Focus on the winning horse(s)
So many rabbits to catch
If there are nine rabbits running around and you want to catch one, focus on only one. If you try to catch them all, you may end up with none. If the rabbit you are chasing proves elusive, change your tactics but do not change the rabbit. You have over 5000 listed stocks on the BSE. Do you want to catch all of them to make it big? The answer is of course in the negative. Even new entrants into the arena would want to bet on winning horses only.
Is it possible for anyone to find the winning horses–stocks with great potential and available at reasonable valuations—in a brutally competitive market? Every stock, these days, is thoroughly researched and outcomes are predicted with a certain degree of accuracy. Research outfits, rating agencies, mutual fund managers, foreign institutional investors, and portfolio managers—have no other job except to focus on winning stocks. Against this background, how does an ordinary investor with very little knowledge and inadequate informational resources at his command, identify stocks that prove to be multi-baggers over time? Should you bet on front-line stocks and remain there or should you chase mid and small-cap stocks? Or concentrate on microcaps that are not on the radar screens of any fund house or research outfit? What if the obscure stock remains in the dark room forever?
To be on the safe side, one does the capital allocation, usually, taking cues from sane market voices and respected research analysts. For example, 40 percent to large caps, 30 percent to mid-caps and 10 percent to micro caps, 10 percent to bonds and the balance in cash. The secret of achieving success looks quite simple and known to everyone. If everyone follows this kind of safe path, how come 95 percent of investors lose their money in stocks? How come they are greeted with failure constantly and are forced to make an unceremonious exit from the market when things take an ugly turn?
Scary market swings
By nature, markets perform a belly dance almost every second. They are uncertain, difficult to predict, and seem to defy logic and understanding. All your calculations seem to go wrong quite often because markets dance to the sentiments, and mood swings of millions of investors apart from taking the shocks injected by economic and political factors in their stride. Multi myriad factors dent stock prices almost on a daily or weekly basis. There will be scary swings in stock prices all the time. The one that you bought would sink to a bottom level and the one that you just sold might sky-rocket to astronomical levels. The one that you thought is a winner may dent your portfolio badly. Every bet of yours might work in a rising market. You tend to believe that you are a genius for a few days. When the tide turns, almost any action and every action taken by you might set in doom and gloom. Even the so-called wisely chosen twenty-odd bets from the large-mid-small cap universe might sink to scary levels
Margin of Safety
This is where the margin of safety rule works. You need to bet on stocks that have deep value in every sense. You need to dig deep to find value in a crowded marketplace. Are there any MNC stocks that have tanked due to sentimental reasons? Are there any stocks that have tanked due to regulatory actions? Are there any stocks that are decimated by fund houses, due to redemption pressures? The fear surrounding metal stocks, in recent times, has put a question mark over the long-term profitability of stocks like Tata Steel, NMDC, and Vedanta. The fear surrounding oil and gas stocks due to the imposition of windfall tax has spoiled the show for stocks like ONGC, and OIL India. The sentimental aversion toward public sector stocks has pulled the prices of stocks with excellent dividend yields—like PFC, and REC to miserable levels. Recessionary fears have forced FIIs and DIIs to dump technology stocks with expensive valuations. A discerning investor will certainly be able to read between the lines and pick the winners from the discarded lot with ease and comfort. Historically, high dividend yield stocks have proved to be winning horses. A simple rule of thumb could be to pick stocks with a high dividend yield of above 10 percent (rarely available in a booming market of course) and you have an impressive list of such stocks in a falling market.