Common Investing Myths

You need a broker to invest in equities

Now this is a classic case of not being up to date. We are moving to a paperless world my dear! And at least a dozen depository participants (DPs) will chase you to hell if they come to know you are interested in opening a demat account.

(And you just need to give them one address proof, one ID proof and PAN details for this) India already has about 10 million such accounts holders. So when you can place your order yourself by logging in from your home, where is the need for a broker? Plus, transactions through demat account guarantee transparency, fair play, convenience and saves time.

You can’t beat the market

What this means is that it is not possible for individual traders to earn more than the stock market. This is a long established myth having its roots in the Efficient Market Theory, which claims the financial markets are efficient. So, movements in a stock market are caused by rational investors responding quickly to the news that may affect their stocks.

As a result, the theory states that it’s not possible to outperform the market by using any information that the market already knows. This is not the case. Most mutual funds consistently aim to beat their benchmark index, and are able to do so. In fact, many individual investors too outperform the market.

Index stocks are the best stocks

This again is a myth because if this was true, most investors would safely park their money here to book maximum profit without looking out for other stocks. Most indices are a collection of stocks with highest market cap. Take for e.g. Sensex. Companies comprising Sensex are some of the largest and highly traded stocks in the country.

“The risk is certainly less in index stocks as they are well researched and leaders in their sector, but again margins may not be very high. On the other hand, investing in companies with evolving business models may give you better returns over the same period,” says Angel Broking VP-research, Sarabjit Kour Nangra. So it’s better to keep your eyes open to other stocks too. Who knows, you might be investing in the index stocks of tomorrow!

Stocks trading below their book value are cheap

Let’s first understand what is book value. It is the actual worth of a stock as in a company’s books (read balance sheet). It often bears little resemblance to the current share price. Shares of industries that are capital intensive have higher book value and vice versa. “Book value can’t be the only criteria to pick a stock. In companies with large intangible assets, book value doesn’t tell you much about the price. Whereas in commodity stocks, as most of the assets are tangible, book value can be a criteria,” says Ms Nangra.

So keeping in mind that the effect of book value varies across industries and businesses, it can’t be the sole criteria to value a stock. “In stock markets it’s very difficult to generalise things as everything is stock specific. The same is true even for book value. It is not necessary that all the stocks trading below their book value are cheap. For example, companies in services or knowledge sectors do not require huge capital investment. Thus, their book value itself may be very low. So, these stocks trading above or below their book value has no meaning,” says a fund manager at SBI MF, Jayesh Shroff.

Stocks trading at low P/E ratio are under valued

Investors usually think price to earning ratio (P/E) of a stock as a single reflection of how cheap or expensive a stock is because of the simplicity of the strategy. And from this come the ‘theory’ that stocks with low P/Es are cheap and vice versa. P/E alone doesn’t tell much about the pricing of a stock and should be seen with other fundamentals like the risk factor involved, company’s performance and growth potential. “P/E multiples may be a quick way to see a stock but one should look at these in correlation with expected growth earnings,” says Sharekhan research head Sandeep Nanda.

Also, the idea behind dividing price to earning is to create a level playing field where some kind of comparison can be made between high- and low-priced stocks. Since P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of stocks in that sector to make a judgment.

Penny stocks make good fortunes

Penny stocks by nature are low-priced, speculative and risky because of their limited liquidity, following and disclosure. If it’s easy to invest in penny stocks — as here you shell out much less money per share than you would require for a blue-chip firm — it’s also easy to lose it. Chances are you make a high fortune from these, keeping in mind its high volatility, but you should also be prepared to lose all the money parked in. “Just because they come cheap, you can’t pick penny stocks.

As they have high volatility and risk factor, it’s a wrong notion that penny stocks make good investment,” says Mr Nanda. “This is the biggest myth in the stock markets in India. In fact, investing in penny stocks is a very high-risk strategy. History has shown that most investors would have only lost money by investing in penny stocks,” says Mr Shroff. “Investment in equity market is an art and a science and it is not as easy as it may seem to make money in this market. Least by way of investing in penny stocks,” he adds.

Anyone, who disagrees?

The worst is over in the stock market or the market has peaked

Timing the market is a common strategy among investors. However, there is no ideal way of smart investing by which one can time the market. Timing the market means forecasting and that should better be left for tarot readers. “One should concentrate on timing the stock than timing the market. If you have done your valuation studies, you shouldn’t worry about the timing of market,” says Ms Nangra. In June-end, 2004, who knew that Sensex, that was trading at 4,800-level, would cross 14,000-mark in December 2006

Fixed income are safest

Fixed income avenues are often chosen by senior citizens, as this provides a safe and steady flow of income, keeping in mind their low-risk appetite. But also keep in mind that your aim is to make profit after factoring in the rate of inflation, which, not too long back, was hovering around 7%-level. Investing in equities may be a little risky but it also gives much better returns.

“While fixed income products have less risk, they also give low returns relative to more riskier asset classes like equities. In today’s world, it is not advisable to go with a zero-risk policy as one needs to take care of returns also,” says Mr Shroff.

Diversification is the key to investment

Well, diversification does help, but in falling markets, most often than not, almost all stocks will take a hit. Diversification is a virtue but if it’s done only for the sake of it, it may become a vice. In fact, if you are not sure, it’s still better to focus on a few companies in which you are comfortable irrespective of what sector they belong to. This should be done by taking into account the fundamentals, past performance and future outlook of the company as well as its sector.

“I have been trading since the past 4-5 years but I focus on only a handful of companies I am comfortable in because it’s easier to study and keep a track on them,” says a retail investor Kavita Tekriwal from Varanasi. Diversification helps only when it is done without compromising on the attractiveness of the stock being selected. Adds Mr Shroff, “Diversification is an effective tool to reduce the risk of your portfolio. While diversification does not ensure return on your investment, it reduces the risk that is carried on such investments.”

Volatility is the culprit

On the contrary, there are always some excellent opportunities in a volatile market. How can one possibly make profit in a stable market? What is needed is the understanding of the situation. Down-trending markets shift money rapidly to new sectors, which may be tomorrow’s BIG thing. “Volatility is a culprit when leveraged. In fact, volatility can give good opportunities to buy or accumulate stocks,” adds Mr Nanda.

Hoping that few of the myths on investment are put to rest. Just one last bit. It’s true that equities are riskier than bonds - as they see more ups and downs in a short while - but please keep in mind that in the long run, it’s the stocks that pay you more, with dividends. Sensex alone has given a consistent return of about 18% in the past 10 years and that’s after factoring in inflation. So just do your homework well, have an open mind and stay invested!

Via Economic Times