We have discussed two broad themes concerning investment strategies
here. One is about how different companies have differing
characteristics, even though the underlying principle for every company
is to provide adequate returns to its shareholders. The second theme is
on a very famous concept of rupee cost averaging, referring to a
technique of identifying a select set of stocks for investment, and
buying into these stocks even when they go down, thereby averaging the
cost of investment.
First, we look at how companies can be
segmented. Just as investors are classified as conservative, moderate
or aggressive, companies too are broadly categorised into cyclical,
defensive, growth, speculative and value. After all, State Bank of
India and Infosys Technologies do not have similar characteristics. SBI
is a play on the Indian banking sector and the economy at large. Hence
it could attract longer-term investors who believe in the India story.
On the other hand, investors in Infosys could typically be more of
those seeking higher returns in software exports for a little more
risk, and more concerned about the company’s quarter to quarter
earnings. Hence, some understanding of the different types of stock
segmentation is required to avoid unpleasant surprises at a later stage.
Cyclical : In a cyclical business, a
company’s earnings fluctuate sharply with a change in the business
cycle. The cycle affects all companies within the industry. When the
cycle heads up, companies do well with good growth in sales and
profits, and investors buy their shares, leading to gains for
shareholders. But when a downturn hits the industry, sales plateaus and
profits decline. Cyclical companies typically operate in commodity
businesses like cement, steel and paper. They lack product
differentiation though good companies try to minimize the commodity
element in their business, by integrating forward into products, or by
expanding into new geographies. In cyclical stocks, the easiest way to
make money is to get into the companies before the cycle turns up. If
you get into cyclical stocks during a downturn, anticipating an upturn
be prepared for a long wait.
Defensive : Defensive shares offer a
hedge during an economic downturn. They comprise companies whose
products are necessary in any economic climate, and hence are
relatively shielded during economic contractions. Sectors which have
this characteristic include fast moving consumer good companies,
utilities and pharmaceutical companies. But this theory may not hold
good always; if these stocks have risen along with the market in a bull
run, then they will fall too when the market declines. Investors can
expect such companies to have relatively low business risk and not
excessive financial risk.
Growth : Growth stocks are companies
that have valuations, which may make them seem expensive. But their
sales and profits grow faster than market, which ensures that investors
in these stocks gain, despite seemingly high valuations. Growth stocks,
by definition, plough back most of their retained earnings back into
the business, and also tap the primary market for funds more often.
Investors
pay a premium to buy these stocks, hoping to benefit from their
superior growth prospects. The market price of growth stocks can also
be very volatile. They usually move up faster than other stocks, but
can come down sharply too. If an investor’s expectations of growth is
not met, these stocks can fall sharply too.
Growth stocks are also
defined as those which will deliver better gains compared to other
stocks in the market, with a similar risk profile. That’s because the
market undervalued its potential at some point in time. A handsome
profit awaits the investor, who can identify a stock, which can not
only grow faster in terms of sales and earnings, but also is relatively
under valued in the market.
Speculative : It is a company whose
business profile involves huge risk but can also bring in capital
appreciation for its investors. Some examples are that of a company
involved in new drug research, oil exploration or a company boasting of
breakthrough technology. But even otherwise, shares of normally growing
companies can turn speculative if they become takeover targets for the
assets they own (land, machinery, copyrights, brands and so on) or are
expected to benefit from a huge contract (tender for pipes used in
deep-sea oil exploration).
In stock market parlance, however, stocks
whose prices are rigged, in which a group of people manipulate prices
by spreading rumours, are also known as speculative stocks.
Value : It is used to describe
stocks that are trading below their intrinsic value. Value investors
typically like to purchase stocks that are worth much more than what
they paid for. Eventually, they believe, the market will recognize the
true value of the stock and run up the price. But the term 'value' can
be misleading. One, if intrinsic value is mistaken for replacement or
liquidation value of a company. These last two measures are more
relevant for an entity which is planning to acquire the company, not to
an ordinary investor.
Two, accounting measures such as
price-to-earnings or price-to-book, used to specify value in a stock
trading at a discount to its peers, lose relevance as they are based on
historical numbers. And lastly, a stock which is trading at a discount
may actually be rightly traded so because of certain business
fundamentals. Public sector companies, turnaround companies, companies
in asset-based industries, which normally trade at a discount to
market, are often touted as value plays. Bear in mind that these
categories still could mean different things to different people. And
as investors, it is up to you to decide which stocks that suit your
risk profile.
Rupee-Cost Averaging How many times
have you cursed your luck for not buying shares of Infosys Technologies
when it was only Rs 400? Then again, you could have bought it for Rs
1,200 and even at Rs 2,000. Sounds familiar? As common investors, we
all remember not having bought a particular share when it was cheap.
Well, all's not lost. Here’s a new method to ensure that you don’t miss
the next opportunity, even though it is not a panacea. It even helps
you keep low your purchase costs. It is called dollar-cost averaging
(rupees for us).
It is an easy technique that requires
discipline, in which a person invests a fixed rupee amount on a regular
basis, usually monthly for purchase of equity shares. Let's say you
have a monthly surplus of Rs 5,000 to invest in equity shares. This can
be used to buy 10 shares of company ABC at Rs 500 per share. Or six
shares of company ABC at Rs 500 per share and eight shares of company
XYZ at Rs 250 per share. You could do this every month with the same
companies or you could even expand the list of companies. The choice is
yours.
The idea is to invest a constant amount in a few selected
shares over a longer term. To continue with the above example, you
could have invested Rs 30,000 at the end of the sixth month, instead of
a monthly Rs 5,000. But that would not have allowed you to lower your
purchase cost. To benefit from fluctuating share prices, it is better
to invest smaller amounts of money. Since more number of shares can be
purchased when prices are low. But when share prices move up, a fixed
amount will buy lesser number of shares. It turns out that this method
will keep your average cost lower than the prevailing market prices.
Assume
that you had bought 10 shares of ABC at Rs 500 in the first month and
seven shares in the second month as its price moved up to Rs 650
(5,000/650 rounded off to the lower denomination). Your average price
would have been Rs 561.76 (9,550/17), leaving you a profit 88.23 per
share (650 minus 561.76) or Rs 1,500. But if you had put off the
purchase to the next month when you have a lumpsum Rs 10,000, you end
up buying 15 shares (10,000/650 rounded off to the lower denomination)
at Rs 650. Your gain by using the cost averaging method : two shares
(17 minus 15) at Rs 650 that is Rs 1,300.
Remember that stock
prices often fluctuate for reasons unrelated to its fundamentals. With
fixed rupee-cost averaging, an investor eliminates his or her chances
of buying too many shares at too high a price. Periodic declines in a
stock market give opportunities to buy at lower prices.
A few do's and don't :
Be sure that you have a steady stream of income.
If income is not steady as expected, it could curtail purchases at
times attractive for additional purchases. | Make a short list of the shares that you want to
buy. Run this method over at least six or seven stocks, since one or
two stocks will end up being a disappointment. | | If fundamentals change, get rid of your under performers. | | Don't try to time your purchases. That could turn you into a speculator instead of an investor. | | If you think share prices are too high, don't purchase. Or buy stocks that you believe haven't yet appreciated. | Lastly, don't hesitate to liquidate your portfolio
before your target time horizon, if circumstances lead you to believe
this to be appropriate. |
The rupee-cost
averaging method is quite similar to a systematic investment plan,
which all mutual funds tout. They work like this: After an initial
minimum investment (ranging from Rs 500 to Rs 10,000 depending on the
type of fund), an investor hands over post dated cheques for the next
few months to the AMC (amount could range from Rs 500 to Rs 5,000). But
be warned, that none of these approaches can save you in a declining
market (in fact, you could end up buying more and more shares in a
falling market). |
