The world of investing is full of choices. Choices that lead you from bust to boom, and back to bust. Many think of equity investing as a “game” where you outwit the odds loaded against you to come out “victorious”. Your choices (as expressed by your actions while this game plays out) determine the outcome of your game.
Here they are, for those who are yet to make these mistakes. As also for those of you who have already blundered along this way, for you are still vulnerable. Just like I am.
Mistake 1
Buying without researching. Shocking but true. Many bad stock picks are attributable to the simple tendency of buying in a hurry, without verifying basic business and financial details. Whenever there’s a mad rush to buy something, I smell a rat. Did you buy IFSL, Atlanta and other duds in the 2005-7 bull run, egged on by your broker's frenzy? Now if only you would have paused to check the track record and business models of these companies…I didn’t, and paid the price.
Mistake 2
Ignoring the value of a stock. Just because stock prices are rising does not mean they can rise further. Mind you, they might rise and tempt you to think that the stock market is ignoring the fundamentals. But how long can it afford to do so? And will it remember to inform you when the fundamentals begin to exert a downward force?
Example: Sugar is a commodity, and I know several people who elevated it to the status of a “virtual noncyclical” around six months ago and bought sugar stocks at P/E multiples in the high teens!
Mistake 3
Ignoring the competition. Then again, you might find some interesting reasons why the big daddies of the industry are staying away from some of the audacious choices being made by small upstarts. Not all upstarts are wrong, but it pays to check out what the industry leaders have to say.
Or perhaps your latest stock pick is a hotel company with fabulous properties and aiming for premium tourist walletshare. Well, how do they compare with the Oberoi or Taj hotels in these cities? And how or why would they make more money? If you’ve paused to ask these questions, there’s a good chance that you will make a more confident investment decision.
Looking at the competition also gives you benchmarks on cost structures, growth rates and P/E. It’s not meant to narrow down your vision for your stock picks, so don’t go overboard and disbelieve good things about a company if the competition is doing different things. Instead, look for the reasons underlying the differences. Sometimes you might end up buying the competition.
Mistake 4
Getting foxed by data. There’s so much by way of financial jugglery that companies indulge in nowadays, that one can actually list some common acts of fudging. Most of this is par for the course, in that the onus is on you to figure out the fine print, and the law allows these companies to get away with misleading financial statements. Here are a few ways:
(a) Padding profits with one-time or extraordinary gains to report higher earnings. Quizzing managements about other income or revenue break up by product is the best way to figure out where the profit padding has taken place.
(b) Some managements resort to withholding information on sales volumes and values of products in their annual reports. Any company that is loathe to share product details is probably hiding something from its investors.
(c) Many corporates do not provide for tax in their reported quarterly financial data. They claim they will provide for deferred tax (and sometimes even current tax) only in the final quarter of the financial year. However, this distorts reported profits across quarters and defeats the purpose of quarterly reporting of profits by “front-ending” reported profits over the course of the year.
What’s important is that you find a way to cut through the jargon and “adjust” reported earnings to what should really have been reported. And then figure out the P/E or EV/E or any other valuation parameter that you might fancy.
Common (especially among the more sophisticated and market savvy investors) that it makes sense to include these items in our honour roll—of what not to do when investing.
(By Dipen Sheth, Head of Research, Wealth Management Advisory Services)
