LESSONS FOR STOCK MARKET INVESTORS
ALI ALVI (email@example.com)
Mar 23 - 29, 2009
The other day, two school kids were talking to each other ñ exchanging jokes. I happened to be around and overheard the following joke.
"One day, a moron decided to swim across the English Channel. He started with a lot of enthusiasm. He had crossed around three fourth of the channel. Tired and exhausted, he thought this was enough and he could not go any further. So, he swam all the way back."
Well, this is a good joke from the perspective of the kids. They enjoyed the situation that the moron put him in to.
However, that set me in thinking as the humor echoed a resemblance of the luck of many investors in the stock markets. By the way, why do often the markets have to start rising immediately after we sell? The re-bound in the market seems to come just after the investor loses his patience and liquidates his holdings.
Rational thinking suggests that an investor chooses to invest in the "risky" stock market securities to reap high rewards. However, reality suggests that many investors enter the market during a bull-run, expecting that it will continue forever and they will never see the prices coming down. Such investors do not take account of the risks inherent in the stock market, the impact that short-term market volatility can have on their liquidity conditions. These investors become impatient just when the market takes a dip and end up liquidating their holdings at lower values.
Two main factors decide the ability of an investor to hold on holdings through market volatility. The first factor is the conviction in the analysis at the time of making the investment. If the investor is confident about pre-investment analysis and has an idea of the intrinsic value of the investment, he will be able to grab holdings firmly during a period when the market decides to undervalue stock values. On the other hand, if the investment was made without prior analysis, then even a slight dip in the price will make the investor panic and compel him to liquidate his holdings.
The second factor is the solvency or liquidity requirements of the investor. In certain cases, even if the investor has conviction in the analysis supporting his investments, other liquidity requirements might force him to liquidate his investments. In order to avoid this, one should always have a comfortable liquidity cushion before committing to equity investments. If one cannot digest a temporary 25% decline in the investment value over a short time then he should refrain investing in equities.
The question is where does the conviction come from? Conviction comes from supreme confidence in what one knows and understands. What is this knowledge?
"Stock prices are slaves of the profit growth of underlying companies over longer periods."
This simple line sums up all the knowledge that one needs to have in order to develop the confidence. As Benjamin Graham puts it,
"In the short run, the market is a voting machine - reflecting a voter registration that requires only money, not intelligence, or emotional stability - but in the long run, the market is a weighing machine."
If one understands this and has confidence in the economic growth, undeterred holdings could be highly rewarding. There comes the question of short-term movements of the prices. Someone has very nicely said that many short terms make a long term.
It takes enormous courage to stay calm amidst the noise of the short-term boils - what with media tickers, friends, brokers, internet - giving out number of messages. It takes a lot of patience to stay balanced in such a hullabaloo. Then again, patience is a rare virtue and it only comes from having conviction about investment decisions. Warren Buffet has correctly said, "The stock market is a device for transferring money from the impatient to the patient."
To sum it all up, our advice to equity investors would be as follows:
a) Only expose your risk-capital to the equity asset class
b) Leave aside ample liquidity to serve any short-term requirements before investing in equities
c) Conduct an analysis of the equity market and the economic conditions with the help of your investment manager and invest in equities only if you are truly convinced by the investment scenario
d) Keep a long-term investment horizon and stay patient through short-term volatility
The writer is an employee of UBL Fund Managers Limited.