Investing in stocks is made to look easy by the media and is unfortunately sold as a day at the races. There have been and always will be suckers who think that investing is easy. Charlie Munger (partner of Warren Buffet) says that investing is simple but not easy. In fact if one is not careful, investing in the stock market is like going through a revolving door. There cannot be any fixed methodology for investing in stocks and each person has to find what is right for himself and the answer will vary from person to person i.e. there will be a different methodology for each person. In other words each investor will have to find a methodology that suits his or her personality. Broadly speaking the various methods used for investing in stocks are:
The most popular one is technical analysis which entails no knowledge of fundamentals and is mathematical. Master technicians have an array of tools viz moving averages, Japanese candlesticks, Eliot wave, Fibonacci numbers and knowing what works and when can take years. It is not for the faint hearted and can hardly be said to be foolproof.
The second one is fundamental analysis which in my humble opinion involves number crunching and is not everybody’s cup of tea. There is a dichotomy in this technique since to perform a present value analysis one must predict the future which unfortunately is not predictable. In the end it becomes an excel spreadsheet and investing on the basis of an excel spreadsheet is not advisable.
There is a third method which is used by the old timers and people who have been in the market for a considerable amount of time and that is a study of investor sentiment. This method can be practised easily by all classes of investors (even novices in the investing world), if they are a little methodical and disciplined. The idea is to buy, or conversely sell, expectations and not prices. When something is loved by everyone it is best avoided (this is very true in the investing world and outside of it i have no right to comment!!).
One of the best methods of gauging most loved and most hated stocks is to track the NIFTY and study the rebalancing mechanism. The index composition is reviewed twice a year (in Feb and Aug) and the effective dates from which the changes are to be made effective is announced. The reasons for the changes in index composition and the methodology of stocks selected is beyond the scope of this blog and also something which investors should not bother about. There are 10 Broad Market Indices disseminated by the NSE, apart from these there are sectoral and thematic indices the details of which are available on nseindia.com. If one were to do a study of names which were dropped from the indices (NIFTY) the results would be an eye opener, it follows that the the least loved stocks get dropped from index computations and tend to outperform in the aftermath. Like all things in investing this is not a rule but then there are no fixed set of rules in investing. It can be used as a benchmark all the same. The reason is simple, the investor sentiment on the names that get kicked out of the NIFTY computations is at it’s lowest and any good news after that gets a favourable price tick. Just see the table below showing the prices of stocks included and excluded from the most recent rebalancing of the NIFTY on 3 dates (i.e. the date of announcement, date of inclusion/exclusion and the current date)
STOCKS DELETED |
A |
B |
C |
% MOVE |
|
CNX NIFTY |
JPASSOCIATES |
40.50 |
49.35 |
57.40 |
41.73 |
RANBAXY |
367.75 |
346.55 |
468.45 |
27.38 |
|
STOCKS ADDED TO |
A |
B |
C |
% MOVE |
|
CNX NIFTY |
TECH M |
1820.95 |
1833.45 |
1771.80 |
-2.70 |
MCDOWELL |
2364.00 |
2655.85 |
2853.40 |
20.70 |
|
A = ANNOUNCEMENT DATE = 27/02/2014 |
|||||
B = EFFECTIVE DATE = 27/03/2014 |
|||||
C = CURRENT DATE = 17/04/2014 |
|||||
The statistics prove the point. The fact of the matter is that index funds have to realign their schemes according to the index composition and the churning results in a volatility in the price and in the investing world volatility is opportunity spelled differently. I am not trying to suggest that any stock that gets dropped from the indices should be bought but it can provide a great reference point for stock selection. The correction in stocks dropped from index computations can be used as an opportunity to buy fundamentally good businesses.
Another important metric for gauging investor sentiment is to see the inflows and outflows of mutual funds, historically inflows top at major market peaks i.e. when everyone and their grandmother is in love with the market. Gold as a store of value was the darling of investors in the calendar year 2012 only to fall from grace in 2013. There is as they say a reversion to the mean in case of all asset classes and when sentiment gets polarised in any one direction it is safe to assume that a reversion to the mean will take place. When any asset class overshoots or undershoots its long term trend then there is a gravitational force which brings about a correction in price. Incidentally Gold and mining stocks in general are one of the best performing asset classes in the first quarter of 2014.
BLOGROLL
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