WHY DO WE BUY STOCKS?
So we have decided that we will invest in to stocks. The simplest thing is to go buy in to some mutual fund schemes and not think too much beyond that. However, if you are going to buy shares in a company, have you figured out a rationale? Or is it that we simply buy shares for one of the following reasons:
- Some analyst on TV has recommended;
- A stock market rag sheet has recommended;
- A paid stock investment newletter has recommended;
- A neighbour has strongly recommended;
Many such reasons abound. Or it could be because you looked at a companys website and then did some reading, thinking and came to the conclusion that this company has a good future and you want to be part of that.
There are several other regular buyers who use things like P/E, growth, book value and similar jargons to identify buying opportunities.
Let us leave all that behind and start thinking. Why do we buy a share? Obviously, we buy so that we are able to sell it in future, at a higher price. And the price appreciation should be such that it is much higher than what a Fixed Deposit would normally be. We also know that the price of a share is determined in the stock market, based on a number of factors and each one has a different theory backing his buying or selling If every one was perfectly aligned, then no one would buy or sell. Right? So, we know that the stock market is a place where stocks get traded at prices that are determined by demand, supply, future expectations and a few hundred other factors! It is really a jungle out there, with reasons changing from person to person and from season to season.
We buy stocks for one of the following reasons ( if we pause to think ):
- The stock is available at a price that is ‘value’. In other words, something that would cost Rs.1000 to build, is available at less than that, due to some temporary disturbances in the market or the industry or the company. We feel that this is an aberration and things will return to normal, sooner rather than later. This amounts to something akin to “Value” buying. We buy because the return to normalcy will provide the shift in the price that will give us a profit. Stocks in commodity sector, say Cement or Steel or Copper etc would fit this hypothesis;
- The stock is priced fully or fairly. However, we think that the company will grow its sales and profits at a very rapid pace over the next five to ten years. In other words, the earning power will increase fast enough to justify a price I pay today. For example, if I pay Rs.1000 for an earning of Rs.30 per annum, it is foolish. By keeping it in a savings account , it will earn Rs.50 plus per annum or a fixed deposit would give us nearly Rs80 per annum. However, I think that this company, which earns just Rs.30 per annum, is growing its earnings so rapidly that in three years or less, it will beat the earnings on the fixed deposit very comfortably. For example, if the Rs.30 grows by 50% each year, it would become Rs,100 in just four years! So, in a sense, we are betting on ‘growth’ . Companies in segments that sell direct to consumers- like FMCG or Pharma would be examples. Or in technology sector, where labour cost advantages drive growth in Indian companies would be such examples;
- We buy because we think everyone else is going to buy this and run the prices and I will just sell it off quickly. I do not know the value or growth potential. This is pure speculation. I am neither supporting nor opposing this. Each one is his onw master.
So we can label the first one as Value, the second as Growth and the rest can be nameless. Thus, in the Value segment, we all need some discount to the value for us to make a profit. We should not buy Value thinking it is a ‘growth’ story, though many times the Value segment can take on the avataar of growth. One way to segregate this is to presume that most of the “Value” stocks derive their worth primarily on account of the assets they own. The ‘growth’ companies drive profits because of brands, marketing and differentiation. This is a good primary sort. Most ‘value’ companies have replicable businessess and there is really not much difference between two competitors.
So, each time you buy a share, try and think about what you are buying and whether the logic of buying appeals to you.
The article was also published in the Deccan Chronicle of 27/12/2015.