In 5 tips on how to pick a stock, I spoke of the parameters I consider when buying stocks.
But before we narrow down on a stock and do our research, we have to hear about it. Sometimes, this can happen through the most unexpected sources.
Years ago, when the tech rally took a turn for the worse, I saw a middle-aged gentleman talking to my sub-broker. He was trying his best to put on a brave face. "I bought 50 shares of Silverline at Rs 950 some days back," he said. "Now, I bought 50 more at Rs 750 to average the price."
I could have sworn he had never sat in front of a computer, had absolutely no idea of Silverline's business model or knew anything at all about the company for that matter. He had obviously invested in it based on a tip.
Yet, it is not fair to say that all 'tips' are bad.
How do we decide what advice to take?
Understand what you buy
Look around you and you will get some good leads.
For starters, be partial towards companies which are mainly driven by domestic demand. Walk into a nearby paan shop and you will soon find out ITC is the undisputed leader in cigarettes. Now, stroll into a kirana shop and you will soon realise Saffola in edible oils and Parachute in hair oils is quite popular in urban India.
This is very basic and overly simplified example, but nevertheless it is a starting point.
There are many articles published in financial dailies about the market share of various FMCG and pharma companies across categories. Investors would do well to read them.
Every young person in this country knows that remix versions of old songs are in vogue for a while now. Did any of them buy Saregama?
I am not an expert in the steel sector but I was reading for some time that steel prices have bottomed out and they are due to go upwards (this was more than 18 months ago). The surest sign came when a friend of mine in construction complained that with steel prices going up every month, he is forced to increase home prices.
Listen to all the experts but do your own research
A well-known stock broker often gave investors stock advice through the media. But he too consistently told investors to do their own study and have conviction.
A few years ago, when the bear market was the order of the day, he recommended a stock called Max India as a value pick. It turned out to be a multi-bagger (giving returns many times your investment) later. In those bad days, though, Max India went down week after week. The broker had to assure some irate investors he was convinced of the stock's potential and had invested in it himself. But they were not convinced and felt he had misled them.
On the other hand, I personally know many who argue they have immensely benefited by following his advice blindly in the current bull run.
The moral of the story: Blind faith in any person/ institution may give huge returns during a bull run, but it just doesn't work in a bear market. Don't blindly follow the advice unless you are convinced of it yourself.
Those who followed Harshad Mehta and Ketan Parekh, at one time the demi-gods of the stock market, made obscene amounts of money when the going was good. But most of them lost out when the market began to slide downwards.
The idea I am stressing is that investors should learn to pick their own stocks if they want to survive the rough and tumble of the markets.
For a small investor, survival in the stock market is of paramount importance. That alone can assure good returns over a long period.
Verify and weigh (don't ignore) advice coming from unexpected quarters
Sometimes, you may get brilliant advice from unexpected quarters but choose to ignore it because it is not expert advice.
My brother-in-law, for one, constantly regrets the fact that he ignored his father's advice one time.
It was a few months after 9/11 when most stocks were still quoting at abysmally low prices. At that time, he decided to invest in the market. His father suggested Shipping Corporation of India since that was where he worked. His father was not an investor in markets but he was seeing a lot of business being generated. It was going for Rs 25-Rs 30 in December 2001. My brother-in-law, on the other hand, looked upon it as a fuddy-duddy public sector stock.
By November 2003, the price was Rs 150. He had missed out on a six-bagger (a return of six times his investment)!
Of course, advice can be destructive too. I'm sure all of us have had those experiences when we follow a lead which burns a hole in our wallet.
So, next time you get a tip or are told that the Sensex will breach 12000, always ask why.
Even if you are convinced that the Sensex is headed in that direction, it does not mean that all stocks are going to go up for sure.
Indians discuss endlessly about politics and cricket and come up with some interesting analysis but seem to lose this analytical power when it comes to stocks.
No matter how close the friend who gave you the tip, do your homework. Remember the famous line in the movie Wall Street: "If you want a friend on the street, get a dog."
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