With markets trading in the all-time high range, new investors would be tempted to invest in the stock markets with a view of making quick money. There are chances are that these new investors would end up in investing in the stocks that have already moved up a lot and have become expensive in the valuations. They might also invest in the stocks that appear cheap in absolute price but the business is not powerful enough to put a stellar performance in future.
Both of these types of stocks, in most probable scenario, would drop in prices when markets correct. The new investors would then keep holding these shares for years in order to recover the losses. This strategy is a definite way to underperform.
When markets are reaching new peaks, a lot of quality stocks also become expensive in valuation terms. The long term investors would take a breather and book profit in such stocks which will cause short term correction in the stock prices. This can give a good entry opportunity in quality stocks. Once the profit booking phase is over, fundamentally good stocks are again in demand. One should use this principle in the markets. To become a successful investor, it's best to stick to the fundamentals. A fall driven by profit booking is a normal process and new investors should use it intelligently as an entry point. One however should investigate what led investors to book profit, a fall driven by erosion of business environment, regulatory action, higher competition, corporate governance issues, etc. would be severe and hence these stocks should be avoided unless there are signs of abating pressure. Don't just buy stocks that have fallen, the fall is due to a cause which should be investigated carefully.
A class of stocks like penny stocks have the inability to grow their business. While not all penny stocks will remain penny stocks in future and some will graduate to the smallcaps and midcaps, one must pay attention to business, industry dynamics, management quality, balance sheet, etc.
As a new investor, do not invest in companies which have seen relentless run when market is on the top and also in penny stocks which are yet to prove their capabilities. Instead, stick to companies with proven track record. Once you have gathered enough confidence, you should be able to take a calculated risk.
WATCH YOUR STEP
- When markets are soaring, valuation of many quality stocks rise
- Long-term investors would then book profit in such stocks, that results in fall in prices
The writer is senior equity research analyst, Angel Broking
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