Rules For Investors

In investing, we were told that “Buy and Hold” is one of the best ways to achieve superior investment gains. In other words one has to remain “patient” after buying a stock. But in my opinion this aspect largely ignores an investor’s “Entry” and “Exit” strategies and refers only to the “Patient” holding period. In my opinion “Patience” is required in all three aspects of investing which is Buying, Holding and Selling. Let us see why Patience is required in each aspect

Patience to Buy:

We as investors, most of the time get carried away by Good News flows specific to an economy, or a sector or a company. With the fear of losing away the next big investment opportunity, we chase stock prices which would have already risen based on “Good News” or “Good Results” specific to a company. By getting carried away with “Good News”, we tend to ignore the valuation aspect of each stock. And buy them after all the good news is factored in the price. Later we find out that the stock price is not moving any higher than what we expected it to be. Either it moves in a sideways direction or gets corrected significantly on seeing next set of quarterly results. But markets would have priced in it already. This may result in poor returns for an investor.

What makes us Impatient during this phase?

• Of losing the next big investment theme of the year
• Get carried away by single good quarterly results
• A Recommendation by a famous Guru or an Analyst
• News specific to a sector or a company which makes the stock ride high

What Should be Done in this Phase ?

• Analyze the result or good news and its potential impact on the fundamentals of the company before jumping the gun. Present valuation of the company compared to its fair value is also important. Otherwise gains maybe limited.
• Wait for a correction after a good news – Stocks eventually give back some of the gains
• My preferred buying period is when stocks are surrounded by bad news. Check whether the stock is priced at steep discount when compared to its estimated fair value at which it may trade when good news happens.

Patience to Hold:

The holding period is certainly the most difficult part because markets will truly test our patience by making fun of us. Markets will take their own time to price a fundamentally good stock up to its fair value but instead it will reward instantly, stocks with very poor fundamentals. At times, a fundamentally good stock may not move much in a year or two. But rather we will find several loss-making, or companies with poor cash flows or questionable accounting practices or companies with high valuations , etc.. become multi-baggers within a period of few months. That will make us to question our faith in “Value Investing” itself. But history has proven that there is no better investing method for wealth creation other than Value investing on a consistent basis. For example, the famous Value investor Mr. Warren Buffett never invested in “Dot Com” stocks in the 1990’s even though many of them gave huge returns and later eventually collapsed. Likewise, many Real Estate stocks gave huge returns in 2000’s but eventually collapsed post 2008. Even in present circumstances in 2016, majority of the stocks are rallying towards new 52 week highs or all time high levels. Some had posted good returns in 2014 and some gave good returns in 2015. Its difficult to pin point which stock will perform better in a particular year but it is imperative to follow the simple rule “Stocks Follow Earnings” as guided by renowned investment guru Peter Lynch. Although there maybe time lag for markets to acknowledge such good earnings growth in a company. Till then it pays to patiently hold on to such stocks.

To summarize, What makes us Impatient during this phase?

• Inability to see other stocks rising higher than the ones we hold
• Extended period of bad phase in a business cycle which frustrates investors to hop on to the stocks in good phase with elevated valuations

What Should be Done in this Phase ?

• Hold on to the stocks if there is no great damage to the balance sheet or its business model
• Buy and read books written by value investing gurus and calm ourselves that value investing works over time.

Patience to Sell:

Realizing the maximum gains out of an investment is the ideal goal of any investor. But whereas not many of us have the patience to hold on to the gains. Most of us get tempted by a few percentage returns in a particular period and sell out early. But once again, investors should be aware of the historical PE Ratios or Replacement cost or a reasonable estimate of the fair value of each stock before committing a “Sell” decision. At times, many investors also get frustrated when the stock moves in a sideways direction and sell out early. But it so happens that the stock starts its upward journey only after many of us sell it due to frustration. One should also remember it is very difficult to consistently sell a stock exactly at its peak price. So an investor should also be ready to sacrifice some of his unrealized gains when he decides on sell decision after knowing that the fundamentals do not justify the present valuation.

What Makes Us Impatient During This Phase?

• As soon as we realize quick gains (like 30-50% return), we tend to book profits in a fear of missing out such gains
• When our stock moves in sideways direction whereas various other stocks show rapid rise
• When a stock dives 20-30% from the purchase price, some investors sell them out of fear

What Should be Done in this Phase ?

• Understanding fair value of a stock, historical valuations, present fundamentals of the industry and company, investor sentiments surrounding the stock. These can help us guide in our “Sell” decision

Conclusion:

In my opinion, Patience in investing is required in all three phases such as “Buying”, “Holding” and “Selling” to achieve superior investment returns. To help us be patient, gaining knowledge about each individual stock, its fair value , its historical price patterns and valuations can be a good guide. Along with that, a preset mindset that excellent returns are achieved only with the holding period in excess of three years can also be of help.