At the Morningstar Investment Conference 2014, Parag Parikh, Founder of PPFAS AMC Pvt. Ltd, shared his views in a panel discussion on value investing.
Being an expert on the subject of behavioural finance, a stock market veteran and an author, his insights were brilliant. He nailed it down to one single take-away.
There are no stock market geniuses. Just those savvy in controlling their emotions. You can never get wealthy if you let emotion get the better of you. But if you rein in your impulses, you have a very good shot at accumulating wealth.
Below are his views on the context and how to work around the buy and sell urges that come so naturally to us.
When the market is bullish, everyone is on a shopping spree. Along comes the inevitable correction, and those very stocks are kicked to the curb. What has changed? Just sentiment.
If the market falls on a certain day, fear dominates and investors are reluctant to invest. Once the market bounces back, greed takes over. What’s completely ironical is that investors perceive a stock to be more risky when nobody is buying and the price is low, and less risky when everyone is buying and the price is high. It would be hilarious if it was not so lamentable.
How does one counter the impulse to act?
Give thought to your purchase.
Value investing is about buying a stock quoting less than its intrinsic value. If you make a purchase higher than its intrinsic value, you are looking at the greater fool theory to come into play -- that someone would buy it again from you enabling you to make a profit.
There is a difference between value in use and value in exchange. Water is an essential commodity which has got a fantastic value in use, but not many people will give you any money for it. And value in exchange is something like a diamond; it may not be useful to you. If someone is dying, it would be more useful to offer them water than a diamond. But the diamond has got a tremendous amount of exchange value.
So, for example, a power stock may not have pricing power, but will have fantastic value in use. If you think those companies will be able to make phenomenal profits over time, you could be wrong. Simply because there are certain constraints on how much power can be priced at.
Ensure that you....
- Understand the business you are investing in.
- Check for credible management that treats its minority shareholders well.
- Look for a strong moat and pricing power.
Give thought to your sale.
A value investor’s basic investing philosophy is based on the “law of the farm”.
The laws made by men can change and are manipulative in nature. For example, you short and you make money, you buy futures and options and you make money. You give an upfront commission and you get more clients. These are all short-term manipulative practices.
On the other hand, the laws of God are universal principals. One of them is the ‘law of the farm’. You cannot sow something today and reap tomorrow. A seed has to go through different seasons, before it turns into a tree and starts bearing fruit.
Ditto with value investing. Waiting is part and parcel of the game. Incidentally, it is the most difficult part. You can do your research well and buy a great stock, but it will be an exercise in futility unless you have a long-term view. Imagine growing grass. You water the ground every single day. You won’t see shoots instantly, but over time you will have a garden.
Ask yourself why you are in a hurry to sell:
- Do I urgently need the money right now?
- Is my rationale for buying the company still sound?
- Will the current developments have any negative bearing on the company's future earnings? Let’s say we are faced with a scenario where crude oil prices touched $100/barrel. Analyse how this would impact the company’s bottom line. Do you foresee this rise as a blip due to geopolitical turmoil and see it stabilizing soon?
- Is the market overreacting to one quarter's dismal performance?
- What is my research telling me? Is it compatible with what the management is stating?
If you are convinced that holding on to the stock is the right thing to do, you could even look at the possibility of purchasing more in the event of a considerable fall in price. If you picked it due to some “tip” or purely as a speculative play, you might as well sell. If not for a profit, at least for peace of mind.
Nothing lasts forever. A bull phase is followed by a bear phase. Maintain your equanimity in the market.