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Why investing on market talks can be dangerous

Investors fall for stories that may not be supported by numbers. Sometimes such investments may lead to permanent loss of capital.

December 07, 2015 / 12:11 PM IST
Vikas Singhania
Trade Smart Online

Warren Buffett, the legendary investor, has often said that people make investing more difficult than it seems. Entire premise of investing is based on creating complex financial models for projecting future earnings. It’s probably this angle of investing that the general public stays away from it. Plus all the financial jargon in which market commentators talk, further scares the retail investor.

The investor in order to make an ‘informed’ decision then gets hooked on to either rumours or ‘stock stories’. There is no point discussing rumours and giving them any respect. As for stories, these are wrapped as value added research to gullible investors.

Investors are projected about the huge opportunity that lies in front of the company and how it is the best placed to take advantage from it. Such tales are normally spread when there is euphoria in the market. People looking for stocks to buy fall prey to such stories. The beauty of such stories is that they come with a price target and time period in which the stock will be touching these levels.

Most of the bubbles are preceded by such stories of great opportunity lying ahead. Take the dotcom bubble for example. Stories were told of the market reach that the internet companies will have and money that they can generate from it. The recent valuation of the e-commerce company is similar to the dotcom bubble.

Thankfully none of the ecommerce companies are listed in India, though some listed companies are trying to take advantage of the boom in the private equity space by starting ecommerce businesses. Already companies in the e-commerce space are closing down their businesses since their model was always about attracting customers rather than making profits, which should be the aim of the business.

If e-commerce was such a great business it is noteworthy why none of the big business houses have invested in a big way in it. Those who have invested are doing business on their own terms keeping their bottom-line and brand image in mind, rather than competing with other websites who sell everything under the sun.

However, not all stories are negative but believing them blindly without looking at the company’s financials is a sure way to failure. Most investment decisions by fund managers are based on such stories, except that they put a number to it. The stories are translated into growth numbers and profitability numbers.

Also, there are certain sectors and companies which are being valued on such perceived opportunities. For example, analysts expect growth from pharmaceutical companies’ launches of new products that are going off patent in developed markets or a completely new molecule is given a high valuation on the hope that the product will do well. Likewise, analysts accord a value to automobile companies who are likely to launch a new product. They assign a value to the new product based on their analysis and market survey. In case the product does not perform as per initial estimates the stock tanks as the perception in the market would be that investors had bought based on analysts estimated growth numbers. Sometimes the stock does much better than expectation, if the actual demand surpasses the estimated demand for the new product.

Predicting the future is a difficult if not an impossible task. Even the best of analysts, including Warren Buffett and his guru Benjamin Graham did not get their predictions right. Ben Graham used to say ‘you are an investor not someone who can predict the future. Base your decisions on real facts and analysis rather than risky, speculative forecasts.’

Legendary investor Philip Fisher rightly puts it that the market is full of people who know the price of everything, but the value of nothing. The greatest of investors have very simple strategies. They buy stocks that are deep in the money. In other words they buy a stock for a fraction of what they are worth.
Investing is serious business. In order to succeed as an investor, retail or large investor will have to think of investing as starting any other business. In order to succeed in a business one needs to know how the business operates. One does not start a business on hearsay. It is destined to doom if he does so. Same is the case with investing.

While ‘stories’ can sketch a picture for the future, it is important to know where the company fits in and if it is capable of capitalising on the opportunity. Just before the 2007-08 when the stock market peaked, power sector was considered to be big opportunity in a country of over a billion people, where a sizeable population did not have access to power round the clock. Almost every company announced massive projects and raised money at atrocious valuation.

‘Stories’ were making the rounds on how one company is better than the other and where they will be in five years’ time. We all know where they are. Gullible investors pumped in money without looking at the valuation or track records. All it would have taken to save their money was a little financial prudence and knowledge.

To recap in great Benjamin Franklin words, an investment in knowledge pays the best interest.

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