I bought a scrip at 10 which is now trading at 6. Should I buy (more and average) / hold (for how long) / sell (to prevent further loss) ?
This is a question raised by many retail participants in the market. If an investor follows the principles of value investing, he rarely finds himself in a position to ask this query because the buy / hold and sell decisions are made while critically evaluating the stock much before the actual buy happens in the first instance.
Some individuals limit their profit or losses to a certain percentage. They say "If the stock moves up 20%, I will sell and book profits". Statements such as these limit your chances of a greater profit which you deserve for hour hard earned money, considering the risk you are taking in the financial markets.
The decision to buy, hold and sell should be based on the actual valuation of the company compared to the price offered by it in the market. The best single number to suggest a fair valuation is the PE ratio. As the PE ratio increases, the stock becomes more expensive and vice versa.
Here is a simple guide to decide on how to buy / sell / hold depending on the previous movements of the Indian market in the recent years.
The PE ratio of the market (http://www.nseindia.com/products/content/equities/indices/historical_pepb.htm) is an equally important consideration, because a cheap stock should ideally be bought in a cheap market and a expensive stock sold in an expensive market.
The PE of the market should take precedence over the PE of the individual stocks.
For example
If LIC housing is trading at a PE ratio of 9.9 when the PE of the market is at 17, what do you do?
Buy
Stock PE 28 Market 22
Preferably stay out
Stock PE 15 Market 25.5
Never enter the counter
Stock PE 3 Market PE 21
Buy with extreme caution
Stock PE 8 Market PE 13
No better opportunity to buy
Thus according to this principle, one should rarely have an individual stock with PE over 25 in his portfolio and should never own a stock at all when the market PE is above 25.
Remember that these recommendations hold true only if the basic principles of stock selection good management, steady performance, adequate market cap etc. are followed and it is just a guide that can help you in timing a buy, hold or sell in co-relation with the market.
This I believe is the most basic fundamental principle to be followed by every market participants, especially retail participants to escape a frenzied market, when it (the market) roars of even higher highs on expensive valuations. But its a fact that whenever markets reaches those peak levels of valuation most of us forget this very simple mandate of value investing and get trapped at higher levels.
ReplyDeleteI strongly support the views expressed by the author and the suggested levels of PE, in an Indian context based on a statistical perspective and would also like to encourage the author to continually give these valuable thoughts for an intelligent investor.
So Mr Deepu. Now with markets hittingits highest levels,but market PE around 16.87 in the current market scenario is it time to but?
ReplyDeleteOr our clocks starts ticking to keep a close eye on the market PE to go down?
Mr. Davis John. That is a good question.Now the basic principle is to check whether a better return is possible else where in the long term. A general rule regarding PE ratio and your return percentage is that it is roughly equal to 25 or 27 - PE ratio. E.g if the PE ratio is 18 your annual compounded return will be 25-18=7% or 27-18=9%. So if you are getting a better annual compounded guaranteed interest elsewhere why risk your hard earned capital in the market. But again the PE of the stock also has an important role to play here as written in the post. For me it is a good PE ratio to hold in general and selectively buy if some stocks with good fundamentals are still available at a discount.
ReplyDeleteConsidering the current market conditions, markets are frenzy nearing elections and if we have to take past data's to be a base, its going to be a volatile session immediately after election with last election giving 20% upmove and previous ones giving 10% down move or so.
ReplyDeleteSo fresh investment i think we should stay away at this moment considering valuation reaching upper band in terms of forward PE valuations (roughly 20 it should be i guess) which is essentially higher than the quoted present PE.
Long term holdings in my opinion should be partly booked and if some steam will be left after election you can reenter or stay put. Markets will always give opportunities.
Also along with valuations we need to agree to the fact that markets not only move with valuations but also coz of liquidity that too cheap liquidity which is finding its way from liquidity flush from global central banks as part of their QE. This phenomenon is already on its way to taper off.
To conclude the liquidity or so called 'modi' driven rally is nothing but; yet another euphoric phase in markets which is an exit for the value investor.
One more thought about PE vs return which as mentioned by Y2 is 25-18=7. This may be case for developed markets where inflation is negligible. In India as the inflation is high the return expectations should be even higher. Simply put look at our interest rates for deposits which is 9% compared to 3-4% in developed markets. This difference is nothing but the inflation which is there in our country. So return calc should be 25-16-7(inflation). Which is essentially near 0. This explain why for an investor its better to remain in risk free fixed deposit against equities at this point in time.