How to use market corrections for investments

Vikas SinghaniaTrade Smart OnlineThe stock market is a device for transferring money from the impatient to the patient says Warren Buffett the legendary value investor. No one but he and his partner and friend Charlie Munger can say these words with authority. They are the guys with patience who have accumulated wealth over the years which the impatient ones left at their door steps. Star fund manager of Fidelity Investments Peter Lynch says the same thing differently. He says that the most important organ in the body as far as investing is concerned is the guts, not the head. But being patient is only part of the game in investing. Munger says - it takes character to sit there will all the cash and do nothing. I didn’t get to where I am going after mediocre opportunities. The point being that sitting on cash and watching the market fall is the patience part, but buying quality stocks when they are beaten down in where the skill comes in. To put it simply when opportunity knocks we should be ready with our wish list. Preparing this wish list however, requires some homework. Market corrections can be classified into two main types. In the first case, we see sharp falls with sharp rebound. These are event based and can be a result of some news breaks or policy changes. But these sharp falls can give an investor a chance to enter into stocks which they have seen runaway in a very short time. One of the better ways in identifying such stocks is to identify the ones that were the strongest just before the fall. The strength has to be fundamentally driven; ideally those stocks should be on the radar which has made some corporate announcement that resulted in the rally prior to the fall. Since most investors including fund houses would have missed the opportunity to buy as the stock would have spurted on news, they would be looking to get a chance to join in the party in the correction. The trick here is to be ready with the list of stocks which have spurted on an event announcement. If price comes back to these levels, they are the best plays the market has to offer when it resumes its journey upward. The second type of correction is the fundamental one. Here the market can fall sharply in value and then either slide slowly or languish around the same level so that time correction is completed. Such falls normally always result is change in stock leadership. Take any sharp market fall, be it the 2000 dotcom bubble or the 2007 financial meltdown. The stocks leading the 2000 rally where mostly from the IT sector while those in the 2007 rise belonged to power and infrastructure sector in India. After the fall these sector languished for a long time. Many companies that had caught investor fancy during the boom failed to survive the bust. The strategy of chasing strength in such a market will thus be a risky preposition. Other matrix will be needed to identify the next market leader. These are difficult to acquire skills which even the best investors openly confess that they do not have in identifying the next market leader. The next best thing to do is look at businesses that are still doing reasonably well as the economy collapses. It is only when others are fearful that you should start investing is one of the famous oft quoted words from Buffett. Though defensive stocks will feature in the list, there will be market leaders in various sectors who will be surviving the onslaught. Sector leaders are nimble footed and adapt to situation by cutting costs and waiting for opportunity to gain market share as other weaker players fall by. These are the companies which will attract the first round of investment as markets start changing from weak hands to stronger ones. But patience is a virtue that will be severely tested in investing. As Buffett says “Unless you can watch your stock holding decline by 50 per cent without becoming panic stricken, you should not be in the market.” This is coming from a person who buys deep in the money with a lot of safety built in. Investing is not a perfect science. An investor has to place his best bets and then wait for them to move. Some might move immediately, some might take years to go move while some other might go down before moving higher. But the key is in identifying good stocks at low prices and ridiculous valuations. Opportunity in term of valuations comes when markets are crashing. A sound mind is all that is needed when you have identified the stocks to press the buy button.