Continuing from the last post on what makes a successful investor, I believe that the next important quality that is needed to succeed over the long term in equity investing is understanding the role played by various other visible participants in the market and how that impacts their opinions and actions, which in turn impacts your opinions and actions as an investor.
This is especially important if an investor is either new to the equity markets or gets interested in equities only when they are either going up fantastically in the recent past (actively looking to buy) or going down miserably in the recent past (actively looking to sell), as the chances of trying to see what the others are saying or doing and deciding our actions on that basis is the highest in such a situation, completely ignoring the slightly longer term picture.
I guess the main participants in the Indian Equity Markets can be categorized broadly as follows:
1. Indian Brokers
2. Foreign Brokers
3. Indian Institutional Investors
4. Foreign Institutional Investors/ Private Equity Investors
5. TV Analysts/Newspapers
6. Blogs like this one
7. Promoters acting in concert with market operators
6. Blogs like this one
7. Promoters acting in concert with market operators
1. Indian Brokers: Well what can we say about them. Almost every stock under the coverage of an Indian Broker is a buy and their reports need to be read with the utmost caution and mostly as a source of gathering some background on what a company does and is planning to do in the future rather than as a serious investment decision. Sure there are a few exceptions, but by and large their main motive of being in the market is to earn brokerage income from retail clients and investment banking mandates from the small and mid cap companies under coverage and thus every stock is a buy candidate. I sometimes think their research reports should contain statutory warnings like the ones we see on cigarette packets, thats how dangerous they are, especially in a bull market :)
2. Foreign Brokers: Their main reason for existence is to serve the FII. Their reports generally tend to be of a slightly better quality both in terms of research and appearance, but again the bias towards recommending a buy is just as high and thus the Caveat Emptor principle applies here as well.
A very interesting point to note is whether the analyst himself owns the stock that he is recommending as a buy. If not, I think he should point that out specifically so that we all know where he is coming from. Seriously think about it, if I am asking you to invest in a company and don't have the balls to do so myself, then there is something seriously amiss. Alas most of the reports do not have any such disclaimer on whether the analyst himself owns the stock or not.
One of the most important things to keep in mind while reading any research report is to look at the assumptions underlying the future projections and whether they are in touch with reality. Generally after a few quarters of favorable business environment for the company, this tends to be the biggest risk factor in a research report as an analyst will be making the same or even rosier projections for the next few quarters ignoring any possible risk factors to the growth going ahead. This is also where I believe the maximum money is lost for retail investors a a whole, especially the late comer types.
Another thing to note is that the analyst community, just like the investor community, suffers from group thinking and delusion, as they keep sharing ideas and opinions with each other and thus are very likely to miss even big changes happening within a company. For example, before the Infosys results last Friday, how many brokerages had a sell rating on the stock? I would think hardly any and all of them missed the big changes happening within the company just like the rest of the world.
3 Indian Institutional Investors: Generally includes MFs and Insurance Companies in India. From the POV of the individual investor, one needs to be careful about blindly buying into stocks that have been bought by big MF houses recently. Also one needs to be extremely careful of buying into an IPO/FPO or a company that has just come out with a QIP where big MFs have put in money, as in most of the cases the promoters dilute their stake to the public near the top. The MF manager may have various compulsions to invest in a company but an individual investor does not have any of those and should use that flexibility to pick and choose very very carefully. I am sure all of us remember examples like RPower and DLF.
4. Foreign Institutional Investors/Private Equity Investors: Can be of various kinds like ETF, SWF, Pension Funds, Long Only Funds, Hedge Funds, Institutional Trading Desks etc. They have the maximum impact in moving share prices due to their size. An investor should generally look to invest in companies where the FII holding is less so that in the future the share price has plenty of room to move up when a FII invests in the company, especially in the mid cap space. Higher the % of FII holding in a company, higher is the chance of wild swings in the stock price and in most cases on the downside. Prime examples of this are stocks like Onmobile Global and Educomp. Again in case of a new investment by a FII, please think for yourself if the company is suitable for you. A long only pension fund can easily have a five year horizon and can easily stomach a 30-40% drop in the share price after investment, but how many of us have that kind of time horizon, belief in our analysis and stomach for losses?
5. TV Analyst/Newspaper: An investor does the max. harm to his investments when he tries to listen to what is being said on TV/newspaper during sharp up moves and down moves in the markets. I have realised that if an investor just ignores the media and invests in companies that are sound fundamentally and available at the correct price (most likely the case in case of sharp drops in the broad markets), he/she will easily outperform majority of the investors over the long term.
What a fundamental long term investor needs to realise is that even though a TV anchor may sound very smart, his job is basically to report what has happened yesterday and not think about the future and remember equity investing is about the future. Also since their target audience is the traders who are glued to their TV screen for any small market moving event, it can only do you immeasurable harm if you base your decisions about your long term investments on what is said on TV/newspapers. And for heavens sake, pls do not base your decision to buy/sell a stock on the advice of technical analysts that are sitting on tv channels who basically are just price and trend followers and have negative knowledge about fundamental business valuation. Remember their time frame is the next week at max whereas your horizon should be the next couple of years at least.
I have been guilty of this in the past and the results are easily there for me to see.
6. Blogs like this one: Blogs and sms tips are the latest craze in the markets today. Please use the most severe form of skepticism while buying/selling on such an advice. Remember most likely the blogger is already invested or short the stock and wants you to act to further move the stock price in his direction. This is especially the case for illiquid small cap and mid cap stocks that trade less than 20-30K stocks per day. Also think about it, you start reading such blogs and acting on them only when the markets are going up furiously and everyone is looking to make a quick buck.
7. Promoters acting in concert with market operators: We only need to look at the sharp fall in many small and mid cap stocks since last November to realise this. I was recently told by a cousin, who has a friend in SEBI, that if they actually start clamping down on these market operators and promoters, a large number of such stocks would come crashing down.
I will give you an example of a recent case. Just look at the following chart of a company called Twilight Litaka Pharma. The CEO of this pharma company had come on CNBC in June 2010 and said all the right things which attracted me to the stock, after a check of the fundamentals of the company the story looked nice. The stock was at around 110 then and soon shot up to 195 in no time by October 2010.
And we can all see what happened after that.
Moral of the story: If a stock is up like crazy without any real change in fundamentals recently and has hit your fair value assumption in a very short time itself, stop admiring your genius and take your profits home. Even though the above example was of a small cap stock, we can be sure that a lot many other promoters in the mid cap and large cap space are doing this as well.
Please note that the objective of this article is not to belittle or criticise any of the people above. My only objective is to make the readers realise that just like in life, each and every person in the market also has an agenda and a lot of the times his/her agenda is not in the best interest of the investor.
It is almost certain that an investor from time to time will get sucked into investing in a stock based on one or more of the points mentioned above, but we can try and control our emotions better if we keep the above points in mind before taking any rash decision.
2. Foreign Brokers: Their main reason for existence is to serve the FII. Their reports generally tend to be of a slightly better quality both in terms of research and appearance, but again the bias towards recommending a buy is just as high and thus the Caveat Emptor principle applies here as well.
A very interesting point to note is whether the analyst himself owns the stock that he is recommending as a buy. If not, I think he should point that out specifically so that we all know where he is coming from. Seriously think about it, if I am asking you to invest in a company and don't have the balls to do so myself, then there is something seriously amiss. Alas most of the reports do not have any such disclaimer on whether the analyst himself owns the stock or not.
One of the most important things to keep in mind while reading any research report is to look at the assumptions underlying the future projections and whether they are in touch with reality. Generally after a few quarters of favorable business environment for the company, this tends to be the biggest risk factor in a research report as an analyst will be making the same or even rosier projections for the next few quarters ignoring any possible risk factors to the growth going ahead. This is also where I believe the maximum money is lost for retail investors a a whole, especially the late comer types.
Another thing to note is that the analyst community, just like the investor community, suffers from group thinking and delusion, as they keep sharing ideas and opinions with each other and thus are very likely to miss even big changes happening within a company. For example, before the Infosys results last Friday, how many brokerages had a sell rating on the stock? I would think hardly any and all of them missed the big changes happening within the company just like the rest of the world.
3 Indian Institutional Investors: Generally includes MFs and Insurance Companies in India. From the POV of the individual investor, one needs to be careful about blindly buying into stocks that have been bought by big MF houses recently. Also one needs to be extremely careful of buying into an IPO/FPO or a company that has just come out with a QIP where big MFs have put in money, as in most of the cases the promoters dilute their stake to the public near the top. The MF manager may have various compulsions to invest in a company but an individual investor does not have any of those and should use that flexibility to pick and choose very very carefully. I am sure all of us remember examples like RPower and DLF.
4. Foreign Institutional Investors/Private Equity Investors: Can be of various kinds like ETF, SWF, Pension Funds, Long Only Funds, Hedge Funds, Institutional Trading Desks etc. They have the maximum impact in moving share prices due to their size. An investor should generally look to invest in companies where the FII holding is less so that in the future the share price has plenty of room to move up when a FII invests in the company, especially in the mid cap space. Higher the % of FII holding in a company, higher is the chance of wild swings in the stock price and in most cases on the downside. Prime examples of this are stocks like Onmobile Global and Educomp. Again in case of a new investment by a FII, please think for yourself if the company is suitable for you. A long only pension fund can easily have a five year horizon and can easily stomach a 30-40% drop in the share price after investment, but how many of us have that kind of time horizon, belief in our analysis and stomach for losses?
5. TV Analyst/Newspaper: An investor does the max. harm to his investments when he tries to listen to what is being said on TV/newspaper during sharp up moves and down moves in the markets. I have realised that if an investor just ignores the media and invests in companies that are sound fundamentally and available at the correct price (most likely the case in case of sharp drops in the broad markets), he/she will easily outperform majority of the investors over the long term.
What a fundamental long term investor needs to realise is that even though a TV anchor may sound very smart, his job is basically to report what has happened yesterday and not think about the future and remember equity investing is about the future. Also since their target audience is the traders who are glued to their TV screen for any small market moving event, it can only do you immeasurable harm if you base your decisions about your long term investments on what is said on TV/newspapers. And for heavens sake, pls do not base your decision to buy/sell a stock on the advice of technical analysts that are sitting on tv channels who basically are just price and trend followers and have negative knowledge about fundamental business valuation. Remember their time frame is the next week at max whereas your horizon should be the next couple of years at least.
I have been guilty of this in the past and the results are easily there for me to see.
6. Blogs like this one: Blogs and sms tips are the latest craze in the markets today. Please use the most severe form of skepticism while buying/selling on such an advice. Remember most likely the blogger is already invested or short the stock and wants you to act to further move the stock price in his direction. This is especially the case for illiquid small cap and mid cap stocks that trade less than 20-30K stocks per day. Also think about it, you start reading such blogs and acting on them only when the markets are going up furiously and everyone is looking to make a quick buck.
7. Promoters acting in concert with market operators: We only need to look at the sharp fall in many small and mid cap stocks since last November to realise this. I was recently told by a cousin, who has a friend in SEBI, that if they actually start clamping down on these market operators and promoters, a large number of such stocks would come crashing down.
I will give you an example of a recent case. Just look at the following chart of a company called Twilight Litaka Pharma. The CEO of this pharma company had come on CNBC in June 2010 and said all the right things which attracted me to the stock, after a check of the fundamentals of the company the story looked nice. The stock was at around 110 then and soon shot up to 195 in no time by October 2010.
And we can all see what happened after that.
Moral of the story: If a stock is up like crazy without any real change in fundamentals recently and has hit your fair value assumption in a very short time itself, stop admiring your genius and take your profits home. Even though the above example was of a small cap stock, we can be sure that a lot many other promoters in the mid cap and large cap space are doing this as well.
Please note that the objective of this article is not to belittle or criticise any of the people above. My only objective is to make the readers realise that just like in life, each and every person in the market also has an agenda and a lot of the times his/her agenda is not in the best interest of the investor.
I am sure that most of us already know these points, but as Tony Robbins says "It’s not knowing what to do, it’s doing what you know".
It is almost certain that an investor from time to time will get sucked into investing in a stock based on one or more of the points mentioned above, but we can try and control our emotions better if we keep the above points in mind before taking any rash decision.
2 comments:
"I was recently told by a cousin, who has a friend in SEBI, that if they actually start clamping down on these market operators and promoters, a large number of such stocks would come crashing down".
:)
Good insight,...can we have some post on business valuation in near future...
Sure will post some of those also soon.
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