One of my clients, Naren, is a salaried individual who earns Rs 18 lakh per annum. He invests in shares, but recently he lost a significant amount of money in the market fall. His portfolio was down by 70 per cent when the market was down by 55 per cent at the same time. How did that happen?
Recap
Naren’s relationship manager (RM) with a Broking House had recommended 38 stocks to him. The RM believed the value of these stocks would go up by about 70 per cent within the next 12 months.
I asked to see the list of stocks and the analyst reports to study the RM’s recommendations. Interestingly, Naren produced a printout (not on a company letterhead) with no mention of the company’s name or the RM’s name.
There was a list of 38 stocks each with a 12 month target. The sheet also calculated the percentage upside from the current stock price, that is, the percentage by which they expected the stock price to go up. Naren’s RM advised, “Infrastructure stocks are likely to do very well over the next few years. A stock like Jaiprakash Associates has fallen by upto 90 per cent from the peak.” Naren, trusting his word, was about to go ahead and invest in a large number of midcap stocks, in an effort to regain some of his earlier losses.
Naren was obviously being taken for a ride. To prove my point, I told Naren to ask his RM to give the same list on the company’s letter head supporting them with analyst reports. It’s been weeks since, he has not received any letter and the relationship manager has stopped picking up Naren’s calls.
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A stock broker makes money based on the traded value and hence most brokerage houses keep giving 'free' stock tips in all markets. Keep in mind that it is you who could make the losses. There are some basic rules you need to abide by if you don’t want to be cheated out of your money.
Rule 1: Study the tips before investing
Do the litmus test. Before you invest, test the tips suggested by analysts for a certain period of time before you take the plunge.
Most brokerage houses provide stock tips for no charge. They claim to have large research teams and churn out a large number of reports, yet provide it free of cost as a value added service. How do you think they sustain? They make money out of you; the more you trade, more money they make irrespective of whether you make money or not.
Rule 2: Research before you invest, not after!
Research the stock picks before investing. Also, ask your broker for detailed reports on the picks. Invest only if you are convinced that the long term prospects are good and if the company has a good long-term competitive advantage. Do not waste your time on tips that give you a trigger price and target price.
Rule 3: What goes up faster, comes down faster
Any statistics that you would have read in the peak would have had strong rationale for growth. However, be a little cautious when stocks/sectors have run up too much. High P/E multiples indicate that the stock market is discounting very high growth rates of the company in the future. It is difficult for a company to continuously maintain such high growth rates as the company keeps growing larger. The stocks could be re-rated downwards if the growth outlook for the stock changes in the market. A perfect example of this was in 2000. Technology companies were growing profits at 70-100% for a few years. Companies like Wipro and Infosys did not make a loss or even post lower profits. Their guidance was that profits will grow around 30-35% and this led to a significant drop in share price.
Rule 4: If you don’t have the time, use mutual funds
If you do not have the time to track each stock in your portfolio, do not invest directly in the equity market. Investing through the mutual funds in a Systematic Investment Plan can create significant value without having to get into detail on your individual stocks.
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