Don’t let greed affect your assessment of a stock’s valuation

THE markets have been lacklustre, and giving mixed signals. Investors have lost a lot of money and become loss averse. However greed still lurks, and when prices go down, investors are tempted to buy. It's a good thing to do, provided you’re getting stocks at the right valuations. Now, what is right valuation? Just because a stock was Rs 300 and is now available at Rs 150, that doesn’t mean it’s necessarily the right price for it. We do this as we are “anchored” at the high price, and when that halves, we believe that it is value. Be wary of this anchoring effect. The market never goes down in one shot. It sways between fear and greed, and drops gradually. In between, you get rallies when people feel the worst is over and jump in, only to find the next day that they made a mistake. When such “Cheater's Rallies” occur, more people get trapped by them. The important thing at this stage is to keep greed under control. Human nature wants activity, right now, it’s introspection time. Stocks that hit investors the hardest are those that were hyped and commanded hefty valuations, and stocks quoting at triple-digit P/Es. Avoid them even if they are from reputed managements. Reliance is a strong brand in the capital markets. But some of its stocks, like Reliance Natural Resources, are at a P/E of over 350, after touching a high of 800. Such valuations cannot hold in the long run. Indiabulls Real Estate, too, had a P/E of over 800 in January 2008. Even now, its P/E is over 600—a dangerous P/E to buy a stock. These are just a few examples of companies with reputed managements. And there are plenty of triple-digit stocks from lesser-known managements. Investors should also avoid little-known large companies. In a bubble, little companies may become large due to the market cap rising because of a spike in the share price. Hyderabad-based Visual Soft, during the IT boom, is a fine example. Its stock price shot up to Rs 10,000 (face value of Rs.10). It was recommended heavily by reputed analysts. Investors lost a fortune when the tide turned. Financial Technology is another little-known company that got attention because the financial sector was growing fast. It promoted the Multi Commodity Exchange of India. It’s a good company with able promoters and a good business model. But, with a triple digit valuation of over 120 P/E, in the mid-cap category is not a good investment idea. Behavioral lessons: Be fearful still, and avoid greed. Do not be anchored to past prices of stocks. Being in cash is also investing. Opportunities don't come everyday, but when they do, you must have the cash to buy. We have seen a bull phase for the last four years. Can it go on forever? Investment opportunities come in bear phases. Shouldn’t we be happy that such times are going to come?