Seven axioms for investors

Retail investors must understand that the present frenzy on stock markets is largely confined to big companies, and that the high prices are due to massive FII (foreign institutional investor) buying in large companies, cautions Mr Kanu Doshi, a Mumbai-based chartered accountant.

“FIIs are drawn to our capital markets because of our strong Indian rupee and buoyant economy coupled with the weakening US dollar,” he explains, during the course of a recent e-mail interaction with Business Line.

“By definition, big size companies are part of all indices and hence the unabated rise in the Sensex. Exit from big size companies for a large investor is much smoother than from smaller companies, should it become necessary on account of any unexpected contingency.”

While there is no sign of a scam or a bubble at this stage in the markets, small investor should be well advised to refrain from buying anything at these high prices, insists Mr Doshi. His counsel to the retail investor is to book profits by selling 50 per cent of holdings, only to repurchase at a correction that is to come sooner than expected.

Excerpts from an interview.

We are getting used to new highs, aren’t we?

Looks like the year 2007 will go down in the history of Indian capital market as the year of several all-time highs. Such as, the rise in the Sensex to over 18,000; the highest-ever GDP (gross domestic product) growth at over 9 per cent; the highest-ever, again, in market capitalisation, FII investments, AUM (assets under management) with MFs (mutual funds) in India, corporate profits, corporate tax collections, and executive remunerations; and foreign exchange reserves at an all-time high (over $275 billion). Plus: Huge infrastructure investments are underway; FDI inflows are massive; consumer spending has vaulted triggering the retail boom; and the middle class income has been rising. Above all, the market regulator, SEBI (Securities and Exchange Board of India), is vigilant, as a check against stock market scams.

Which explains why the small investor is confused?

True. In all this hype and hoopla of the Sensex frenzy, a retail equity investor feels totally dazed and lost. Hence the need for a few pointers of good behaviour for the investors in the turbulent times ahead.

Such as?

I would present them as seven axioms for equity investors, in these turbulent times. One, keep cool and maintain mental balance. Two, study the financials before buying. Three, management, management and management. Four, think long term. Five, diversify. Six, invest in MFs also. And seven, constant monitoring.

Why ‘balance’ tops your list of what may be the seven habits of highly effective equity investors?

Going by media reports, the coming festive season of 2007 may witness further bouts of rising Sensex pushing certain stock prices to mind-blowing heights. This will trigger all-round euphoria of panic-buying of all kinds of shares. It is here that a cool-headed investor will have to refrain from doing anything foolish like buying cheap penny stocks in the hope of making quick money.

It will demand great discipline and sage-like mind control to practise this particular rule. Those who will do this will save lot of money and heartburn. In short, no impulsive action; only deep breathing!

By emphasising on the financials, you advise to take a look at the fundamentals, right?

That’s right. In any frenzy, the study of financials before buying a stock is the first casualty. Those who carefully consider all aspects of the company including its financials will surely benefit, because the purchase would then be backed by a sound study of fundamentals of the company and the industry.

Management, management and management. What’s that?

In any stock selection, the vital question to ask is the quality of management.

Several investment experts have repeatedly advised that bad business under a good management is likely to turn around and generate profits but a good business under bad management can never be a long-term play. Therefore, do select a company from a respectable sound, proven business house. The best action would be to pick the leader in the industry even if high-priced.

Why think long term?

Because the long-term investor buys into part of the business of the company.

Such an investor should ignore the temporary movement of its stock prices; if fundamentals of a company justify the investment, short-term variations in price – rise or fall – should not unnerve the long-term investor.

Diversify, but to what extent?

For starters, it is a good policy to diversify investments across a few industry sectors to insulate against vagaries of business cycles affecting different sectors at different times, and thus to minimise the investment risk (e.g. paints and cement during monsoons, and FMCG sector during non-festive times).

While diversifying, investors should ensure that they do not end up owning a zoo! Three to five industries are a decent, manageable number. It is advisable to have larger number of shares per company rather than fewer of too many companies.

The smaller the number of companies, the easier it is to monitor each one. Ensure, therefore, meaningful stakes in each company. Shares are like children; fewer the better. Both demand attention and care. Warren Buffett has only seven – shares, not children.

Is it beneficial to invest in MFs?

Yes. Thanks to generous concessions under our taxation laws, ELSSs (equity-linked saving schemes) of good MFs have attracted a lot of funds from retail investors.

Also, because of the three-year lock-in in these schemes, fund managers have been able to deliver decent returns to investors over the longer time frame. Some part of your investible resources therefore could be parked in these schemes of MFs with good track record to take the benefit of tax relief and also enjoy the decent growth offered by expert teams of fund managers.

What should be the frequency of ‘constant monitoring’?

Daily. Looking up the daily prices of your stocks in the ‘markets’ pages in the morning triggers a healthy appetite for a hearty breakfast!

This cannot, however, be a substitute for a serious study of your invested companies almost on daily basis.

Investment gurus have regularly preached that eternal vigilance is the price of investing, as much as it is of liberty.

Investors should at all times keep a strict vigil on their investments and all that is happening to their companies and the industry and in the economy, in order to be equipped to take informed decision whether to hold or sell their investments.

Mr Doshi, a senior practising CA is the Dean-Finance at the Welingkar Institute of Management, Mumbai, where he teaches ‘corporate tax planning and financial management’.

He is also a consultant to AMFI (Association of Mutual Funds in India) and several other MFs and companies on taxation, company law and financial matters. Mr Doshi has co-authored books on Tax Holidays, Financial Accounting and recently Special Economic Zones. He serves on the boards of companies such as Reliance Capital Asset Management Ltd and BOB Capital Markets Ltd.