Monday, February 27, 2012

Identified that no-brainer investing strategy? Read this before you invest

Sometimes, a particular investing strategy seems just so obvious that we wonder why nobody around us gets it. It is easy to get seduced by the logic that we have XYZ credentials(read CFA/CA/MBA etc), have worked in ABC place(best equity/PE/hedge fund) and have spent so much time on the analysis(think of academics who spend months/years on a research, and the endowment bias makes them reluctant to abandon it without atleast publishing something!), and so we should know better than those multitudes of noise traders out there who have made the market inefficient. But remember that the market can remain irrational longer than you can remain solvent, also that your analysis itself may be flawed/misplaced. Below are some examples of seemingly no-brainer strategies, which need a deeper critical thinking before being acted on
  1. Growth Sector story: Every bubble-be it IT stocks, realty, telecom, education, consumer goods or microfinance-starts with the promise of an penetrated Mecca, which is accessible to the lucky investor who parks his money NOW. But, think whether the low hanging fruit has been already plucked by those PEs/VCs/angel investors who invested in the first movers. Are you investing in the lemons who are approaching you after being rejected earlier, and who will need to spend more to grab market share from incumbents, and run more risks. See this from the micro level, not assuming that those glossy consulting reports/graphs 'halo effect' will help your company as well.
  2. Fundamentally cheap(low price to earnings):- This is especially the case in cyclical stocks, or those stocks at the fag end of their growth cycle. So try placing the stock/industry within their respective business cycle and growth stage, before comparing the multiples with other stocks. PEG ration helps here for such an analysis. 
  3. Intermediary/Distribution model:- Here, the company does not run credit risk but usually runs a platform to facilitate transactions. Think But even there, you need to think critically-when will that information asymmetry go away? Already, price comparison websites(whcih are ad-supported) are threatening to disrupt the business models of travel and book retail sites. So do not assume that agency model is riskless and can grow for ever. 
  4. Low price to book:- Even for very low price to book multiples of say 0.1, it needs the most detailed balance sheet analysis to look for cash losses(which depress the ROE/balances), contingent liabilities, low asset quality, corporate governance risks like tunneling/related party transactions etc. 
  5. High dividend yield:-Besides the obvious risk(can this be sustained), you should also see the future plans/track record of the company. Stocks that yield more than bonds, do not stay that way for long-either someone takes them over or promoter looks for better business opportunities.
  6. 52 week lows:- While such stocks may get hyped up, look for the 3yr H/L and also all time lows. Also, remember to look for stock splits/bonus/rights issues which the price reporting service may have forgotten to adjust for. Else, you will end up being the sucker waiting for them to go up. And lows usually have a reason, so do not skip that analysis in the feeding frenzy to catch it at the lows.
These are just a few examples, of the need to always keep that critical thinking filter open. 

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