now because that's where all the action is, think again. While traders can bounce in and out of stocks several times a day, an investor should look to where the action isn’t much, meaning less of “Extreme Volatility”.
Sector rotation happens all the time in the market. Several groups are hot (like ICE – Infotech, Communication and Entertainment Stocks) while other groups are getting dumped (names like Gujarat Ambuja, Grasim, Tata steel are examples). As an investor, you should look at taking profits from stocks that are fully valued and re-investing in stocks that have a big 'Buy' sign written all over them. In other words, dump some of the winners and buy some of the losers who are not down because of major problems that look to be insurmountable but because of temporary concerns that can be closely scrutinized.
Sector rotation occurs because of fear and greed, the two emotions that run markets. The real challenge for an investor is to determine what the right entry price is and what is out of favor at the moment. Some of the Technology stocks such as Infosys have PE multiples of over 100 times. Whereas some of the fundamentally sound stocks such as Tata Steel whose stocks can be bought for less than 10 times earnings.
The very bullish will point out that tech is where the growth is while financials are always hurt in an upward moving interest rate environment. They're right on both counts. However, the tech stocks are priced to perfection. If any of them don't deliver earnings at or better than expected, they're going to get hammered. And the financials are priced for interest rates going up dramatically from here, not another 25 basis points or so.
The point here is not to recommend financial stocks (or non-durables or drug stocks) but to make investors aware of this sector rotation phenomenon. Take the time to build separate portfolios in each of the sectors you have an interest. It becomes very obvious where the money is flowing and where it's coming from. As an investor the challenge is to wait for prices that you can't believe in quality stocks, and then make your move. You will not catch the bottom of the stock (OK, maybe a few of you will). But you will own a stock that will come back into favor whenever the current troubles have passed and sector rotation occurs once again. Only this time, you'll be riding the hot stocks.
Top Measuring Portfolio Performance
The performance of a portfolio has to be measured periodically – preferably once a month. The performance of the individual will have to be compared against the overall performance of the market as indicated by various indices such as the Sensex or Nifty. This way a relative comparison of performance can be developed.
Lets now learn to compute the “Total Yield”. For example if the portfolio value of Mr. X is Rs 2,00,000 at the beginning of this month. During the month he added Rs 8000 to the fund. During this month he also received a dividend income of Rs 1000. Assuming the value of the portfolio at the end of this month is Rs 2,20,000.
The total yield will be = ((220000 – (2,00,000 + 9000)) / ( 2,00,000 + (1/2 * 9000)) ) *100 = 5.38% per month
To elaborate, in the numerator we are trying to find out the increase in value of portfolio after deducting the extra amount of Rs 8000 and the income of Rs 1000. It is assumed that this sum of Rs 9000 is put to use somewhere in the middle of the month and hence only half of Rs 9000 is added to the value of the fund at the beginning. The denominator can be adjusted as per the amount that you reinvest (part or fully) out of dividend income and what point of time during the period do you actually plough back such part of the money.
Beta Factor “Beta” indicates the proportion of the yield of a portfolio to the yield of the entire market (as indicated by some index). If there is an increase in the yield of the market, the yield of the individual portfolio may also go up. If the index goes up by 1.5% and the yield of your portfolio goes up by 0.9%, the beta is 0.9/1.5 i.e 0.6. in other words, beta indicates that for every 1 % increase in the market yield, the yield of the portfolio goes up by 0.6%. High beta shares do move higher than the market when the market rises and the yield of the fund declines more than the yield of the market when the market falls. In the Indian context a beta of 1.2% is considered very bullish.
You can be indifferent to market swings if you know your stocks well. Or you can put your portfolio into neutral or bias for the upside if you're bullish or a little for the downside if you're bearish. One way to do that is to have a mix of stocks that have certain betas in your portfolio. When investors are bullish on the market, they like to have high beta stocks in their portfolios because if they're right, then their stocks go up faster than the market in general, and their performance is better than the market. If investors are bearish on the market, then they use the low beta or negative beta stocks because their portfolios will go down less than the market and their performance will be better than the general market. And if they want to be neutral, they can then make sure that they have stocks with a beta of 1 or develop a portfolio that has stocks with betas greater than 1 and less than 1 so that they have the whole portfolio with an average beta of 1.
A beta for a stock is derived from historical data. This means it has no predictive value for the future, but it does show that if the stock continues to have the same price patterns relative to the market in general as it has in the past, you've got a way of knowing how your portfolio will perform in relation to the market. And with a portfolio with an average beta of 1, you can create your own index fund since you'll move more or less in tandem with the market.
Module 10 - Learn To Manage Your Portfolio.
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| Importance of diversification. Diversification helps you protect your investments from market fluctuations. Diversifying means allocating your money to different investments avenues and shields you from price risks. As you pick the best stocks from the hottest sectors, the fluctuation risk of the stock eroding your investment rises correspondingly. Since some stocks in the IT and media sectors are highly volatile, you need to protect your portfolio by investing in some defensive stocks or other industry groups. It would also be wise to diversify your investments into bonds or FDs as these are low risk - fixed income avenues. The primary objectives of any Portfolio management are
Diversifying means buying stocks belonging to different industries with very low correlation i.e to find securities that do not have tendencies to increase or decrease in price at the same time. What you're working towards should be at least five industries for the stock portion of the portfolio with each stock being the best stock, in your opinion, in their respective industry group. There should still be money invested in a money market fund (the equivalent of cash) as well as some in fixed income. | ||||||||||||
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Portfolio – Age relationship. Your age will help you determine what is a good mix / portfolio is
These aren't hard and fast allocations, just guidelines to get you thinking about how your portfolio should look. Your risk profile will give you more equities or more fixed income depending on your aggressive or conservative bias. However, it's important to always have some equities in your portfolio (or equity funds) no matter what your age. If inflation roars back, this will be the portion of your investments that protects you from the damage, not your fixed income. Also, the fixed income of your portfolio should be diversified. If you buy bonds and debentures directly or if you invest in FDs, then make sure you have at least five different maturities to spread out the interest rate risk. Diversifying in equities and bonds means more than buying a number of positions. Each position needs to be scrutinized as to how it fits into the stocks or bonds that already are in your portfolio, and how they might be affected by the same event such as higher interest rates, lower fuel prices, etc. Put your portfolio together like a puzzle, adding a piece at a time, each one a little different from the other but achieving a uniform whole once the portfolio is complete. | ||||||||||||
| Top | ||||||||||||
Review of portfolio Portfolio Management is an incomplete exercise without a periodic review. Every security should be subject to severe scrutiny and a case made out for its continuation or disposal. The frequency of review will depend on the size, amount involved and the kind of securities held in the portfolio. Spend a bit of time; you'll get a little bit of results. If you spend more time, your results should improve. We would suggest you spend a minimum of one hour a day during normal times while on the days of high volatility, its suggested that the investor monitor the situation closely.
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| Top | ||||||||||||
Look analyze and do some adjusting Look at your portfolio and do some adjustments. But don't just sell the losers (or the winners) randomly. There are several consequences of any action whether it's the taxes, the asset allocation, or the timing of the transaction. Here are a few things to consider. If you liked a stock because of its earnings and it continues to deliver, hang on even if the price has not moved up. It will because earnings are the engine of any stock's price. As always, patience is heavily rewarded in the market because it is the rarest commodity. As for selling a stock and then thinking you can buy it back after some days. There are two problems with that type of thinking. One, you generate two rounds of commissions (sell, then buy) and two, you may not get to buy the stock back at a decent price because the stock might have run dramatically in the month you did not own it. If you sell a stock, do it with finality and move on. Don't try to time the market. No one can do that with perfection. | ||||||||||||
| Top | ||||||||||||
Sector Rotation You've probably noticed that tech stocks are hot, financials are not. Neither are the Consumer durables or some of the large-cap FMCG or Pharmaceuticals. If you're thinking about jumping onto tech stocks now because that's where all the action is, think again. While traders can bounce in and out of stocks several times a day, an investor should look to where the action isn’t much, meaning less of “Extreme Volatility”. Sector rotation happens all the time in the market. Several groups are hot (like ICE – Infotech, Communication and Entertainment Stocks) while other groups are getting dumped (names like Gujarat Ambuja, Grasim, Tata steel are examples). As an investor, you should look at taking profits from stocks that are fully valued and re-investing in stocks that have a big 'Buy' sign written all over them. In other words, dump some of the winners and buy some of the losers who are not down because of major problems that look to be insurmountable but because of temporary concerns that can be closely scrutinized. Sector rotation occurs because of fear and greed, the two emotions that run markets. The real challenge for an investor is to determine what the right entry price is and what is out of favor at the moment. Some of the Technology stocks such as Infosys have PE multiples of over 100 times. Whereas some of the fundamentally sound stocks such as Tata Steel whose stocks can be bought for less than 10 times earnings. The very bullish will point out that tech is where the growth is while financials are always hurt in an upward moving interest rate environment. They're right on both counts. However, the tech stocks are priced to perfection. If any of them don't deliver earnings at or better than expected, they're going to get hammered. And the financials are priced for interest rates going up dramatically from here, not another 25 basis points or so. The point here is not to recommend financial stocks (or non-durables or drug stocks) but to make investors aware of this sector rotation phenomenon. Take the time to build separate portfolios in each of the sectors you have an interest. It becomes very obvious where the money is flowing and where it's coming from. As an investor the challenge is to wait for prices that you can't believe in quality stocks, and then make your move. You will not catch the bottom of the stock (OK, maybe a few of you will). But you will own a stock that will come back into favor whenever the current troubles have passed and sector rotation occurs once again. Only this time, you'll be riding the hot stocks. | ||||||||||||
| Top | ||||||||||||
Measuring Portfolio Performance The performance of a portfolio has to be measured periodically – preferably once a month. The performance of the individual will have to be compared against the overall performance of the market as indicated by various indices such as the Sensex or Nifty. This way a relative comparison of performance can be developed. Lets now learn to compute the “Total Yield”. For example if the portfolio value of Mr. X is Rs 2,00,000 at the beginning of this month. During the month he added Rs 8000 to the fund. During this month he also received a dividend income of Rs 1000. Assuming the value of the portfolio at the end of this month is Rs 2,20,000. The total yield will be = ((220000 – (2,00,000 + 9000)) / ( 2,00,000 + (1/2 * 9000)) ) *100 = 5.38% per month To elaborate, in the numerator we are trying to find out the increase in value of portfolio after deducting the extra amount of Rs 8000 and the income of Rs 1000. It is assumed that this sum of Rs 9000 is put to use somewhere in the middle of the month and hence only half of Rs 9000 is added to the value of the fund at the beginning. The denominator can be adjusted as per the amount that you reinvest (part or fully) out of dividend income and what point of time during the period do you actually plough back such part of the money. Beta Factor “Beta” indicates the proportion of the yield of a portfolio to the yield of the entire market (as indicated by some index). If there is an increase in the yield of the market, the yield of the individual portfolio may also go up. If the index goes up by 1.5% and the yield of your portfolio goes up by 0.9%, the beta is 0.9/1.5 i.e 0.6. in other words, beta indicates that for every 1 % increase in the market yield, the yield of the portfolio goes up by 0.6%. High beta shares do move higher than the market when the market rises and the yield of the fund declines more than the yield of the market when the market falls. In the Indian context a beta of 1.2% is considered very bullish. You can be indifferent to market swings if you know your stocks well. Or you can put your portfolio into neutral or bias for the upside if you're bullish or a little for the downside if you're bearish. One way to do that is to have a mix of stocks that have certain betas in your portfolio. When investors are bullish on the market, they like to have high beta stocks in their portfolios because if they're right, then their stocks go up faster than the market in general, and their performance is better than the market. If investors are bearish on the market, then they use the low beta or negative beta stocks because their portfolios will go down less than the market and their performance will be better than the general market. And if they want to be neutral, they can then make sure that they have stocks with a beta of 1 or develop a portfolio that has stocks with betas greater than 1 and less than 1 so that they have the whole portfolio with an average beta of 1. A beta for a stock is derived from historical data. This means it has no predictive value for the future, but it does show that if the stock continues to have the same price patterns relative to the market in general as it has in the past, you've got a way of knowing how your portfolio will perform in relation to the market. And with a portfolio with an average beta of 1, you can create your own index fund since you'll move more or less in tandem with the market. |
| Chapter 2 Module 11 - Learn from others mistakes. Common pitfalls to be avoided |
1. Not being disciplined and failing to cut losses at 8% below the purchase price A strategy of selling while losses are small is a lot like buying an insurance policy. You may feel foolish selling a stock for a loss -- and downright embarrassed if it recovers. But you're protecting yourself from devastating losses. Once you've sold, your capital is safe.The 7%-8% sell rule is a maximum, not an average. Time your buys right, and if the market goes against you the average loss might be limited to only 3% or 4%. |
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