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Profit from dips

It’s not easy to time the markets, but it’s sure easy to spot a dip in this market and cash in on the opportunity. The recent knee-jerk reaction of the market after SEBI announced changes in its P-note guidelines created exactly the type of buying opportunities investors should be looking for.

By Clifford Alvares        Print Edition: Dec 02, 2007

Corrections are fantastic opportunities to buy—but selectively.

It’s not easy to time the markets, but it’s sure easy to spot a dip in this market and cash in on the opportunity. The recent knee-jerk reaction of the market after SEBI announced changes in its P-note guidelines created exactly the type of buying opportunities investors should be looking for. At 9:57 am, Bombay Stock Exchange’s Sensex plummeted 1,743.96 points or 9.15 per cent to 17,307.90. But despite all the hullabaloo and pessimistic predictions, the market bounced sharply and crossed the 20,000 mark. It’s now hovering around the 19,500 levels, netting investors a decent 13.2 per cent returns.

Bull market corrections are a great time to go bargain-hunting. Investors have had plenty of such opportunities recently as the market has seen many such corrections, some that lasted for days. On the whole, corrections have ranged from 30 per cent to 9 per cent, but the bounce-backs have been profitable, netting investors up to 44 per cent returns. As long as you can wait out the correction and volatility, you can bag bargains easily if you look in the right spot. For instance, Reliance Industries tumbled to Rs 2,278 the day the Pnote announcement came through and stayed low for a few days, providing investors an attractive entry point. The stock is now up to Rs 2,661, up 16.8 per cent.

Winning Dips

In the past, stock market declines in India have been swift and sharp, and very volatile. Foreign institutional investors—the major sellers during many past corrective dips —sold heavily and the selling pressure could not be absorbed by the markets. On the other hand, the bounce-backs were slow and easy, providing investors ample time to make use of these corrective declines. But these days, investors have to be nimble-footed to grab the opportunity as the rebounds are equally swift, and bargain-hunting periods do not last for long.

Corrections, however, have to be meaningful for investors to make the best use of them. Says Lalit Thakkar, Director of Research, Angel Broking: “Dips of 8-10 per cent are good corrections and give plenty of comfort for an investor who’s waiting to enter.” In other words, the bigger the correction, the better it is for longterm investors looking for bargains. As long as the India growth story continues, the long-term trend of the stock market will remain up. But after a broad market correction, fast-growing companies bounce back strongly in the short run as their valuations turn attractive. Says Amitabh Chakraborty, President-Equities, Religare Enterprises: “Good quality companies can be bought at every dip.” But Chakraborty also cautions that not all momentum stocks are necessarily good buys. At times, a stock’s valuations can overshoot its fundamentals in a frenzied bull market and, therefore, investors must pick carefully even during corrective dips. While investors must seize corrective opportunities, it’s not any easier to call the top or the dip. But after a long run-up, it’s natural for the markets to correct and that’s what investors must be ready for.

Keep a little bit of money on the sidelines to cash in on market dips. How much cash one should have in a portfolio depends on one’s comfort level and risk appetite. When stocks are on the rise, too much cash is not a good idea as it tends to mute returns. On the flip side, in a falling market, the more the cash position, the better a portfolio is protected from losses. But to make the best use of corrective dips, investors can keep aside about 15-20 per cent of cash.

Where to Invest

When a market corrects, investors should be able to find great bargains in many sectors. The best returns can come from stocks that have dropped the most as the rebound begins. Corrections present a good opportunity to focus on rapidly growing companies that have corrected more than the market. There are many fast-growing companies in industries such as oil & gas, utilities, power, capital goods and real estate. Look for companies that are not too dependent on the overseas markets. Investors can increasingly look at the mid-cap space, where the valuations are a shade lower than the broad market. Look for companies whose earnings are projected to grow by at least 30 per cent, and where the correction has been around 15-20 per cent. Once the price corrects, the price earnings ratio will reduce to attractive levels.

Recoveries may not always be swift and fast as sustained selling pressure tends to drag the market down. At such times, investors will have to wait out the volatility and have a disciplined approach. Says Chakraborty: “Nobody can time the market; it’s discipline that determines whether investors win or lose over the long term.” Investors should not worry about catching the lowest price of the correction, as that’s easier said than done. But if the stock continues to correct due to selling pressure, one can keep buying at lower levels and reduce the average buying price. This strategy will work only if the company is fundamentally sound and you are convinced of its growth potential going forward. Avoid the companies that you know have run up far ahead of their fundamentals, even though the forward growth story looks compelling—there are plenty of other opportunities in a correction.

The market looks less risky in a correction, so the risk-reward ratio turns in favour of the investor. At such times, more investors tend to go bargain-hunting. So, don’t wait for the market to go further down as many retail investors usually do. Savvy investors, who ignore the volatility of a correction, reap rich returns once it comes to an end, as it will in a bull market.

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