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5 great lessons on buying stocks

Saturday, June 23, 2007

There are some serious problems here. Let's pick up some important lessons.

Lesson 1

The moment the prices of scrips drop, say, by 5-10 per cent, we get worried. In that anxiety, we want to sell and get out.

Let's say the Reliance [ Get Quote] share you bought last week is down 10 per cent. So what? Will Reliance business close down? Or will Mukesh Ambani run away with your money? No.

The movement in stock prices has no impact on the business. Reliance will continue to make profits and grow. Mukesh Ambani will continue to build world-class projects. If that is the case, Reliance shares will see new heights in future. Why bother about these falls, which likely will only be temporary?

The problem is, we buy stocks, not businesses. The Tatas and Birlas have been around for over 100 years. Hundreds of successful companies have run for decades and continue to grow irrespective of the stock market volatilities.

Yes, some businesses succeed, some fail. There are ups and downs. That is the inherent nature of a business. But, in the long run, they will make profits and grow. That is where management counts. Good managements run profitable operations.

Second, that's why we diversify. Even if we lose money in a few stocks, we will still make lots of money in others.

Moral: Buy businesses, not stocks.

Lesson 2

Recently, I read that if you had invested Rs 100,000 in Infosys [ Get Quote] at the time of IPO, it would be worth about Rs 64 lakh (Rs 6.4 million) now. But how many people made that kind of money? None, I guess, except the employees and a lucky few who bought the shares but forgot about it.

Answer honestly: wouldn't you have sold the shares when it doubled or tripled or became a ten-bagger? How many of us would have had the patience to hold on?

The problem is, we watch stock prices, not businesses. If people had kept track of the business, they would have seen the company had the potential to grow at 30-40 per cent per annum. Then they would have never sold their shares.

I know many people who got out at 10,000 Sensex levels, thinking the markets will correct and they will re-enter at lower levels. They are now ruing their decision. The problem: they were so obsessed tracking the Sensex that they didn't see strong economic and business growth.

Moral: Watch business growth, not rise in stock prices.

Lesson 3

The moment people buy a stock, they expect it to double soon. They see the stock ticker 10 times a day. They call their broker a couple of times daily to find out what is happening.

I have one question for such people. Can you set up a steel plant in one day? Can you build a power plant over the weekend? Can you start a mobile company and expect to have 1 million customers on Day 1? No.

Businesses take time to set up, acquire customers and generate profits. Only when the companies increase their profits will the share price also increase.

Therefore, having bought a good business and good management, give it time to prosper. If you don't have the patience, you might as well go to a casino or call-up Shah Rukh Khan at KBC.

Moral: The stock market is a serious long-term business, not a make-money-overnigh t casino.

Lesson 4

Another interesting aspect is the stories we hear in local trains, buses, parties, offices, of how so-and-so doubled/ tripled his money.

We end up feeling like fools not to invest in the market. At the first opportunity, we buy a few stocks without proper research and understanding.

I am not saying they are lying. But I would like to ask them about their other investments too. More often than not, for every successful investment, they would have made five other poor investments and lost money. They won't tell you about those.

The point is, when our investment is motivated by others' half-truths, we never have the patience and discipline required for successful equity investing.

Moral: Don't be fooled by others' so-called success stories.

Lesson 5

As I mentioned earlier, people sold looking at the Sensex levels and lost out on the huge potential profits. There are many waiting for the Sensex to fall to the 'right' levels to enter the market.

There are two points here. I highlighted one earlier: watch the economy not the Sensex.

Second, timing. Given that humans can switch from irrational exuberance to extreme pessimism and back in a matter of days, I believe even God will find it difficult to time the markets.

Moreover, I bet not even 1 per cent of you will enter the markets if they started crashing from tomorrow. The Dalal Street [ Get Quote] was totally deserted during the historic crash of May 2006, which was actually a great time to buy.

So I suggest let's get over this fixation with timing the markets. Let us look at business potential and invest with a long-term perspective.

Moral: Time in the market is more important than timing the market.

Discipline and patience - that is the mantra to creating wealth on the stock markets. Unfortunately, both are in short supply. If you have them, you make your riches. If not, you could be in trouble.

I am not very sure how many would agree with the above lessons or even follow them. Such is human nature: guided by greed and fear, than by reason and logic.

Posted by FR at 11:47 PM  

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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.