Are you ready to earn from a growing equity market?

The performance of the Colombo Stock Exchange (CSE) has been remarkable during the current year. It has outdone many of its counterparts and is ranked 12th in the world. (Refer table 1).

The All Share Price Index (ASPI) has recorded a remarkable growth of 21.4 percent in the current year while the S&P SL 20 Index has outperformed the aforesaid index by recording a growth of 22.2 percent. The latter captures the price movement of ‘blue-chip’ companies.

A blue-chip company is a nationally recognized, well-established and financially sound company. Blue-chips generally sell high-quality, widely accepted products
and services.

Blue-chip companies are known to weather downturn and operate profitably even in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth. These are generally considered as fundamentally strong. Market growth fuelled by fundamentally strong stocks is seen as a healthy trend. This was not seen during the bull run in 2010/2011.

Further on, foreign participation in the market during the past few months is noteworthy. Impressive valuations became an ideal investment destination. The foreign inflow has been Rs.10 billion this year. Foreign purchases are higher than their sales, indicating the demand for listed entities among foreign investors.

The preceding year also recorded considerable growth with the ASPI growing by 4.78 percent. This exceeded the growth figures recorded by its regional peers such as Mumbai, Singapore and Hong Kong. The S&P SL 20 Index recorded a growth of 5.79 percent in the year 2013.




The S&P SL 20 Index outperforming the ASPI for two consecutive years gives us signals on the sustainability of the current trend. It will be suitable to state that the market that was at one time considered highly volatile has stabilized and entered a path of sustainable growth.

The current growth momentum is a mark difference when compared to the market boom during 2010 and 2011 that was backed by undue reliance on highly volatile stocks (in some countries these stocks are referred to as penny stocks). The investment culture in our financial market has developed rapidly since then.
Further on, the prudent measures taken by market stakeholders have created the necessary infrastructure and a regulatory environment required to expand the market while protecting the interest of investors.
 

Markets are cyclical

Rational investors anticipate markets to continue to grow. However it is important to bear in mind that stock prices are based on demand and supply. Thus, could be subjected to short-term fluctuations. The CSE is no exception.

These market fluctuations could be incorporated to elevate the value of an investor’s portfolio if market participants, including investors, jointly play their role in a responsible manner. Given below are a few guidelines for our readers.
 

CSE offers a wide range of stocks to suit your needs

It is true that the market is currently fuelled by the S&P SL 20 Index that entails blue-chip companies and a balanced portfolio will give prominence to such stocks. Ideally around 70 percent should be invested on fundamentally strong stocks. The eligibility criterion for the above index includes market capitalization, liquidity and financial viability. Only companies that have reached a certain level are included in the index.

There are other well-performing stocks that don’t fall within the above-mentioned criteria but have generated impressive returns. Such stocks could be incorporated to one’s portfolio. Further on, the performances of blue-chips have a trickledown effect on the rest of the listed entities. Thus, the increase in prices of these stocks could increase the prices of other companies as well.

Be a bargain hunter among quality stocks. Smart investors are constantly on the lockout for good bargains and they know that low prices need not necessarily make great stock picks. Make sure you compare your picks with peer group companies. However, focus on bargains in blue chips and liquid counters but not on highly volatile stocks.



 

Stay away from questionable counters

During the last bull run, there were situations when stock price increased rapidly when the company was running at a loss. There were also situations when prices shot up when there were decisive court cases against the company. The increase in prices could not have been justified at any cost. Many knew the risk involved but purchased them with anticipation of higher returns.

Another sector of clients blindly follows the ‘big players’. Their objectives may differ from yours. Moreover, you will never know the precise time when they exist, what their overall portfolio is and what their time horizon is. It is better for you to form your own investment goals rather than following big investors.

There are two types of clients in the market. Some are ‘investors’ while some are ‘traders’. Investing and trading are two very different methods of attempting to profit in the financial markets. However, at times, you might find investors with both of these traits.   

The goal of investing is to gradually build wealth over an extended period of time through buying and holding a portfolio of stocks. Trading, on the other hand, involves the more frequent buying and selling of stocks with the goal of generating returns that outperform buy-and-hold investing.  

As we all know, relying simply on long-term returns is not practical. Investor’s expectations on short-term returns are justified but investing in highly volatile stocks is not the answer. Any market requires a certain amount of trading to maintain reasonable levels of liquidity in the market.

Trading requires a certain amount of skill coupled with discipline and the correct mentality. We can’t expect the market to generate returns over night. New investors should refrain from heavy trading as it is a skill that is mastered with years of experience.
 

Be an informed investor

Making informed decisions will enable investors to make wise decisions. Market rumours may seem very realistic but never invest unless you have reliable sources to support it. Investors should study about the market prior to investing. They could read annual reports, research reports, etc., to enhance their knowledge. Pay attention to the circulars and directives issued by the Securities and Exchange Commission of Sri Lanka (SEC) and CSE.
 

Borrow, but within limits

Another common phenomenon in a growing market is investing on credit excessively. Investing on credit might be lucrative in a growing market but could fuel a bubble if there is excessive trading on credit. As stated earlier, we can’t always expect the market to go up.

From an investor’s point of view, investing on excessive credit could increase margin calls and result in financial losses if there is a change in the market trend. Increase in margin calls could further intensify the downward trend.

Nevertheless, the importance of credit could not be undermined. It is vital to strike a balance by limiting your exposure to credit. This would be a tedious task when many stocks seem lucrative in a growing market as investors would be tempted to grab all these opportunities by investing on credit.

Pay attention to the amount you take on credit and the stocks you purchase with this money. Make sure your income is adequate to meet repayment obligations. It is advised that investors refrain from utilizing such money to invest in volatile stocks. Once again, margin trading is suitable for seasoned investors.

It is also important for margin providers/stockbrokers to scrutinize investors on their financial credibility prior to granting margin trading facilities. The market bubble followed by the market drop in the recent past was partly due to the mismanagement as well as misuse of credit facilities. Thus, if we are to continue this growth momentum, it is important for both investors and margin providers to manage and use credit within a well-monitored system.



 

Diversify equity exposure across sectors

Diversification acts as a natural hedge during market cycles. It is a good strategy to diversify your equity investments across sectors. An investor should pick four or five best performing sectors and ensure that the risk is well diversified.

They should invest only a percentage of their savings. The stock market is a form of investment. Hence, investors should invest money they don’t require in the immediate future. It is also advised to invest in various asset classes to minimize risk.
 

Don’t trade with money you can’t afford to lose

There is a clear difference between trading and investing. Allocate only a small portion of your net worth for trading. Don’t trade using the money that you can’t afford to lose like the money to pay your home loans, bills, education fees, medical bills, etc.
 

When it rains, everything gets wet

Another point noteworthy is the importance of remaining calm during market fluctuations in the short run. In a bear market, everything could fall temporarily. If you have invested based on solid reasoning, there is no reason to make rash investment decisions based on market rumours unless they are backed by
solid reasoning.

Apart from the above stated, the article will unfold a few more tips investors should bear in mind when investing.



 

Read carefully

•  Due diligence is a must.
• Do not gamble away your hard-earned money.
• Read about the stock. This is an advice difficult to practice. Yet, you must read, at least sections on risk factors, litigations, promoters, company history, project, objects of the issue and key financial data.
•  

Follow lifecycle investing

•  As you cross 50, start getting out of risky instruments and focus on long-term less risky investments.
• You can afford to take greater risks when you are young.
• By 55/60, you could limit your exposure to equity and divert your funds towards unit trusts.

Invest in IPO, in both debt and equity.

• Initial public offerings (IPOs) are a good entry point mainly for new investors.

During bull runs, almost all IPOs provide positive and in many cases huge returns on the listing day. If an investor does not book profit, he is either greedy or takes a wrong call on the company/industry/market. He should then not fault the IPO price. Remember that:

•  The problem is that we put IPOs on a pedestal and expect them to perform forever. An IPO becomes a listed stock on the listing date. It will then behave like that.  
• IPOs have to be bought; these are not forced upon the investors.
• Decide whether you are investing in an IPO or in a company; if as an IPO, then exit on the listing date. If as a company, then remain invested as you would in a listed stock.
•  

Learn to sell

•  Remember, you cannot maximize the market’s profits so don’t be greedy.
• Most investors buy and then just hold on forever.
• Profit is profit only when it is in your bank (and not in your register or excel sheet).
• Set a profit target and sell.

Deal only with registered intermediaries

• Unauthorized operators in the market could lure you with promises of high returns and then vanish with your money.
• Dealing with registered intermediaries is a must. Check if your investment advisor is a ‘Certified Investment Advisor’.

Let not greed make you an easy prey

• People could try to exploit your greed.
• Study about the entity that gives you financial advice and seek your money.

Beware of media, especially stock-specific advice on social media

• Also beware of the get-rich schemes being sold through SMS and emails.
• There are too many ‘saints’ in the capital market offering free advice.
• In reality, many of these people have vested interests.
• Always work with a licensed advisor and verify the advice given by him.

Don’t get taken in by advertisements

• The job of an advertisement is to make you feel good.
• Don’t get carried away by attractive headlines, appealing visuals, catchy messages. Verify the information you get through these sources prior to investing.
•  

Don’t get overwhelmed by sectoral frenzies

• Remember, all companies in a sector are not good. Each sector will have some very good companies, some reasonably good companies and companies that are not as good as the others.
• Be wary about the companies that change their names to reflect the current sectoral fancy.

Don’t blindly take decisions based on accounts

• Read qualifications and notes to the accounts.
• Incidences of fraudulent accounts and of mis-advertising of financial results have been reported globally.
• Look out especially for unusual entries-related party transactions, sundry debtors, subsidiaries’ accounts, etc.

Cheap shares are not necessarily worth buying

•  Price can be low because the company in fact is not doing well (but hype over the company/sector may induce you to purchase).
• Do not chase price, chase value.
• Worse, the price can be low because the face value has been split.

Be wary of companies where promoters issue shares to themselves

•  Preferential allotments to promoters are almost always made for the benefit of the promoters only. (The fair route should be rights issue).

Invest in unit trusts, but select right fund and scheme

• You could invest with a small amount.
• Unit trust is an ideal vehicle for less sophisticated investors.
• There are various forms of funds. Hence, carefully select the right one.

Be honest

•  Be honest to yourself as only then you can demand honesty.

The returns generated by the CSE in the long run have always surpassed other financial instruments with a vast margin. It is promising to note that the market is poised for further growth. Hence, it is the time for investors to act wisely and reap the benefits of a growing market.
 

“When it rains gold, put out the bucket, not the thimble”                 -Warren Buffett