Are there any safe stocks when the market is being battered every day by bad news?

Safety is a relative word. What one investor considers safe, another may find too risky. However, there are some stock sectors investors have looked to in troubled times as a safer haven than the general market.

No matter what the economy is doing, people still must eat and pay for utilities.

Won’t Stop Buying: You can think of other goods and services that the public isn’t going to stop buying, even in a recession - toilet paper is the classic example.

It is dangerous to assume that every company in these safe sectors is also a safe investment during tough times.

Investors should take a close look at individual companies before making decisions - not every consumer paper-goods company is a good investment.

How do you decide which companies to consider?

Look for a consistent pattern of earning across past periods of economic uncertainty.

You can do this on most financial sites.

A quick check using moneycontrol stock screener will provide various utilities with a five-year earnings growth.

This is a way to get started with finding investment candidates. The next step is a more thorough analysis, but financial websites help you narrow down the field.

12 Important Questions: How Warren Buffett decides which stocks or companies to buy.

1. Is the business simple and understandable?

Buffett will not invest in a business he can not understand, which is one of the reasons he avoided technology stocks even during the boom of the late 1990s. If you understand a business, you have a better chance of seeing opportunities and problems before they arise.

2. Does the company has a consistent operating history?

Although past performance is no guarantee of future results, it does show whether a business can operate in a variety of business conditions.

3. Does the business have favorable long-term prospects?

This may seem like a no-brainer, however Buffett believes in holding good companies for the long term and that meant seeing a clear future. Companies that operated on trends, fads and technology that is out of date tomorrow didn’t fit his model regardless of how profitable they were in the short run.

4. Is the management rational?

Buffett places a great deal of importance on management and one of the areas he focuses on is how excess cash is used. If the company can generate above average returns by reinvesting the cash in the business it should do so because this builds shareholder value. However, if not the management should return the cash to shareholders. In other words, the decision should be rational.

5. Is the management candid with shareholders?

Although strides have been made in opening company books, Buffett believes that many company executives still hide behind accounting conventions and don’t fully report to shareholders. He admires managers that admit mistakes and take responsibility for the company.

6. Does management resist the institutional imperative?

Buffett describes the institutional imperative as that need for managers to act and do like their peers no matter how irrational it may seem. Call it peer pressure for CEOs.

7. What is return on equity?

Buffett focuses on return on equity rather than the more popular earnings metric in evaluating companies. His rationale is that earnings are fleeting and can be manipulated. Long term, return on equity will have a more profound effect on the company’s fortune than earnings.

8. What are the company’s “owner earnings?”

Buffett uses a rough calculation that replaces the traditional cash flow calculation to give him a clearer picture of company value. His calculation includes estimates of future capital expenditures, something missing in cash flow calculations.

9. What are the profit margins?

If a company can’t convert sales into profits, it has obviously failed. One of the ways this happens is to keep expenses to a minimum. Buffett avoids companies with bloated expenses because it reflects a lack of discipline even if the company is profitable – it would be more profitable if expenses were always controlled.

10. Has the company created at lease one dollar of market value for every dollar retained?

Buffett notes that this is the test of correct capital allocation. Has the company correctly use capital to created market value (shareholder value) with cash it retained? If the company is holding on to cash, but not creating value for shareholders, what’s the point?

11. What is the value of the company?

Buffett says the value of a company is simply the total of the net cash flows (owner earnings) expected to occur over the life of the business, discounted by an appropriate interest rate. This model differs from most you’ll find because it depends on being able to predict earnings for the life of a company. Buffett says if you pick company that has the attributes mentioned above, you can do this.

12. Can it be purchased at a significant discount to its value?

This is pure Buffett and where he gains his margin of safety. By buying at a discount, he knows that even if he is off somewhat of his evaluations, the discounted price will cover the difference. However, my guess is he doesn’t need that margin very often.

Can you duplicate Buffett’s success? Probably not, but there are valuable lessons here for us all.

Source: “The Warren Buffett Way” by Robert Hagstrom. Published by Wiley Books.

You probably know it is not a smart decision to put all of your investments in a single stock.

Diversifying your stock portfolio is a smart way to reduce - but not eliminate - risk. Diversification spreads your investments so no one piece will be deadly to your portfolio if it fails.

But, what is the best way to diversify?

You should spread your stock investments in the following ways:

1. Own big, middle and small companies as measured by market capitalization. The more conservative your strategy is, the larger percentage of big companies.
2. A more aggressive strategy will favor middle and small companies, since they offer the most opportunity for growth (or failure).
3. Own companies in different industry sectors - some manufacturing, some financial, some telecom and so on.
4. Mix up growth and value stocks. If you are more risk oriented, favor growth over value.
5. Add a small percentage of foreign stocks (usually no more than 5-10 percent).  
6. You can probably do this with 8 to 12 individual stocks. If you are concerned about picking foreign stocks, buy a good low-fee mutual fund or an Exchange Trade Fund. 

There are two other components you need to consider in diversifying your total portfolio:

• Bonds should be in all but the youngest investors portfolio. Subtract your age from 100 and that's a good place to start. The answer is how much you should have in stocks. 
• Cash is always good. When interest rates are low, cash may not provide much of a return, however some part of your total portfolio should be in cash (money market funds, short-term Treasury issues, bank CDs, for example).

If you want to take diversification a step further, add in hard assets such as precious metals or real estate.

There are no hard and fast rules on diversification, but these guidelines will get you started.

Make adjustments based on your investment goals and tolerance for risk. Once you find a mixture you like, stick with it. That means at least once a year you should rebalance your portfolio if needed.

In our article on Price to Earnings Ratio or P/E , we noted that this number gave you an idea of what value the market place on a company’s earnings.

The P/E is the most popular way to compare the relative value of stocks based on earnings because you calculate it by taking the current price of the stock and divide it by the Earnings Per Share (EPS). This tells you whether a stock’s price is high or low relative to its earnings.

Some investors may consider a company with a high P/E overpriced and they may be correct. A high P/E may be a signal that traders have pushed a stock’s price beyond the point where any reasonable near term growth is probable.

However, a high P/E may also be a strong vote of confidence that the company still has strong growth prospects in the future, which should mean an even higher stock price.

Because the market is usually more concerned about the future than the present, it is always looking for some way to project out. Another ratio you can use will help you look at future earnings growth is called the PEG ratio. The PEG factors in projected earnings growth rates to the P/E for another number to remember.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = P/E /(projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 2 (30 / 15 = 2).

What does the “2” mean? Like all ratios, it simply shows you a relationship. In this case, the lower the number the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you see that what looks like a value may not work out that way. For example, a stock with a P/E of 8 and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG: 

• It is about year-to-year earnings growth
• It relies on projections, which may not always be accurate

Before you buy a particular stock, you may want to find out whether existing large shareholders are buying more or selling off their shares. This can help you evaluate the stock in the context of how their actions may influence the stock's price.

The reality for most well known stocks is institutions (mutual funds, large accounts such as retirement funds and pension funds, and so on) hold the majority of outstanding shares. You may want to consider this information when evaluating a particular stock.

Teams of Analysts

These large companies and institutions (known as Foreign Institutional Investors as well as Domestic Institutional Investors) employ teams of analysts to invest billions of dollars. It makes sense that they are going to spot good places to put their money, right?

The answer is a definite yes and no.

Of course, they are looking for a good return on their investments just like the rest of us. They look for good companies with good growth prospects, most of the time.

If the institutional investors are buying a stock, that is an endorsement of sorts that the stock has good prospects. If they are selling, it could mean something is wrong.

Where to Find Data

Before we talk about the value of this information, let us show you where to find it. The quickest way to do that is to use one of many online services that capture that data for you.

We like BSE & Moneycontrol website. Enter the stock symbol or code of the company you are researching, and then look at its share holding pattern, BSE provides information on share holding for past quarters. To see recent buying and selling of stocks by domestic mutual funds, you can use Moneycontrol.

Wrong Assumption

It is wrong to assume that institutional investors and individual investors share common goals. Institutions often have performance goals to meet, which push them to trade much more frequently than a normal individual investor.

For example, it is not uncommon for a growth mutual fund to turnover its portfolio 100% in one year. That means the fund managers have bought and sold every holding in the fund in one year.

This type of activity may drive them to buy or sell a stock with little regard to the underlying company’s fundamentals. You could see a big mutual fund dumping their shares of a stock and incorrectly assume there was something wrong with company’s future prospects.

This brings up another real danger of institutional ownership of a stock. When institutions become interested in a stock, they can drive up the price quickly with their huge block orders.

Just as quickly, the stock can collapse if the institutions decide the stock is flawed or there is a better opportunity with another stock. If they begin pulling their money out in big chucks, it will drive down the price. More institutions bail out and the stock goes into a free fall.

Could you recall Satyam story? Nobody expected that the price will fall from 170 Rs levels to a single digit price of Rs 8 in just 3 days. It was because of institutional investors, who sold off entire stake of Satyam.

What are investors to make of institutional ownership of a stock they want to buy?

First, most stocks will have some institutional ownership unless they are very small.

Secondly, watch for big changes one way or the other in ownership – are the institutions buying or selling. A change by a large number of institutions could mean something significant has changed at the company.

Finally, don’t ignore the company’s fundamentals. They still tell the best story about a company’s long-term chances for success in building value.

One way to evaluate a stock is to look at how effective the company’s management is in utilizing the resources available to them.

This measure of management effectiveness provides you with an idea of how well the company is being run relative to others in its sector and the market as a whole. Consistently low numbers are a red flag.

Unlike many comparisons, you can use these ratios to compare companies in different industries. The ratio's are:

• Return on assets 
• Return on investment 
• Return on equity 

Fortunately, you don’t have to compute these ratios yourself. Many websites provide this information.

Return on Assets

Return on assets tells you how well a company’s management uses its assets to make a profit.

You calculate the ROA by taking the net income and dividing it by the total assets. The ROA comparison works better over time so you can see a trend in how well management uses assets to the advantage of the company.

The higher the ratio, the better and the continued high level over time is even better because it indicates management makes a habit of managing with efficiency.

Return on investment measures not only the company’s contribution, but also the purposeful use of leverage or debt to extend company’s reach.

You calculate ROI by dividing net profits by long-term debt plus other long-term liabilities plus equity.

Managers choose to combine the company’s equity with outside debt to extend programs quickly and efficiently.

Skillful use of debt can change a 50 million project into a 75 million project. If everyone has done their homework correctly, the company can see additional profit from a larger project than they could have afforded without the debt.

Return on Equity

If numbers are good, return on equity is like a music for stockholders ears. It measures how well management did in earning money for them.

Unlike return on assets and return on investment, this measure goes directly to the stockholders and their stake in the company.

Unfortunately, ROE is somewhat flawed. You calculate ROE by taking net income and dividing by shareholders equity. Missing from this equation is debt and that distorts the picture somewhat.

Although ROE is somewhat helpful in looking at companies, it doesn’t provide the guidance the ROA does.

Averaging down is a strategy to lower your average cost in a stock that has dropped in price. Is this a good idea or throwing good money after bad?

The answer depends on several factors. First, let us describe how it works. You buy 500 shares at Rs50 per share, but the stock drops to Rs46 per share. You then buy another 500 shares at Rs46 per share, which lowers your average price to Rs48 per share.

Admittedly, this is a simple example, but you get the idea.

Good Strategy or Bad?

Now, is this a good strategy or not? If the stock rebounds to Rs60 per share, then it was a great strategy. However, if the stock continues falling, you have to decide to keep averaging down or bail out and take a loss.
Which brings us back to the question, is averaging down a good strategy or not? Before we can answer that question, we need to decide if we are investing in a stock or a company. The distinction is very important.

Investing in Stock: If you are investing in a stock, you look for buy and sell signals based on a number of indicators. Your goal is to make money on the trade and you have no real interest in the underlying company other than how it might be affected by market, news or economic changes.
In most cases, you don’t know enough about the underlying company to determine if a drop in price is temporary or a reflection of a serious problem. Your best course of action when investing in a stock (as opposed to a company) is to cut your losses at no more than 7%. When the stock drops that much, sell and move on to the next deal.

Investing in a Company: If you are investing in a company (as opposed to a stock), you have done your homework and know what’s going on within the firm and its industry. You should know if a drop in the stock’s price is temporary or sign of trouble.
If you truly believe in the company, averaging down may make sense if you want to increase your holdings in the company. Accumulating more stock at a lower price makes sense if you plan to hold it for a long period.

This is not a strategy you should employ lightly. If there is a heavy volume of selling against the company, you may want to ask yourself if they know something you don’t. The “they” is this case will almost certainly be mutual funds and institutional investors.

Swimming against the current can sometimes prove profitable, but it can also get you swept over the waterfall.

Hence, if you’re playing stocks, averaging down probably doesn’t make any sense. Take a small loss before it becomes a big loss and move on to the next trade.

If you invest in companies, averaging down may make sense if you want to accumulate more shares and are convinced the company is fundamentally sound.

The Bulls

A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Things are just plain rosy! Picking stocks during a bull market is easier because everything is going up. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. If a person is optimistic and believes that stocks will go up, he or she is called a "bull" and is said to have a "bullish outlook".

The Bears

A bear market is when the economy is bad, recession is looming and stock prices are falling. Bear markets make it tough for investors to pick profitable stocks. One solution to this is to make money when stocks are falling using a technique called short selling. Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a bull market. If a person is pessimistic, believing that stocks are going to drop, he or she is called a "bear" and said to have a "bearish outlook".

The Other Animals on the Farm - Chickens and Pigs

Chickens are afraid to lose anything. Their fear overrides their need to make profits and so they turn only to money-market securities or get out of the markets entirely. While it's true that you should never invest in something over which you lose sleep, you are also guaranteed never to see any return if you avoid the market completely and never take any risk.

Pigs are high-risk investors looking for the one big score in a short period of time. Pigs buy on hot tips and invest in companies without doing their due diligence. They get impatient, greedy, and emotional about their investments, and they are drawn to high-risk securities without putting in the proper time or money to learn about these investment vehicles. Professional traders love the pigs, as it's often from their losses that the bulls and bears reap their profits.

What Type of Investor Will You Be?

There are plenty of different investment styles and strategies out there. Even though the bulls and bears are constantly at odds, they can both make money with the changing cycles in the market. Even the chickens see some returns, though not a lot. The one loser in this picture is the pig. Make sure you don't get into the market before you are ready. Be conservative and never invest in anything you do not understand.

Before you jump in without the right knowledge, think about this old stock market saying: "Bulls make money, bears make money, but pigs just get slaughtered!"

To get the best from mutual fund (MF), it is important to follow the right approach and make the right decisions. It is commonly perceived that only those investors who invest directly in the stock market are likely to suffer a setback. The fact, however, is that mutual fund investors, too, run a risk - if they error their decisions. Below are some common mistakes investors make and an advisory on how these can be avoided:

Investing without a plan: Many investors start the investment process without determining the investment objectives and deciding on the right asset allocation to achieve these objectives. Though the MF investment process is simple, it still requires planning, perseverance and time.

Underestimating risk, overestimating reward: It is quite common to see MF investors make this mistake. One needs to be careful about this aspect of investing, as different schemes have different risk profiles and you should expect returns commensurate to that.

Going for short term gains: Many investors often lose sight of their long term objectives to fulfill their short-term needs. In this process, they end up making wrong decisions. As a result, they either lose a part of their hard-earned money or earn much lower returns.

Allowing portfolio to ride: Many equity fund investors allow the portfolio to ride when the market is in a bullish phase. In times like these, they often forget about the original mix of equity and debt and/or large-cap and mid-cap stocks. No doubt, the equity market requires a long term commitment to secure investment benefits, but it is equally important to rebalance the portfolio from time to time.

Averse to trying investment options: Investors, who invest in conservative options offered by mutual funds, often hesitate to look at other smart options like monthly income plans, equity and derivative funds and well-diversified equity funds. These funds, if held in the right proportion, have the capability to improve returns for a long term investor. Though investment risks and economic uncertainties can never be eliminated. MFs - thanks to their mix of experience, research and analysis - are in a much better position to ensure that investors in different segments achieve their investment objectives.

Discontinuing SIP in a falling market: SIP, or systematic investment plan, is the best way to build up capital over a period of time for those who don't have a lump-sum to invest. However, it requires discipline to continue irrespective of the state of the market. There are investors who get panic whenever the market witness a fall and get tempted to discontinue to SIP.  However, the fact is that an investor, who takes the SIP route, benefits in a falling market, as he gets more units for the same amount. Therefore, one needs to carry on and reap the benefits in the long run.

Investing in same category NFO: Many investors perceive wrongly that NFO (New Fund Offering) is cheaper as compared to other available funds in the same category. The simple reason is that investors look at the price of 10 Rs per unit which does not make any difference in terms of returns if compared with old fund. Investment in NFO is suggested only if fund offers some value services which is not available in existing funds. Investing in NFO in the same category should be avoided as fund does not carry any past performance. Moreover, NFO promotion and advertisement cost is paid by the fund manger from the total corpus collected from investors. 

Not analysing a fund's track record: One of the most important parameters in the selection process is the past performance. Many investors, however, make the mistake of either ignoring the track record or considering short-term performance while selecting funds. While analysing performance, the focus should be on differentiating investment skill of the fund manager from luck and on identification of those funds with the greatest likelihood of future success.  The following factors are important in evaluating the track record of a fund manager:

• Consider long-term track record rather than short-term performance. It is important bacause long-term track record moderates the effects, which unusually good or bad short-term performance can have on a fund's performance.
• Evaluate the track record against similar funds. Success in managing a small - or in a fund focusing on a particular segment of the market - cannot be relied upon as an evidence of anticipated performance in managing a large or a broadbased fund.
• Discipline in the investment approach is important, as the pressure to perform can make a fund manager susceptible to change tracks in terms of stock selection as well as investment strategy.

Doing it themselves: Many investors do not consider finding a good advisor as crucial. As a result, they either end up making wrong investment choices or dealing with those who don't do justice to their hard-earned money. It is vital to deal with professionals, who have the knowledge and the capability to ensure that the investor remains on course of achieving the investment objectives.

As an investor in stocks, you should always be asking what the company will do for you tomorrow.

By that, Investors are particularly concerned with future growth in earnings and, ultimately, the stock’s price and dividend if it pays one.

A company can have a great year and the stock can reflect that performance, but if there is no brighter tomorrow, how is future stock price growth going to be justified?

This concern with short-term growth is often criticized as a problem that penalizes companies that make decisions good for the long term, but detrimental in the near term to earnings.

Stock is Hammered

That’s not always the case if management is trusted by investors to make good decisions, however in many cases a company's stock is hammered in the market if there is not a clear pattern of year-to-year growth.

This is especially true of companies tagged as growth investments and in sectors such as technology that are marked by high growth rates.

While this may seem unfair to some, it is a perfectly logical way for the market to allocate investment assets to those stocks that will produce the highest returns in the near future.

Stocks for Long Term

Individual investors are rightly cautioned to invest for the long term and many successful investors do just that, however they only do so when they find a company that has a good chance of providing a sustained growth over a long period.

Investing in company for the long term that does not grow is a pointless exercise (unless you are investing in a utility, for example, for a nice fat dividend and don’t care much about the share price).

The Stock investors should always looking forward and should not be concerned with past performance other than in providing a reference point.

Leverage Financial Ratios

Those financial ratios that show the percentage of a company’s capital structure that is made up on debt or liabilities owed to external parties

Liquidity Financial Ratios

Those financial ratios that show the solvency of a company based on its assets versus its liabilities. In other words, it lets you know the resources available for a firm to use in order to pay its bills, keep the lights on, and pay the staff.

Operating Financial Ratios

These financial ratios show the efficiency of management and a company’s operations in utilizing its capital. In the retail industry, this would include metrics such as inventory turnover, accounts receivable turnover, etc.

Profitability Financial Ratios

These financial ratios measure the return earned on a company’s capital and the financial cushion relative to each dollar of sales. A firm that has high gross profit margins, for instance, is going to be much harder to put out of business when the economy turns down than one that has razor-thin margins. Likewise, a company with high returns on capital, even with smaller margins, is going to have a better chance of survival because it is so much more profitable relative to the shareholder's contributed investment.

Solvency Financial Ratios

These financial ratios tell you the chances of a company going bankrupt. There’s really no elegant way to say that. The whole point of calculating them is to make sure that a company is not in danger of going under anytime soon.

How much cash do you have in the bank? Can you pay all of your current bills and still have a positive balance?

If so you are considered highly liquid, meaning enough of your assets are either cash or easily converted to cash.

For stock investors, a company’s liquidity is an important consideration in looking for potential investments.

Companies that have good liquidity are able to ride out bumps, the economy may put in their way.

The question for stock investors is how do you measure liquidity.

Cash Ratio

The cash ratio is the most conservative ratio for measuring liquidity is often used during periods of economic turmoil.

The cash ratio is easy to calculate. It is:

Cash plus easily marketable securities divided by current liabilities.

Current liabilities are defined as those bills due within one year, such as bills to vendors, suppliers, daily operating expenses, and so on.

You can find the values for this equation on the balance sheet.

The cash ratio should be close to 1 and higher is better.

Ignores Assets: The reason the cash ratio is considered a very conservative view of a company’s liquidity is that it ignores such values as inventory (which turns over at least once a year for most companies).

The cash ratio also ignores the daily cash generation of the business as it sells products and services.

Why use the cash ratio?

In difficult times, cash is the most important asset many companies possess.

If a company has a ready supply of cash, it can survive sudden drops in sales that might put another less liquid company out of business.

The cash ratio is a good gauge of how a company can weather difficult times.

It is not a good ratio to use when considering the value of a company because it excludes valuable assets such as inventory and property. It is not a good ratio to use by itself, because much is missing from the total health of the company.

However, it is a good signal that a company is worth further consideration or a red flag that a company with a poor cash ratio may lack the liquidity to survive a difficult economy.

Like the fabled tortoise that beat the hare in the race, the investor who stays in for the long term is more likely to achieve his or her goals than the investor who chases “hot tips” for quick profits in the stock market.

Time is an investor’s best friend (or worst enemy if you wait too long) because it gives compounding time to work its magic. Compounding is the mathematical process where interest on your money in turn earns interest and is added to your principal.

Consider the following four investors ages 25 – 55. Each invests Rs 2,000 per year and earns 8%.

At age 65:

The investor who started at age 25 has over Rs. 585,000

The investor who started at age 35 has just Rs. 250,000

The investor who started at age 45 has just Rs. 98,800

The investor who started at age 55 has just Rs. 30,700

The results are quite dramatic and, as you might expect, the youngest investor comes out the best. However, look at the difference starting 10 years sooner can make. The fewer years invested the more dramatic the difference with the next youngest age. The investor who starts at age 45 still earns over three times as much as the investor who starts at age 55. Of course, part of the difference is the 45-year-old investor has 10 years (Rs. 20,000) more to invest, but the rest of the difference is the power of compounding.

This may not be the most “real life” example, since we can’t go back to age 25 and start over. Let’s look at the power of long-term investing from a different goal. What will it take for each of these investors to accumulate Rs 750,000 at age 65, assuming they all earn 8% and ignoring inflation and taxes?

The investor who started at age 25 needs to invest Rs 213 per month

The investor who started at age 35 needs to invest Rs 500 per month

The investor who started at age 45 needs to invest Rs 1,650 per month

The investor who started at age 55 needs to invest Rs 4,072 per month

While all four investors reach the goal of Rs 750,000, it is obvious that the younger investors get a lot more “heavy lifting” from their investments. The lesson is clear: The earlier you start the less you have to invest to reach your goal.

Problems & Corrections

The examples above describe the mathematical advantage of starting early, however they don’t represent a “real world” situation. It is highly unlikely that you could achieve a constant return of 8% over a long period. The reality is there will be times when your investments earn less and other times when you will lose money. There may also be times when you will earn more.

The investor with a long- term perspective can also correct for mistakes along the way. For example, that stock you thought was going to soar like an eagle turned out to be a turkey. If you have a long-term perspective, you can change investments that aren’t working for other alternatives. However, if you will need the money from your investment in the near future (fewer than 5-7 years), a mistaken investment can create real problems in meeting your goals.

Long-term investors, especially those who invest in a diversified portfolio, can ride out down markets like the one that began in March of 2000 without dramatically affecting his or her ability to reach their goals.

However, for the investor just starting out at age 55, a market downturn can be disastrous. There is no room for error with only 10 years left before retirement at age 65. The reality of investing is that the market will go up and the market will go down. Investors that begin early and stay in the market have a much better chance of riding out the bad times and capitalizing on the periods when the market is rising.

There are three main areas of influence that move a stock’s price up or down. If you understand these influences, it will help you decide whether the price movement is a buy, sell or sit tight signal.


Fundamentals Changes 

Clearly, the most direct influence on a stock’s price is a change in the economic fundamentals of the business.

If revenues and profits are on a steep upward trend with no indication of leveling off, you can expect to see the stock price rise as investors bid up this attractive company.

On the other hand, if the profit picture is flat or, worse, declining with no change in sight, look for investors to abandon the stock and the price to fall.

These are simple examples of changes in fundamentals. Other, more complex and subtle changes can occur that may not dramatically affect the stock price immediately (increased debt, a poor acquisition and so on can also trigger price changes).

The point is that changes in the underlying business have a direct impact on the stock’s price. Smart investors spot the subtle changes before they become price-movers and take the appropriate action.

Sector Changes

Changes in the stock’s sector can have positive or negative affects on price too. Some sectors or industries are cyclical in nature and you should know that would affect price.

However, when whole sectors catch of fire (think real estate stocks) or burn up (think real estate stocks, again), even those companies that have solid fundamentals are pulled along with the rest of the sector.

You may hold a stock that is a victim of “guilt by association” when an industry falls out of favor. Likewise, stocks can see prices artificially inflated if they find themselves in the right industry at the right time.

Market Swings

The market goes up and the market goes down. That’s about all you can say with certainty concerning the stock market.

As the market moves up and down, your stock may move with or against it. Most large-cap stocks will follow the market to some degree, but smaller companies may not get the same push every time.

In general, a strong market move either up or down will carry more stocks with it than not, so your stock may be up or down for no other reason than the market was up or down.

How do you use this information?

A change in fundamentals may be an opportunity to buy more shares of a growing company or it may signal the time to sell if the changes are for the worse.

A change in the sector is usually temporary so most long-term investors will ride out dips due to these factors. However, if something drastically changes in the stock’s industry due to regulation or a new technology, for example, you may want to reevaluate your position. Is the company capable of adapting or do you own a dinosaur?

Market swings that move your stock’s price can be opportunities to buy additional shares (assuming all the company’s fundamentals still checkout). If the rising market pushes up your stock’s price, it may be time to take a profit on part of your holdings and wait for the price to come back down to earth to reinvest.

Fundamental analysis is the process of looking at a business at the basic or fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives you an idea of the value its stock.

Many investors use fundamental analysis alone or in combination with other tools to evaluate stocks for investment purposes. The goal is to determine the current worth and, more importantly, how the market values the stock.

Earnings

It’s all about earnings. That is what investors want to know. How much money is the company making and how much is it going to make in the future.

Earnings are profits. It may be complicated to calculate, but that’s what buying a company is about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend.

When earnings fall short, the market may hammer the stock. Every quarter, companies report earnings. Analysts follow major companies closely and if they fall short of projected earnings, sound the alarm.

While earnings are important, by themselves they don’t tell you anything about how the market values the stock. To begin building a picture of how the stock is valued you need to use some fundamental analysis tools. These ratios are easy to calculate, but you can find most of them already done on various financial websites.


Below are the most popular tools of fundamental analysis. They focus on earnings, growth, and value in the market.

• Earnings per Share – EPS
• Price to Earnings Ratio – P/E
• Projected Earning Growth – PEG
• Price to Sales – P/S
• Price to Book – P/B
• Dividend Payout Ratio
• Dividend Yield
• Book Value - BV
• Return on Equity - ROE

We published articles on EPS and P/E ratio, you will get the updates on other tools in Saral Gyan future Articles. No single number from the above list is a magic bullet that will give you a buy or sell recommendation by itself, however as you begin developing a picture of what you want in a stock, these numbers will become benchmarks to measure the worth of potential investments.

Saral Gyan team spends a great deal of time explaining things to the clients as well as many other individuals that do not necessarily revolve directly around specific "investments". Over time we have seen that there are a number of issues that individuals should know and understand prior to making investing decisions. This is our list of the top 10.

• Investing in a vacuum is never a good idea.

Set and establish goals for your future and determine how those goals are influenced by the results of your investing. It is never wise to invest solely for the sake of "doing well" or "I want to retire comfortably". Goals such as these leave too much ambiguity and room for error. Your portfolio should reflect your goals (to retire at 55 with a specific income), risk tolerance (I feel comfortable with a -8% annual loss exposure) and time horizon (the kids start college in 10 years, I have 18 years until retirement). Think of it this way, you are on a journey. How do you know if you have arrived if you do not know where you are going?

• You have an advantage over the professionals.

Professional money managers are usually always tied to beating "the market" month to month and quarter to quarter. They are judged solely by their performance and are therefore influenced to take more inherent risk in order to beat indexes and peers. The professionals also do not have the luxury of holding on (or buying more of) when a specific security starts to tank. You should have no such worries over performance measurement but can simply sit back, focused on the long-term, and wait it out.

• Asset allocation is the most important part of investing*.

Much more so than choosing the right security or being lucky enough to own the next Infosys, asset allocation determines over 91% of the total portfolio performance according to an Ibbotson study. A good, sound selection of asset classes mixed together will establish the framework of your portfolio performance over the long run.
* Asset Allocation cannot assure a profit nor protect against loss. Investments are subject to market risks including the potential loss of principal invested.

• Investing is risky.

No matter what you invest in there is an inherent level of risk associated with all investments. If you choose to be ultra conservative and invest in cash deposits then you are assuming inflationary and income generating risk. Investing in bonds can contain as much risk as stocks at times.

• The higher the rate of return the higher the risk you assume.

Earning a high level of return requires taking more risk, but taking more risk does not always equate to a higher return. It is a well-known fact that in order to achieve higher return rates you must assume a higher level of risk which can and typically does equate to losses within a portfolio greater than many investors are comfortable with accepting. However, just because a holding or portfolio is high risk it is not necessarily capable of generating high returns. In some cases something is considered "high risk" because it is unlikely to generate a moderate or high return.

• The Rule of 72.

The rule of 72 is one of those rules of thumb for quick and basic calculation. Take the rate of return and divide it into 72. This will be the approximate amount of time it takes for the money to double at the specified rate of return. For example, if you assume a 12% rate of return and divide 72 by 12 then your money would double in 6 years. For those of you who wish your money to double every 3 or 4 years this should give you an idea of the level of return (and subsequent level of risk) you must achieve.

• Never allow the tax to eat returns of a portfolio or holding.

Tax decisions absolutely have an impact on the overall return of a portfolio but allowing the tax issue to drive portfolio decisions can have detrimental results. Investors hold onto an asset much too long because of not wanting to pay capital gains on the sale of the asset. Instead they realized a much larger loss from movements within the particular asset when the price falls. Make sound investment decisions on logic and do not let the emotion of taxes drive you.

• Watch what you watch and read.

Turn off the talking heads on TV and put down the latest investment periodical. These formats are informative if taken lightly and in the proper amount but they are more interested in selling subscriptions and driving ratings than they are about giving quality advice. The movements generated by the advice of those in the television and print media are not always the best for the investor. News only sells when it gets our attention and unfortunately that hardly ever equates to good news.

• Good well-established companies do not always make great stocks.

It seems counterintuitive that a well-established, well-known company would not automatically make a great stock to hold. Good, even great companies can and do falter as well as the lesser-known companies. In fact many of the well established companies have a hard time growing beyond the boundaries in which they have typically always existed. Too much exposure to too many of these giants can have a less than stellar effect upon your portfolio.

• This one could really be 2 in 1.

Do not put more than 10% of your money in your companies stock or within any 1 individual stock. In addition, within any portfolio (look at the holdings in the aggregate and not strictly by account) make sure that you have any individual stock position limited to no more than 10% of your holdings. We all think that the stock we have loaded up on is a high flyer and because of their business model or sales or new product coming on the market it is bound to double in price. Every stock you purchase was from someone else who wanted out. Do not expose yourself to excessive risk with excessive positions.

As Saral Gyan Team have stated on a very frequent basis, and will continue to do so at every opportunity, investing is risking and should be approached with care. One should never avoid investing but should approach it with diligence and understanding. The lack of knowledge of basics is one of the biggest hurdles we see most investors struggle with in regards to what they are looking for and what they expect. Balance out expectations with reality and see how well they fit. Get a good understanding of investing basics, especially including the emotional side to investing and utilize sound logic and reasoning. Chasing returns on the up side or running away from them on the down side never accomplishes either race. Utilizing logic and emotional balance as well as good asset class selection and you should find a much better fit. You and your portfolio will be much better served and more comfortable as a result.