The first quarter's results for the financial year 2011-12 released so far have left many investors jittery. This is exemplified by their reactions to the results. Bad results are punished quickly. The sudden decline in performance of some the blue-chip companies have indeed been unsettling. After the results, some of them have lost nearly a third of their market value.
For the first time, there are cracks in the confidence levels reposed by investors in domestic companies. The opinion that they are good in managing the macroeconomic challenges has lost some sheen. The sudden drop in the price of a share can cause substantial damage to a portfolio. A question that then arises is what is the remedy for such a catastrophic impact on a portfolio after the results, and whom should an investor trust for a stock recommendation.
The ideal answer would be nobody. Self analysis is the best strategy for picking stocks, that will help a portfolio grow. But today's investors do not have time to research a stock to invest in. Further, research is a continuous process that requires time and effort. On the other hand, a portfolio's exposure to stocks either directly or through mutual funds is necessary to achieve higher returns. One way of solving this dilemma would be to invest in companies that are well-researched.
Usually, company research reports are generated by three segments of analysts. In-house research teams of mutual funds generate research reports for their exclusive use, brokerages issue reports on companies free of cost for their clients and independent research companies provide research reports for a fee.
The reports of mutual funds are technically called buy-side reports and are expected to be more accurate as the analyst's earnings are pegged to the performance of the stocks they recommended. Reports generated by brokerages are called sell-side reports and are expected to be bullish with the aim of inducing investors to buy. Independent research reports are expected to be unbiased.
As most individual investors have access only to the second and third categories of reports, they can use them to construct their investment portfolios. However, a preliminary check on the given recommendations is imperative to remove any bias that may have crept into the report.
Some checks that can go a long way in protecting a portfolio:
Check whether the recommendation is for trading or investing. Trading stocks are recommended for an upside of a few percentage points and come with a strict stop-loss trigger. They may not be suitable for investing.
The costs of frequent trading can be a huge drag on performance over time. It makes sense to buy stocks as an investment and hold on to them for the long term.
Read the report closely to check if the projections are too optimistic.
Check the P/E ratio of the company to ensure it is at reasonable levels. Unusually high P/E companies may correct sharply when the tide turns against them.
Ask two questions before investing - is this a high-quality company, and is its stock priced attractively.
Check if there are any immediate triggers that can make the stock attractive.
This checklist can give you reasonable protection from sharp falls in security prices. But there could still be a surprise or two where despite taking all the precautions the stock price tanks due to unsavoury acts by the management.
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