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Rising Stock Markets
A rising market can pose challenges: buying becomes difficult as quality stocks turn expensive, and it is tough to decide whether to hold or sell the stocks you have. Sanjay Kumar Singh helps you make these decisions.
1 While buying, pay heed to valuations
If you scan a list of stocks and their valuations, you will find very few trading below their long-term, say, five year, average valuations. If you do find something inexpensive, it is likely to be a small-cap--they carry high risk--or will have a poor track record. With sentiment turning optimistic, analysts' predictions are getting rosier. High earnings growth rates are being predicted on the basis of an economic turnaround. Still, you should be wary of paying too high a price. What if sentiments change for the worse? No one knows how severe the impact will be when the US Fed raises interest-expected to begin next year--on fund flow to India. There are geopolitical risks as well. If you can't find reasonably priced stocks, don't buy.
2 Hold stocks with sound, long-term prospects
As the bull run continues, valuations of many stocks in your portfolio will turn expensive, tempting you to encash your gains. If you are a long-term investor with a horizon of 7-10 years, and the stock's prospects are sound, avoid the temptation to sell if the degree of over-valuation is marginal. Good companies can keep growing their earnings for years. By selling, you will forgo this growth. Besides, you will incur trading costs. If, however, the margin of over-valuation is high compared to historical averages, book your gains gradually. Often, the valuations scaled during one bull run are not touched again for years. Selling will also enable you to rebalance your portfolio. If you sell a quality stock, keep monitoring it and repurchase when its valuation turns reasonable.
3 Sell the laggards
A bull run often lifts all types of stocks, including the ones with relatively weak fundamentals. Some of the stocks that you have picked may turn out to be duds despite the due diligence by you. If you hold stocks that haven't performed up to your expectations, it is likely that their valuations have also risen in the bull run. Make a comparison of all the stocks in your portfolio and rank them in the order of prospects--from best to worst. Use the opportunity offered by the current bull run to weed out the weaklings from your portfolio.
4 Have a mix of cyclicals and defensives
After clocking 4.7% growth in 2013-14, the economy is expected to grow at 5.5% in 2014-15, and at nearly 6.5% in 2015-16. The government is focusing strongly on reviving investment. If inflation moves along the RBI's expected trajectory, there may be room for rate cuts next year. If investment revives, it will be positive for sectors like capital goods, industrials and infrastructure. Rate cuts and income growth will be positive for auto and real estate. So, evaluate the prospects of stocks in these sectors. While focusing on cyclicals, don't ignore the foreign defensive sectors like pharma and IT. Contrary to expectations, pharma stocks have continued to do well in recent months, while the expected turnaround in the earnings of cyclicals hasn't materialised.
5 Avoid these pitfalls
A bull market offers temptation to make easy money, with long-term investors changing overnight into short-term speculators. Instead of sticking to a fundamental-based investment approach, they adopt momentum-based trading strategies without adequate safeguards. In the short run, you may make money, but when the market sentiment turns negative, you may be left holding stocks of dubious quality. Their value may sink and not revive for a long time, if ever. So, stick to the basic tenets of investing: pick stocks with sound growth prospects and high-quality management; pay only a reasonable price for your purchases; and have an investment horizon of five years or more.
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