Tushar's Stock Tips: December 2011

The investor, institutional or retail, is bruised. Even mutual funds don’t hold out much hope. Things have not been good for day traders either, as arbitrage volumes have crashed.

Retail investors are apathetic. Even mutual funds do not get much investment, and make no new offerings because they cannot pass on the high cost of mobilisation to investors.Large retail brokerages are closing branch offices. Once again, the capital market is not the place to look for employment.

In the past two decades the market has thrice seen phases where everything appeared to go wrong.

But then the bad times passed. The current bad times will turn too – for the better.

When the recovery happens, will you be able to recover today’s losses? You can, provided you do not repeat your mistakes. We list 10 things an investor and a trader must keep in mind to benefit from a market recovery when it comes.

Develop the skill to take a contrary stand

There is an old market axiom: everyone knows the price of a stock, but only a few know its value.

Today everyone is taking about the European crises, Indian inflation, high interest rates and consequent stressed company bottom lines. Investing in stocks now seems a mad thing to do. But just consider: had these problems not been there, stock prices would not be so low. The prices have already factored in the bad news.

Around this time last year everything seemed hunky dory — indices were scaling new highs, the economy was fine, a western world recovery appeared possible and Indian paper was a must in any international portfolio.

Supposing you entered the market late in 2010 to pick up some blue chips hoping to hold them for a while, the best case scenario for you now would be that your stock would have quoting 15 per cent under what you had paid for it. The worst-case scenario: an 80 per cent value loss in one year.

In 2007 some of those very blue chips saw daily volumes of two million shares. Today, barely a few thousand change hands in those stocks though prices are low. Tempting enough to rush to the market to buy them? Hold your horses.

Essentially, this lack of interest in those stocks indicates the herd mentality of investors and traders alike. When prices are on the rise, everybody wants a piece of action. But when instead of price, value is put on the table, only a few would go and buy a stock.

This is the time to buy, though the market may drop another 10 per cent. And in three years you may look back with the satisfaction of having done the most sensible thing and as an investor. Don’t ignore a stock just because of all the bad news around. Don’t keep tabs on the stock on a daily basis. Do not decide on momentary reading of price, as many tend to do. Being able to take a contrary decision is developed skill, not an acquired one.

Restructure your portfolio

Many investors refuse to admit mistakes and stay with a stock — even if its price is halved price — in the hope it will recover one day. But the fact is most stocks don’t recover, they languish for years. Particularly true of stocks bought in a sectoral bull run.

For example, IT stocks. Except one or two, none has reached levels touched in 2000. Even the best IT companies, today five times bigger than they were in 2000, are at less than half the levels they were then. So, anyone who invested them in 2000 has lost money.

A similar situation exists today in real estate stocks. Many investors still keep them in the hope of a quick recovery once interest rates go down. Of course, there is high probability that a stock quoting Rs 400 in 2008 and Rs 50 today will gain 100 per cent and touch Rs 100. But touching Rs 400 again has low probability.

A scrip with a discounting of 20 at the height of its sectoral bull run is unlikely to get similar discounting again.

A stock underperforming the broader indices after a sectoral bull run should be seen as dead wood. Just book a loss and move to others doing well. It is better to own 50 HDFC shares than 1,000 shares in a mid- or small-cap realtor that has no hope of great recovery.

First book profits in other asset classes

The market being what it is today, the flavour of the season is fixed deposits, property and gold. Everyone is rushing to them. The point is these assets have no indices to go by. So you do not know if they are overbought or need a correction.

No one tells you on a daily basis if the piece of land you bought is losing value. Because there is no transparency in this market, there is no psychological pressure to sell. Even if you do, you don’t know if you are getting the right price.

Property prices have risen sharply everywhere over the past seven years, in some cases by six or seven times. So play by the ear and book profit and put part of the takings in equity. It may help to know that a fivefold appreciation in seven years is unlikely to be repeated in the property market.

Like every other asset class property prices will also correct themselves. But the interesting feature of the market is that the correction is rarely a downward move, rather prices stay where they are. Not quite. Not quite. Inflation ensures that real value as well as profit are down.

If you are drawn by the glitter of gold, it is good to remember that the metal is good as long as western economies do not recover. Once they stabilise, it will lose its glitter. It is anybody’s guess when. But once that happens gold will stay range-bound for a long phase.

Once again, it is a good idea to book profit in other assets and invest in equity when prices are close to the lower end of the cycle. Not easy for most people, when everyone is in a gold rush that has given 20 per cent return in one year. But be bold and be a contrarian. It pays.

The problem is, for every person who may advise you to sell property there are nine others who will say, “don’t”.

If you look at 25 years of property prices, the trend you see now was seen even in 1995 when prices spiked and remained range-bound for a year.

If you heed this advice, make sure you buy large-cap stocks with a low probability of corporate governance going amiss. Be prepared to hold the stocks for at least 18 months.

Don’t look at indices on a daily basis

Indices have their own relevance but getting fixated by them while taking investment decisions is strictly a no-no. Media always hypes up their importance to such an extent that everyone believes that’s the only yardstick to go by.

When investing, think companies and their valuation, not the index level. Don’t wait for the index to drop to, say, 4,500, to enter the stock market. Do not bother about indices if a stock is at a level where even on basis of dividend yield it gives you a return of more than 5 per cent. Volumes in indices like Nifty have increased because quantitative funds are active and trading in high volumes, as they tend to do. Nifty futures are good for them, not you.

Index below a particular level does not make a stock cheap. Look at the long-term performance of companies like HDFC, HDFC Bank, ITC and Nestle. They were always good buys with a 24-month perspective and have always given good returns irrespective of the indices.

On the other hand, the so-called momentum stocks have patently failed even when the indices were scaling new highs in 2010. There is a new fad called “Sensex earning”. The point is while “index earning” was actually stagnant between 1995 and 1999, many stocks gained 300 per cent.

The affliction of “excess index disorder” is that it makes you more bullish when you need to be cautious and extremely cautious when it is time to be bullish.

Keep an eye on arbitrage opportunities

No doubt intra-exchange arbitrage has plummeted, making life tough for jobbers and intra-day traders. But new windows of opportunities have opened up in derivatives which now see much greater volumes than in the cash market. But these opportunities are not for the simple trader. It is a complicated matter requiring a thorough understanding of the basics of the derivatives market.

There is enough time value floating in various options both of indices and certain stocks. One needs to know how to seize them. But first one needs to know how the options work and how cross-hedges are created between contracts of various months.

Sometimes the arbitrage in the cash and derivative segments of NSE is high but that requires special skills to capitalise on. There are great many investors who refuse to learn about the derivatives market and products. They are simply running away from the fact that this segment today constitutes 80 per cent of all market volumes.

Reverse arbitrage opportunities are aplenty and available during the results season. There is software that brings in stocks with arbitrage potential. The opportunities can be seen to enable a trader to make the best trade. Ask your broker if he has the software. If he has, he can advise you on the best arbitrage opportunities.

Look at performance of your fund manager

A large number of investors actually believe they have done their bit by investing in mutual funds and there is nothing more to do than wait for automatic, good returns. But take a closer look at the mutual funds’ performance in the past three years. A large number of them have done pathetically.

The bottom and top of the market are the points when to check on the performance of the fund manager handling your money. If your scheme has underperformed the benchmark both in bullish and bearish markets, the best thing to do is to move out and entrust your money with some other manager has been outperformed at least the bullish market.

That fund managers are not allowed to take short positions and have to be invested all the time in the market even if they see a disadvantage of a bearish market. But if a scheme is underperforming the benchmark in a bullish market, the problem is with the fund manager. Like a stock not performing well needs to be dumped, an underperforming scheme too needs to be jettisoned, and a fresh beginning made.

Invest your time along with money

Before investing most of investor don’t even bother to check what a company manufactures. Any dip-stick among new buyers of large-caps like Reliance Industries and L&T will show that a large number of them are unaware of even basics like what these companies do or manufacture, or from where their revenues come.

Yet they invest in them. Investor knowledge of mid-cap companies is even more abysmal. Only a few of them know who the promoters are.

Going back to the basics is, therefore, an imperative. Look at the promoters, their track record of simple things like paying dividends and tax payments, which industry it belongs to, and its position vis-a-vis its peers. Today, even this much of information is not enough to be able to function profitably as an investor. One needs to go to stock exchange websites where a trove of information is available. Also, look at the company’s website for its shareholding pattern. That will enable you to take a more informed decision.

Don’t have wildly diverse portfolio

Often an investor has such a large portfolio that it makes managing all stocks difficult and he ends up not making much gain. Excessive diversification leads to low average returns.

For example, it is pointless to have both metal producer like Hindalco and Hawkins Cooker in your portfolio. When metal prices rise, Hindalco’s stock rises. But Hawkins Cooker's margin will be under pressure because aluminium is a key input. Its stock will underperform. So, the net return will be lower in such a portfolio.

Similarly, mining companies do well when ore prices rise. But the stocks of those converting ore (for example, steel companies without captive mines) will suffer. Understand the business relationship between various companies. Don’t have more than seven companies in your portfolio. If you want more, it is better to look at good mutual fund schemes.

Check on relationship managers

There is nothing called free lunches. So, when your relationship manager calls with a suggestion to buy a stock, ask him a few questions. Ask him if he knows well the company, what it manufactures or what services it provides. Most likely his information will be meagre. He is recommending the stock because his salary depends on the brokerage he earns by making you trade regularly.

His only objective is to make sure that you churn your portfolio so that his brokerage till keeps ringing. If in the process you make some money, thank your luck rather than any hard work by the relationship manager.

Most relationship managers are so glib they can make you believe you are the best thing that happened to the trading world. You end up counting your losses.

Do not believe armchair advisers. Next time one calls up, the best way to put him off your trail is to ask him his salary structure. There is a good chance that he won’t bother you any more.

Avoid compulsive trading

There are instances galore of people not really intending to trade but ending up trading regularly. This is patently compulsive trading. There are phases when the market does not move much either way and profitable trades are very few and far between. If you are still trading, you are a certified compulsive trader.

The objective should be to increase the ratio of right trades to wrong trades. For example, if a trader takes in 10 deals, five of which make a profit and rest lose, the net result it zero. In that case, why trade in the first place?

The idea is to increase the incidence of right trade. And this can be done only when a trade is taken with a higher degree of certainty that it will result in a profit. Such opportunities don’t come everyday. So, avoid trading just for the sake of trading. Conserve capital for bigger and better opportunities.

( The writer is director of independent brokerage Elan Equity Services and consulting editor of Financial Chronicle)