5 common investment mistakes

Retail investors tend to be burdened with information on how they should go about investing their monies. Distributors, agents and fund houses all play their part in “educating” investors on this front. Our experience with investors suggests that apart from the aforesaid, there is also a need for investors to be aware of a few common and frequently committed mistakes. We present a checklist of 5 common investment mistakes that investors need to steer clear of.

1. Not setting an investment objective
A large number of investors are habituated to carrying out their investment activity in a haphazard and sporadic manner. Very often they fail to set an investment objective which is a basic tenet of financial planning. Investors should adopt a more systematic approach to investing by creating distinct portfolios for all their needs i.e. short-term (planning for a vacation), medium-term (buying a car) and long-term (planning for retirement) needs respectively. Setting of investment objectives also incorporates a degree of discipline which is a vital ingredient for the success of any the investment activity.

2. Not doing your homework
Investing like any other serious activity needs a fair degree of preparation at the investors’ end. Investors need to gather information and acquaint themselves with all the options available to them. Investing in a given asset class (for example fixed deposits) simply because you have conventionally done so is inappropriate. Investors have a plethora of options ranging from mutual funds, fixed deposits, and bonds to small savings schemes to choose from. After getting the facts in place, investors should select instruments that are best equipped to fulfill their investment objectives.

3. Succumbing to the “noise”
Every time the equity markets hit a purple patch, investors come face-to-face with a lot of “noise”. Fund houses go on an IPO (Initial Public Offering) launch spree and distributors do their bit by convincing investors that the recently lunched scheme is the place to be. For example recent times have seen a surge in interest in funds of the flexi cap and mid cap variety. Investors tend to succumb to the noise and get invested simply because everyone else is doing so. The trouble is that investors could discard their pre-determined asset allocation and make investments contrary to their risk appetite.
Investors must exercise a lot of discretion and resist falling prey to the herd mentality, especially at a time when everyone around them is busy painting a rosy picture of the investment scenario.

4. Getting attached to investments
Investors must remember at all times that investments are a means to achieve ends (financial goals) and not goals by themselves. If investments have failed to perform their requisite task, then investors should be flexible enough to act on the same. Investors should never get attached to their investments and stubbornly cling on to them. Assess at regular intervals how well your investments have performed and initiate the necessary corrective measures.

5. Timing the markets
A large number of investors like to believe that they can time the markets; nothing could be farther from the truth. If this notion was correct, we would have experienced a surfeit of fund managers and investment gurus. Instead of trying to outsmart the markets and failing in the process, adopt a more scientific approach. Use the SIP (Systematic Investment Plan) route and invest regularly to benefit from the markets. Don’t try to beat the markets, join them instead

What Should Firms Do With 'Excess' Cash?

Last week a high profile fund manager appeared on a business television program and explained his "value" screening methodology that has generated positive returns over the last five years.

His quantitative approach screens for companies with the "highest shareholder yield" for possible inclusion into the fund. High shareholder yield is basically the sum of dividend yield and the returns generated by an existing company share buy-back program. A technical study known as price momentum (which in this case is a simple three- and six-month rate of change) is also part of the screening process.

Companies who embrace a "high shareholder yield" strategy may be good for Wall Street, but in the long run it may be bad for Main Street.

International Business Machines Corp. (IBM) is a good case study on the topic of high shareholder yield.

Back in 1995, IBM (dubbed Big Blue) began what was to be a series of dividend increases and share buybacks. On Nov. 26, 1996, IBM's board of directors approved the company's purchase of an additional $3.5 billion of its own shares on the open market. That is addition to already having spent nearly $10 billion since January 1995 buying back its stock.

Some analysts questioned whether this was good or bad for the shareholders. Over the short term the answer is "yes" because the share price tripled over the next three years.

But a long-time IBM watcher and critic argued that those billions should have instead been spent on investing in new businesses to generate growth. Bob Djurdjevic, president of Annex Research, described the buybacks as little more than a bribe to Wall Street to keep a "buy" rating on the company's shares. In other words, with a major stock buyback scheme, investors could hardly lose on the investment.

Wall Street knew that IBM was willing to spend billions to buy the shares so it can pump up the price.

The reality is that paying dividends suggests the company must, at least, have "excess" cash on hand. Thus, the question boils down to what should a company do with its "excess" cash?

Such a company has two alternatives either invest the money in projects (internal expansion or acquisitions) or distribute it to shareholders. The choice between these two alternatives is simple if the company has good growth prospects then it should invest in these projects as they would create value to shareholders and to the local community as they expand their work force.

Otherwise, the company should distribute the "excess" cash to shareholders in the form of dividends.

Super-investor Warren Buffett has always said that Berkshire Hathaway Inc. would never pay a dividend as long as there is a promising way to put the cash to work. Buffett claims that, in the past, Berkshire has earned well over market rates on retained earnings, and under such circumstances distribution (dividends) would be contrary to the interests of the shareholders.

Our chart this week plots the monthly closes of Dow component IBM above a very long-term, 40-month moving average.

Note the booming "Wall Street" period of the late 1990s when the company used excess cash to shrink the stock float and inflate the earnings per share. Note the subsequent "Main Street" period of 2000 to date when "Big Blue" sold off divisions and "restructured" its workforce.

A few weeks ago, IBM said it's cutting up to 13,000 jobs, primarily in Europe, as part of a global cost-cutting plan. IBM recently closed a deal in which China's largest computer company acquired IBM's personal computer business.

IBM's troubles began in July of 1980 when IBM representatives met for the first time with Microsoft's Bill Gates to talk about writing an operating system for IBM's new hush-hush "personal" computer.

For its problems today, I could use a four-letter word DELL. Dell Inc. did spend $3 billion last year on stock buybacks, but paid no dividend. The company explains its dividend policy on its website, "We believe that our earnings are best utilized by investing in internal growth opportunities, such as new products, new customer segments and new geographic markets."

Last April, IBM shares plunged from $90 to $70 in just 14 days and on April 26, 2005, IBM directors tried to halt the big slide by adding another $0.02 to the company's dividend and authorizing $5 billion to buy back stock. Here is a suggestion for IBM. Lose the high shareholder yield schtick and grow the company. In the long run, Wall and Main Streets will be better off.

8 investing tips

Equities: 8 investing tips

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on

Manage greed/fear:This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals. Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back. It is apt to note here what Warren Buffet, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, “It means we miss a lot of very big winners but it also means we have very few big losers…. We’re perfectly willing to trade away a big payoff for a certain payoff”.

Avoid trading/timing the market:This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers’ end at the end of the day. In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again. In Benjamin Graham’s (pioneer of value investing and the person who influenced Warren Buffet) words, “Basically, price fluctuations have only one significant meaning for the ‘true’ investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market”.

Avoid actions based on rumours/sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investors’ portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffet, “Be fearful when others are greedy and be greedy when others are fearful”.

Avoid emotional attachment/averaging: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price. However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company’s performance may improve for the better and the stock would provide an opportunity to exit at higher levels. Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffet’s words, “Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.

Avoid over-leveraging:This behaviour is typical in times of a bullrun when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards). However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements. In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

Keep Margin of Safety:In Benjamin Graham’s words, “For ordinary stocks, the margin of safety lies in an expected ‘earning power’ considerably above the interest rates on debt instruments”. However, having a stock with a high margin of safety is no guarantee that the investor would not face losses in the future. Businesses are subject to various internal and external risks, which may affect the earnings growth prospects of a company over the long-term. But if a portfolio of stocks is selected with adequate margin of safety, the chances of losses over the long term are minimised. He further points out, “while losing some money is an inevitable part of investing, to be an ‘intelligent investor,’ you must take responsibility for ensuring that you never lose most or all of your money.”

Follow research:The upswing in the stock markets attracts many retail investors into investing into equities. However, picking fundamentally strong stocks is not an easy task. In fact, it is even more difficult to identify a stock in a bullish market, when much of the positives are already factored into the stock price, making them an expensive buy. It is very important to understand here that owning a stock is in effect, owning a part of the company. Hence, a detailed and thorough research of the financial and business prospects of the company is a must. Given the fact that on most occasions, research is influenced by vested interests, the need of the hour is unbiased research. Information is power and investors need to understand that unless impartially represented (in the form of research) it could be misleading and detrimental in the long run.

Invest for the long-term: Short-term stock price movements are affected by various factors including rumours, sentiments, market perception, liquidity, etc, however, in the long-term, stock price tends to align themselves with its fundamentals. Here it must be noted what Benjamin Graham once said, “…in the short term, the market is a ‘voting’ machine (whereon countless individuals register choices that are product partly of reason and partly of emotion), however in the long-term, the market is a ‘weighing’ machine (on which the value of each issue (business) is recorded by an exact and impersonal mechanism).” Of course, it must be noted that the above list is not exhaustive and there may be many more points that an investor needs to understand and follow in order to be a successful investor. Further, the above points are not just a read but needs to be practiced on a consistent basis. While making wealth in the stock markets was never an effortless exercise, it becomes all the more difficult when stock markets/stock prices are at newer highs.