Knowing More Will Hurt You in the Stock Market

Stock research could be enervating. The classic analyst tracks and studies several indicators before picking a stock, yet the work never seems to end. That should not be surprising. Listed companies have businesses and operations so widespread and multifaceted that no time is sufficient to make up your mind. That’s what gives rise to “analysis paralysis”—you become so entangled in analysis that you can’t make a decision. 

In spite of this, broking firms spew out stock recommendations, thanks to the pressure to deliver. But that’s a different problem; let’s leave discussing it for another day. Let’s come back to analysis paralysis. The core of the problem of analysis paralysis is trying to know too much. And that’s a vicious process. The more you know, the more you want to know and the more confused you are. That’s natural as well. No company is free from problems. All have their strengths and weaknesses. Once you start focusing on the weaknesses, you will find more and then even more. Eventually, you decide to shun your stock and move on. But you wonder when that same stock becomes a multibagger.

Financial parameters aren’t flawless either. Each has its drawbacks and frequently they fail to capture the reality. Sometimes they are even manipulated. So, tracking multiple financial parameters also doesn’t help as eventually they will throw conflicting signals.

In the stock market, you never have full information. The decisions have to be made amid healthy uncertainty. Of course, you have the past financials, forecasts, management outlook, peer views and so on, but the more you focus on them, the more you distance yourself from making a timely call. Little surprise, one of the secrets of successful stock-picking is “picking” the stock.

To do so, you have to deliberately cut your information intake. Yes, don’t look for more data. Rather, cut the existing sources. Knowing more is counterproductive to stock-picking; it’s not the other way round. What’s important is that you make a timely judgment. The next important thing is to stand by your stock. Don’t let the ever-present barrage of information affect you. Learn how to ignore.

Remember that wealth is made in the stock market by picking winning stocks and standing by them, not through endless research.

Silly Things People Say about Money # 4 

One problem with the Indian way of thinking (or perhaps that’s observed worldwide) is to focus on income. The size of your pay cheque tends to determine your financial well-being—the more you earn, the more well-to-do you are believed to be. There’s indeed a direct correlation between your income and your financial health, but your income is not the only determinant of your financial health. There are at least two more: your assets and expenses. 

The other day I was talking to someone who has a fat paycheck. The person was lamenting that it still isn’t enough. He just manages to get by. That was surprising. I asked him if he tracked his expenses. He said he didn’t and honestly he had no idea about where his money was getting spent. 

This is a classic case of expenses ruining your future. This person has allowed his expenses to grow to such a level that he no longer has an idea of them. Clearly, in his case, income is not the problem, though he would want to believe otherwise. 

The simplest thing you can do to check your expenses is to track them. Don’t let them go unnoticed, for if they do, they soon get out of control. Tracking them brings them to your attention and you can control them in time. 

It’s natural for your expenses to rise with your income. The second way you can check them is by diverting your income to assets—the second determinant of your financial health. When you direct part of your income to asset-building, you naturally restrain your expenses. The assets created further strengthen your financial position. An asset that generates cash flows can also supplement your income and in turn help build more assets.

Next time if you want to spot a financially successful person, don’t see his income alone. Rather, focus on his balance sheet and expenses. They are much more reliable indicators.

Read the other articles in this series:

Silly Things People Say about Money # 1

Silly Things People Say about Money # 2

Silly Things People Say about Money # 3

The Best Stock-Selection Strategy

There is no dearth of stock-picking strategies. From value investing to growth investing to tactical investing to dividend investing and so on, investors have a lot to choose from. Many investors do like to use a cocktail of various classical strategies. And of course, you can devise your own strategy. Others who have gained experience in the market develop their own insights.

Once you are successful with a strategy, you may also want to experiment with others, or even formulate many more of your own. This experimentation aspect of the stock market is what keeps the average investor “interested” in the market. If there were just one method of investing, many investors would have left investing out of sheer boredom.

There’s nothing wrong with experimenting. However, over time, you should be willing to reject strategies than try new ones. It’s true that different strategies may work in different market phases, yet by following too many strategies or even a couple of them can unnecessarily increase your work without contributing meaningfully to your returns. Worse, when you allocate a part of your portfolio to a particular strategy, you must find opportunities to fit that strategy. If such opportunities are not easily available or if the companies which you eventually select are of doubtful nature, you may actually do yourself harm than good.

In the stock market, trying to do many things isn’t a sign of maturity. On the contrary, it shows a lack of confidence or too much indulgence in the market or overexcitement or overactivity or anything. Over time, you should be able to come down just one or two ways of investing and stick to them. You will not just save a lot of effort, time, energy and money but you will also likely generate better returns.

India: A Foolproof Investment Destination

Enough has been said about the demographic potential of India. With over 130 crore people, the Indian market is any marketer’s dream project, yet the ongoing “slowdown” has deflated investor spirits and cast doubt on India’s potential. Rating agencies have lowered their outlook. All this is a temporary phenomenon, which warrants little attention.

Quite a few things are working in favor of our country today. A large young population; a huge market, where penetration is not yet deep; development that is far from reaching saturation, etc., make India a promising opportunity for both investors and entrepreneurs. In India, if your product or service is not working, that’s not likely a problem of demand but of a faulty business model or management.

Anything and everything has a market in India. All these markets are far from maturity. This evolving nature of the Indian market can accommodate just any kind of entrepreneur, at any level. If someone fails as an entrepreneur here, it’s likely not the idea but the execution. Similarly, as an investor, you can do well in this country if you simply avoid the pitfalls. As an investor in India, your job is not to look for great companies but simply avoid bad ones. The upside will take care of itself. The upside is built into the investment – such is the case of the Indian market.

This is very different from the case in developed markets where you have to try hard to find growing businesses, both as an investor or an entrepreneur. The so-called great global companies have stagnant revenues and profits in developed markets. Entrepreneurship has reached all echelons of society, with mom-and-pop stores being commonplace. That’s why foreign investors are so keen to invest in India. 

So, if you are an entrepreneur, start now. Don’t worry about how good your idea is. Focus on execution. As an investor, pick stable companies with clean managements and just sit back. With time your wealth will naturally grow. 

Why Listening to the Management Is of Limited Use

Savvy investors actively track management commentary, CEO’s message, and other such forward-looking stuff. They think that by tracking these, they can get valuable insight into the future performance of the business. I have even seen analysts “reading” and “decoding” the management’s body language and confidence level. In my view all this is dispensable. Even if someone must pay attention to this sort of things, he should use it in conjunction with other data or sources. However, what the management does is always useful information. That’s because actions speak louder than words. 

The case of an Indian airline is exemplary. This is the largest airline in the country and has about half the market share. In an industry where it’s difficult to turn profits, it has been consistently profitable. Its IPO also saw a surge in its share price. Everything seemed to be fine with the company until the tussle between its founders broke. The founders traded barbs, acted like recalcitrant children and sought mediation at multiple forums. One founder actually questioned the business practices of the airline.

The ego war between the founders of this airline tells us a lot about the airline’s management. Companies have a tendency to sugarcoat things. Even when they are “honest” about a gloomy scenario in the future, they still tend to hold back information or juxtapose bad news with many “howevers.” That could make the analyst believe that after all the situation isn’t so bad and probably the company would recover soon. 

Broadly, what people do tells you more than what they say. When it comes to speech, we put our best foot forward. But actions are what reveal the truth. Hence, paying attention to what people are saying is of limited use. Instead, look at what they have done. That can provide you more information. Similarly, while analyzing a company, discount what the management or the CEO is saying. Instead, see what the company has done in the past. That’s more insightful. 

One Sector that Most Investors Can Avoid… and One that Most Can Buy

In the stock market, you can make money in two ways: by buying a stock that appreciates in value and by avoiding one that’s going to fall. This is a simplistic statement and surely there are many conditions that apply to this rule. However, most investors worry about the first way only; they actively look for stocks that will appreciate. How do you make money off the second way?

One sector that most investors can conveniently leave is banking and finance. The reason for this is that this sector is most prone to frauds, scams and corporate-governance issues. The business of finance and banking is such that it allows manipulation at a great scale, which most investors can’t sense until something goes wrong. Let alone investors, most experts can’t sense that. History is full of examples when problems arose in banking and finance and took the whole economy down. The 2008 recession happened because of reckless lending. The ongoing banking mess in the country is another example.

Of course, there are good companies in banking and finance as well. But let “smart” investors spot them. For most investors, simply avoiding this sector can preclude a lot of pain, astonishment and loss. Sure, you will have to give many companies a pass, but then you will still have many more remaining. The Indian market is dominated by banking and finance companies and it could be very difficult for any investor to overlook all of them. Yet do it. If you must take an exposure toward this sector, keep it low and only to stocks generally perceived as high quality. 

Is there any sector that’s just the opposite? In my view, the FMCG sector is one, especially the big names in this sector. The FMCG sector is a faithful sector that doesn’t give its investors tears in the process of generating returns. Of course, there could be exceptions to this general rule as well, yet sticking to the big names should do the job for most of us.

Remember that in the Indian context if you can spot and avoid wealth-destroying stocks successfully, the upside in your portfolio will take care of itself.

Why You Should Get Active about Passive Investing

Passive investing means investing in an exchange-traded fund (ETF) or an index fund. By doing so, you can track an index and get returns like those of an index. For instance, by investing in a Nifty 50 index fund or ETF, you can get returns like those of Nifty 50.

Passive investing is an uncool way of making money over the long term. There is no thrill involved in it—just a very long wait. The returns aren’t going to be dazzling either. In India, you would probably get 8–12 per cent per annum, yet passive investing can’t be overlooked.

Passive investing is perhaps the most foolproof way of investing. When you pick individual stocks, you may err, which can hurt your returns. If you invest in an actively managed mutual fund, your fund manager’s bets can go awry. But when you invest in the market or an index, you are sure to get index-like returns. The costs of most index funds/ETFs are also low. This further adds to your return. You don’t have to track an index fund, as you track a stock or an actively managed fund. Finally, you don’t have to suffer the extreme emotions that active investing subjects you to. If you add up all these advantages, passive investing has a strong case.

Of course, you shouldn’t allocate 100% of your portfolio to index funds. In my view, 20% is fine. This part of your portfolio is a no-stress portfolio. You absolutely have to do nothing about it. Over time, if the rest of the determinants remain fine, returns will naturally flow. No sweat. Let the rest 80% part of your portfolio take care of market-beating returns.

Which index funds/ETFs to pick? In India, passive investing is still a new concept. Most ETFs, leaving a few, have low trading volumes. Hence, go for index funds, where the fund house concerned will ensure liquidity. Also, opt for the basic indices, not their derivatives or not the ones which have some engineering done to them. Index funds/ETFs tracking the market, mid-cap and small-cap indices are just fine.

The problem many investors face with passive investing is that they have been injected with the idea of beating the market. For some reason, getting market-like returns has a negative connotation; that shouldn’t be so. Plus they can’t miss all the action that active stock-picking requires. Passive investing is all about patience and inaction; many adrenalin junkies can’t bear it. But this quote from Paul Samuelson, an American economist, sums it up well: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”