We Indians are price-conscious; we know what value for money really means and we go out of our way to ensure that we get it. And we all love a good bargain. Case in point: The Big Bazaar Republic Day Sale. The first time Big Bazaar introduced it, there were so many people wanting to buy on sale that there was almost a stampede. The store had to be closed for some time and the sale was extended for another two days. The traffic jams were still there. Everyone throngs to the Big Bazaar stores to make the most of the incredible discounts.
Owning equities
Now contrast this to what happens in the stock market. You understand the importance of owning equities in your portfolio. You begin investing for your retirement which is some 10-15 years away — so you are essentially investing for the long term. You have probably even decided to invest a fixed amount every month. And, yet, when the Sensex falls 500 points, you wonder if you should sell your investments.
When to buy?
It falls another 200-300-500 points and you actually go ahead and sell your investments because you think it is going to fall further. But stop and think for a moment. If you actually want to buy something, which is the better time to make the purchase; when it is at full price or when it is on sale?
Let us look at an example: You have had your eye on the Infosys stock for a long time. You like the company and the reputation of its management. You have been reading in newspapers and magazines about how Indian IT companies are riding the offshore boom and are expected to do good business for the next three-four years at least. You are comfortable with the kind of revenue growth and profits Infosys is expected to make and you think in, say, five or 10 years, an Infosys share could be worth anywhere between Rs 5,000 and Rs 7,000. So, although the Infosys stock price has gone up from Rs 1,600 in July 2006 to almost Rs 2,300 in January 2007, you decide to buy the stock. You buy a few shares at Rs 2,300 and plan to buy more as soon as you have some savings to invest.
Stock on sale!
Fast-forward two months, the market has fallen and your Infosys stock is down to almost Rs 2,000, which is 13 per cent less than the price you initially bought the share at. So, how do you feel and what do you do? Will you get scared that the price will fall even further and, therefore, sell now and get out of the market while you still can? Or will you be happy that the Infosys stock is on `sale'! A 13 per cent sale! You can now buy more shares for the same investment amount!
Factors at play
This, of course, was a very simplistic example. At any given point, there are several factors at play that determine prices in the stock market.
How an investor responds to changes in stock prices is also a function of his overall financial situation, the money available to invest, and the asset allocation. But all said and done, the most important thing to remember is the difference between `stock price' and `company value'.
Regardless of which valuation tool you use to arrive at the `company value', the basic rule is:
when the `stock price', is higher than the `company value', the stock is expensive and although you have money to invest, you might want to keep that money in the bank instead of making an expensive purchase;
when the `stock price' is less than the `company value', the stock is on `sale' and it might be a good idea to consider buying the stock instead of putting money in the bank.
When things are `on sale', the discount that makes it attractive to you is purely a matter of personal preference. Some people think a 10 per cent discount is a good deal while others may think that a sale is really a good deal only when the discount is more than 40 per cent.
You decide what your preferred discount rate is. And the next time you read about a market crash do not forget to check and cheer because the companies you want to invest in may now be on sale!
And, congratulations! In addition to gaining a new interpretation of market crashes, you have also just learnt the philosophy behind a mutual fund category called `the value fund'. Simply put, `value funds' generally buy stocks when they are perceived to be on `sale' and sell them when they get expensive — when the stock market price exceeds their estimate of the company's value.