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Take
a deep breath. Fasten your seatbelts. Hold tight. Steel your gut.
Try not to yell too hard. By the sound of investment pros, venturing
alone onto the stock market is not very different from going on
a multiple loop rollercoaster called something like 'Hellmountain
Jack'. The bravehearts who've actually done it might even tell you
that this metaphor is not inaccurate. In fact, they might even suggest
more hair-raising names to describe the experience.
Do yourself a favour. Ignore them for a moment,
and take a good look at the armchair featured across the page. It
is a better description of your stockmarket experience-if you follow
this recommendation closely.
Self Conviction
The big reason for letting professionals manage
your investments is that you have neither the time nor the resources
to do a good job. The jargon does not seem very inviting either.
Moreover, do you have the inclination to monitor your picks' progress?
But then, there's no easy way out, no matter
which route you take. As the saying goes, a lazy investor (in terms
of mental faculties, that is) is no investor. "You have to
regularly monitor your mutual fund investments also," says
Ambreesh Baliga, Vice President at Karvy Stock Broking. No fund
manager will ever tell you when to time your exit from the mutual
fund; this is a decision you must take yourself.
So, if time, attention, and effort must be
devoted to your money anyway, why not equip yourself with the tools
you need to go all the way yourself?
Sounds tempting, you might argue, but don't
these tools require high levels of financial expertise?
Not the tools being recommended here, thankfully.
These require no more than widely published figures and a simple
calculator.
Big Buck Earners
First, admit that you are not an expert in
stock valuations, and may not be able to identify small stocks that
can turn out to be market scorchers. For retail investors, straying
too far from known entities is inadvisable. "They have to restrict
themselves to big companies with proven track records and transparent
accounting practices," says Nilesh Shah, Senior Vice President
and Head, Portfolio Management, at Kotak Securities. "This
strategy could enable him to reduce capital erosion in difficult
markets," he continues.
So, big is the way to go. The next question
is: what criteria should be used to assess how 'big' a company is?
The commonly used ones are market capitalisation, sales, and net
profit (also called 'earnings'). Since market capitalisation is
simply the sum of money required to buy all the shares at the prevailing
market price, this figure could go wildly up and down in accordance
with market vagaries. The sales figure, thus, is a better indicator
of the company's size as a business. But it is profit that attracts
investors-so this is the main figure to look for.
So here's the strategy: pick the big buck earners.
Look through all the shares on a wide-ranging index, such as the
BSE 500, which features 500 most heavily traded stocks listed on
the Bombay Stock Exchange, and list the top 30 ranked by net profit.
Buy these. More specifically, put together a portfolio with each
stock represented in proportion to its profit figure, and you could
do very well over a three-four year span.
By way of experiment, we made a theoretical
back-selection of the 30 biggest profit-makers from the BSE 500
(see The 30 Big Buck Earners). The weight given to each company
was in proportion to its profit. The results? You will need to pinch
yourself: Rs 100 invested in June 2000 would have become Rs 264
now, as visible from the accompanying chart, while Rs 100 invested
in the 30 Sensex stocks would have grown to just Rs 107 (see The
Big Buck Earners' Performance). That's awesome.
Does It Work?
The big test of such a strategy is whether
it can be used even now to make money. For this, we must understand
the strategy's success. The profit-orientation, first of all, keeps
the portfolio to hard facts, instead of the hype that goes with
phases of market exuberance. The turn of the millennium saw many
stocks soar way beyond the prices justified by their earnings, but
our strategy would have avoided that trap-since size here is defined
by actual money made, not fantasies. Beyond that, the actual big
buck makers of 2000 are still the desired stocks of today, and that's
how the strategy clicked.
Yet, that still doesn't mean the strategy works
under all circumstances. To take an extreme case, if there had been
a tectonic shift in business, for instance, the big winners of 2000
may have turned out badly in 2004. According to Jyotivardhan Jaipuria,
Head of Research at DSP Merrill Lynch, the strategy works well only
"in sectors where the growth is constant". Under conditions
of stability in the operating environment, that is. "But it
may give wrong results with cyclical stocks," he cautions,
"This is because you have to buy these companies when the cycle
is at its bottom, when most of the companies may be in loss or will
have only very little profit." True. This is also why such
a strategy works only for a well-diversified portfolio that includes
stocks both stable and volatile, non-cyclical and cyclical. The
top 30 earners serve as a fairly diverse portfolio.
Refining The Strategy
To take another extreme case, the strategy
could fail if a big bull frenzy ensues, profit size-our strategy's
basic idea-becomes an abiding mania in the market, and the big buck
earners become grossly overvalued.
In actual likelihood, that could happen to
some big buck earners, not all. To minimise the danger, you could
refine your list of 30 stocks by applying another tool to evaluate
the stocks you've ranked by profit, and replace some with others.
The idea is to buy only 'reasonably priced' stocks.
The basic issue, really, is what price you
must pay for every rupee of earnings for the year, and this is captured
by the price-earnings ratio (share price divided by earnings-per-share,
which works out the same as market capitalisation divided by net
profit). Of course, you buy the share once, but the earnings come
year after year-and could keep rising too, sometimes dramatically,
which is why growth sizzlers have such high p/e ratios. Still, as
a filter, strike shares with p/es of over 30 off your list (an arbitrary
cut-off; you could use any other), and move down the profit rankings.
The beauty of the armchair strategy is its
simplicity. Take the biggest profit-makers, replace the overpriced
stocks with more reasonably priced ones, and then buy them in proportion
to profits.
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