GET AHEAD

Investing to WIN in stocks

By NS Sawaikar
October 27, 2008 15:44 IST

When Warren Buffet, perhaps the greatest investor in the world, speaks on investing the world listens. Some days ago Buffet wrote a column in the New York Times, stating that he was putting his money in US stocks and explaining his reasons.

Though his article was about the US markets, much of his reasoning applies to Indian stocks as well; particularly since Indian markets are now so closely tied to their international counterparts. Buffet summarised his philosophy with the following phrase: 'Be fearful when others are greedy and greedy when others are fearful'.

What this means is that the right time to enter the markets is precisely when panic has driven down prices below their fundamentals and when many blue-chip stocks are available for cheap. Conversely the time to be fearful was when the markets were rising from one high to another and valuations were moving far beyond what was reasonable.

Other Get Ahead features:
Gifting ideas for Diwali
Fashion Week: Sabyasachi's grand finale
10 tips to survive a layoff, financially
Getting married on a shoestring budget

What about the argument that investors are better off trying to time their investment and wait before moving into stocks? Buffet makes the simple point that no one knows when markets will turn. Furthermore, historically, markets have often recovered from downturns before the wider economy and general investor sentiment. Therefore investors who wait till all the risk is gone are likely to lose out on much of the return as well.

All this doesn't mean that investors can indiscriminately jump into markets today when valuations are low. Some companies, with unsound business models and too much leverage (borrowing far more than their repayment capacities) genuinely deserve lower stock prices. The point is that even much better companies with good managements and bright earnings (profits) prospects are being pounded because of the current widespread panic. Such stocks are being driven far below their fundamental value and are therefore likely to be good bargains.

To understand how it's possible to distinguish sound from unsound companies it helps to look at the ideas of one of Buffet's mentors, the famed investment writer, Benjamin Graham who developed many of the principles of value investing and fundamental analysis.

Market crisis: How to cope
What you should do in today's market
What if the Sensex falls below 10k? Still invest
Lump sum or SIP? How to invest in bad times?
How to play the markets now

The basic idea of value investment is that intelligent investors can figure out the intrinsic value of a company through careful analysis and then buy stocks which are trading below their intrinsic value. The analysis can take several forms: for example looking at the industry in which the company operates and its long term prospects as well as the management to see if it is pursuing an effective strategy for long-run profitability.

Value investing often looks at various financial ratios to decide whether a company is a good buy. One such measure is the price/ earnings multiple which gives investors an idea of how a stock is priced relative to the company's annual profits. A company with sound financials and a low P/E indicates a good buy. Unfortunately this combination is quite rare during normal times when good companies typically trade at relatively high multiples of above 15 or even 20.

This is where the crisis and the panic sentiment comes in driving the prices of many good companies far below where they would normally trade meaning lower P/E multiples. This is why market panics provide smart investors a great opportunity to pick up good bargains.

Of course a multi-billionaire like Warren Buffet can afford to take risks that the average investors like you and I can't. Also the average investor may well have short-term liquidity (cash) needs for which s/he needs to keep funds at hand.

Therefore what you need to do is establish a time-horizon of your liquidity requirements. For any short-term requirements, say within a year or two, you should invest your money in safe assets like fixed deposits. However when it comes to the money you wish to devote for long-term investment needs, stocks should probably remain an important part of your portfolio.

It's important to note that no one, including Warren Buffet, knows when the market downturn will end. It may be in two months or two years. Therefore it's possible that you may continue to lose money for some time even if you invest in good companies trading at relatively low prices. However, provided you are patient and hold onto those stocks, the chances are high that eventually you will see excellent returns.

This is what investing your money to win is all about.

NS Sawaikar

NEXT ARTICLE

NewsBusinessMoviesSportsCricketGet AheadDiscussionLabsMyPageVideosCompany Email