May 24, 2009

Are you feeling excited ?

The last one week has seen one of the biggest spikes in stock prices. Almost every kind of stock, has recorded a big jump in prices. Those of us who were lucky or had the foresight or both in buying stocks in the last 6 months, are now sitting on decent gains and must be feeling pretty smart and good about themselves.

I would hold my horses on that.

There is no harm in feeling good about it, but I would not let this feeling stop me from thinking rationally on what to do next.

Planning based on market forecasts !
One cannot be sure whether these price levels will sustain themselves or not. You will find every tom dick and harry trying to forecast or predict on what is going to happen. Well, if you are basing your strategy on these kind of predictions, then good luck with that.

I, for one have no clue and will not plan based on anyone’s predicitions or my ‘feel’ of what is going to happen. I did not have a clue in march, that the market would go up so soon and I don’t have a clue about the future market direction now.

During the period october 08 to March 09, I was a net buyer and commited a decent amount of money on a simple logic – The prices of the stocks I liked were attractive and way below intrinsic value and when they dropped below 50% of the intrinsic value, I bought.

Plan going forward
I have been analysing the annual results of all the companies I hold and re-evaluating the intrinsic value. If the price after the runup is still below instrinsic value and I expect the company to continue to do well and accordingly increase the intrinsic value at a decent rate, I will continue to hold. It would be stupid of me to sell a stock which still sells below instrinsic value, just because it has gone up by x%.

So what to sell ?
Now may also be a good time do some portfolio clean up. There are some holdings, especially in my
graham style portfolio which are not doing too well in terms of business performance.

These companies have a stagnant or decreasing intrinsic value and hence holding them longer is of no benefit. I plan to take advantage of the recent runup to sell such holding and re-invest the cash elsewhere.

Finally, if the stock price has exceeded the instrinsic value and I don’t expect the increase in intrinsic value to be above a certain threshold, I will start liquidating the holding.

Let me explain: Suppose my estimate of intrinsic value is 100 and stock sells at 120. Now lets assume for simplicity sake that I think the company will increase the instrinsic value at 10% per year. So by the end of year two, the intrinsic value of the stock would be 121. Now for sake of an argument, lets say that the stock will contine to sell at a 20% premium to instrinsic value – 141.

On the other hand I can liquidate the stock at 120 and invest the capital in another company which is selling at say, 40% discount to intrinsic value. If this company also increases its intrinsic value by 10% per year and at the end of year two sells at intrinsic value, then the value of my holding would be 242.

The above is ofcourse a simplistic sceanrio and there are several other factors involved, but the thought process should be clear.

It is important to try to remain rational at all times as far as possible. Being overly giddy and happy now will hurt as much as being fearful did in the last six months.


Neeraj said...

Hi Rohit,
Very very well said...controlling emotions (greed) is the need of the hour, just like it was (fear) a coupla months ago.
all the very best and keep up the good work...

Rohit Chauhan said...

Hi neeraj
yes greed has to be controlled. also one needs to focus on the correct variable - which is value in the stock and not the price alone.

Anonymous said...

Hi Rohit,

I am a new investor and have been trying to teach myself the fundamentals of investing.As I understand learning how to calculate the intrinsic value of stocks is the what one needs to begin with. I am going through all your previous posts but could you point out a specific blogpost(own/other) which focuses on this so I could expedite my learning.Thanks for sharing your thoughts esp on your learning process .

Charu Gupta's Blog said...

Hi Rohit,

Very well and aptly said. I also follow the concept of Value Investing and thus know it very well that while investing in stock markets, one should keep the emotions in control.

Phil Town's "ERI i.e. Emotional Rule of Investing - If you buy this business, immediately after you buy it, the price will go down, down, down. But if you don't buy it, the price will go up, up, up until you buy which the price will then go down, down, down" aptly summarizes the role of emotions in the investment world.

We just need to control it and "Be greedy when others are fearful, and be fearful when others are greedy" - Warren Buffett.


Rohit Chauhan said...

Hi anonymous, charu
thanks for your comment