the stockmarket, as in life, there are two scarce commodities. Unbiased
investment guidance and time. Ask any fund manager, and you will
be cautioned against two dangers: venturing out into equities directly,
and timing the market (when to enter and exit) all by yourself.
A person who dares either of those activities, you'll hear over
and over, is either very brave or very foolish.
If a binary choice it must be, go ahead, press
the buzzer for 'brave'. A fund manager's job is two things: making
money for clients and preserving his job. Yours? Making money and
preserving your independence of judgment. Whatever be the eventual
difference in performance, your job, dear investor, sounds a lot
First things first. Market timers make more
money than passive investors. This is self-evident. Markets go up
and down, both, and the classic investment fantasy is to profit
from the ups and stay away from the downs.
Still, if you're in the habit of questioning
anything touted as self-evident, simple calculations show that if
you had bought an entire Sensex-worth basket of shares every month
since 1991, your would have made a paltry return of about 5.5 per
cent-which, dear investor, is worse than a bank deposit. On the
other hand, had you picked up shares on the dips (low valuation
periods) and sold on the highs, you would have enriched yourself
quite a lot more (See charts). This kind of active investing, indeed,
is the reason that the equities excite investors so. Speculative?
Sure it is. That's business. A reward for money risked.
Timing the market is about keeping trigger-detection
sensors sharp enough for action
Ten On Ten Efficiency
Almost without exception, investment theorists
are fans of the so-called 'efficient market theory', according to
which, capital markets are self-corrective in nature, and so to
the extent of all distortions getting balanced out over a reasonable
span of time. Reasonable enough, that is, to incorporate all the
information relevant to the future business prospects and value
Conceptually, the theory is elegant. When things
are out-of-whack, it posits, good sense will filter through to the
trading floor and adjust prices upwards or downwards to attain an
As with all things elegant, the theory also
serves as a tool to justify all sorts of actions and advice. Fund
managers, for instance, are known to use the theory to suggest that
hunting for 'undervalued' or 'overvalued' stocks to bet on is a
futile exercise, since what you know is already known to thousands
of better-informed players, and so your information (unless you
happen to be privy to something very very special), has already
been taken into account and is already reflected in the prices.
Well, the fact is that most fund managers make
lots of money on this supposedly futile exercise themselves, and
there's no reason why you should not.
Today, even the strongest fans of the efficiency
logic admit that price overshoots are common-and often for extended
periods, too. This shouldn't be a surprise. Just close one eye and
try bringing your two index fingers into alignment with one another...
If nothing else, the very volatility of the
market should make you think, and think hard.
Barely half a year back, the bse Sensex was
stuck at the 3,000 level. In fact, when BT wondered aloud about
the prospect of Sensex 4,000, some readers thought an overworked
editorial staff was in desperate need of a vacation. But by the
time this magazine wrote that "valuation parameters are just
right for another major rally" in its editorial of May 11,
2003, FII money was ready to gush in. And so it was. The Sensex
has gained nearly 2,000 points since, enriching a lot of people
out there, especially those who timed their bets well. Rarely have
equity portfolios appreciated so fast in the history of Indian stock
Bad news must reach you faster than good
news. diversify your news sources
At the time of writing, the Sensex was in the
region of 4,900, and now this is being touted as the index's appropriate
level. So have you missed all the action? Are you too late already?
Not at all. So long as volatility remains volatility, and change
is a bankable concept, the timing game is open to everybody. Read
What you saw earlier in the year was a rally
'trigger'. It wasn't the first and won't be the last. The big players
on the bourses know this only too well. Timing the market, to them,
is mainly about keeping their trigger-detection sensors sharp enough
to swing into action. This turns them into obsessive information
junkies and opinion tracers, but also highlights the importance
of background study. Data often needs the processor of prior knowledge
for conversion to usable information.
As a retail player, it's scary to contemplate
the sheer magnitude of the big players' scale, be it in terms of
investment corpus or research resources. Since all you have, in
contrast, is that head on your shoulders, take this advice: don't
underestimate it. There's much use you can put it to. You can still
study companies, their source of profits, their strategies, their
business environments and their performance, and then take a call
on whether a stock is undervalued.
Stock valuations are complex. "Whether
the market is cheap or expensive can't be decided just based on
a specific price level (or an index level if one considers the whole
market)," elaborates Ajay Bhatia, Head of Research, Enam Securities.
This is because the price is dependent on the company's earnings.
The stock price can double and still retain its old valuation-the
P-E or price-earnings ratio-if earnings also double. Other valuation
parameters are the p-b ratio (price/book value per share) and the
dividend yield (dividend per share/price). The BSE posts updated
values on its website every day, so the internet can save you all
the miserable arithmetic.
Move in at the start of a bull incline,
and exit just as the market reverses
Yet, the very choice of a valuation parameter
can be a head-scratcher. Historical calculations show that investors
who used p-e ratios would've fared the worst, and dividend yield
ratio, the best. But don't be misled by this. The reason for the
difference is simple. The BSE's posted ratios are trailing ratios-calculated
with past records of earnings, book value and dividends. What matters
is the future. "A company that grows faster deserves a higher
p-e compared to a slow growing one," says Ashim Syal, Chief
Investment Officer, ING Vysya Mutual Fund. Dividends, being corporate
decisions, are often declared with a view of future prospects-and
so this ratio already includes the management's take on the future.
You, of course, will have your own views. The
smartest way to operate, then, is to use expected earnings as your
input for P-E ratios, and go by these. Fast profit-growing companies,
naturally, ought to have higher p-e ratios. An old rule of thumb:
if you expect a company's earnings growth rate to be higher than
its current P-E, it is undervalued. If lower, it is overvalued.
Anyhow, back to the timing part. If you find
an interesting undervalued share and expect a trigger sometime not
too far in the future, you could 'buy and hold'. The trigger could
be market related or stock-specific.
What you must be extra sensitive to is a crash
trigger. Bad news must always reach you faster than good news. Diversify
your information sources. You will, of course, mis-judge some triggers
along the way-but that's part of your learning curve.
Join The Dots
Now to the point. What does the BSE look like
right now? Our calculations show that on all parameters, valuations
of the mainline stocks are no longer 'cheap', but are still 'low'.
The newspapers, in the meantime, are filled
with glowing corporate results. These, however, are no guarantee
that the rally is likely to resume. This is because the results
have already been 'discounted' by the market. In volatile times,
what matters most is 'market sentiment'. Even a trigger is often
a big turning point in sentiment. But that's an event. The trick
is to watch sentiment as it slowly accumulates. To do this, technical
analysts use a whole set of price charts. "Investors should
not try to forecast the future, but just try to understand the emerging
trends and act only when the trend actually changes," advises
Deepak Mohoni, an independent technical analyst.
Anyway, start with a simple chart. Use statistical
graph paper, put value on the vertical axis, days on the horizontal
axis, and plot the closing price of a stock (or Sensex value) every
day. After a fortnight or so, join the dots. Look at the jagged
pattern, and if successive peaks are higher, the trend is upwards.
Or vice versa. Sit down, study the chart, and ask yourself what
caused the turns.
Once that has been mastered, get into 'moving
averages', which condense longer-period trends neatly into smooth
curves. "The computation as well as the rules for buying and
selling are simple here," says C.K. Narayan, Technical Analyst
at ICICI Securities. It's easy, really. Junior school arithmetic.
Take the last fortnight's average closing price, and plot it against
today's date. Tomorrow, take the past fortnight's average again
(dropping the earliest day's data and adding tomorrow's data), and
put it down. Keep plotting it to get a curve. Now take just the
current day's price. If this is above the moving average line, it
signals a market turning bullish, and vice versa. If you're plotting
two different moving averages, then the shorter-period trend going
above the longer one is a bull signal. It's all about putting volatility
in perspective. At the moment, for example, the technical charts
are pointing up.
In And Out
The generic strategy is to move in at the start
of a bull incline, and exit just as the market reverses (or before
it does so). The exit decision is critical, don't forget. Be clear:
timing is about buying and selling to book profits. You mustn't
get out-timed by the market.
Your job is to maximise returns, and there
will never be a 'best time to sell' or any such thing. Even what
constitutes a market reversal depends on your time horizon. What
you need, therefore, is a clear time-frame for your play (calculate
moving averages accordingly). Depending on your perspective, a short-frame
reversal-if you zoom out and look at the longer period charts-may
be just a blip. You could play a quarterly game on volatile stocks,
while keeping a separate portfolio of longer term bets. Otherwise,
a year's investment horizon would be just fine, which is long enough
for some equilibrium-seeking mechanisms to do their work.
Once you start correlating price trends with
other information, you're in the groove. To enhance your understanding
of the interplay of different factors, tune yourself in to varied
arguments-after all, someone's boon could be someone else's bane-but
don't let them dominate your mind. As a solo retail investor, you
should value your independence above all else.