By Tensing Rodrigues*
Now that the stock prices seem to be moving up is it the right time to get into the equity market? That’s a question that faces many of us these days.
Nifty closed above 9,400 mark for the first time ever on Wednesday, the 10th May. The same day the Nasdaq Composite index surged nine points to close at record 6,129. Most of the Asian markets are edging higher. Japan’s Nikkei 225 has gained 45 points and Hong Kong’s Hang Seng has advanced 154 points. Does that mean that good days are here and it is time to join the party?
May be, but I would not give much importance to it. Because outside the trading ring nothing has changed. The world is still what it used to be – the same strengths, the same weaknesses, the same opportunities and the same threats. My choice would be to maintain the status quo. Keep buying what I was buying before. If I saw value in the market before I still see the value now. Perhaps all that would change is the small details. And I will stop buying only when I see the stock market unjustifiably over heated. The rising stock prices only increase my comfort level. Ido not seem to be the only fool around but when the foolishness turns into frenzy then definitely I will be uncomfortable. The bottom line of the story is simple. Let not the market movements dictate our buying behavior in the stock market except at the extremes.
If not the market movement what should guide our investment in the equities? The value of the stocks certainly. And what is this value? In the technical language of equity investment, they call it intrinsic value. Let us call it just value to keep it simple. Value of an equity share is the sum of what it can earn for us in future adjusted for the fact that these earnings will come over a period of time not immediately.
And, by earnings we do not mean what we will get when we sell the share. Not even the dividends that the company may distribute. By earnings we mean the profit that the company will make. In other words, our earnings from a share is the profit we would have earned if we had invested in that business. Let me put it by way of a simple example. Let us suppose we pay Rs 100 for an equity share of Tata Motors. Let us take it as Rs 100 invested in the business of manufacturing cars. The profit that Tata Motors earns per share in a year is our profit from the business of manufacturing cars per year, in which we have invested Rs 100 That is the concept of earnings that we use to calculate the value of an equity share.
The simple thumb rule then is, if we see more value in a share than the market price it is worth buying. It matters not if its price is rising or not; nor does it matter if its price is expected to rise or not. Are the market movements totally irrelevant? No. Though they cannot decide whether to buy or not, they can help us decide whether to buy today or tomorrow. If we find value in a share and we expect its price to rise, we might as well buy it today rather than tomorrow. Just the same way that we decide about buying mangoes.
*The author is an investment consultant. Readers can send their comments and queries to firstname.lastname@example.org