Schumacher is right: Small is beautiful (In Stock Investing)...

In another article in this blog, I argued just the reverse

In that article, I argued that one of the mistakes that retail investors make is to focus on Number of Shares they own instead of focusing on Return on their investment. My point in that article was that for the same amount of investment, Large Caps provide higher returns to a retail investor than small and midcaps. 

In this article, I am going to argue the reverse. With a BIG CAVEAT.

If you are willing to hold on for long term (5 years to 30 years), if you are able to identify the good midcap, if you are willing to ride the storm of ups and downs in the share price, all the time staying invested to your convictions.....

If you do all that,

Then small is beautiful.

Let us take some examples.

If you had invested Rs.3500 in ICICI Bank in 1998 (which I did) and stayed with the stock till today (which I didn't, I am  a retail investor remember?) that investment would be worth Rs.140000 today.

If you had invested Rs.5000 in SBI in 2000 and stayed with it, that investment would be worth Rs.270000 today.

If you had invested about 10000 in WIPRO in 1980 and stayed with it, that investment would be worth  Rs.480 Crores today !!

An investment in Infosys of Rs.9500 in early 90s would be worth about 12 Crores today !!

Huge returns are possible in stock market if,

You identify the right companies

You buy early

You stay with it for long term across market cycles

Or,

If you are plain lucky Like Sridhar's Father in Law

Sridhar is an advertising professional in Bangalore. He is a friend of Nandan Nilekeni. In early 90's when Infosys came out with IPO, Nandan asked Sridhar to invest in Infosys. While he is not into stocks, Sridhar invested Rs.95000 in the stock to purchase 1000 shares of Infosys since he was not able to say no to Mr.Nilekeni.

Those were the days of physical certificates. Sridhar was fully allocated the shares and he got 10 gleaming Share Certificates each for 100 Shares.

That was the time he had got married. He wanted to impress his wife by gifting something to his Father-in-law (men do such stupid stuff all the time). Sridhar gifted his FIL with 500 shares of Infosys. 

Since the shares were in physical form and share transaction costs were high and there was not much demand for Infosys shares early in the 90's and also as a courtesy to Nandan Nilekeni,  the FIL did not sell the shares.

That investment of 47500 (0.05 Million Indian Rupees) is worth 60 Crores (600 Million Indian Rupees) today !

His Father In Law thinks that Sridhar is the smartest Son-in-Law in the universe.

Sridhar, on the other hand, feels that he is the stupidest Son-in-Law in the universe.

Coming back to the topic, the question is, do you have the courage of your convictions?

I don't. When I buy a share at a low price, I have very modest expectations. If the price goes up by about 50% I sell. I make profit all right, but I don't build wealth.

But you should have. 

So here is my advice. A new bull market is starting in Indian stock market. There are going to be huge opportunities if you are ready to buy good and wait. This is the right time to enter. Once you enter, stay. Do your due diligence (Can you see the product of the company, have you used the product, what others are saying about the product, is the firm making profits....) and buy. Once you buy do stay for at least 3 years. You will make huge profits, I can assure.

This is the best time to buy low and sell high...

Like Schumacher said, small is beautiful in stock investing.

Schumacher is wrong, small is not beautiful (In Stock Investing)...

While investing in stock market, there is a rookie mistake that retail investors make. 

Number of shares is given more importance than the return on your investment.

Let us say that you have Rs.5000 to invest. You have a choice between two stocks. One, that of ABC Ltd is trading at Rs.50 per share. The other of XYZ Ltd is trading at Rs.2500 per share. 

Which company shares will you buy?

If you  are like what I was about 3 years ago, you will do a calculation as follows.

If I buy ABC Limited, I will get 100 shares and in case of XYZ company, I will get only 2 shares. 100>2 ergo, I will buy shares of ABC Company. 

Another logic that you will use, like I used to do, is that if the company declares 10% dividend, you will get Rs.100 in case of ABC Company and Rs.2 in case of XYZ Company.

There are many fallacies here that I have learned over the course of having made losses multiple times. 

1. There is a reason that ABC and XYZ are trading at the respective prices. ABC is a novice, it is just testing the waters. XYZ is tried and tested. It has a history of giving good returns on Investment to the share holders. Many people want to buy that stock and that is why it is trading at a higher price. You must at least analyse why the respective shares are trading at their prices. 

One reason may by that ABC is in an industry undergoing recession. For example, if ABC is a company in commodities, its share price will be low during Commodity Downturn.

Another important reason the share price of ABC is low may be due the large quantity of floating shares available in the market. Due to the sheer number of shares, the price per share will tend to be very low. The share price will find it very difficult to climb upwards since for every rise in share price there will be many people who may want to offload their shares. 

2. What about the dividend calculation, you may ask. As per my math, you may say, ABC will give me Rs.100 while XYZ will give me only Rs.2. To you my counter question is, have you checked the dividend history of XYZ before you did the math? Chances are that it will give dividends much in excess of 10%. Total dividend from XYZ may turnout to be much higher than Rs.100.

Anyway, you are not buying stocks only for dividend. Most of the return that you expect from a stock is through capital appreciation. 

Which brings me to my next point.

3. Look for the expected Return On Investment, not on the number of shares that you have.

As an investor, you are investing Rs.5000 and you are looking to maximize your ROI. Since most of the ROI in stock investing will come from Capital Appreciation, you have to look at how fast your investment is expected to increase. For example, if you are looking at a return of 50% on your investment, the price of a share of ABC purchased at Rs.50 has to increase to Rs.75, while the price of XYZ purchased at Rs.2500 has to increase to 3750. Since there is more demand for the shares of XYZ, the chances are that the price of XYZ will touch 3750 quicker than price of ABC touching 75. 

I learned these lessons about three years ago. While looking at my portfolio, I found that absolute value of my returns, for the same amount invested, was significantly and consistently high for the shares of companies like XYZ, (Large Caps, as they are called) than for the shares of companies like ABC (Small and Midcaps). To get a good absolute return in ABC Company, I have to invest significantly high amount of money in those companies and that was leading to increase in my Risk Profile. 

I also found that over a multi-year, large caps have given me positive returns irrespective of at what price I purchased the shares. I remember that I had purchased shares of a company at 1100 about 3 Diwalis ago, and price having gone down to 300 in the interim, it has climbed back to my purchase price.

And I received good dividends and one bonus in those three years !.

So friends, here is my advice. While investing in stocks, always focus on Return On Investment and never focus on the number of shares that you are buying.

Despite what Schumacher says, small is not beautiful when it comes to investing in stock market.

Why Mrs.Preethi Malhotra will not make money in Stock Market?

Mrs.Preeti Malhotra (PM in Short) is my neighbour in my apartment complex. What with my work taking me away from home early in the morn and dropping me back close to naptime, I hardly get to meet my neighbors. However, the news has gone around that I know a bit about investing and is enthusiastic about giving free advice.

So I have somehow become the neighborhood investment consultant.

I hardly get to meet PM. The other day, I met her in the market.

"Hello Ram, good to see you here", says PM, "I was planning to meet you. Needed some advice on investment. I have about 3 Lakhs (300,000) to invest. I was wondering where I can invest.. What are my options?"

"Why don't you invest in Stock Market?", I ask an innocent question.

"Baap re baap, no, no. no...I don't want to invest in Stock Market. Last time I invested, I lost some money. I invested in a stock of Wipro at 700 and soon after it came down to 500. I sold it off and cut my losses", came the emphatic reply.

('Baap re baap' is the ultimate emotional statement of dislike for an Indian Lady. It loosely translate to 'Oh My God', and is normally followed by a negative statement.)

"But now the price of Wipro is 1500", I pointed out.

"Yes, but I lost money no?" came the irrefutable statement. Who can argue with that?

"Let me ask you something. What are you going to buy in this market?", I enquired, pointing around.

"I came to buy some vegetables-you know tomatoes, onions and other vegetables", she responded.

"How much do you think is the fair value of a Kilo of Tomato?" I asked.

"I don't know, may be around 20 bucks", she replied

"What if you find that the price is 10 bucks per Kilo? ", I asked

"Then I will buy 2 or 3 Kilos. It is difficult to get good tomatoes even at 20 rupees. So 10 bucks per kilo will be a flea market bargain", she responded

"What if the price is 50 rupees per Kilo?"

"Then I will cut down on tomatoes. May be buy a quarter Kilo", said PM.

"Now let us look at Stocks. What do you think is the fair price of the stock of ABC Company?" I asked.

"Considering their last quarter earning and the earning potential, I think 200 rupees is a fair value for the Stock,", PM replied.

"Suppose today you open the paper and see that the stock price of ABC Company is Rs 100, will you buy the share?"

"Of course not", PM replied, "I don't know why the price fell. May be there are some bad news about the fortunes of the company that is floating around that is bringing down the stock price. I will wait for the price to turnaround."

"Assume that it has bounced back from 100 to 200 (your fair value), will you buy now?" I queried.

"No, I won't. I think that I should have purchased it at 100, I feel that all the profit potential has been factored in. I will wait for it to come back to 100". She replied.

"What if it didn't come to 100? Instead it went up to 500, will you buy?" I persisted.

"I think I will take an interest in it. When it has come from 100 to 500, there should be some news about it that I don't know of. I will buy it. Definitely", PM responded

"And you will sell if, after you purchase, the price come down to say 400. This is what you did with Wipro." I pointed out.

"True, I will assume that I made a mistake and get out of the stock", she was categorical.

You see, right there, you have the reason why Mrs.Preeti Malhotra will not make money in stock market. When she buys a food item like Tomato, she has a fair value in mind and if the price is less than the fair value she will buy more of the same and if the price is high she will buy less. This is the typical Demand Curve.

The demand curve based transactions have been tested and perfected over 5000 years. It is the most effective way to buy anything.

Except, for some people, when it comes to buying stocks.

When the price falls lower than the fair value, they get afraid and do not buy the stock. Or they buy less. And when the price have gone through the roof, when everyone and their mother in law has made money in Stock Market, people like Mrs.Preeti Malhotra become greedy and will venture into the world of stock market.

It is the cycle of fear - greed - fear.

Smart people in the market are waiting for people like her to enter the market. Her entry into the stock market is a cue for them to exit the market. Their exit leads to market downfall, bringing down the price of PM's shares as well.

So PM lose her money in the stock market. This reinforces her perception that she is not good at investing in stock market.

Let us summarize our purchase experience of buying Tomatoes vs buying Stocks.

In case of Tomatoes, if the market price is less than fair price, buy more.

In case of stocks, if the market price is less than fair price, wonder what you are missing, become skeptical and fearful and stay out of market. After all who can tell when a crash is impending?

In case of Tomatoes, if the market price is higher than fair price, buy less.

In case of Stocks, if the market price is higher than fair price, wait for it to correct. However if the price still keeps going up, become greedy and buy at a high price.

And when the price falls soon after you buy the stock, sell it and book a loss. And congratulate yourself on having got out of market with minimal losses. Vow to never invest in stock market again. Become an 'Anti Stock Market Propagandist'.  After all you are the living proof that investment in stock market is a gamble and that the game is rigged and that you can't win the game.

What about people who made money? 

They must have rigged the market. Or have insider information. Or they may be just lucky.

"So PM, where are you going to invest your three lakhs?" I asked.

"I think I will invest in some Bank Fixed Deposit", replied the lady.

There is no way Mrs.Preeti Malhotra will make money in stock market !!.