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How to win in the stock market
Sandeep Shanbhag, Moneycontrol.com | October 31, 2006
'When the markets are rising investors are aplenty, when they are falling, there is none in twenty.' This is a slightly improvised Sidhuism.
Well, the markets have touched 13,000 and I am sure all of us are finding it difficult to wipe the smile off our faces. However, I am sure June 14th is also etched in our mind. . . for it was on this day that the Sensex was at its lowest at 8,929 -- a fall of almost 30% from the earlier peak of 12,612.
So it was hardly four months back that we were overcome by a collective self doubt. Was the market too expensive? Were the valuations stretched? Should we book profits and stay in cash? Will this correction be more severe? How do we play this situation?
And now four months later, when the index is flirting with 13,000 and poised to move upwards, its ironical that we are asking ourselves the same questions -- Is the market too expensive? Are the valuations stretched? Should we book profits and stay in cash? Will this pace be maintained? How do we play this situation?
That in itself is the mistake. I suggest let us try and keep our eyes on the ball and not the situation.
Let us revisit the same investing principles -- hopefully these will help you deal with the ball at hand and not get overawed with the surrounding situation.
First of all, we all agree that questions such as will the market continue to rise, when will be the next correction, is it better to book profits and stay in cash, etc., if at all, can only be answered, by someone who can look into the future.
Now, since we don't have the ability, the next best thing I propose we do is use two tools that will help us tackle each delivery to the best of our ability. And what are these?
Albert Einstein called compounding the eighth wonder of the world. And just how smart Albert really was can be gauged by the following story -- it really sort of puts things into perspective.
This is a story in which a simpleton of a king lost a well-fought game of chess to an ordinary farmer. The king asked the farmer to choose his reward and all that the farmer asked for was one grain of wheat for the first square of the chess board, two grains for the second square, four grains for the third, eight for the fourth and so on and so forth for all the 64 squares. The king was very happy for being let off rather lightly and readily granted the wish. The real snag came when he tried to settle the claim.
He required 18,446,744,073,709,551,615 grains of wheat!
Now isn't that mind-boggling? Let me try to be more concrete. There are about 25,000 grains in 1 kg of wheat. The king required about 737,870 million tonnes of wheat to fulfill his obligation. Now, here are some statistics for comparison. Our total national agricultural produce (wheat, rice, sugarcane, cotton, etc.) in the year 2004 was around 200 million tonnes.
The required quantity of wheat is about 3,690 times this amount. Even all the wheat produced by man from all over the world, ever since he learnt the art of cultivation will be far less than this quantity! If the king had decided to settle this liability in cash, say, at a super wholesale rate of Rs 3.50 per kg, he would be required to pay Rs 25,82,54,417 crore. This is over 2,000 times the Indian Gross National Product (GNP), which is the total value of all industrial as well as agricultural goods and services produced by India.
What happened there was that the smart farmer used the power of compounding to his advantage. And such is the power that the king didn't know what hit him. Realize that things were fine till the first few squares. It was only by the 10th square or so that it went out of hand.
In other words, compounding, though the eighth wonder, only works if used over the long-term. In fact, long-term investing and compounding are two sides of the same coin --- one cannot exist without the other.
Take a look at the following scheme returns:
In all there are over 200 equity oriented schemes operating in the market and the above selection is just an example of some well performing equity schemes. Of course there are other schemes whose performance has been good, the only point here is to showcase how compounding actually works.
Rs 1 lakh invested in say HDFC Equity five years ago would have been worth around Rs 7.95 lakh today. Will such returns be repeated in the future? I don't know. Will such returns be not repeated in the future? Again I don't know.
What I do know however is what the world went through in the past five years: the dot-com bust, September 11, Afghanistan, Iraq, Greenspan swinging rates up, then down and then up again, oil falling and then rising and then falling again, FIIs (foreign institutional investors) pulling their money out only to fall over themselves to get in again -- domestically too -- Parekh came and left, the Left came but is yet to leave, Brothers Ambani split. . . whew, I am almost out of breath.
And all this while, quietly in the background, King Compounding was at work -- those who had the faith are raking it in today.
It is not as if I have not made the same mistakes. . . having learnt these lessons the hard way, just thought will share them with you.
In fact, my very first investment technically was a recurring deposit in a bank across the road. As a child and a student, it was my graduation of sorts from the piggy bank at home. Breaking it open was an event that I have vivid and fond memories of.
Working on the parents as only a child can, I managed to add two hundred rupees to my princely capital of eight hundred and soon I was the delighted owner of a Rs 1,000 bank deposit. Periodically adding to it gave me a special thrill as it meant a visit to the bank and acting all grown up.
Looking back, the RD (recurring deposit), proved to be a great investment. Although the capital was nothing that would make a Donald Trump look over his shoulder, the entire process, perhaps, instilled a sense of savings discipline at an early age. Not to mention the fact that I could use the money to make my very first foray into the stock market . . . 100 shares in a well known scrip was my first investment as a professional.
Actually, talking on this subject brings tears to my eyes, not on account of the nostalgia but because as a novice investor, I made the mistake of getting out of the stock way too early. . . just as soon as I had made a few bucks. Had I held on, perhaps Donald would really have looked over his shoulder.
Having robbed compounding of its partner I paid for it. Big time. Which, jokes apart, brings me to wonder how many of us really invest for the long-term? Mr Warren Buffet himself says that a total of twenty trades is more than enough in the life time of any investor. Although that may be stretching things a bit, I cannot help but wonder whether our parents and their parents had always got it right when they bought their shares, put them into the family trunk and forgot about it.
A kind of 'Fill it - Shut it - Forget it' investment strategy that indeed paid handsome dividends (pun intended) over time. In the absence of social security, our senior citizens largely depend upon these blue chips accumulated over a lifetime to tide them through. And the way things are currently, social security is not coming anytime soon -- but will we have the 'blue chips' to fall back upon?
Investing is hard work indeed. No wonder the word 'work' is always prefixed with the adjective 'hard'. Having to earn a living is no walk in the park, what with trying to keep the nose to the grindstone, shoulders to the wheel, eye on the ball and ears to the ground. One rarely has the time, energy and inclination to worry about when, where and how to invest.
Want to win in the market? Take the following words of Calvin Coolidge to heart -- Nothing in the world can take the place of persistence. Talent will not, nothing is more common that unsuccessful people with talent.
Genius will not, unrewarded genius is almost a proverb. Education will not, the world is full of educated derelicts. Persistence and conviction are the key. In other words, time in the market and not timing the market is what makes the difference between a successful investor and an also-ran.
Therefore, I think I will just let king compounding do the job for me. Efficiently and silently as it has been doing throughout history. In other words, I will not play situation 13,000 - but every stock on its merit. Now only if Dravid & Co. could learn this.The writer, Sandeep Shanbhag, is a tax and investment advisory firm. He may be reached at firstname.lastname@example.org