Busting Common Stock Market Myths
When it comes to the stock markets, we can hear a lot of unrealistic and outright wrong beliefs and views i.e. stock market myths. Following these myths blindly can be dangerous and lead you to make incorrect investment decisions.
Few of the common myths in the market – ‘Stocks with low P/E are cheap!’ – We’re sure you’ve heard this one many times before. But is it really true? Not always! And what about ‘Stocks with low P/BV are cheap’? This myth may also not hold true always and we might make the wrong decision by just following this. It is very important that we are aware of these myths, so we don’t base our decisions solely on them. Hence this series will help you bust these myths and take better investment decisions.
As intelligent shoppers we always look for great bargains. And we tend to do this while investing in stocks, as well! The most common way to identify great bargains in the stock market, is to look at stocks with a low P/E. Infact, it has become a favourite valuation metric to find hidden gems.
But, is it actually as effective as it has been made out to be?
At the end of FY 2003, Nestle India was trading at a P/BV of 19.85 and Indage Vintners at a P/BV of 0.18. Going by the market rule of thumb we should have invested in Indage Vintners while avoiding Nestle India to earn hefty investment returns.
But what would have been our actual returns had we followed this strategy? And does this strategy of investing in stocks by just looking at low P/BV actually work?
During FY 2001, Hindustan Unilever limited (HUL) paid a whopping 58% of its profits as dividends whereas Infosys paid just 11%!! Going by the general myth that investing in high dividend paying companies gives better returns, we should have invested in HUL and earned high returns while giving Infosys a miss.
But what would our returns look like after 10 years? Would we have laughed all the way to the bank with our investment in HUL or did Infosys actually nudge ahead? And does this strategy of investing in high dividend paying company actually work?
‘Risk toh Spiderman ko bhi lena padta hain’! Investing in the stock markets and risk go hand in hand. And to earn high returns we need to take high risk! At least that’s what most of us think. But taking higher risks increases our chances of losses, while what we should actually be doing is minimizing our downside potential!
So is there a method that could lower our risk and at the same time increase our returns?
An IPO is one of the most sought after event be it a novice just starting his investment career or a seasoned investor. Even though quite a few burn their hands and their pockets by investing in them, the next IPO is again the same story. Euphoria surrounding the IPO release, media buzzing with the ‘once in a lifetime investment opportunity’ stories and brokerage houses selling the issuing company rather than analyzing it! The end result is throngs of people rushing to get a piece of the IPO action believing it will lead to great returns.
So, is investing in an IPO worth it and should you join the mad rush?
Investors have a tendency to label some companies as ‘Good Companies’. This is usually based on the perception that its products are good and liked by everyone or it has reputed management. Predictably then, the investment advice that we often get is: ‘Buy ‘Good Companies’ and the investment returns will be high’. It seems quite logical that well managed companies should be worth more than poorly managed ones, doesn’t it?
But the question we investors should be really asking is, ‘Does investing in ‘Good Companies’ always guarantee you good returns?
We are constantly on the lookout for various strategies to profit from the stock market. Out of the numerous “lucrative strategies”, one that is frequently practiced is that of investing in stocks which appear to be cheap i.e. quoting at Rs. 10,20 etc. This strategy is usually supported by the argument that buying such cheap stocks enables you to buy more number of shares as compared to a stock trading at say Rs. 500 or Rs. 1000. Also, we tend to think that there is a higher possibility of a cheap stock turning out to be a multi-bagger than a Rs. 1000 stock.
So, does a low priced stock actually give us better returns than a high priced stock?
Investing in the stock markets is risky. And conventional wisdom says that the elderly among us should take as little risk as possible, keep their hard earned money safe and handy, etc. Thus, most of us are faced with this dilemma at some point of time in our life:
Should we reduce our investments in stocks as we grow older?