MYTH NO 1: STOCKS TRADING BELOW BOOK VALUE ARE CHEAP
Book value (BV) is the actual worth of a stock as in a company's books/balance sheet, or the cost of an asset minus accumulated depreciation. BV depends more on historical cost and depreciation and often has little correlation to the current share price.
Shares of industries that are capital intensive trade at lower price/book ratios, as they generate lower earnings. On the other hand, those business models that have more human capital will fetch higher earnings and will trade at higher price/book ratios. "Price/book (ratio) of below 1 may be cheap but one should see other aspects such as earnings forecast, guidance, management and debt on the books of the company," says Angel Broking's equity derivatives head Siddarth Bhamre.
MYTH NO 2: STOCKS TRADING AT LOW P/E ARE UNDER-VALUED
Price to earning ratio (P/E) is one of the most talked about ratios in the market. This is based on the theory that stocks with low P/Es are cheap. However, P/E alone doesn't tell much about the stock price. P/E multiples may be a quick way to value a stock but one should look at this in correlation with expected growth earnings, the risk factors involved, company's performance and growth potential. "
This is surely a myth. It is also an indication of uncertain future earning of the stock concerned," says Birla Sunlife Mutual Fund CEO A Balasubramanian. The idea behind dividing price with earnings is to create a levelplaying field where some kind of comparison can be made between high- and low-priced stocks. Since P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of stocks in that sector.
MYTH NO. 3: PENNY STOCKS MAKE GOOD FORTUNES
Penny stocks by nature are lowpriced, speculative and risky because of their limited liquidity, following and disclosure. If it's easy to invest in penny stocks - as here you shell out much less money per share than you would require for a blue-chip firm - it's also easy to lose. Says Bhamre,
"Fortune can be made by high-denomination stocks also. Denomination has nothing to do with the rationale for picking a stock. Generally, retail investors are fond of stocks that are at sub-Rs 100 levels.
But there may be stocks that may be trading in Rs 1,000-plus price but may well be cheap. Clarity on earnings is more important here. Anytime, I would be more comfortable buying an ICICI Bank (currently trading at Rs 1,038) than an IFCI at Rs 45. One should look at earnings visibility."
Timing the market, a common strategy among investors, means forecasting and that should best be left to astrologers and tarot readers. If one has done one's valuation studies, one shouldn't worry about timing the market. No one had predicted the bull run would take the Sens*x from a level of 10,000 in February 2006 to over 21,000 in January 2008 - just as no one had any idea of the following crash, which saw the same index plummeting to 9,000 in March 2009.
"Timing the market is more of a gut feeling. It's more on the basis of perception, as there is no such thing (that the worst is over) when the future is uncertain. One can never surely time the market. The worst is over is more of a probability than a certainty. Timing the market is very difficult as market is driven not just by earnings but also by sentiments," says Balasubramanian.
MYTH NO 5: STOCKS THAT GIVE HIGH DIVIDENDS ARE THE BEST BET
This comes from the notion that regular dividends are extra in-come in the shareholder's hand. This may not always be true. While a company may be making decent payouts every year, the share price appreciation may not be comparatively high. Before investing in companies paying high dividends, it's important to analyse if the company is reinvesting enough profit to grow its earnings consistently.
Says Brics Securities' research VP Sonam Udasi: "It's not dividend that matters but the yield. For eg, a company may pay a 100% or even a 300% dividend on a stock with face value of Rs 10. So, the investor may receive Rs 10 orRs 30 per share when the stock may be currently trading at Rs 800 or Rs 1000. This would translate into an yield of 1% or 3% only.
Also, such companies may not necessarily be reinvesting their earnings in the business to generate future earnings and so there may be no stock movement. The dividend may be high but the EPS and growth per se may be constant."
MYTH NO 6: INDEX STOCKS ARE THE BEST STOCKS
If this was true, most investors would safely park their money in such stocks in anticipation of maximum profit without looking out for other value stocks. Most indices are a collection of stocks with the highest market cap.
Take, for eg, the Sens*x. Companies that make up the index are some of the largest, with stocks that are highly traded based on their free-float. "Index stocks may not necessarily be the best stocks as they are mostly based on market-cap or free-float of the company and not earnings. This doesn't mean that all stocks of the Sens*x are highearning stocks.
One must take a stock-by-stock call," says Balasubramanian of Birla Sun Life Mutual Fund. The stock price of a company depends on its earnings. One can find high-earning stocks outside the key indices as well, he says. The risk is certainly less with index stocks as they are well researched and leaders in their respective sectors, but, again, the margins may not be very high. So it's better to keep your eyes open to other stocks, too.
MYTH NO 7: STOCKS TRADING AT 52-WEEK LOW ARE CHEAP
Says Udasi: "There may be a time in the economic cycle when a blue-chip stock may hit a 52-week low. But the first thing that should come to one's mind is why did the stock hit the 52-week low. There must be something fundamentally wrong with the stock if it has hit a 52-week low, and chances are they may hit a new 52-week low.
52-week low in itself guarantees nothing. If at all one is picking stocks at 52-week lows, they should have a long-term horizon so that when the economic cycle turns, the stock is able to recover." Needless to say, quality matters most while buying any stock.
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