Research stocks well to become smart investor

Research stocks well to become smart investor
1 Jan, 2008, 1730 hrs IST,Prerna Katiyar, TNN

Guptaji has got a “hot tip” on a buzzing stop and he can hardly wait for the markets to open to place his order. He got this tip from his colleague, considered to be an old hand in stock markets. His colleagues stock ideas come from a couple of websites that claim to give recommendations on stocks that give high returns. So Guptaji was glad to see his transaction executed and was already making a rough estimate on his expected returns. To his surprise, within the next few trading sessions the stock shed nearly 30%.

Guptaji is not alone. The market seems to be flooded with information from news channels, newspapers, websites, hotlines, and even astrology-linked tips, not to forget our own friends and colleagues, continuously feeding us with stock picks. Retail investors and first-time investors are becoming a easy prey hoping to make quick bucks sitting at home.

Making investments based on these heard-on-the-street tips not only makes investor’s lose their hard-earned money, but also sends wrong notions that the stock market is meant to be understood by a niche few.

Ask any retail investor and one can hear innumerable stories about people who have made amazing gains as well as nerve-wrecking losses by speculative trading based on these hot tips. “When I started investing in 2004, I followed tips offered by a few websites and lost close to 40% of my principal. I was so disappointed that I stopped investing after that,” says a retail investor from Jaipur, Sudip Verma.

There have been instances when the people who gave stock recommendations through popular means were caught doing exactly the opposite so as to benefit themselves out of this contrarian situation. “It needs to be seen if the source himself is well informed or not. In most cases, one should avoid these tips unless one is sure of the authenticity of the source,” says SBI mutual fund manager Jayesh Shroff.

The idea here is to do your own homework before making any investments. Popular and quite easy ways to do this is to check the company’s website to accustom oneself of the company’s line of business, working model, management, performance over a couple of years, new products, latest announcements, etc.

Key numbers to judge the performance are rate of increase in revenue and net profit over past few years, return on equity, return on capital employed, dividend history, relative price to earning ratio (P/E) vis-à-vis its peers, price to book value (BV) and so on. Most of these numbers can be compared not just with the corresponding period of past quarters and years but also with the peers in the same sector.

In addition, one should take into account the market capitalisation of the company, as risk of manipulation is higher if you have decided to invest in a low-cap company. Large caps, because of their sheer size, are less prone to manipulative trading. In fact, attending the annual general meeting, if one gets the opportunity, is also a good idea as one gets the chance to talk to the management on their plans and can also get their individual doubts clarified.

It’s not that one should keep himself totally aloof from these recommendations. The stock ideas one gets from
various sources may act as a cue but needs to be validated by checking the fundamentals (and if possible the technicals) yourself. There are few genuine reasons to take a hint from these recommendations.

First, it’s not practically possible for a retail investor to carry out an extensive research on quality of management and future plans of the company. Second, there can be islands of opportunities among this vast sea of recommendations. So choosing the right stock and not betting on anything and everything that comes your way may be a good idea.

“An investor should first prepare his own trading strategy. Protecting one’s capital is of primary importance, and before taking any advise one should have the basic idea as to how much of it he is ready to lose if he runs into a sequence of losing trades,” says Deepak Mohoni, who gives stock recommendations for the short term. “Following a particular target is not a good idea, as the target either limits profits or is never reached. Traders should use stop losses and trailing stops instead,” he adds.

After all, we do ask the vendor to cut the watermelon and show if it is red or not before buying, compare prices of the same product across different brands, try a dress if it actually fits our size, and the like. Don’t we do that, Guptaji?