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-- An Insights on Investor Behaviour
Have you ever wondered how the rich got their wealth and then
kept it growing? Do you dream of retiring early (or of being able to retire at all)? Do you know that you should invest, but don't know where to start? If you answered "yes" to any of the above questions, you've come to the right place. The world of finance can be extremely intimidating, but it is firmly believe that the stock market and greater financial world won't seem so complicated once you learn some of the lingo and major concepts. It is emphasize, however, that investing isn't a get-rich-quick scheme. Taking control of your personal finances will take work, and, yes, there will be a learning curve. But the rewards will far outweigh the required effort.
Contrary to popular belief, investors don’t have to allow banks,
bosses or investment professionals to push your money in directions that you don't understand. After all, no one is in a better position than you are to know what is best for you and your money. Regardless of your personality type, lifestyle or interests, this will help you to understand what investing is, what it means and how time earns money through compounding. But it doesn't stop there. This will also teach you about the building blocks of the investing world and the markets give you some insight into techniques and strategies and help you think about which investing strategies suit you best.
Stocks To Riches
-- An Insights on Investor Behaviour
1.2 What Rich Means Rich, what this means in today’s business world, whether it is person with huge wealth or a person who is able to maximise his wealth day by day, year by year. There are two things needed in these days; first, for rich men to find out how poor men live; and second, for poor men to know how rich men work. A great amount of accumulated money and precious possessions: affluence, fortune, pelf, treasure, wealth. Riches are not an end of life, but an instrument of life Have you never been moved by poor men's fidelity, the image of you they form in their simple minds? Why should you always talk of their envy, without understanding that what they ask of you is not so much your worldly goods, as something very hard to define, which they themselves can put no name to; yet at times it consoles their loneliness; a dream of splendor, of magnificence, a tawdry dream, a poor man's dream --and yet God blesses it!
Stocks To Riches
-- An Insights on Investor Behaviour
INVESTMET INVESTMET OPTIONS OPTIONS
MUTUAL MUTUAL FUNDS FUNDS BOND BOND COMMODITY COMMODITY BANKS BANKS
EQUITY EQUITY Primary Primary Market Market Secondary Secondary Market Market
POST POST OFFICE OFFICE NSC KVP NSC KVP GOI SAVING GOI SAVING BONDS BONDS
A private investor who buys shares through a stockbroker for his/her private portfolio. √ Mutual Funds A mutual fund is a company that pools money from many investors and invests the money in stocks. as opposed to an institutional investor." a mutual fund is one of three basic types of Investment Company. or other securities. Legally known as an "open-end company. 4 .An Insights on Investor Behaviour WHO CAN INVEST??? WHO CAN WHO CAN INVEST? INVEST? RETAIL RETAIL INVESTOR INVESTOR MUTUAL FUND MUTUAL FUND COMPANIES COMPANIES FOREIGN FOREIGN INSTITUTIONAL INSTITUTIONAL INVESTOR (FII’s) INVESTOR (FII’s) INVESTMENT INVESTMENT COMPANY COMPANY HUF HUF INSURANCE INSURANCE COMPANIES COMPANIES BANKS BANKS POST POST OFFICES OFFICES √ Retail investor An individual who purchases small amounts of securities for him/herself. Also known as individual investor or small investor.Stocks To Riches -. bonds. The two other basic types are closed-end funds and Unit Investment Trusts (UITs). short-term money-market instruments.
individual investors should be able to save on trading costs since the investment company is able to gain economies of scale in operations. END OF CHAPTER I “Never invest in a business you cannot understand” CHAPTER II 5 STOCKS . There are two types of investment companies: open-end (mutual funds) and closed-end (investment trusts). International institutional investors must register with the Securities and Exchange Board of India to participate in the market.An Insights on Investor Behaviour √ Foreign Institutional Investor (FII’s) FII means an entity established or incorporated outside India which proposes to make investment in India. insurance companies. √ Investment Company Firm that invests the pooled funds of retail investors for a fee. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies. pension funds and mutual funds.Stocks To Riches -. By aggregating the funds of a large number of small investors into a specific investments (in line with the objectives of the investors). An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. The term is used most commonly in India to refer to outside companies investing in the financial markets of India. Also. an investment company gives individual investors access to a wider range of securities than the investors themselves would have been able to access. Institutional investors include hedge funds.
Booming stock markets create confidence and spur the governments to go ahead with their economic policies. governments need booming markets. and upgrade their equipment.Stocks To Riches -. No government likes depressed stock markets. Now let’s see what each one wants from the markets. On one side. √ Government At this point when the world has become a global village and each country wants to attract foreign capital. The place where we all meet. He who understands this psychology is able to manipulate the markets by using the different participants at different times. you have the owners of corporations who are looking for a convenient way to raise money so that they can hire more employees. you have people like you and me who buy shares of stock in these corporations. Stock markets are the barometer of an economy. The way they raise money is by issuing shares of stock in their corporation. On the other side. build more factories or offices. √ Regulator 6 .1 The Stock Market: The Biggest Auction in the World Think of the stock market as a huge auction or swap meet (some might call it a flea market) where people buy and sell pieces of paper called stock. 2.2 The Psychology of Stock Market Participants Understanding the psychology of the participants is the key to knowing how they will behave when they are gripped by fear and greed. is the stock market.An Insights on Investor Behaviour 2. They send positive signals to foreign investors when they are in a bull phase. the buyers and sellers.
√ Brokers In a bull markets the clientele increases and so do business opportunities.Stocks To Riches -. margin trading. the regulator also like booming stock markets.An Insights on Investor Behaviour Appointed by the government. During boom periods. √ Banks Their business increases with soaring stock markets as opportunities open up in lending against stocks. The feel good factor drives investors to banks for various financial services. depository and custodial business. √ Stock Exchanges They facilitate stock transactions. etc. etc. A rising market is evidence of good governance. This results in higher incomes for the brokers. The net worth of owners increase and companies can mop up more capital for expansions. incomes skyrocket by way of transaction charges from brokers. √ Companies Rising markets lead to higher stock prices. and keep their shareholders happy. Financially healthy companies are able to attract and retain good talent. listing fees. It also results in additional revenue in the form of higher transaction and service charges due to the increase in turnover. √ Mutual Funds 7 .
They are also able to come out with different kinds of funds to satisfy every requirement. He is aware that the Bull Run psychology creates the Bull Run. An increase in investors means increased viewers/readers. Day traders become very active as they are rewarded with easy gains. √ Operators He is the smartest and shrewdest of all.An Insights on Investor Behaviour Higher Stock price means increased net asset values. which translates into increased advertisement revenue. and higher asset management fees. Rising markets attract more investors which mean more money under management. He is the king-maker who uses his knowledge to win over investors. he understands the psychology of the participants. brokers and company management. and he has the ability to exploit that for his own benefit. √ Media The media plays a pivotal role in spreading information.Stocks To Riches -. He knows the system. 2. √ Investors The lure of quick money draws investors in a bull market.3 Understand the Term .STOCK 8 .
Prices will drop when a particular industry takes a fall. When a company issues stock for the first time. such as the BSE & NSE.An Insights on Investor Behaviour In financial markets. to pay off debt and acquiring other companies. Stock is simply a portion of a company. An IPO is underwritten by an investment banker that decides what the stock is worth and when it is best to issue it. Volatility is when a stock price goes up or down. By owning stock. stock prices rise and fall with supply and demand.4 Classifying Stocks: Income. Stocks are bought and sold on stock exchanges. when the economy has a general downturn. The aggregate value of a company’s issued shares is its market capitalization. Professional analysts and investment bankers who issue buy/sell/hold ratings also affect the price. Nonetheless. there are other reasons for stock prices to fluctuate. Usually stock is issued to raise money for a variety of reasons: expansion. The price will rise when everyone wants the stock and is buying it. or when there is too much debt. Usually. Value. when the company management is failing. A person or organization which holds shares of stocks is called a shareholder. 2. developing new products. it is called an initial public offering or IPO. however mass sales will also drive a price in the negative direction. & Growth 9 . stock is the capital raised by an organisation through the issuance and distribution of shares.Stocks To Riches -. you are a shareholder.
Value stocks are often those of old-fashioned companies. so you have to report the money you receive to the IRS. even if not as quickly as other stocks. is determining what a company is really worth—what investors call its intrinsic value. if the company doesn’t raise its dividend each year and many don’t—inflation can cut into your profits.Stocks To Riches -. which is fine with the conservative investors who tend to buy income stocks. Another advantage of stocks that pay dividends is that the dividends reduce the loss if the stock price goes down. Just because you own stock in a so-called conservative company doesn’t mean you will be protected if the stock market falls. or value. Second. It takes a lot of research to find a company whose price is a bargain compared to its value. There are also a number of disadvantages of buying income stocks.g. are attracted to income stocks because they live off the income in the form of dividends and interest on the stocks and bonds they own. Finally. Value Stocks Value stocks are stocks of profitable companies that are selling at a reasonable price compared with their true worth. Growth Stocks 10 . Some low-priced stocks that seem like bargains are low-priced for a reason. Investors who are attracted to value stocks have a number of fundamental tools (e. dividends are considered taxable income. First. income stocks can fall just as quickly as other stocks. The trick. In addition. of course. They may not rise or fall as quickly as other stocks. Some investors. stocks that pay a regular dividend are less volatile.An Insights on Investor Behaviour Income Stocks The first category of stocks is income stocks. usually older individuals who are near retirement. such as insurance companies and banks that are likely to increase in price in the future. P/E ratios) that they use to find these bargain stocks.. which include share of corporations that give money back to shareholders in the form of dividends (some people call these stocks dividend stocks).
no earnings. penny stocks are stocks that usually sell for less than a rupee a share (although some people define a penny stock as one selling for less than Rs. That reason could be poor management. with only Rs.Stocks To Riches -.50. The advantage of trading penny stocks is that the share price is so low that almost everyone can afford to buy shares. They are also called pink sheet stocks because at one time the names and prices of these stocks were printed on pink paper. Most of the time. This is because growth investors believe that the corporation will earn money in the future and are willing to take the risk. the trading volume on penny stocks is exceptionally low.0. Because growth stocks are so volatile. This is ideal for short-term traders but unnerving for many investors. That is the beauty of penny stocks.1000 you can buy 2000 shares of an Rs 0. growth stocks won’t pay a dividend. but whatever it is. there usually aren’t enough buyers to make the stock go higher. you could put your order in at Rs 0. It happens all the time.5 What Makes Stocks Go Up or Down 11 . you made a 100 percent profit. For example. 2. They are often in high-tech industries. or too much debt. A number of traders specialize in these stocks. penny stocks are so cheap for a reason. although this is not easy. they can make sudden price moves in either direction. On the other hand.50 penny stock.5 a share). After all. Even with their low price. The price of growth stocks can be very high even if the company’s earnings aren’t spectacular. as the corporation wants to use every cent it earns to improve or grow the business. If the stock ever makes it to a rupee. Penny Stocks Just as their name suggests.An Insights on Investor Behaviour Growth stocks are the stocks of companies that consistently earn a lot of money (usually 15 percent or more per year) and are expected to grow faster than the competition. and a couple of days later the stock could fall to Rs.75 a share.
Stocks To Riches -. and whether the United States was going to war. of course. END OF CHAPTER II “Never Love or Marry your Stock. or real estate. It doesn’t always work out that way. it is uncertainty. You make money in the stock market by buying a stock at one price and selling it at a higher price. It’s that simple. If you can anticipate how an event could affect the stock market. Even the stocks of good companies can sometimes go down. that you’ll make money. a war. then the stock you own should go up in price.6 You Buy Stocks for Only One Reason: To Make Money The stock market is all about making money. but that is the risk you take when you participate in the market. Any one of these events can send the market lower as investors seek protection in cash. Some events seem to come out of nowhere —perhaps a terrorist attack. gold. There is no guarantee. whether we would win the war on terrorism. Some pros believe that having a thorough understanding of the investment environment is more important than picking the right stock. you should be rewarded with a higher stock price. Sometimes it helps to step back and see the bigger economic picture. you should pay attention to anything that may affect your stocks. Quite simply. Just have a Short Term Affair” CHAPTER III 12 INVESTORS . One of the reasons the most recent bear market lasted so long was that no one knew when the recession would end. or a recession will cause havoc with the stock market. 2. If you buy stocks in companies that do well. if you buy stock in a company that is doing well and making profits. you can shift your money into more profitable investments. As an investor or trader. you must be aware of outside events. If there is anything the market hates.An Insights on Investor Behaviour When you invest in the market.
The control over the ETC (entity. philanthropy. The control over taxes 5. The control over income/expense asset/liability ratios 3.1 The Ten Investor Controls 1. timing. The control over access to information 10. need more control.Stocks To Riches -. timing. The control over giving it back. and characteristics) 8. This is where many investors lack control. and characteristics. redistribution of wealth. 3.” Many people find investing risky because they are not in control of one or more of these ten investor controls. The control over the management of the investment 4. investor may gain some insights on how he can gain greater control as an investor—especially control number 7. The control over the terms and conditions of the agreements 9. However.An Insights on Investor Behaviour “A person who makes investments” “A person whose principal purpose is to invest money prudently and productively over the longer term with the investment objectives being achievement of a reasonable return and capital appreciation to preserve purchasing power. The control over when you buy and when you sell 6. 13 . or simply lack any basic understanding about investing. The control over brokerage transactions 7. The control over yourself 2. the control over entity.
This investor would be considered an “outside” investor as opposed to an “inside” investor. however. A long-term investor who has chosen to invest for security and comfort may very well qualify as an accredited investor. √ Investor 1. If you can qualify as an accredited investor. To be successful in choosing your investments. Through their education. qualified investors include stock traders and analysts. The control over yourself 2. you should turn your money over to competent financial advisors who can assist you with your investment decisions. As it relates to the stock market. A qualified investor is usually an accredited investor who has also invested in financial education.2 Types of Investors The Accredited Investor The accredited investor is someone with high income or high net worth. they have learned and understand the difference between fundamental investing and technical investing. he said qualified investors would include most professional stock traders. Here. The control over income/expense asset/liability ratios 5. you still need financial education. Generally.Stocks To Riches -. The control over when you buy and when you sell 14 The Investor Controls Possessed by the Qualified . for example. If you choose not to invest your time in your financial education. The Qualified Investor The qualified investor understands how to analyze publicly traded stock. you will have access to investments that most people do not.An Insights on Investor Behaviour 3. we define qualified investor as a person who has money as well as some knowledge about investing.
” In addition. It is a world where you definitely do not want to do things on your own. They know that on one side of the coin.An Insights on Investor Behaviour The Sophisticated Investor The sophisticated investor typically has all “three Es. the world is a world of black and white and they also know that the other side of the coin is a world of different shades of gray. √ Investor 1. some investors can invest on their own. The control over brokerage transactions 6. The control over taxes 4. If you want to become a successful investor but do not wish to build your own business to do so. The control over the E-T-C (entity. the sophisticated investor understands the world of investing. timing. an investor must enter with their team. and securities laws to maximize both earnings and to protect the underlying capital. characteristic) The Investor Controls Possessed by the Sophisticated 15 . your goal should be to become a sophisticated investor. On the black and white side of the coin. The control over when you buy and when you sell 5. these investors know that there are two sides of the coin. The control over income/expense and asset/liability ratios 3. On the gray side of the coin. From the sophisticated investor on. corporate. The control over yourself 2. He or she utilizes the tax.Stocks To Riches -.
you have to work more hours. making your money work for you maximizes your earning potential whether or not you receive a raise. It's actually pretty simple: investing means putting your money to work for you. The point is that it doesn't matter which method you choose for investing your money.your money . reading the paper or socializing with friends. mutual funds. or starting your own business. That way. or real estate (among many other things). And that's exactly what most of us do. bonds. or even mowing your lawn. decide to work overtime or look for a higher-paying job. while you are putting in hours for your employer. you need to send an extension of yourself . the goal is always to put your money to 16 . Growing up.to work. Quite simply. you can also be earning money elsewhere. there is a limit to how many hours a day we can work. it's a different way to think about how to make money." Each of these vehicles has positives and negatives.An Insights on Investor Behaviour END OF CHAPTER III CHAPTER IV INVESTING Investing is not risky. There are many different ways you can go about making an investment. which we'll discuss in a later section of this tutorial. There's one big problem with this: if you want more money.” 4. Essentially. This includes putting money into stocks. sleeping. Sometimes people refer to these options as "investment vehicles. not being in control is risky.Stocks To Riches -. most of us were taught that you can earn an income only by getting a job and working. not to mention the fact that having a bunch of money is no fun if we don't have the leisure time to enjoy it You can't create a duplicate of yourself to increase your working time. However. so instead.1 What Is Investing? The act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit." which is just another way of saying "a way to invest.
2 What Investing Is Not Investing is not gambling? Gambling is putting money at risk by betting on an uncertain outcome with the hope that you might win money. understands the behaviour of the stock markets. he or she performs thorough analysis and commits capital only when there is a reasonable expectation of profit. however. but investing is more than simply hoping Lady Luck is on your side. The herd mentality was at work and the markets crashed as each one wanted to get out faster than his neighbour. But the sentiment changed. For example. 4. Market fluctuations are based on the varied opinions expressed by its participants. It’s the crowd behaviour that dominates the decision-making and is responsible for the sudden changes in the sentiments.Stocks To Riches -. Yes. What precipitated this huge fall? Had anything gone drastically wrong with the performance of the companies whose stock prices crashed? Definitely not.3 Why Investing so Difficult The most difficult part of investing. Take for instance the black Monday in May 2004. A "real" investor does not simply throw his or her money at any random investment. there still is risk. may come from the way some people use investment vehicles. The BJP being voted out of power was a big change and normally we do not like changes. it's the most important concept for you to understand.An Insights on Investor Behaviour work so it earns you an additional profit. Even though this is a simple idea. True investing doesn't happen without some action on your part. it could be argued that buying a stock based on a "hot tip" you heard at the water cooler is essentially the same as placing a bet at a casino. Hence there was gloom all around and people dumped stocks as though there was no future. and there are no guarantees. If you were emotionally strong and you have ended making a huge 17 . 4. which in turn are subject to change commensurate with the changing sentiments of people. The market lost around 700 points when the elections brought the Congress to power. Part of the confusion between investing and gambling.
Without risk there is no return.An Insights on Investor Behaviour fortune. Stock market investments also work that way. Understanding behavioral science is the key to success in the financial markets. If we invest in the right stocks with the right business model and fundamentals.4 The Law of the Farm Stock Market investing is all about managing the rewards associated with the risks undertaken. rain. The seed has to endure summer. There are no short cuts. Getting carried away by the greed of quick returns ultimately destroys wealth. At the point of time to go against crowd is the most difficult but the most sensible thing to do.Stocks To Riches -. Invest you must but before that you must bear in mind the law of the farm. 4. over the long run we are assured of optimum returns. Many of us forget that nature and society are one. You reap what you sow but the crop is also subjected to changing seasons. However. Its application not only helps you control your emotions but also helps you to understand other’s emotions and benefit from their mistakes. as it does not conform to the law of nature. winter and spring before it turns into a full-blown tree. 18 . But this seems easy only in hindsight. to do this requires patience and we have to go through the ups and downs but it is important to stay the course.
Stocks To Riches -.An Insights on Investor Behaviour 19 .
We admire them but usually in retrospect. one must have the money to invest. news. 1. they are in no hurry to invest. the second is Physically Difficult and the third is Emotionally Difficult Path. They have a strong belief in their abilities and. This path is pursued by those who have a profound understanding of investing. and can comprehend business and the environment. and a few others have taken the intellectually difficult path of beating the markets. since their goal is investing long-term for cash flows as against capital gains.An Insights on Investor Behaviour 4. They are therefore. John Templeton. can see future trends clearly. A good knowledge of the field of liberal arts is basic to the development of various investment concepts. This method is all about the cash flow approach. A good grasp of the various fields of management is required to understand organisations and their ability to capitalize on various business opportunities.Stocks To Riches -. One is Intellectually Difficult. very careful about allocating resources. we may see them as being misguided. As long-term investors. The Intellectually Difficult Path Investors like Warren Buffet. They are not perturbed by events. They never buy on impulse. Here the name of the game is patience. they are willing to wait for them. They know that patience is a virtue and therefore take long-term positions.5 Three Ways of Investing” There are three ways by which an investor can invest to achieve superior results. rumours and gossip that create short-term volatilities. even years. Charlie Munger. Such investors are always on the lookout for good opportunities and bargain prices. Initially. but that is only because of our inability to grasp their point of view. 20 . They strongly believe that opportunities are always there but that when the biggest of them come. and how economic policies and market forces affect the business environment. It is the most difficult path as it requires a keen mind of study the different concepts of investing – how different businesses work. They can be out of the market for months.
At the office they scan their terminals and the CNBC news for market movements and at home they keep tabs on the BSE and NSE. The reason they are intellectually capable is because they work hard and make the effort to reach that stage. We all want to be such investors but we cannot. Moreover. They come early to the office and stay late. trying to understand economic policies and its effect on business environment. 21 . etc. The Physically Difficult Path Most people are deeply involved in the physically difficult way of beating the markets. They keep in touch with a number of brokers as they believe it will increase their efficiency in the stock markets. They constantly explore opportunities by talking with managements. They are constantly on the telephone making calls and receiving more calls though most of the time the answering machine takes the calls. They are overloaded with information. Intellectual investors are also emotionally strong. Their intellectual capability is derived from their hard work and their strong belief in the long-term approach to investments. Their talk revolves round finding the next best investment opportunity to make money. more luncheon meetings and even more dinner meetings. Brokers usually do not like such investors as they do not churn their portfolios regularly. 2. They carry with them all the newspapers to read whenever time permits. examining different viewpoints on business. That is the reason they are able to exercise such restraint.Stocks To Riches -. This is a wrong notion.An Insights on Investor Behaviour They have the patience to wait till the right moment. They do not know what their children are doing as they don’t have time for them. They are always busy with the breakfast meetings. Intellectual investors as they do not churn their portfolios regularly. They continuously monitor stock price movements. They carry home huge reports to read before the next day. as we believe that we are not all as intellectually blessed as they are. They choose work over the family. they use common sense in their judgements and are not swayed by rumours. They visit companies and plants and talk with the management.
An Insights on Investor Behaviour When they are on the move. and GDP growth figures play an important role in their lives. Market gossip excites them and they make decisions based on rumours. how can any one of them achieve better results??? Good opportunities come once in a while and you spot them only when you are cool and have the time to think. Life is simple. They tend to time the markets on such news. Show the world they are busy. We make it complicated.Stocks To Riches -. After a couple of rings. But they don’t realise that others are also doing the same. The physically difficult path is based on the assumption that there are a lot of opportunities out there and you have to keep digging hard to be successful at investing. They spend the entire day collecting information and make decisions based on that information. In every way they expend tremendous physical energy and effort to beat the market by outmanoeuvring the competition. inflation figures. The telephone rang but he did not answer it. So. monsoon forecasts. the call went to the answering machine. they are busy on their mobile phones. change in a minister’s portfolio. 22 . The current volatility in the markets is the result of too many people trying to invest by this method. The day traders also take the physically difficult path of investing. This is how most of them behave. News regarding political developments. with all the fund managers and the day traders treading the same path. My experience in the stock market dealing with fund managers has been really amusing. They sincerely believe that keeping themselves busy this way makes them look important and increases their ability to pick up the winners. Once I was at the office of a fund manager and we were chatting informally.
be wary of such news. In that case we could opt for what is called the emotionally difficult path. When you broker tells you to sell as he sees bad times ahead do not listen to his advice and sell. don’t follow them. don’t be tempted. When analysts on TV tell you that the market is going to crash and the stock prices will nose dive. this path is very straightforward. This how you do it. When you banker offers credit facility against your shares to buy more shares. It often pays to go against popular opinion. When your friends or your broker tell you about a great investment opportunity and they say it is a great time to buy. stay calm and unconcerned. don’t sell. Patience focuses an investor’s attention on the goal of compounding money over a long period. Emotional discipline is the most difficult.An Insights on Investor Behaviour 3. Simply work out a longterm investment policy that is right for you and be committed to it. When your neighbours exit the stock markets. It can be magic even when the rate is modest. To give an example: If one were to compound money at a modest rate of seven percent the money would double at the end of 10 years and it would be 16 times at the end of 40 years. The emotionally difficult path like the intellectually difficult pay lays stress on the virtue of patience. The stress is on the cash flow approach.Stocks To Riches -. But you need to believe in yourself and the investment policy to which you are committed. 23 . The Emotionally Difficult Path Most of us may find the intellectually and the physically difficult path too daunting. Both are based on the view that the long-term approach to investments is the only strategy that can enrich investors and increase their wealth. don’t sell. Actually. Patience also helps you to control transaction costs. When the newspapers report big investment opportunities. don’t buy. It is not easy to control your emotions and go against the herd. When your neighbours tell of how the stock markets have made them rich in the last couple of months. When newspapers report a bear phase and tell you to liquidate portfolio.
"Do not put all your eggs in one basket. so that in case of a downturn in any one sector. Systemic risk is that which impacts all sectors and companies. Thus. The emotionally difficult path requires an understanding of how our emotions guide our decision-making especially when we deal with money. All these costs could be avoided if one has patience. there is a case to invest in stocks across sectors. geopolitical risks and government policies. and even the most seasoned of industry veterans have got it wrong occasionally. 4. Understanding our own anomalies as also that of others will help us become better investors. there are 2 types of risks .6 Investing: Diversification or concentration? The basic logic for diversifying one's portfolio is. Now. On the other hand. he or she is putting himself/herself at risk at times when the steel cycle starts to turn down. cannot be diversified. the performance of stocks from other sectors would make up for the losses suffered in that sector. We have to learn to think with our emotions rather than have our emotions do the thinking. Examples of such risks include events such as 9/11. changes in political leadership. thus. unsystemic risk is a risk that is specific to a particular company.systemic and unsystemic. and. keeping track of such trends is no easy task. or a fire at Bombay High for ONGC. Let us understand the basic rationale for diversification. 24 . Our emotions directly affect our decisions on investments and expenditure.Stocks To Riches -. For example. It is to reduce risk.An Insights on Investor Behaviour The more you churn your portfolio the more you pay the broker in terms of taxes of brokerage and off course the government in terms of taxes on your capital gains. an attack on an important crude pipeline. Now. such as a strike by factory workers for Hero Honda." This theory has a solid foundation behind it. if an investor decides to invest only in steel stocks.
rather concentrating it towards a few stocks. as mentioned above.Stocks To Riches -. such a strategy would more likely than not involve a higher degree of risk.. Now. One must understand that returns can never be de-linked from risk . and time it accordingly.. As a result. an investor can (still) get higher returns. Therefore. . in order to execute such a focused investment strategy.they are never mutually exclusive and always co-exist.An Insights on Investor Behaviour Therefore. an investor must have the ability to spot trends in his or her sector of interest. their business models. Of course. diversification of a stock portfolio serves the purpose of reducing the unsystemic risk of that portfolio. a major purpose of diversification is 'optimising' returns (as opposed to maximizing returns. For example. while the software sector undoubtedly has strong growth prospects. by not diversifying the stock portfolio. taking a call on which stock to invest in to outperform the benchmark index is a none-too-easy task for a retail investor. which might involve a higher level of risk). an investor decides to tilt his or her stock portfolio towards software stocks. management teams and future prospects.and against! On the other hand. who might not have the time to study the stocks. END OF CHAPTER IV Investing is risking and should be approached with care!!! 25 .
An Insights on Investor Behaviour 26 .Stocks To Riches -.
Stocks To Riches
-- An Insights on Investor Behaviour
Guide to Stock-Picking Strategies
When it comes to personal finance and the accumulation of
wealth, few subjects are more talked about than stocks. It's easy to understand why: the stock market is thrilling. But on this financial rollercoaster ride, everyone wants to experience the ups without the downs. Here, investor will find some of the most popular strategies for finding good stocks (or at least avoiding bad ones). In other words, investor will see the art of stock picking – selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average. Before exploring the vast world of stock-picking methodologies, investor should address a few misconceptions. Many investors new to the stockpicking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! This doesn't mean investor can't expand his wealth through the stock market. It's just better to think of stock-picking as an art rather than a science. There are a few reasons for this: 1. So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that investor can work with, but quite another to determine which numbers are relevant.
Stocks To Riches
-- An Insights on Investor Behaviour
2. A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do investors measure the qualitative factors, such as the company's staff, its competitive advantages, and its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process. 3. Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably. And unfortunately, when confidence turns into fear, the stock market can be a dangerous place. The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory - a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits investor personal outlook, time frame, risk tolerance and the amount of time investor want to devote to investing and picking stocks. At this point, investor may be asking why stock-picking is so important. Why worry so much about it? Why spend hours doing it? The answer is simple: wealth. If investor becomes a good stock-picker, he can increase his personal wealth exponentially. Without further ado, let's start by delving into one of the most basic and crucial aspects of stock-picking: fundamental analysis, whose theory underlies all of the strategies explore here. Although there are many differences between each strategy, they all come down to finding the worth of a company.
Stocks To Riches
-- An Insights on Investor Behaviour
5.1 Fundamental Analysis
Ever hear someone say that a company has "strong
fundamentals"? The phrase is so overused that it's become somewhat of a cliché. Any analyst can refer to a company's fundamentals without actually saying anything meaningful. So here we define exactly what fundamentals are, how and why they are analyzed, and why fundamental analysis is often a great starting point to picking good companies.
√ The Theory
Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value; a fancy term for what investor believes a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, investor’s analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock. Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And this which the Rs.1 investor receives in a year’s time is worth less than Rs.1 you receive today. The idea behind intrinsic value equaling future profits makes sense if investor thinks about how a business provides value for its owner(s). If investor has a small business, its worth is the money he can take from the company year after year (not the growth of the stock). And he can take something out of the company only if he have something left over after he pay for supplies and salaries, reinvest in new equipment, and so on. A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value.
investors can simply ask the standard five Ws: who. Then you can move onto the next question. what. To assess the strength of management. √ Management The backbone of any successful company is strong management. specifically.Stocks To Riches -. A management team consisting of people who come from completely unrelated industries should raise questions. Investor should ask himself if these backgrounds make the people suitable for directing the company in its industry. If the CEO of a newly-formed mining company previously worked in the industry. Among other things. their educational and employment backgrounds. Here investor will look at how the analysis of qualitative factors is used for picking a stock. CFO.2 Qualitative Analysis Fundamental analysis has a very wide scope. The people at the top ultimately make the strategic decisions and therefore serve as a crucial factor determining the fate of the company. again investor should ask himself whether he or she has the necessary qualities to lead a mining company to success. 30 . Valuing a company involves not only crunching numbers and predicting cash flows but also looking at the general. and find out who is running the company. √ Where? Investor need to find out where these people come from. COO and CIO (chief information officer) are. where.An Insights on Investor Behaviour 5. when and why? √ Who? Do some research. more subjective qualities of a company. you should know who its CEO.
√ Why? A final factor to investigate is why these people have become managers. it may be a sign to invest elsewhere. promoting an open.An Insights on Investor Behaviour √ What and When? What is the management philosophy? In other words. in what style do these people intend to manage the company? Some managers are more personable. If a company is doing poorly. Look at the manager's employment history.Stocks To Riches -. Investor should ask himself if he agrees with this philosophy. Once investor knows the style of the managers. otherwise. Investor can discern the style of management by looking at its past actions or by reading the annual reports MD&A section. His long tenure is a good indication that he was a successful and profitable manager. and if it works for the company. given its size and the nature of its business. which is a nice way of saying "a change in management due to poor results". Other management philosophies are more rigid and less adaptable. the shareholders and the board of directors wouldn't have kept him around. valuing policy and established logic above all in the decision-making process. for example. transparent and flexible way of running the business. find out when this team took over the company. Jack Welch. such as self-appointment after inheriting the company? 31 . or has s/he acquired the position through questionable means. one of the first actions taken is management restructuring. If investor sees a company continually changing managers. was CEO of General Electric for over 20 years. Does this person have the qualities investor believe are needed to make someone a good manager for this company? Has s/he been hired because of past successes and achievements. and try to see if these reasons are clear.
Stocks To Riches -. "What is the company's business model?" √ Industry/Competition Aside from having a general understanding of what a company does. such as its growth potential. How does this company make money? In fancy MBA parlance. 32 . A mediocre company in a great industry can provide a solid return. investor should analyze the characteristics of its industry. if the demand for the industry is growing. Having a portfolio of brands diversifies risk because the good performance of one brand can compensate for the underperformers.An Insights on Investor Behaviour Know What a Company Does and How It Makes Money A second important factor to consider when analyzing a company's qualitative factors is its product(s) or service(s). Take for example the most popular brand name in India: Reliance. Of course. the question would be. discerning a company's stage of growth will involve approximation. √ Brand Name A valuable brand reflects years of product development and marketing. Many estimate that the intangible value of Reliance brand name is in the billions of rupees! Massive corporations such as HLL rely on hundreds of popular brand names. but common sense can go a long way: it's not hard to see that the growth prospects of a high-tech industry are greater than those of the railway industry. It's just a matter of asking. while a mediocre company in a poor industry will likely take a bite out of your portfolio.
√ Buying a Business. its high quality. The value investors seek companies that seem to be incorrectly valued (undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation.3 Value Investing Value investing is one of the best known stock-picking methods. Value investors have to do their homework and be confident that they are picking a company that is cheap given 33 . such as market volatility or day-to-day price fluctuations. Not Junk! Value investing doesn't mean just buying any stock that declines and therefore seems "cheap" in price. Not a Stock Investor should emphasize that the value investing mentality sees a stock as the vehicle by which a person becomes an owner of a company . and cash flow .An Insights on Investor Behaviour 5. Because their method is about determining the worth of the underlying asset. In the 1930s. book value. and therefore are not seen to have any effect on the value of the business in the long run. The value investor looks for stocks with strong fundamentals including earnings. value investors pay no mind to the external factors affecting a company. not by trading. dividends. Benjamin Graham and David Dodd. √ Value. finance professors at Columbia University. The concept is actually very simple: find companies trading below their inherent worth.that are selling at a bargain price. These factors are not inherent to the company. given their quality.to a value investor profits are made by investing in quality companies. laid out what many consider to be the framework for value investing.Stocks To Riches -.
on the other hand. there's nothing boring about outperforming the S&P by 13% over a 40-year span! 5.An Insights on Investor Behaviour √ The Margin of Safety A discussion of value investing would not be complete without mentioning the use of a margin of safety. a technique which is simple yet very effective. it relies on a strict screening process. You have concluded with a high degree of certainty that it's perfectly safe to stand 100 feet from the center of the explosions. Growth investors. when technology companies were flourishing. at this moment.but this is done with the belief that the companies' intrinsic worth will grow and therefore exceed their current valuations. But just remember.Stocks To Riches -. √ Value versus Growth The best way to define growth investing is to contrast it to value investing. Consider a real-life example of a margin of safety. they look for stocks that. growth investors buy companies that are trading higher than their current intrinsic worth . But before any investor jumps onto the growth investing bandwagon. you implement a margin of safety by setting up barriers 125 feet from the explosions. Value investing is not as sexy as some other styles of investing. Unlike value investors. growth investing techniques yielded unprecedented returns for investors. 34 . are trading for less than their apparent worth. s/he should realize that this strategy comes with substantial risks and is not for everyone. with much less emphasis on its present price. which will include flames and explosions. focus on the future potential of a company.4 Growth Investing In the late 1990s. Value investors are strictly concerned with the here and now. But to be absolutely sure no one gets hurt. Say you're planning a pyrotechnics show.
Typically a growth investor looks for investments in rapidly expanding industries especially those related to new technology. the investor must consider the company in relation to its past performance and its industry's performance. √ No Automatic Formula Growth investors are concerned with a company's future growth potential. The theory is that growth in earnings and/or revenues will directly translate into an increase in the stock price.An Insights on Investor Behaviour As the name suggests.as a framework for their analysis. but there is no absolute formula for evaluating this potential. √ What Is GARP? 35 . Every method of picking growth stocks (or any other type of stock) requires some individual interpretation and judgment. The application of any one guideline or criterion may therefore change from company to company and from industry to industry. 5.Stocks To Riches -.5 GARP Investing Do you feel that you now have a firm grasp of the principles of both value and growth investing? If you're comfortable with these two stockpicking methodologies. but these methods must be applied with a company's particular situation in mind. hybrid system of stock selection. Growth investors are therefore primarily concerned with young companies. then you're ready to learn about a newer. Growth investors use certain methods . Profits are realized through capital gains and not dividends as nearly all growth companies reinvest their earnings and do not pay a dividend. or GARP. Here we take a look at growth at a reasonable price. growth stocks are companies that grow substantially faster than others. More specifically.or sets of guidelines or criteria .
Another misconception is that GARP investors simply hold a portfolio with equal amounts of both value and growth stocks. Like most respectable methodologies.Stocks To Riches -. this is not the case: because each of their stock picks must meet a set of strict criteria. but a combination of the two. some misconceptions about the style persist. The criteria which GARPers look for in a company fall right in between those sought by the value and growth investors. fence-sitting method that fails to establish meaningful standards for distinguishing good stock picks. However. selecting stocks that have neither purely value nor purely growth characteristics. GARPers identify stocks on an individual basis.An Insights on Investor Behaviour The GARP strategy is a combination of both value and growth investing: it looks for companies that are somewhat undervalued and have solid sustainable growth potential. Below is a diagram illustrating how the GARP-preferred levels of price and growth compare to the levels sought by value and growth investors? √ What GARP Is NOT Because GARP borrows principles from both value and growth investing. Critics of GARP claim it is a wishy-washy. GARP doesn't deem just any stock a worthy investment. 36 . it aims to identify companies that display very specific characteristics. Again.
more established firms. which have reached a certain size and are no longer able to sustain higher levels of growth. The more important gauge is the dividend yield. and this trend should continue in the future. Utility companies. √ Who Pays Dividends? Income investors usually end up focusing on older. dividends are more prominent in certain industries. stocks can also provide a steady income by paying a solid dividend. When investors think of steady income they commonly think of fixed-income securities such as bonds.Stocks To Riches -. for example. calculated by dividing the annual dividend per share by share price.100 and a dividend of 37 . For example. mature firms tend to pay out retained earnings as dividends as a way to provide a return to their shareholders. Thus. a company with a share price of Rs. However. Dividend Yield Income investing is not simply about investing in companies with the highest dividends (in dollar figures).6 Income Investing Income investing. This measures the actual return that a dividend gives the owner of the stock. Here we look at the strategy that focuses on finding these kinds of stocks.An Insights on Investor Behaviour 5. have historically paid a fairly decent dividend. is perhaps one of the most straightforward stockpicking strategies. These companies generally no longer are in rapidly expanding industries and so instead of reinvesting retained earnings into themselves (as many high-flying growth companies do). which aims to pick companies that provide a steady stream of income.
7 CANSLIM CANSLIM is a philosophy of screening.An Insights on Investor Behaviour Rs. higher dividends will result in lower retained earnings. Keep in mind that high dividends don't automatically indicate a good company. Stock Picking. The risk associated with any equity security still applies to those with high dividend yields. the co-founder of Investor's Business Daily. or 6% return from dividends. over the last half of the 20th century. Dividends Are Not Everything You should never invest solely on the basis of dividends. Developed by William O'Neil. although the risk can be minimized by picking solid companies. In this section we explore each of the seven components of the CANSLIM system. Because they are paid out of a company's net income. it is described in his highly recommended book "How to Make Money in Stocks". met CANSLIM criteria before increasing enormously in price. The name may suggest some boring government agency. 38 . The best thing about this strategy is that there's evidence that it works: there are countless examples of companies that.6 per share has a 6% dividend yield. but this acronym actually stands for a very successful investment strategy. purchasing. as well as intangibles like a company's overall strength and ideas. What makes CANSLIM different is its attention to tangibles such as earnings.Stocks To Riches -. Not Fixed Income Something to remember is that dividends do not equal lower risk. 5. The average dividend yield for companies in the S&P 500 is 2-3%. Problems arise when the income that would have been better re-invested into the company goes to high dividends instead. and selling common stock.
distinguishing between market leaders and market laggards is of key importance. a new market.An Insights on Investor Behaviour √ C = Current Earnings O’Neil emphasizes the importance of choosing stocks whose earnings per share (EPS) in the most recent quarter have grown on a yearly basis. a company’s EPS figures reported in this year’s April-June quarter should have grown relative to the EPS figures for that same three-month period one year ago. O’Neil found that 95% of the companies he studied had experienced something new. S = Supply and Demand The S in CANSLIM stands for supply and demand. The system indicates that a company should have shown good annual growth (annual EPS) in each of the last five years. Whether it is a new management team. see Types of EPS. or a new high in stock price.Stocks To Riches -. √ L = Leader or Laggard In this part of CANSLIM analysis. In each industry. a new product. providing great gains to shareholders. there are always those that lead. and those that lag 39 . For example. (If you're unfamiliar with EPS. which is often necessary for a company to become successful. √ N = New O’Neil’s third criterion for a good company is that it has recently undergone a change.) √ A = Annual Earnings CANSLIM also acknowledges the importance of annual earnings growth. which refers to the laws that govern all market activities.
M = Market Direction The final CANSLIM criterion is market direction. CANSLIM suggests that a stock worth investing in has at least three to 10 institutional owners. CANSLIM is great because it provides solid guidelines. When picking stocks. This component of CANSLIM may require the use of some technical analysis tools.An Insights on Investor Behaviour behind. it incorporates tactics from virtually all major investment strategies.Stocks To Riches -. which are designed to help investors/traders discern trends. Although O’Neil is not a market timer. Volumes CANSLIM maintains that the best way to keep track of market conditions is to watch the daily volumes and movements of the markets. he argues that if investors don’t understand market direction. keeping subjectivity to a minimum. this criterion is based on the idea that if a company has no institutional sponsorship. Basically. all of the thousands of institutional money managers have passed over the company. and even a little technical analysis. Think of it as a combination of value. growth. The idea is to separate the contenders from the pretenders. it is important to recognize what kind of a market you are in. Best of all. I = Institutional Sponsorship CANSLIM recognizes the importance of companies having some institutional sponsorship. they may end up investing a trend and thus compromise gains or even lose significantly. Against the Daily Prices and 40 . whether it is a bear or a bull. fundamental. providing returns that are mediocre at best.
Picking Stocks with Technical Analysis Technicians have a very full toolbox.An Insights on Investor Behaviour 5. whether up or down. However.Stocks To Riches -.8 Technical Analysis Technical analysis is the polar opposite of fundamental analysis. depending on what direction the data is saying the price will move. technical analysts look at the past charts of prices and different indicators to make inferences about the future movement of a stock's price. select stocks by analyzing statistics generated by past market activity. holding positions for short periods in order to capitalize on fluctuations in price. Technical analysts are usually very active in their trades. using stop-loss orders to mitigate losses. he or she wastes little time deciding whether to exit his or her position. Technical analysts. Definitely not. it is important to note that no one indicator or chart pattern is infallible or absolute. the 41 . or technicians. prices and volumes. Which is the basis of every method. Is Technical Analysis a Long-Term Strategy? The answer to the question above is no. the technician must possess a great deal of trading agility and know how to get in and out of positions with speed. Sometimes also known as chartists. They literally have hundreds of indicators and chart patterns to use for picking stocks. If a stock does not perform the way a technician thought it would. Whereas a value investor must exercise a lot of patience and wait for the market to correct its undervaluation of a company. A technical analyst may go short or long on a stock.
concerned with the present. √ Some qualitative factors affecting the value of a company are its management. or its intrinsic value. and this process is more subjective than formulaic.9 Bird’s Eye on the above Strategies Let's run through a quick recap of the foundational concepts that are already covered in the above well-known stock-picking strategies and techniques: √ Most of the strategies discussed in this tutorial use the tools and techniques of fundamental analysis. In other words. a company is worth the sum of its discounted cash flows. whose main objective is to find the worth of a company. √ Value investors. 42 . it is worth all of its future profits added together.An Insights on Investor Behaviour technician must interpret indicators and patterns. seeking a steady stream of income from their stocks. √ The GARP strategy is a combination of both growth and value: investors concerned with 'growth at a reasonable price' look for companies that are somewhat undervalued given their growth potential. √ In quantitative analysis. as reflected by its fundamentals. Growth investors are concerned with the future. buying companies that may be trading higher than their intrinsic worth but show the potential to grow and one day exceed their current valuations. look for stocks selling at a price that is lower than the estimated worth of the company. look for solid companies that pay a high but sustainable dividend yield.Stocks To Riches -. 5. business model. industry and brand name. √ Income investors.
institutional sponsorship. the polar opposite of fundamental analysis. supply and demand. annual earnings. √ Technical analysis. and leadership in industry. and market direction. END OF CHAPTER V “Be fearful when others are greedy. Be greedy when others fear” 43 . but instead looks at past market activity to determine future price movements. is not concerned with a stock's intrinsic value. new changes.An Insights on Investor Behaviour √ CANSLIM analyzes these factors of companies: current earnings.Stocks To Riches -.
An Insights on Investor Behaviour 44 .Stocks To Riches -.
So the most important thing before entering is a proper homework and build confidence. “It involves ratios. At a micro level. making money has never been so simple and secondly when we talk of ‘Stock Investment’.An Insights on Investor Behaviour CHAPTER VI BEHAVIOURAL FINANCE 6. many people stick to ‘stock’ and forget the word ‘investment’. it does not matter how much you invest. it is a combination of both science and art. Stocks or equity is one of the asset classes like savings instruments. this is a question to a group of people with common interest that ‘is stock investment is an art or a science?’ and got varied answers. interest rates and possess enough knowledge to join all the points to get the right picture and build the conviction to make up mind to buy or sell or to have patience not to buy or sell is an art. It is relative to the duration that you’ve held the stock and relative to the risk you have taken. to understand the global scenarios. funds. commodities and real estate for investment. ratios is science. supply/demand. Quick came the reply.1Conversation with STOCK INESTOR If u ask a simple question to a stock investor. ‘what is your objective of stock investment?’ who showed interest in knowing the stock market. At the macro level. “Picking the right time to sell and buy is an art”.Stocks To Riches -. Firstly. 45 . and cash flow. details of the company finance. calculations. ‘I want to make money as soon as possible’. When a common person builds interest in stock markets. But in a nutshell. market sentiments and trends. so it is a science”. the first question asked is ‘How much investment investor should start with to realize good returns?’ The first thing to remember is that return is relative to many factors. numbers. Now turning focus back to stocks. balance-sheet.
000. If a stock yields a return of 5% for Rs 1. They repented their stand and prayed for his early recovery so that he could come back to teach. 46 .2Emotions Change Paradigms This is a true story of a person who ran a coaching class with one of his colleagues. They thought that they had been successful in removing him. He informed the students of this calamity. Indeed.Stocks To Riches -. One day that person learned that the colleague had brain tumour and needed an operation. So never measure the return in absolute terms but in Percentages. Moreover he was a brilliant professional and an able tutor. The allegation was that he was very short-tempered and arrogant. 6. Frequently emotions prompt us to make decisions that may not be in our rational financial interest. That person was worried. To start with one should understand that rate of return is not relative the amount you invest.000 will also yield the same 5 per cent for Rs10. After six months a few students complained to person about his colleague’s rude behaviour. Hatred and resentment gave way to empathy and love. The purpose of this story is to understand that as humans we are emotional beings and our behaviour and decisions are guided by our emotions. investor invested. as now his partner would be out of action for quite some time. and investor was expecting more’.An Insights on Investor Behaviour The next common comment is ‘Investor got only Rs 50 return for the Rs1000. This news shocked that person. They wanted him removed or else they would discontinue the classes. The students were stunned and this shock changed their attitude. They visited him at the hospital and took him flowers. decisions that enrich us emotionally may impoverish us financially. After a couple of weeks the colleague fell ill and was absent for some time. They started off well and within a couple of months they were full to capacity. Behavioural finance is the study of how emotions and cognitive errors can cause disasters in our financial affairs. The students were very happy. His colleague was his partner and he could not be removed.
3 Classical Economic Theory v/s Behavioural Economic Theory The Classical Economic Theory talks about efficiency of the markets and people making rational decisions to maximise their profits. we give tips at the end of the meal. Consider this example. If you and I were walking down a busy street in Colaba and you said saw a Rs. If tips ensure good service we should be tipping before the service starts. This is a common mistake we make without realizing its pure economic implications. The acronym TIPS stands for: To Insure Prompt Service. So many people walk this road and the markets being efficient someone would have definitely picked it up. Behavioural finance raises a couple of important issues for investors. This shows that the markets are not as efficient as they seem to be. I would say it’s impossible. Yet. However behavioural economists believe that the markets are inefficient and human beings are not rational beings. It also assumes that humans are rational beings and will act to maximise their gains. The first is whether or not it is possible to systematically exploit 47 . It assumes that the markets are efficient and no one can take advantage of its movements. 5 coin on the road. Behavioural finance researchers seek to bridge the gap between classical economics and psychology to explain how and why people and markets do what they do. if we assume that people make rational decisions to maximise profits then how do we explain people giving to charities or throwing a party to celebrate a birthday or an anniversary? Definitely this is not about maximising profits by rational people. Yet. Tipping is more a custom. Further.An Insights on Investor Behaviour 6. Here’s another example for how irrational we can be. in economic theory we are rational beings always intent on maximising our economic status.Stocks To Riches -. We do it mechanically. We even give tips when the service is substandard. But in reality we do come across such instances. unaware that we are behaving irrationally.
Jump in late and busy stocks that have peaked Take desperate risks and gamble wildly when Avoid taking the reasonable risk of buying Never find the right price to buy and sell stock. a fact that is being increasingly recognised. Behavioural finance explains why in a rally just before the price declines. Students and proponents of behavioural finance create investment strategies that capitalize on irrational investor behaviour. The goal is to close the gap between how we actually make decisions and how we should make decisions. promising stocks unless there is an absolutely ‘assured’ profit. √ Investor: Hold on stocks that are crashing. Ridiculously overvalue and undervalue stocks. 48 . Psychology can play a strategic role in the financial markets. These mistakes cause under priced or overpriced securities. our stocks fall. Buy when we have to sell and sell when we Buy because others are buying and sell In the stock markets.An Insights on Investor Behaviour Irrational market behaviour when it occurs.Stocks To Riches -. The second issue is how to avoid making sub-optimal decisions as an investor. They seek to identify market conditions in which investors are likely to overreact or under react to new information. and to benefit from the subsequent jump or fall in prices once they do. because others are selling. The goal of behavioural finance strategy is to invest in or disinvest from these securities before most investors recognise their error. should be buying. Sell Stocks that are rising.
rationalizing their decision with "everyone else is doing it". many people feel much less 49 . √ Regret Theory Fear-of-regret.4 Understanding Investor Behavior When it comes to money and investing.and a vicious cycle ensues where avoiding regret leads to more regret. the result is regret of buying a losing stock and the regret of not selling when it became clear that a poor investment decision was made . as well as the embarrassment of reporting a loss. Faced with the prospect of selling a stock. Oddly enough. "What are the consequences of repeating the same purchase if this security were already liquidated and would I invest in it again?" If the answer is "no". investors become emotionally affected by the price at which they purchased the stock. Investor is not always as rational as they think they are . they avoid selling it as a way to avoid the regret of having made a bad investment.which is why there's a whole field of study that explains investor’s-strange behavior. So. theory deals with the emotional reaction people experience after realizing they've made an error in judgment. or simply regret. Let us look Where an investor. We all hate to be wrong.Stocks To Riches -. otherwise. Some investors avoid the possibility of feeling this regret by following the conventional wisdom and buying only stocks that everyone else is buying. don't we? What investors should really ask them when contemplating selling a stock is. Regret theory can also hold true for investors who find a stock they had considered buying but did not went up in value. it's time to sell.An Insights on Investor Behaviour 6. fits in? Insight into the theory and findings of behavioral finance.
√ Mental Accounting Humans have a tendency to place particular events into mental compartments. let's say you paid for the Rs 20 ticket in advance.than about losing on an unknown or unpopular stock. Pretty silly.An Insights on Investor Behaviour embarrassed about losing money on a popular stock that half the world owns like Reliance and Infosys . for example. different mental compartments.Stocks To Riches -. same amount of money. you aim to catch a show at the local theater. People tend to place too much credence in recent market views. that in both scenarios you're out Rs 40: different scenarios. gains. people get accustomed to healthy. Say. they're more hesitant to sell at the smaller profit margin. When the market correction deflates investor's net worth. however. and mistakenly extrapolate recent trends that differ from historical. They create mental compartments for the gains they once had. When you arrive at the door. albeit paper. huh? An investing example of mental accounting is best illustrated by the hesitation to sell an investment that once had monstrous gains and now has a modest gain. During an economic boom and bull market. long-term averages and probabilities. Now. When you get there you realize you've lost a Rs 20 bill. and tickets are Rs 20 each. √ Anchoring In the absence of better or new information. and the difference between these compartments sometimes impacts our behavior more than the events themselves. Do you buy a Rs 20 ticket for the show anyway? Behavior finance has found that roughly 88% of people in this situation would do so. causing them to wait for the return of that gainful period. 50 . you realize your ticket is at home. investors often assume that the market price is the correct price. opinions and events. Notice. Would you pay Rs 20 to purchase another? Only 40 % of respondents would buy another.
Over-/Under-Reacting Investors get optimistic when the market goes up. When did it become a rational decision to invest in stock with zero earnings and thus an infinite price-to-earnings ratio (think dotcom era. investment decisions are often influenced by price anchors. √ Overconfidence People generally rate themselves as being above average in their abilities. A consequence of anchoring. assuming it will continue to do so. with trading costs denting profits. investors become extremely pessimistic amid downturns. They also overestimate the precision of their knowledge and their knowledge relative to others.Stocks To Riches -. placing too much importance on recent events while ignoring historical data. investor greed moves stocks beyond their intrinsic value. Overconfidence results in excess trades. At the peak of optimism. 51 .or under-reaction to market events may lead to market panics and crashes. But in reality there's an overwhelming amount of evidence that proves otherwise.or under-reaction to market events which results in prices falling too much on bad news and rise too much on good news. This makes the more distant returns of the past irrelevant in investors' decisions. is an over. circa year 2000)?! Extreme cases of over.An Insights on Investor Behaviour In bull markets. Many investors believe they can consistently time the market. prices deemed significant because of their closeness to recent prices. Conversely.
it often results in quirky. Behaviorists will argue that investors often behave irrationally. In fact.An Insights on Investor Behaviour Bird’s Eye Behavioral finance certainly reflects some of the attitudes embedded in the investment system. not to mention a dent in your wealth. Questions remain over whether these behavioral finance theories can be used to manage your money effectively and economically. 52 . investors can be their own worst enemies. Trying to outguess the market doesn't pay off over the long term. producing inefficient markets and mispriced securities . consistently uncovering these inefficiencies is a challenge. Implementing a strategy that is well thought out and sticking to it may help you avoid many of these common investing mistakes. irrational behavior.Stocks To Riches -. That said.opportunities to make money. But. That may be true for an instant.
An Insights on Investor Behaviour END OF CHAPTER VI “Gaps between perception and realty are where Investment opportunities are born” 53 .Stocks To Riches -.
no matter how many times people try to stop Investor from losing money in the market. The most obvious clue that something is going wrong with his investments is that losing money.An Insights on Investor Behaviour CHAPTER VII 7. investor need a plan before they buy their first stock. To keep your losses small.1 Why Investors Lose Money INVESTOR LOSE MONEY Unfortunately.Stocks To Riches -. It is only after losing most of their money that they finally admit that they made mistakes. The main point is that investor should take action when their stock is losing money. They lost. the biggest mistake investor can make is not recognizing himself that he had made one. sell. so they sell the stock. One rule is so important that investor should post it in front of their computer or on their desk: If they lose more than 10 percent on an investment. The reasons investor hold onto losing stocks is primarily psychological. 54 . some of the mistakes which are done by retail investors are as follows: √ Mistake #1: Investor Don’t Sell Losing Stocks For a variety of reasons. There is nothing wrong with or unusual about making mistakes. Failure to get out of losing positions early is probably the number one reason why so many investing and trading accounts are destroyed. They can put a stop loss order at 10 percent below the purchase price when they buy the stock. some investor holds onto their losing stocks too long. Actually. A loss of more than 10 percent on an investment is a signal of a problem. or they can make a mental note. Here. Remember this: Do not invest in the stock market in order to lose money. they often don’t listen until it’s too late.
Some are still in denial about the fact that many of their favorite stocks will never return to even. you’d have made more money. becoming too emotional about your investments is a clue that you could lose money.An Insights on Investor Behaviour √ Mistake #2: Investor let their Winning Stocks Turn into Losers It seems as if you can’t win no matter when you sell. Mistake #3: Inability to control their emotions is the main reason why most Investor Get Too Emotional about their Stock Picks people should not participate in the stock market. “There are no geniuses in a bull market. then sat back and watched helplessly while all their profits disappeared (what the market gives. An old but true saying is. In fact. it would have been less painful to have never made money in the market at all than to have won and lost it all. Many people lost not only their gains but their original investment as well. A common problem. and one that especially afflicts those who have tasted success in the market. is overconfidence. you are left with the lingering feeling that if you had held it a little longer. When investing in the market with substantial money at stake. 55 . One of the reasons the bull market was destined to end so abruptly was that too many people were making too much money and thought they were geniuses. allowing your ego to get in the way of your investing is a dangerous sign. Making money should be as boring as waiting in line at the supermarket.Stocks To Riches -. but in fact they were just being carried by the strength of a bull market. the market takes away). Although some self-confidence is necessary if you are going to invest in the market. If you sell a stock for a gain. some people made tons of money in the stock market. In contrast.” The point is that people thought they were geniuses. For these people. many people are flooded with emotions that compel them to make the wrong decisions.
Stocks To Riches -. They were convinced that the good times would last forever. which although legal. Jonathon Lebed.An Insights on Investor Behaviour Before the bull market’s abrupt end. no one stock should make up more than 10 percent of your portfolio. then buy stocks in conservative companies with low P/Es (less than 10) that pump up their returns with quarterly dividends. • Stock analysts and CEOs were treated like rock stars. it also protects you in case one of your investments does badly. The SEC allowed him to keep half his profits. • Many mutual funds were going up by over 100 percent a year. 56 . • Stock prices in companies that had no earnings were doubling and tripling each day.) • Thousands of people were quitting their jobs to become day traders. “Hope is a dangerous thing.) Although diversification limits your upside gains. • The CEOs of dozens of companies were paid hundreds of millions of rupees in salary and compensation. The signs of greed were everywhere: • A 15-year-old boy. You want stocks in companies that are so good that they will be profitable for years. many investors got so greedy that they couldn’t think straight. even though their companies were losing money. did not seem fair to shareholders who lost money.” √ Mistake #4: One of the problems with investing directly in the stock market is Investor Bet Money on Only One or Two Stocks that most people don’t have enough money to maintain a properly diversified portfolio. (In general. If you feel that you must bet all your money on only one or two stocks.” “People are hopeful when they should be afraid and are afraid when they should be hopeful. (Many made their millions through stock options. made a million rupees pumping and dumping penny stocks.
It means that you have to stick to your strategy and obey your rules. and a set of rules. your plan. When the easy money stopped and the market plunged. many investors went down with the sinking ship. but you must be realistic enough to realize that you could be wrong. Why? They didn’t know how it felt to lose money. plan. Discipline means having the knowledge to know what to do (the easy part) and the willpower and courage to actually do it (the hard part). you have a strategy. This has always worked for successful investors and mutual fund managers. Because they had made money the wrong way. a plan. Some investors were so rigidly disciplined about sticking with their stock strategy that they didn’t react when the market and their stocks turned against them. 57 . you also need to balance this with a healthy dose of flexibility. and rules. √ Mistake #6: Most experienced investors and traders know that you learn more Investors Don’t Learn their Mistakes from your losers than from your winners. Although the pros are right in claiming that you need discipline if you are to be successful in the market.Stocks To Riches -. In the name of discipline. you stick to your strategy. If you are disciplined. and no matter what you are feeling. and your rules. they were destined to give it all back. You have to be flexible enough to change your strategy. especially if you are losing money. many of them had no idea what to do next. One of the worst things that happened to many investors in the tech boom was that they made money in the market too quickly and easily. Discipline is essential.An Insights on Investor Behaviour √ Mistake #5: Almost every professional investor will rightly claim that a lack of Investors Are Unable to Be both Disciplined and Flexible discipline is the main reason that most people lose money in the market.
Analysts lied.”) The best advice you should received on the market was also the simplest: “Keep your ears shut” 58 . there are some steps you can take to limit your risks. Should you get your stock picks from experts? Don’t forget that most of the experts who appeared on television or were quoted in magazines were terrible stock pickers. there is a simpler way to find stocks to buy—stock tips. The beauty of tips is that investors can make money without doing any work.Stocks To Riches -. economists misjudged the economy. If this sounds too good to be true. (“Everyone wanted to be a player but we ended up being played. These people often become cheerleaders for a stock. In the market.An Insights on Investor Behaviour If you lose more than 10 percent in the market. one of the easiest ways to lose money in the market is by listening to tips. √ Mistake #7: If an investor eyes glaze over when they read about fundamental or Investor listens or Get Tips from the Wrong People technical analysis. Because it’s hard to say no to easy money (especially when the tip comes from a trusted source). At the same time. especially if they come from well-meaning but uninformed relatives or acquaintances. Accept the loss and make sure you don’t make the same mistake again. trying to convince you to buy it. CEOs were overly optimistic. In fact. take the time to understand your mistakes. everything doesn’t always work out in the end. it is. greedy and lazy investors must take responsibility for buying stocks based on tips. there are a few things you can do. and accounting firms fudged the numbers to make losing companies look like winners. Instead of burying your head in the sand. It’s not useful to make excuses and act as if your stock losses are only paper losses that will be made up in the future.
not scared. If you study the lives of some of the greatest traders and investors in the recent past. and it seems like perhaps the worst possible time to invest. you find many periods and events in history that attest to herd mentality—or the “madness of crowds. a market crash. no one rings a bell to announce the end. or an unanticipated event that will ruin the market. a recession. Although the crowds can win. When almost everyone is avoiding the stock market.An Insights on Investor Behaviour √ Mistake #8: If investor want to lose money? Then do what everyone else is Investor’s Follow the Crowd doing. it is excruciatingly difficult to think differently from everyone else. Although you should always hope for the best. you will find that they often made their fortunes by doing the opposite of what the crowd was doing. a signal of a bear market’s end is that people are too afraid to invest in the market. They are not prepared for an extended bear market. Mistake #9: √ Investor’s Aren’t Prepared for the Worst Before investor get into the market. the signal that a bull market is ending is that it seems as though everyone is in the market. not fear. If you study the psychology of group behavior. The biggest mistake many investors make is thinking that their stocks won’t go down. the bear market will end. That means buying when other people are selling and selling when other people are buying. they don’t win for long. Keep in mind that perception about the market change very rapidly. you must be prepared for the worst. As mentioned earlier. You have to figure it out for yourself. Unfortunately. deflation. Even if you don’t expect a financial disaster.” as one author put it. Conversely. create a “crash proof” plan based on logic and common sense. Unfortunately.Stocks To Riches -. 59 . they should be prepared.
Do you want to know the secret to making money in the stock market or with any investment? Don’t lose money. but too much fear can cause you to miss out on profitable investments or trades. In the end. Unfortunately. Usually. fear results from a lack of information. if you can’t manage money. It’s the fear of missing out on higher profits that prevents people from selling before it’s too late. you’ll realize that this makes a lot of sense. A little bit of fear keeps you on your toes. but it’s one of the most important skills to have. That is why it’s essential that you do your own research when a financial opportunity comes your way. It’s the fear of loss that prevents many people from buying at the bottom. it’s not how much you make but how much you keep that matters. not on emotion. 60 . you’re destined to have financial problems. it’s not easy to find investments where you don’t lose money. Just as harmful as mismanaging money is missing out on moneymaking opportunities. Obviously. 7. Many times you’ll be wrong. If you think about it long enough. but that shouldn’t stop you from trying.An Insights on Investor Behaviour Mistake #10: √ Investor’s Miss Out or Mismanage Money Managing money is a difficult skill for most people. you aren’t privy to all the information that you need in order to be 100 percent right. Obviously. This gives you an opportunity to make an informed decision based on the facts. You have to make a decision based on the best information you have at the time.Stocks To Riches -.2 Things Every Investor Should Know (Investing Basics) There are a number of issues that investors should know and understand PRIOR to making investing decisions.
Set and establish goals for your future and determine how those goals are influenced by the results of your investing. This sounds ultra simplistic. and wait it out. Think of it this way. or in other words the higher the rate of return the higher the risk you assume. Earning a high level of return requires taking more risk. In some cases something is considered "high risk" because it is unlikely to generate a moderate or high return.Stocks To Riches -. The level of return you seek is tied to a level of risk. you are on a journey. Your portfolio should reflect your goals (to retire at 55 with a specific income). You should have no such worries over performance measurement but can simply sit back. 61 . They are judged solely by their performance and are therefore influenced to take more inherent risk in order to beat indexes and peers. Goals such as these leave too much ambiguity and room for error. It is a well-known fact that in order to achieve higher return rates you must assume a higher level of risk which can and typically does equate to losses within a portfolio greater than many investors are comfortable with accepting. focused on the long-term. In fact as Mark Twain once remarked. It is never wise to invest solely for the sake of "doing well" or "I want to retire comfortably". However. "I am more concerned about the return of my money than the return on my money". just because a holding or portfolio is high risk it is not necessarily capable of generating high returns.An Insights on Investor Behaviour Investing in a vacuum is never a good idea. but taking more risk does not always equate to a higher return. How do you know if you have arrived if you do not know where you are going? Investor have an advantage over the pros Professional money managers are usually always tied to beating "the market" month to month and quarter to quarter. The professionals also do not have the luxury of holding on (or buying more of) when a specific security starts to tank. risk tolerance.
The Rule of 72. News only sells when it gets our attention and unfortunately that hardly ever equates to good news.An Insights on Investor Behaviour Asset allocation is THE most important part of investing* Much more so than choosing the right security or being lucky enough to own the next Infosys. Take the rate of return and divide it into 72. sound selection of asset classes mixed together will establish the framework of your portfolio performance over the long run. The movements generated by the advice of those in the television and print media are not always the best for the investor. 62 . if you assume a 12% rate of return and divide 72 by 12 then your money would double in 6 years. For example. Many investors I have spoken with over time wonder about how long it takes to double their money. This is typically presented in a statement that they desire their money to double every 3 or 4 years. END OF CHAPTER VII An investor should act as though he had a lifetime decision card with just twenty punches on it. For those of you who wish your money to double every 3 or 4 years this should give you an idea of the level of return (and subsequent level of risk) you must achieve. A good.Stocks To Riches -. asset allocation determines over 91% of the total portfolio performance according to an Ibbotson study. Watch what you watch and read. This will be the approximate amount of time it takes for the money to double at the specified rate of return. The rule of 72 is one of those rules of thumb for quick and basic calculation. Turn off the talking heads on TV and put down the latest investment periodical. These formats are informative if taken lightly and in the proper amount but they are more interested in selling subscriptions and driving ratings than they are about giving quality advice.
if people: Do not understand the difference between investing and speculating. Firstly. 8. without speculation untested new companies like Infosys. risk tolerance and future needs for capital. and risk guidelines. but it is never eliminated. The greatest problem today is that most investors are acquiring speculative habits believing that they are investing. When the buyer buys a stock he takes the primary risk that the stock will go down. would never have been able to raise the necessary capital for expansion. However. The components of most investment strategies include asset allocation. 63 . Satyam. the risk is exchanged every time the stock is sold and bought. and in earlier times companies like Reliance. Investment strategies can differ greatly from a rapid growth strategy where an investor focuses on capital appreciation to a safety strategy where the focus is on wealth protection. Secondly.An Insights on Investor Behaviour CHAPTER VIII INVESTMENT STRATEGIES An investor's plan of attack to guide their investment decisions based on individual goals. The tempting chance of a huge gain is the grease that lubricates the machinery of innovation.1 A Good Strategy There is nothing wrong in speculation as such. The most important part of an investment strategy is that it aligns with the individual's goals and is closely followed by the investor.Stocks To Riches -. However. Speculate without the right knowledge and skill. speculating can go wrong. the seller still retains the residual risk of the chance that the stock he sold may go up. On the contrary it is beneficial in two ways. The attraction of quick money and the advent of the futures market have lured them to margin trading. buy and sell guidelines. Speculate beyond the capacity to take a loss (that is called margin trading).
Keep in mind that you aren’t limited to only one strategy. it’s best to keep an open mind before choosing a strategy. Some investors and traders use a variety of strategies. It can take a long time before you find an investment strategy that not only makes sense but also increases the value of your portfolio. If a particular strategy seems to make sense to you.Stocks To Riches -. This could be bad news especially when they are dealing with their life savings. 64 . Short-term investing (speculation) can also be very rewarding if you are able to time the markets and take advantage of short-term volatility. 8. whereas others are comfortable using only one. you can still lose money. A stock can decline significantly in the short run and yet give a decent longterm return.2 MONEY-MAKING STRATEGIES A strategy is a plan that helps you determine what stocks to buy Or sell. no matter how brilliant and ingenious the strategy. No matter what strategy you use. Nothing is Right or Wrong This conclusively proves a few points namely: Long-term investing can be very rewarding if you buy the right company at the right price.An Insights on Investor Behaviour For a number of people. 2. here are a few things you should remember: 1. In other words. take the time to do more research. this has become a full-time occupation due to the advent of the Internet and online trading. If you are new to the stock market. A strategy is only as good as the person using it. Not all strategies work during all market conditions.
They are focused only on the business. You have to take the time to find the strategy or strategies that fit your personality and lifestyle. the only way to find out what ultimately works on Dalal Street is through trial and error. 65 . there are no magic answers to finding success in the stock market. you are paying very little in brokers’ commissions. They don’t sell because of what is happening to the market. Don’t become so devoted to a strategy that you are blind to the fact that you are losing money. Buy and hold is the easiest investment strategy to use. Unfortunately. or the stock price. The beauty of a buy-and-hold strategy is that you can buy a stock and watch it rise in price without having to constantly watch the market. and. For most people. and RELIANCE in the early days made huge sums of money on paper without having to pay much attention to the market. the economy. in retrospect. The other advantage of buy and hold is that because you are not constantly buying and selling stocks. Perhaps the only time buy-and-hold investors sell is if something fundamentally changes in a company. Investors who bought companies like Infosys. and they intend to hold their reasonably priced stocks as long as possible. √ Buy and Hold: The Most Popular Strategy for Investors The reasoning behind the buy-and-hold strategy is that if you buy a stock in a fundamentally sound company and holds it for the long term (at least a year). it worked extremely well during the bull market.Stocks To Riches -. you’ll realize a profit. TCS.An Insights on Investor Behaviour 3. Money is the scorecard that determines whether your strategy is working.
often costing lot of money. is a difficult strategy. although exciting and potentially profitable. 66 . Momentum investors tend to use technical analysis to look for stocks that will make sudden and dramatic moves in a short period. Many momentum stocks can explode in either direction. Momentum investing works best during bull markets when there is a lot of liquidity. Although it is still possible to find momentum stocks. a surprise announcement or positive rumor could send stocks up 20 or 30 points in one day.) Momentum investing.Stocks To Riches -. Although it’s possible to catch some of these stocks on the upside. you will always be able to find a bigger fool who is willing to buy it from you. Some critics call momentum investing the “greater fool theory. People who used this strategy in the past made tons of money as the shares they bought kept going higher. The idea is that because the market always goes up over time (or generally has in the past). They don’t care too much about the price they paid as long as the stock goes higher.” which means that no matter how high the stock price is. it is definitely not as easy as it looks. especially if it believes the decline is only temporary.An Insights on Investor Behaviour √ Buy on the Dip: An Offshoot of Buy and Hold In this strategy. people buy more shares. In the go-go 2000s. when a stock goes down in price. it’s not as easy as it was a few years ago. √ Momentum Investing: Buy High and Sell Higher Momentum investors are growth investors who look for stocks that are ready to make explosive moves upward. In the 2000s. the shares bought at a lower price will eventually be worth more. it seemed as if no matter which stock you bought— especially if was an Internet stock—the stock would go higher. (And it’s unlikely that we’ll see that kind of market environment again for many years to come. They buy stocks at a high price but plan to sell them at an even higher price.
Practically all such issues have been hugely oversubscribed. there is greater need to exert caution and pick the best IPO investments. these issues have generated huge interest amongst the investors and raised thousands of crores. Day trading is an extreme trading strategy that involves constantly moving into and out of stocks. Four critical factors to be studied in an IPO offer document. Prospects and Price. And most of them have given huge listing gains to the investors. This trend. And predictably enough.An Insights on Investor Behaviour √ Day Trading: Buying and Selling in Minutes Unlike investors. We have more and more companies coming out with IPO’s or additional offers. 67 .Stocks To Riches -. before making an IPO investment. day traders sell all their stocks and move to cash by the end of each day. day traders buy and sell within seconds. The four critical factors which need to studied in an offer document when making an investment decision are Promoter. seems to be tapering off and we are increasingly seeing public issues from the relatively not-so-good or known companies and at fairly stretched prices.3 Simple Investment Strategy: Invest in IPO’s With more and more companies coming out with tempting IPO or additional offers. 8. Usually. it becomes necessary for the investors to become cautious and be more selective about their investments in IPO’s. who may wait years before selling. minutes. or hours. professional day traders try to anticipate where a stock will go in the near future and trade accordingly. One good thing about the IPO market vis-à-vis the earlier times has been that most of them have been from good companies and at reasonable prices. Therefore. In such a scenario it is but natural for the euphoria to pass on to the primary market. Performance. Using technical analysis. however.
investor complaints etc.An Insights on Investor Behaviour √ Check promoter standing This by far is the most important factor in any investment decision.Stocks To Riches -. EPS etc. Poor numbers say the sales. profit. would mean poor performance on the stock exchange. Thirdly. Check for any serious litigation against the promoter or the company. a good management will take all necessary steps to ensure profitable performance. Look for any window dressing. See whether the company is a defaulter to the banks/FIs and the reason thereof. Are they paying reasonable interest? Is the loan likely to be repaid? 68 . √ Study company performance The share price is the reflection of the operational performance of the company. Read the risk factors very carefully especially those pertaining to the promoter/management. Are the numbers in line with the similar companies in the industry? Is there any sudden improvement in the numbers just before the issue. Look at the loans given to group companies. thereby ensuring regular growth in the company. look at the promoter’s background. we are reasonably certain that the company money will not be deliberately misused or siphoned off to the detriment of the shareholders. the experience he has in the industry. Therefore. without any justifiable reasons? Also look at the performance of the group companies and the intercompany transaction within the group. his track record. it is important that the company has a track record of good operational performance. they would be constantly looking at new business opportunities. While businesses may have their ups and downs. A good promoter or management team is important for any business success. the performance of the other companies promoted by him. especially over long periods. Therefore. Secondly. Ensure that there are no dubious transactions.
For follow-on issues the price is more or less known.An Insights on Investor Behaviour √ Understand future prospects The future prospects of the Company and the industry would play an important role in the performance of the scrip on the stock exchange. Buy value nor price. Compare this with the issue price to see if it is undervalued or overvalued. √ Look at the price Finally of course every product/scrip has a right price based on its’ fundamentals and industry prospects. than at the IPO stage. Therefore. If the purpose of the issue is to list the company on the stock exchange and the 4 Ps are positive. Look at the average industry PE and the companies EPS and try and estimate the fair price. should remain the cornerstone of an investment style” CHAPTER IX 69 RATIOS . END OF CHAPTER VIII “Lethargy. Check the objects. bordering on sloth. How will they impact the future prospects? How will the funds raised be utilised? Will it additionally benefit the company? Is the money being raised for a new project. The amounts raised from the issue will not go to the Company. A little time spent in reading the offer document and analysing the IPO on the above factors will help you to make right investment decisions and prevent you from ending-up holding a dud stock. Even if the above 3 Ps were favourable.Stocks To Riches -. Again look for fair valued or undervalued scrip. which will add to the bottomline of the company? If its’ an offer-for-sale. Such issues tend to quote below issue price over a period of time and it may be prudent to enter then. An issue which are overvalued. then one can consider investing. there may not be much listing gain or loss. Therefore. a high price is likely to reduce the prospects of appreciation at the exchange. the Company will not benefit from an offer for sale. it means the existing shareholders are selling a part of their stake in the Company. thereby defeating your purpose of investing.
Among these are: The company's future and recent performance.2 Earnings Per Share . Calculate Ratios. Calculated as: EPS In the EPS calculation. it is more accurate to use a weightedaverage number of shares outstanding over the reporting term.1 Determining share prices Share prices in a publicly traded company are determined by market supply and demand. However. Diluted EPS expands on the basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.An Insights on Investor Behaviour 9. EPS serves as an indicator of a company's profitability. and thus depend upon the expectations of buyers and sellers. the "market sector" Prevailing moods & fashions. 9. New product lines. because the number of shares outstanding can change over time. Prospects for companies of this type. 70 .EPS The portion of a company's profit allocated to each outstanding share of common stock.Stocks To Riches -. data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.
Calculated as: P/E Also sometimes known as "price multiple". If one stock has a P/E twice that of another stock. 71 .3 Price/Earnings Ratio .P/E Ratio: The Granddaddy of Stock Ratios The P/E of a stock describes the price of a share relative to the earnings of the underlying asset.Stocks To Riches -. But comparisons between industries. The lower the P/E. one stock with another.An Insights on Investor Behaviour 9. and between time periods are dangerous. The main reason to calculate P/Es is for investors to compare the value of stocks. relative to what you can expect to earn from it. it is probably a less attractive investment. you should be comparing comparable stocks. the less you have to pay for the stock. The higher the P/E the more over-valued the stock is. A valuation ratio of a company's current share price compared to its per-share earnings. between countries. To have faith in a comparison of P/E ratios.
A company whose shares have a very high P/E either really does have an exceptionally rosy future or the stock may be the subject of a speculative bubble.ROE Measuring the Financial Health of a Company A measure of a corporation's profitability.4 Return on Equity . Either the stock is overvalued or the company's earnings have increased since the last earnings figure was published. 72 . Calculated as: ROE Essentially.An Insights on Investor Behaviour Various interpretations of a particular P/E ratio are possible: 0-13 Either the stock is undervalued or the company's earnings are thought to be in decline. 9. 14-20 For many companies a P/E ratio in this range may be considered fair value. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry. ROE reveals how much profit a company generates with the money shareholders have invested in it.Stocks To Riches -. 21-28 28+ N/A A company with no earnings has an undefined P/E ratio. Also known as Return on Net worth (RONW).
the benefit (return) of an investment is divided by the cost of the investment. That is.5 Return on Investment . if an investment does not have have a positive ROI. or if there are other opportunities with a higher ROI. Calculated as: Return on investment is a very popular metric because of its versatility and simplicity.Stocks To Riches -.ROI A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.An Insights on Investor Behaviour 9. be aware this varies by industry. Calculated as: A lower P/B ratio could mean that the stock is undervalued. it could also mean that something is fundamentally wrong with the company. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.P/B Ratio A ratio used to compare a stock's market value to its book value. 73 . To calculate ROI. then the investment should be not be undertaken.6 Price-To-Book Ratio . However. As with most ratios. 9. Also known as the "price-equity ratio". the result is expressed as a percentage or a ratio.
An Insights on Investor Behaviour This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately.7 Dividend Yield Ratio It is calculated to know what % of cash is earned on investment in particular scrip. in direct proportion to the number of shares held. The dividend per share shows how much the company has paid out on each individual share.8 Dividend Per Share Since the shareholders are the owners of the business. and is usually expressed as an amount per share. the shareholders. This is because the total amount a shareholder gets is reflected by their shareholdings in the company. The company decides on the total payment and this is divided by the number of shares. Calculated as: Dividend yield ratio = DPS / MPS. The resulting dividend is an amount of cash per share. they are entitled to their share of the profits. Publicly traded companies often make periodic quarterly or yearly cash payments to their owners. This is paid out as a dividend.Stocks To Riches -. The dividend yield is the dividend paid in the last accounting year divided by the current share price. By law such payments can only be made out of current earnings or out of reserves (earnings retained from previous years). and so is worked out as:DIVIDEN PER SHARE = Dividends paid Total number of shares issued 74 . 9. 9.
Stocks To Riches -.An Insights on Investor Behaviour 9.9 Profit Margin Indicates what portion of sales contributes to the income of a company. Calculated as: Profit Margin = Net Income/Revenue This ratio is not useful for companies losing money. END OF CHAPTER IX SMART PEOPLE INVESTS SMARTLY KNOWLEDGABLE PEOPLE INVESTS FOOLISHLY 75 . A low profit margin can indicate pricing strategy and/or the impact competition has on margins. since they have no profit.
An Insights on Investor Behaviour CHAPTER X INVESTING FUNDAS 10. They key to making money in the long run is understands the fundamental principles of investing. 8) Price is irrelevant. 7) Waiting for the market to correct. 4) Stop worrying about the 1/8th. These tips are by no means the only way to make money in the market. eight pieces of solid advice that will help you come out on top in the long run.most of which never pan out? Problem is stock picks aren't what makes you a successful investor.Stocks To Riches -. 2) Sell the losers and let the winners ride! 3) Never invest on tips. 76 . however. 6) Don't try to "time the market".1 √ FUNDAS OF INVESTING Tips for the Successful Long-Term Investor Many investing websites have hot stock picks and tips . 5) Pay little attention to the P/E ratio. 1) Use the Stop Loss order. They are.
Stocks To Riches -.2 The 7 Ingredients to Market-Beating Stocks: Ingredient #1: Don’t “Pick Stocks” . Ingredient #5: Know Thyself • Accurately assess your financial and personal situation and build a portfolio that is well-suited to your financial goals and personality.An Insights on Investor Behaviour 10. • Look for companies with wide economic moats. you can objectively analyze stocks.Invest in Companies (At The Right Price) • It’s all about the fundamentals. • Focus on factors such as profit margins. • Don’t forget about price! Ingredient #2: Focus on the Important Factors • Once you filter out the noise in the stock market. cash flow and general financial health. • Think about investments from the perspective of an owner and stop renting stocks. Ingredient #6: 77 . Ingredient #3: Avoid Big Mistakes (and Losses) • After analyzing your stocks for potential red flags. be sure there is still a built-in margin of safety. Ingredient #4: Don't Lose Sight of the Big Picture • Understand how the bigger picture affects a company before you invest in it.
An Insights on Investor Behaviour Avoid Conflicts of Interest • Getting investment ideas from an unbiased source is critical (just ask those who invested in the tech stocks to which analysts had given "buy" ratings while privately calling them "junk"). 5) Give clear and unambiguous instructions to your broker/agent. application forms.g. it’s probably too late. 7) If your broker can't help you to resolve your problem. acknowledgment slips. 4) Ensure that you are holding securities before you sell. write to the appropriate authorities. 8) If the problem is still not resolved. Ingredient #7: Remain Confidently Contrarian • When everyone is talking about something. 2) Always keep copies of all investment documentation (e. 6) IF facing a problem act promptly. Talk to broker and find a solution. Don'ts 78 . then talk to the stock exchange where transacted. contract notes).Stocks To Riches -. 3) Ensure that you have money before you buy. Explain your problem clearly and in brief. Do’s & Don’ts for Investors Do’s 1) Always deal with the intermediaries registered with SEBI.
investment.Stocks To Riches -. investments through post-dated cheques. 79 . 10) 11) 12) Don’t forgot taking due documents of transactions. Don’t forget to take note of risks involved in the Don’t get misled by guarantees of repayment of your Don’t panic when facing a problem. in Don’t fall prey to promises of unrealistic returns. 13) 14) 15) 16) Don’t transact based on rumors generally called ‘tips’.An Insights on Investor Behaviour 9) Don’t deal with unregistered brokers/sub-brokers. Don’t get misled from by companies agencies showing as the approvals/registrations Government good faith even from people whom you know. intermediaries. approvals could be for certain other purposes and not for the securities you are buying.
How old are you: • • • a. Yourself and one more person c. 1. Very secure 80 . Tick the one most applicable to you. This quiz will throw up an answer that will roughly tell you if you have the risk-taking ability. Yourself and three or more people b. but you may not have the profile to do so. Go down substantially b. Over the next ten years your annual family income is likely to: • • • a. Under 35 2. Your income source is: • • • a. Secure c. You are financially responsible for: • • • a. if you get a low score on this test. Grow at more than 15 per cent a year 3. Only yourself 4. Risky b.An Insights on Investor Behaviour The Risk Capacity Game Answer these questions to find out if you should even think of direct stock picking.Stocks To Riches -. Between 36 and 55 c. Grow at slightly above inflation rate c. 55 or over b. You may like to take more risk.
How many years until you expect to retire? • • • a. Less than one year or retired b. On rent. You are retired b. You won't retire for at least another 10 years c.Stocks To Riches -. You won't retire for at least another 20-30 years Score in the following manner: Choice a: 1 point Choice b: 2 points Choice c: 3 points 81 . Your own home on loan c. are: • • • a. Equal to two years salary or more 7. including retirement plans. How far away are your major financial goals? • • • a. More than 8-10 years 6.An Insights on Investor Behaviour 5. Your own home that is fully paid for 8. You are in debt (excluding the home loan) b. Equal to six months salary or less c. 2 to 7 years c. don't own any real estate b. You live in: • • • a. Your savings.
Stocks To Riches -.An Insights on Investor Behaviour Final Scores: 8-13 -. 20-24 -.High risk capacity. Happy stock picking! END OF CHAPTER X “The human proclivity . Stay away from direct stock market investing. Build a core portfolio with funds and then selectively use direct stocks to take more risk. Every investor . And minimize losses to least. You could look at allocating a small part of your equity asset allocation to direct stocks. 14-19 -. You certainly have the ability to go white water rafting.” 82 .Very low risk capacity.it gets feared of losses and Gets induced to greed’s. All equity exposure should come through mutual funds.Medium risk capacity.wants to maximize his profit. This adventure sport is not for you. Use the five tools we discuss to stay dry.
along with co-author Mr. His firm belief in “Value Investing” forms the core of MOSL investment philosophy. he is respected by all in the research and broking industry of his valuable insights on issues related to equity research. Mr. Ram K Piparia. Agrawal authored the book Corporate Numbers Game. Raamdeo Agrawal is the co-promoter of Motilal Oswal Securities Ltd (MOSL) since 1987. In 1986. RAAMDEO AGRAWAL JMD MOSt & Portfolio Manager -MOSt PMS Profile of Raamdeo Agrawal – Date of Birth: 5th April 1957 Educational Qualification: Chartered Accountant Achievements: Co-Author of the book "CORPORATE NUMBERS GAME" in 1986 Joint Managing Director of Motilal Oswal Securities Ltd Author of annual "Wealth Creation Study *. He was awarded the Rashtriya Samman Patra by Central Board of Direct Taxes for a consistent track record of highest integrity in tax payments for a period of 5 years from FY95-FY99.Stocks To Riches -. An equity research stalwart. Agrawal is an Associate of Institute of Chartered Accountant of India.An Insights on Investor Behaviour CHAPTER XI INVESTMENT Guru’s Mr. Mr. 83 .
I used to go my broker’s office and there I saw some possibility of making money without actually investing in the stock market to start with. The entire process was very exciting. I began to think that I knew a lot about the stock market – much more than most of the guys on the street. Even to make a modest beginning. But I did not know how to go about thing so. I started reading balance sheets in 1980. Broking is a great business I first began investing in 1980 on behalf of my brother who had about a lakh of rupees. you needed some capital. The idea was to start as a stockbroker. One grows by learning and every day I’m learning new things. where does one get the first few thousand rupees to start with? I needed an idea that would enable me to begin without the comfort of adequate seed capital. When I began my travails with the stock market. there was a strong desire to make big money. I used to sleep reading them in my apartment. There is nobody who can talk about a perfect philosophy of investing.An Insights on Investor Behaviour CIO: Could we start off by asking you what your overall investment philosophy is? RAAMDEO AGRAWAL: Investment philosophy evolves as one learns and grows The kind of ocean there is term of knowledge is amazing. I believe that one’s investment philosophy evolves as one learns and grows through such learning. earn brokerage income and then invest the surpluses in the stock market.Stocks To Riches -. I don’t think I have learnt even one percent of what there is to be learnt. 84 . Now. I had a good grip on numbers and I wrote a book called The Numbers Game. to be honest. However. I must have read over 500 balance sheets in the following three-four years.
Stocks To Riches -. I came across a book on Warren Buffett. it got a high discounting. Buffett was. In one of his letters he said. The Money Masters and some other book had interviewed him but I was not aware of that. This book was my first introduction to his views.An Insights on Investor Behaviour Then I came across Warren Buffett’s principles Then there was the first breakthrough – a ray of knowledge. Buffett’s letter put things into perspective and I decided that I would never buy a stock that was not likely to earn 20-25 percent on its net worth going forward. and focus on return on net worth. Follow a focused approach to investing 85 . But it was then that I realised that the real foundation on which good investment is based is the return on net worth. famous much before that. I had a rough idea of what it takes to make money. The Warren Buffett Way. A lot of people who followed the stock markets – investors in the United States – had known of him and were regularly reading what he had to say. but the problem is that the whole market knows about such companies. it is likely to go up substantially. A company that has identified its biggest competence and its confident of driving up its ROE substantially because of this is surely going to become rich.” As a chartered accountant. “Don’t focus on EPS. I used to think that if a company was big. I had never really tired to figure out what drove P/E. Though I had a little feel for this sort of thing – the return on my money – I had never focused much on that. Companies that earn a 30-35 percent ROE are no doubt great. The biggest opportunities can be found in a company that currently has low ROE but because of some inherent strength. I think. Focus on Return on Net Worth I also happened to change on some of his letters and I found them extremely interesting. I complied the letters right from 1977 and went through all of them in 3-4 months.
Say for instance you hold shares of a company that manufactures pens. such instances often give you a good investment opportunity. If you do not keep a constant vigil on the businesses you have invested in. you could be caught on the wrong foot. There will be some stocks that are undervalued and some stocks that are fairly valued. If the customs duty on raw material increases or if the import duty on finished pens falls. You need to have patience. it could have an adverse impact on the company’s profitability. It takes time for a young tree to flower and bear fruit. Always be vigilant CIO: You say buy and hold but don’t buy and neglect.Stocks To Riches -. you have to be constantly watching. the prospects of the stocks you hold also change. RAAMDEO AGRAWAL: Yes. Good businesses with sound management generally have a long life and their falling out of favour is normally a temporary phenomenon. All the stocks in your portfolio will never remain at the peak.An Insights on Investor Behaviour Patience is an invaluable virtue I found that it is better to invest within your own stocks provided of course that you have chosen them with care. Even in the larger economies. In fact. things are not stable. the economy as a whole is changing. You have to allow a good company to run its own course before your investment begins to pay off. Focus on generating positive returns 86 . You actually make money by sitting rather than by thinking. The whole environment is dynamic and as circumstances change. In India.
000 crores. If I genuinely feel I have found a stock that will double in three years. I have no hesitation in picking it up. But now I am comfortable if we double our money in three years. that’s not the issue. market volatility is never an issue. My basic philosophy has been very simple. I am not saying that I consider only those companies that have market caps of at least Rs 5. So. In such a scenario. wouldn’t diversification help? RAAMDEO AGRAWAL: I have always focused more on generating positive returns from my investments rather than on what the market index does. After one year. Initially I used to think that we should double our money in two years. The issue is that if it is not already large cap.Stocks To Riches -. the company should have the potential to become large cap. Not that six months or three months is a short period but it doesn’t give me that tax break.An Insights on Investor Behaviour CIO: But right now we are witnessing tremendous volatility in the market. the decision to hold the stock is driven by whether or not I think that it meets my basic criterion – the possibility of doubling in three years. Pick high quality companies I generally invest in big companies. If all my 20-22 stocks were 87 . which I don’t want to indulge in. unless a particular small cap company is really uniquely placed and has interesting ideas. I am basically concerned with picking very high quality companies for my portfolio. No. 000 crores or Rs 10. I somehow don’t value very small cap companies as much as the large cap ones. anything with a holding period of less than a year is not of great interest to me. So long as I am confident of the quality of the businesses that I have invested in. I consider buying a stock with the intention to sell it within a year as speculation.
I did try once or twice and when I look back. However. I am not comfortable even if my total short position is just one percent of my portfolio value. It is always the poor quality stocks that are most affected by market volatility and you need to be extremely worried if your portfolio is made up of such stocks. it is not possible to keep doing so in a sustained manner. If a company has been able to achieve high ROE and ROCE for the last five-six years in a sustainable fashion. So I’m not particularly concerned about market volatility so long as my portfolio is colorful. However. I have never made money by going short. Risk arising out of market volatility cannot be eliminated unless you go into cash. Profit & loss statements and balance sheet numbers can be suitably doctored to show a high return on equity. Of course. going short could be a much better way of making money. I would have made a good fortune had I stuck to my positions. I would be deeply concerned. If you have the right temperament.An Insights on Investor Behaviour affected by market volatility in the same manner and they all fell in line with or faster than the market indices. I am assuming that the laws are conductive to short selling. But I don’t have the temperament to sit with a short position. Identifying a good business in not enough Examine whether good performance has been sustained CIO: In terms of quantitative measures would you say that high returns on equity.Stocks To Riches -. low gearing are some of the………… RAAMDEO AGRAWAL: It is possible that in a particular year a company might show extremely attractive financials. however. it is very unlikely that the management is not 88 . Follow a strategy that suits temperament CIO: Have you ever made money going short on any shares? RAAMDEO AGRAWAL: No. I realise that those were very good decisions. I have never encountered such a position.
It is not easy to follow a disciplined approach to investing. then it becomes difficult to take a contrary stand and sell the stock. this is how one’s thought process would be: If one had bought at Rs 108 and the stock had run up to Rs 120.An Insights on Investor Behaviour credible. Then you need to sell the steel companies you had bought on the premise that prices would rise. I have also been guilty of breaking my own rules in the recent times. one would comfortably get out. Say you thought that steel prices are going to be up but global recession sets in and they actually fall. “Let me wait for the stock to go up to at least Rs 100. Normally. CIO: There is very little literature on what should determine one’s exit from a company: How do you decide when to exit? RAAMDEO AGRAWAL: If you get into a stock because it is undervalued. If you make a mistake. I am not a good enough artist. If it is widely agreed upon that Infosys is a great company and it occupies the front pages of not only the national business dailies but also the global headlines. admit it and get out CIO: Are there any other factors that could influence you to exit a stock? RAAMDEO AGRAWAL: If a company is not behaving the way you thought it would. if your predictions about its performance go wrong. Typically. you should get out when it is overvalued.Stocks To Riches -. by the same logic. one would say. A sustained high ROE. But if the stock had fallen to Rs 88. but because there is so much of consensus that it is such a great stock. low gearing and a growing stream of profit is always associated with some unique business philosophy that has been guiding the company. Not so much for the profit it has made for you. you should consider exiting. you fall in love with a stock when it gets overvalued. however.” But the stock might never again see a price 89 .
” we had talked about the payback ratio or the purchase price recovery ratio.An Insights on Investor Behaviour of Rs 100. As long as I am sufficiently prudent in deciding my purchase price.Stocks To Riches -. wisdom is in getting rid of the stock at any price once you realize that your story has gone wrong. “I walk very slowly but I never walk backwards. as part of our study on “Wealth Creation. I always love to keep that margin of safety when I buy a stock because I can never count on making a good sale. But we find that one can’t 90 . So long as we make good money we are not particularly concerned about the pace at which we do so.” As somebody once said. Could you discuss what this payback ratio is and how it works? RAAMDEO AGRAWAL: Yes. Never count on making a good sale I believe that if you identify about ten fast growing large companies and even if you go wrong on three-four of these. It has been my experience that the successful ones normally yield disproportionately high returns. you could still get desirable returns on your portfolio.” Even a slow and painful progress over time leads us forward. I strongly believe in Buffett’s following two principles. which more than make up or the losses resulting from the failures. The current P/E should reflect the figure growth scenario for a company. We never borrow – neither for our business not for our portfolio. Besides. even a mediocre sale gives me a good return on investment or at least helps me to conserve my capital.” “Rule 2: Never forget rule one. which you call the payback ratio. CIO: You had recently talked about a slightly different or a new valuation tool. “Rule 1: Never lose money. So.
the P/E per se is not a very good indicator of growth. The issue here is how far into the future should one go? We assumed a five-year time frame and experimented with past data of recent multibaggers to see if the theory worked. you’d have made a good investment. So we said let’s take a more relevant measure. If the P/E is 5. So. In 1995. you would have paid a price of Rs 380 crores for Infosys and in the next five years it would have earned Rs 500 crores. It could recover more than what it took to buy it in 1995 in the next five years. There are companies that grow at 25 percent but even then they do not make money. the stocks that we had found to be suitably price based on PEG calculations then. We took their market capitalization as they stood in 1995 and added their profits for the next five years to see whether they ‘paid back’ their market prices during that period. The problem with PEG is that it takes into account the last two or three years that we include. The rewards of identifying such companies at the right time can be truly great. In our last two studies we found that the overwhelming majority of the companies that do well on the stock markets show an earnings growth of at least 25 percent over the last three-four years. your wealth might have had multiplied by as much as 220 times. does it mean that the company can grow at 5 percent? I don’t think it is so. which is not true. So. appear expensive now. Infosys’ payback ratio in 1995 was less than one. However. I think if you bought a company at a price that is less than the present value of its future cash flows. But had you bought it then. It assumes a static condition for G going forward. Today I have the benefit of saying this because I am looking back. This may not be a sufficient condition.Stocks To Riches -. I mean it is coming to everybody’s notice in the last three month that whatever we had assumed in December is no longer true. This is because G has fallen. companies that are not growing at 25 percent 91 .An Insights on Investor Behaviour really figure out clearly how much growth is assumed.
Zeroing in on a low payback ratio is basically about trying to see whether the company can grow its earnings by 25 percent on a consistent basis. Hero Honda had done better than many of the software companies on several parameters – whether it was free cash flow or earnings growth rate. So. is there a rule of thumb? If an investor is looking for a multibagger. what payback ratio should he look at? If he is looking for a steady 20-25 percent kind of return. So. That sequence is very important. it went up from 8 to over 250 for IT companies. Five years back. we saw that while Hero Honda’s P/E fell from 35 to 8 during the period. But there had been no euphoria about the auto company. How much money you finally make will depend on the euphoria that the company generates. If 92 . I don’t mean that it is my starting point. I do not consider an investment in it. then what payback ratio should he look at? RAAMDEO AGRAWAL: I would be very comfortable with a payback ratio of less than one for a potential multi-bagger. That is my last point.An Insights on Investor Behaviour definitely don’t make money. Thus. Unless I believe that a company’s earnings will double in the next five years. Valuation should come last in your evaluation process CIO: So. I will always prefer investing in established large cap companies with good management. Valuations would come after I am satisfied with the business and its management. When I say I expect my investments to double in three years. if you pay 11-12 times current earnings of this kind of company and if your projections are right. If you are saying that 25 percent should be the earnings growth rate. the condition that a company should be growing at 25 percent is a good starting point. it is unlikely that you will not make money.Stocks To Riches -. 25 percent should be the ROE then you PEG ratio should be 1/2.
you could land yourself in serious trouble. I’m not have trading volumes of one or two 93 .000 listed companies. what really determines your population of companies or your circle of competence? How do you go about determining what companies you would consider investing in? How many companies from the universe you would select from? RAAMDEO AGRAWAL: You can afford to completely ignore most companies. In fact. CIO: How important is liquidity in your investment decision making? RAAMDEO AGRAWAL: I give liquidity a lot of importance. I just for keep stocks my that tension levels low.An Insights on Investor Behaviour you start with the valuation first. But I am not averse to investing in stocks that are out of favor looking should million. CIO: Given that there are 10. I have let go of a number of good opportunities in the past because the stocks concerned were not listed. So I hate to invest in company which is not listed. I am stuck with one of my largest investment because it is not listed.Stocks To Riches -. There are just about 100-150 listed companies that are really worth even looking at.
94 . even if you were investing in some other sector. When you feel that a business has peaked out because of some bubble factor. It is. Particularly the risk associated with that business. how frequently do you update yourself? RAAMDEO AGRAWAL: In fact. It’s good you asked me that because I need to put it in perspective. I did reduce holdings in some IT stocks but I went back searching for alternative stocks within the sector. There is constant monitoring with the help of the respective squadron leaders. but in terms of risk management. I have my own research department and I kind of eat what I cook most of the time – 99 percent of the time. CIO: And between these border thoughts of bottom-up investing and top-down investing have you by and large always been a bottom-up investor or you think that top-down investing has relevance an overall investment philosophy? RAAMDEO AGRAWAL: I have largely been a bottom-up investor. When the IT sector peaked. you may not be very much better off.An Insights on Investor Behaviour CIO: Having invested in a stock. it might be wise to go into cash. you get out of one overvalued IT stock and invest into another IT stock that you consider as undervalued at that point of time. I spend lot of time doing that.Stocks To Riches -. But the records are maintained so that I am able to go through them whenever I feel that there is a need to do so. you are actually not reducing your risk. There is a practice of getting a valuation sheet organized value wise and business wise every day although I don’t really look at it on a daily basis. Hence the stock that I replaced my earlier investment with also depreciated almost as much as the one that I sold. Say for instance. nevertheless. top-down investing also has its own relevance. a continuous process. In such circumstances.
Trading volumes witness a massive increase and the market index shows no signs of falling.An Insights on Investor Behaviour CIO: Are you suggesting than an RAAMDEO AGRAWAL: No. In such times. move out CIO: Unfortunately. the seasoned investor must start contemplating an exit. instead of trying to get half a percent more on his old-age provisions. starts speculating in highly volatile stocks. When you see that greed is pervasive. It is like asking should you go to the river for taking a bath. Could you tell us about the obvious indications that one could read into and hence avoid doing so? RAAMDEO AGRAWAL: I think the most obvious indication that the market is ripe for a fall is the entry of a large number of lay investors. I firmly believe that you should remain 100 percent invested both in good and bad times. investor can actually time the market as well? But if you don’t see a suitable investment opportunity. When people who do not know anything about the markets and who are not normally interested in them begin to invest passionately. it is time to move out. small investors typically enter the market at the wrong time. When greed is pervasive. There is no problem about it but if it is actually swollen or extraordinary torrential.Stocks To Riches -. Actually. you’d fare better if you remained out of the market. During such times you’d see that the pensioner. Situations like the 1992 boom or the recent tech boom are akin to the extraordinarily torrential river. it is better sit on cash. 95 . you’d better avoid going there. I am not suggesting that.
I consciously avoid getting deeper into investment techniques that I feel I do not have the temperament to follow. focusing on value and the like. I strongly feel that you must have only one guru. So. margin of safety. I think I have been most fortunate to read Warren Buffett. Buffett has covered most of what Graham propounds – conservatism. Fisher talks more about growth companies and is closer to technology. I have particularly benefited from the concept of ‘margin of safety. Fisher and Buffett. As I told you earlier.” When I buy a stock. the ones that stand out particularly are Graham. But I am talkative and I like reading. I have been most influenced by Buffett and partly by Fisher.Stocks To Riches -. I think I don’t have the capability to become a super doctor after meeting 10 doctors. I find it difficult to absorb things like asset stripping in special situations. I am conservative and I look for value. However. Although I have books on investing by several authors. I look at it as buying a part of the company in question and not just as buying a share. I am listening to all these people. I like more of growth investing than looking for some kind of dead value. 96 .An Insights on Investor Behaviour CIO: Who is your ideal in the investment world? RAAMDEO AGRAWAL: I have read several investment gurus and have benefited from them.
They should ask questions about the earnings growth and consistency in margins return on equity and whether they retain earnings for future growth. then a textile firm. Buffet used a modified valueinvesting approach after he made a mistake by buying Berkshire Hathaway. but their business should have solid economics behind it.An Insights on Investor Behaviour Warren Buffet -. 97 . an empire-builder Background: A follower of Benjamin Graham. Turn off the Stock Market.Ace stock picker. The Buffett Way Step 1. Investment philosophy: Investors should bet on companies that not only fit the Value Investing criteria.Stocks To Riches -. of course and now.
“It is just not necessary to do extraordinary things to get extraordinary results. Buffett does not have a stock quote machine in his office.” Whenever people try something new. particularly when shares of outstanding businesses are available at irrationally low prices.” the first step is the most challenging. Sometimes it is wildly excited about future prospects and at other times it is unreasonably depressed. But if you have done your homework and understand your business and are confidence that you know more about your business than the stock market does. If you can master this first step. If you believe that the stock market is smarter than you are. turn off the market. But just as you would not take direction from an advisor who exhibited manic-depressive tendencies. The Warren Buffett Way is deceptively simple.An Insights on Investor Behaviour Step 2. The stock market is not a preceptor. and he seems to get by just fine without it. Manage a Portfolio of Businesses. There is nothing scientific about valuing a business and then paying a price that is below this business value. Adopting a new and different investment strategy will naturally evoke some uneasiness. not a stock. there is initial apprehension. the rest of the way is easy. neither should you allow the market to dictate your actions. Of course. “What we do is not beyond anybody else’s competence. Don’t worry about the Economy. Step 3.Stocks To Riches -. Step 4.” says Buffett. Step One: Turn off the Stock Market Remember that the stock market is manic-depressive. Buy a Business. There are no computer programs to learn or two-inch thick investment banking manuals to decipher. it exists merely to assist you with the mechanics of buying or selling shares of stock. this behaviour creates opportunities. In “The Warren Buffett Way. give it your money by investing in index funds. If you plan on owning shares in an 98 .
try turning off the markets for three days. whether interest rates or moving up or down. if you select stocks that will benefit by a particular economic environment. we would not be disturbed if markets closed for a year or two. First. If you find yourself discussing and debating whether the economy is poised for growth or tilting toward a recession. and then for a whole week. don’t check the newspaper. Try not to look at the market for forty-eight hours. “We don’t need a daily quote on our 100 percent position in See’s or H.Stocks To Riches -. Why. Often investors begin with an economic assumption and then go about selecting stocks that fit nearly within this grand design. despite your inattention to their stock quotes. what happens in the market on a day-to-day basis is inconsequential. If you don’t believe so. If after two days you companies are well. give yourself a test. Second. You will be surprised that your portfolio weathers nicely without you constantly looking at the market. should we need a quote on our 7 percent interest in Coke?” The same holds true for individual investors. then.An Insights on Investor Behaviour outstanding business for a number of years. Brown to validate our well being. “After we buy a stock. you inevitably invite turnover and 99 . STOP! Give yourself a break. Except for his preconceived notions that the economy inherently has an inflation bias. so too do they worry needlessly about the economy. don’t listen to a stock market summary. or whether there is inflation or disinflation. consequently. don’t read a market dairy. You know you have approached Buffett’s level when your mind is: “Has anybody done anything foolish lately that will allow me an opportunity to buy a good business at a great price?” Step Two: Don’t Worry About the Economy Just as people spend fruitless hours worrying about the stock market. no one has economic predictive powers any more than they have stock market predictive powers. Buffett dedicates no time or energy analysing the economy. Pretty soon you will be convinced that your investment health has survived and that your companies are still operational. Don’t look at a machine. Buffett considers this thinking foolish.H. “says Buffett.
you have the ability to intelligently proceed further in your investigation. it cannot be changed and.An Insights on Investor Behaviour speculation. Not a Stock Let’s pretend that you have to make a very important decision.Stocks To Riches -. initially causing a great deal of confusion. Buffett prefers to buy a business that has the opportunity to profit regardless of the economy. incurs expenses. Whether you correctly predict the economy or not. he would methodically begin with: Business Tenet: Is the business simple and understandable? You cannot make an intelligent guess about the future of your business unless you understand how it makes money. Ultimately. But if Buffett were given the same test. Business Tenet: Does the business have a consistent operating history? Step Four: Manage a Portfolio of Businesses 100 . Tomorrow you will be given an opportunity to pick one business in which to invest. you have to hold the investment for ten years. but overall. Now. what are you going to think about? Probably many questions will run through your mind. macroeconomic forces may affect returns on the margin. let us also pretend that once you have made your decision. furthermore. Of course. Step Three: Buy a Business. Time is more wisely spent locating and owning a business that has the ability to profit in all economic environments than by renting a group of stocks that do well only if a guess about the economy happens to be correct. Buffett’s businesses are able to profit nicely despite vagaries in the economy. If you can understand this economic process. and produces profits. your portfolio is continuously adjusted to benefit in the next economic scenario. To make it interesting. Too often individuals invest in stocks without a due as to how a company generate sales. the wealth generated from this business ownership will support you in your retirement.
“On the other hand.An Insights on Investor Behaviour Now that you are a business owner as opposed to a renter of stocks. you have the liberty to select the best businesses available. the index investor will actually outperform the majority of investment professionals. “when dumb money acknowledges its limitations. able to understand business economics and to find five to an sensibly-priced companies that possess important long-term competitive advantages.Stocks To Riches -. just as Buffett does. “Paradoxically. Buffett explains. will produce the highest level of look-through earnings. in ten years. why should it be any different for the owner of common stocks? Buffett believes that wide diversification is only required when investors do not understand what they are doing. is to create a portfolio of companies that. the competition of your portfolio will change. There is nothing shameful about becoming an “index investor. Multiply the earnings per share by the number of shares you own to calculate the total earnings power of your companies. If a businesses. conventional diversification makes no sense to you.” he notes. “Buffett says. or fifty stocks in your portfolio to achieve adequate diversification. 101 . forty. thirty. If these “know-nothing” investors want to own common stocks.” In fact. The “know-nothing” investors should use an index and dollar cost average purchases. nor do you have to include twenty. “Buffett asks you to consider: Investors can measure the economic progress of their business portfolio by calculating their look-through earnings. Because you are no longer measuring your success solely by price change or comparing annual price change to a common stock benchmark. Buffett points out. The goal of the business owner. they should own a large number of equities and space out their purchases over time. it ceases to be dumb. There is no law that says you must include every major industry within your portfolio. “if you are a know-something investor. other words.
” END OF CHAPTER XI “An investor needs to do very few things right as long as he or she avoids big mistakes” 102 . First. you are less likely to sell your best businesses just because you have profit. many things begin to change.An Insights on Investor Behaviour Because growth of look-through earnings. “that owns a subsidiary with superb long-term economics is not likely to sell that equity regardless of price. now becomes the highest priority in your portfolio. “A parent company.Stocks To Riches -.” Buffett explains.” Yet this seems CEO will impulsively sell stocks in his personal portfolio with more logic than “you can’t go broke taking a profit. corporate management understand this when they focus on their won business operation. not price changes.” A CEO wanting to increase the value of his business will not sell the company’s “crown jewel. Ironically.
Stocks To Riches
-- An Insights on Investor Behaviour
Sector Analysis\ Reasons
1. Festival. 2. Auto Sector 3. Sales will High 1. BAJAJ 2. HERO HONDA 3. MARUTI increase. spending Power, because of bonus, salary increment, 4. rates 5. Easy Availability of Loans. High Credit Demand Low Interest Rates Banking Sector Low Inflation Bond Prices are high. 1 year Laggards 1. High Demand despite of Monsoon Cement Sector 2. Now 2. JP ASSOCIATES Monsoon Over, Prices will be high 3. As per the current situation, Demand is high and supply is low. 1. ULTRATECH 2. PNB 1. SBI Low Interest Diwali
Stocks To Riches
-- An Insights on Investor Behaviour Retail Sector 1. 2. Festival 3. Sales. Increase in More Diwali PANTALOONS INOX PVR Spending power
My Investment Strategy
After completing Workshop on Capital Market, I took decision of investing in shares. I started buying and selling shares in the month of August, 2005, when the bull market was just started, I opened my demat account in India bulls, because 2 of my friends suggested me to do so. Account was opened, now I have to deposit money into the account for buying shares. I started my investment with Rs. 5000, which I borrowed from my father. After completing all the formalities, I start looking which to company to buy, why to buy, what will be my investment strategy and these types of questions was coming in my mind. I started buying shares with the trading strategy, because the amount which I was having was too small, I can’t buy shares and hold, so my goal was to maximise wealth by hook or by crook. You must be thinking with only Rs 5000 how can I trade, because of India bulls, they have a facility called as 4x (times) margin available on ur deposit. So, I can trade unto Rs 20, 000. My investment strategy while buying shares. Is to call the broker, ask him intraday or short selling scrips, and ask him whether it will give profit or not, then too decide how many shares to buy for intraday or for short selling. At the end of the day either profit or loss. This type of investment strategy is because of lack of money.
Stocks To Riches
-- An Insights on Investor Behaviour But then I decided to buy shares for delivery, for that I started investing in IPO’s, which I believe is the easiest path of earning good profits in equities. But after completing this project, I came to a decision, to change my behaviour, and my investment strategy. Want to become a Long Term Investor, or a Value Investor. My aim while purchasing a stock I will its balance sheet and several ratios, which are required while analysing the correct price.
you must take responsibility for your own investments. Don’t stop until you have created a successful portfolio. nor will your broker. you have choice. be aware that you are entering a battlefield populated by sharks that want your money.” 106 . “It’s been a pleasure sharing my knowledge with you. This misinformation that should help you no matter what you decide to do in the future. however.An Insights on Investor Behaviour Conclusion Before you attempt to buy your first stock.Stocks To Riches -. Remember that making money in the stock market is serious business. you can survive and prosper as a twenty-first-century investor. Always be on the lookout for profitable money-making opportunities while remaining cautious. if you decide that stocks are not for you. and more flexible than investors in the past. you have to be faster. If you aren’t willing to do your own homework (independently do research on companies and stocks) and must depend on a stockbroker or a stranger on television to tell you what stocks to buy or sell. On the other hand. In the end. You’re completely on your own. To win. If you are willing to take the time to learn what works on Dalal Street. you must fight them with knowledge (a very effective shark repellant). you are destined to lose money. at least you have a better understanding of how the stock market works. more knowledgeable. Now that you are aware of the risks as well as the rewards. don’t do it. I wish all of you the best of luck and hope that all your financial dreams come true. If you are going to invest in the market. the government won’t help you. It is as serious as raising children or working at a fulltime job. If you lose money. You have no one to blame but yourself when you do. When in doubt.
investopedia.com www.com www.investmentu.esnips. The Warren Buffet Way.An Insights on Investor Behaviour BIBLIOGRAPHY WEBSITES www. Investing Secrets.Stocks To Riches -.com BOOKS India’s Money Monarch.bse. NEWSPAPERS Economic times 107 . How to build wealth like Warren Buffet.com www.
Stocks To Riches -.An Insights on Investor Behaviour 108 .
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