The Hindu Business Line : Much ado about investing

SHAKESPEARE gathered his favourite characters. "Friends, actors, investors!" he began. "Oft have I bought a couple of stocks at a good price, based on an analyst's recommendation and expected it to go up immediately. But it didn't and I lost a lot of money. Where could I have gone wrong?"

The Merchant of Venice said, "Will, I thought I could pay Shylock immediately after my ship returned. But things went awry. The first myth in investing is assuming that as soon as you buy a stock, it'll go up. If every stock goes up as soon as an investor buys, then everyone would be a billionaire today.

"It doesn't happen that way. If you buy 1,000 shares of Microsoft for $27 each, you would like to see the share price going up as soon as you buy it. But it might not go up just by one person buying 1,000 shares on a day. Thousands of investors should be buying the shares and few should be willing to sell. Only then will the share price go up. For the share of a company like Microsoft, which is a $300-billion company, to move up by even one dollar, someone should be willing to buy shares worth $10 billion."

Hamlet said: "Will! You said `All the world's a stage.' Investing too is comparable to drama. It is not enough if the lead actor is a famous person. The public should repeatedly watch it, if it has to make profits. Similarly, small lots of shares being bought by an individual cannot make a dent in the share prices. A large number of people should be willing to buy it.

"Institutional investors mainly drive the share prices. Major institutions such as Vanguard, Fidelity, and so on buy millions of shares at periodical intervals. That's when the share price goes up. Similarly, when they start selling, they sell in large quantities and thus the price of a stock crashes.

"So an individual investor who wants to profit from the stocks has to enter before major institutions start buying the stocks and exit before they start selling the stocks."

Romeo whispered to Hamlet: "I wish I too had been quick to act. I should have snatched Juliet from the balcony before all those villains entered, instead of listening to her soliloquies."

Shakespeare looked quizzically at Romeo, who switched topic. "Actually, Microsoft shares, which did not move up all these months, started rising slowly from July 27, 2005. The shares were trading around $25; as some major institutions started buying the shares, the price went up by more than $3 in less than a week. This is a profit of 12 per cent in less than a week and it is likely to move more soon."

Shakespeare told Romeo: "Your knowledge of finance is amazing! I thought only Shylock was shrewd about money matters." He continued: "What about the analysts' recommendations? Why did they fail?"

Julius Caesar answered: "O bard of Avon! Never trust anyone!" I am not saying everyone is a Brutus.

"Look at these simple facts. There are thousands of public companies in NASDAQ and NYSE combined. Each company is covered by quite a few analysts. A stock is either upgraded or downgraded by various analysts working in major financial firms like Merrill Lynch, UBS, and so on.

"Even an analyst cannot predict whether the stock is likely to go up or not. For example, on July 13, a Merrill Lynch analyst upgraded the stock of Symantec Corp. The stock was trading around $24; he set the target price as $29.

If you had bought that stock, you would have been thinking that the price would go up to $29 and you would be making a profit of around 10 per cent in less than two weeks, right? Wrong! The shares of Symantec were trading around $21.50 in the first week of August.

"An analyst's job is to report the future of the company. He upgrades a stock after it has reached its peak price and downgrades after it drops. Mutual fund managers look at various aspects before pumping in more money into the stock and one such factor is the analysts' recommendation. However, an individual investor cannot profit from the analysts' recommendation as there are too many analysts recommending individual stocks and an individual investor cannot make out all the recommendations by an analyst."

King Lear joined the discussion, "The third and biggest myth of all, whether it is dividing your kingdom among three daughters or investing, is that diversification avoids the risks.

"There is no difference in the risk levels between investing in diversified stocks and individual stocks.

"No one would have expected a huge crash during the dotcom bust. When every investment was going through the roof, everyone predicted the DOW to reach 30,000 and NASDAQ to touch 10,000 by 2005. However, the reality is very different.

"So if we had invested $10,000 in Microsoft five years ago, as of August 2005, the same investment would be worth only $9,000, a loss of $1,000. If the same amount were invested in diversified fund S&P 500, it would be worth only $8,000 — a loss of $2,000.

"The same $10,000 investment in Bed, Bath and Beyond in 2000, would be worth $24,500 — a return of more than 150 per cent; and in Starbucks, it would have become $27,800 — a return of 176 per cent in five years. Similarly, an investment of $10,000 in EBAY would be worth more than $28,000; a return of 180 per cent."

Shakespeare interrupted Lear, "Hmm! To diversify or not to diversify! I understand that when the market goes down, there is no difference between investing in a diversified fund and individual stocks. However, investing in the right stocks would make a big difference to your net worth.

"An individual investor can easily make more than 20 per cent returns, by simply understanding how stocks work and how to choose the right company to invest. If investors want to profit from the stock market, they can do so by simply analysing few companies that they are comfortable with instead of following the entire market."

"Yes," King Lear agreed. "One might understand the retail sector better than technology. In that case, analysing whether Target or Wal-Mart is a better investment would make him much richer than investing in too many companies.

"Warren Buffett, the investment guru, takes time to choose the right company. He has made more than 20 per cent profits consistently for the past two decades.

"Also, he doesn't hold too many stocks in his billion-dollar portfolio. He merely invested in American Express, Coke, Gillette, Washington Post, and more recently in the energy sector. It is easy to become rich. Understand the myths and learn the secrets."

Shakespeare merrily declared: "I have the title of my next play ready: Taming of the Stock Market!"

Racy@thehindu.co.in

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