It’s that time of the year when both investors and the media pop the same question to market experts: “Where do you see the market headed next year?” I am amused to hear the question. Hence, my candid answer has always been, “Your guess is as good as mine”.
Rather than making any prediction, I thought of taking this opportunity to highlight some mistakes made by investors over the past year, and importantly, in the hope that they will be forearmed against committing such errors in future.
Exhibiting “representative bias”
Investors get overly impressed with the performance of certain sectors and blindly purchase their stocks, believing these to be good representations, irrespective of the prevailing valuations. For instance, those who purchased infrastructure-oriented stocks such as Punj Lloyd and JP Associates in late 2008 are still nursing their wounds. Both were down 47 per cent and 30 per cent, respectively, in 2010, despite the Nifty rising nearly 17 per cent.
The flip side is that stung by the poor performance, investors sometimes ignore an investment-worthy stock, because it belongs to a poorly performing category. For instance, a company such as Noida Toll Bridge is shunned by many, as they consider it to be an ‘infrastructure stock’. However, Noida is not afflicted by any negative plaguing such stocks. It actually generates cash rather than perennially guzzling capital. It is not highly leveraged. It also declared a maiden dividend recently. It is important that you judge a stock on its individual merit and not get taken in by broad classifications.
Let some fallen angels lie
Some investors blindly purchase stocks that have fallen significantly from their recent highs. Real estate stocks are their prime examples. Many have lost 80 odd per cent from their highs, and this has induced investors to indulge in ‘bottom fishing’. I compare this to catching a falling knife, and cite such behaviour as a prime example of ‘anchoring’. Investors are merely finding the current rates attractive because they appear cheap in comparison to the prices prevailing earlier. Is there any evidence that those prices were the right prices, and the stocks are undervalued at today’s rates?
The fundamentals and corporate governance of most listed real estate stocks are as bad as what they were two years ago. They do not merit investment because they are much cheaper than what they were before. One must wade through the morass in order to unearth some exceptions. If at all you have the ability, you can go ahead and invest. Otherwise stay clear of these ‘fallen angels’. Do not be ‘anchored’ to old highs.
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Expand your horizon
The past year has reinforced India’s global economic standing. However, the Indian stock market has factored this and has outperformed many other global indices. Consequently, Indian stocks are no longer available at compelling valuations, either on an absolute or a relative basis. It is time for investors to look beyond Indian shores. Many globally-reputed brands such as Nestle and Pepsico with strong growth prospects (owing to significant emerging market exposure) are available on the New York and London Stock Exchanges at valuations that are a fraction of the ones prevailing here. The Reserve Bank of India permits an individual Indian investor to invest up to $200,000 in foreign assets. I think in the coming year, one should take the maximum advantage of this.
Take experts’ recommendations with a pinch of salt
As investors, we are beset with information overload today. Every television channel and business publication has morphed into an investment advisor. Try to cut out the clutter in the year ahead by not listening to the myriad recommendations doled out by the so-called ‘experts’.
True investing involves allocating capital to a limited number of high conviction ideas rather than frittering it away on mindless trading, based on someone else’s recommendations. Often, an investment idea or two in a year is enough to create significant wealth over the long term.
Wishing you all the best for 2011.
[Disclosure: Any/all the companies mentioned in this article may be owned by me/my clients]
The writer is chairman, Parag Parikh Financial Services. Views expressed are his own
