Media reports keep on harping about market volatility. This makes prospective investors scared about entering the markets. They shun stocks as they fear that they may end up losing their money. As a result they lose out on golden opportunity to make money in the stocks.
But every investor must realize that volatility is an inherent part of stock markets. Instead of shunning volatility, it is very important to make volatility your friend. Here is how.
Focus on your long term goal: It is very easy to be affected by the daily market movements. It can make you sell your holding or stop your investments. However this is going to affect your goal achievement. Instead if you keep your eyes on your long-term goal, you will get better returns. Remember “Your time in the market is more important than timing the market” is the key to successful investing. Just take care to review your portfolio periodically.
Overcome your fears: It is easy to get scared when the market crashes. But remember what goes up comes down and vice versa. Markets work in cycles and while your stocks may lose value in the short-term, they will recover their lost ground over a period of time. Also when the market crashes, find out if the crash is due to change in fundamentals or due to some event that is not related to your stocks’ fundamentals.
Diversification: The secret to protecting your investments is diversification. Spread your investments amongst stocks of different sectors, capitalizations as well as amongst asset classes like bank deposits, gilts, gold, real estate and stocks.
Invest in quality stocks: Stocks with strong fundamentals tend to recover faster than those with weak fundamentals. So it is better to invest in such stocks with a long-term perspective ( at least 4-5 years). In fact you can look at any market crash as an opportunity to buy such stocks at cheap prices.
In short, don’t let market volatility scare you. It is the nature of the stocks to be volatile. Use it smartly to benefit from it by using the tips mentioned above.
Till now we have seen the important valuation ratios that help you decide whether the stock is worth buying or not. Now let us take a look at the operational efficiency of the company. It highlights how effectively the company is able to run its business. The first ratio that we look at the Current Ratio.
This ratio tells you the amount of liquidity available with the company in order to fulfill its business commitments. It is obtained by dividing the current assets (those assets that can be quickly sold off to get cash) by its current liabilities (immediate debts).
Current ratio=Current assets ÷ Current liabilities
Usually, if the current ratio of 2:1 for a stock is regarded as suitable, since it gives a sufficient safety margin to the company in order to fulfill its operating cash requirements. If the current ratio is low, the company may have to raise money from other sources like borrowing from lenders both individuals and financial institutions or distribute new equity for fulfilling their commitments.
But if the ratio is very high, it implies the company is not using its assets optimally. It is just sitting on its assets. This can significantly affect the company’s long-term returns. Compare the current ratio of the company you are interested in with that of its rivals.
What makes investors like Warren Buffet and Benjamin Graham successful in the stock market? Why is it that some people make money in stocks while others don’t? The answer – they follow the simple mantra of investing: buy low, sell high.
Though this mantra is popular amongst stock market investors, the question is how do you define low. What is low? How do you know that the stock price is at the lowest?
To understand that, check if the market price of the stock is lesser than its value. This is because market price is the price the market is ready to pay for the company’s share. The value is the price of the company’s business. Unlike the price of the stock which fluctuates from moment to moment, the value of the company’s business is stable, as the nature of the company’s business doesn’t change very quickly.
When we say buy low, we mean buy the stock when its price is lower than the value. This lets you get quality businesses at bargain prices.
E.g. if the value of the company’s business is Rs 200 and its price is Rs 130, the stock is said to be available cheaply.
It is called as “margin of safety” principle, advocated by Warren Buffet and Benjamin Graham.
In the next part, we’ll see how to calculate the value of the company.