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Are You Right Because Your Stock Moved Up 200%?

I find a lot of Mrs. and Mr. Right these days in the stock market – people who bought a few stocks in the past 6-12 months and have seen all or most of them sky-rocket 100-200% since then.

For instance, a schoolmate who is a housewife with no business dealing in stocks, has started recommending trading tips in our batch’s online group, “because” she is getting her price calls right!

Then, someone wrote to me yesterday “praising” how my “recommendations” like BHEL, Engineers India, Crompton, Voltas, HMVL and Tata Motors have finally been “successful” as they have risen sharply in prices.

This very person had written a hate mail to me last year when some of these stocks – or let me say, their prices – were down in the dumps. 😉

Such is the way we behave as investors.

My observation is that most people out there in the stock market – maybe, including you – judge the quality of their investment decisions by one single factor – the short-term price movement of the underlying security.


Image Source: Yahoo Finance

So, if you are pitched a stock to buy by someone – which is a bad business – and the price of the stock moves up say 30-40% during the next few weeks for whatever reason, you will be more than willing to buy into the next tip from that person.

On the other hand, if the same person asks you to buy a stock – which is a great business – and the price of the stock falls by say 30-40% during the next few weeks for whatever reason, you will avoid him and his tips the next time.

So the Gujarati saying – “Bhaav Bhagwaan che!” – seems to be the ultimate truth for most stock market investors. The stock price is treated as the most sacred thing, and business fundamentals are relegated to the backseat.

In one recent article on Gurufocus, the author calls this fixation on short-term stock price movements to judge performance as a “…predictable irrationality caused by a combination of reinforcement and social proof.”

The author writes…

We talk about how to sharpen our analytical skills and how to value a business very often but we don’t talk enough about how to avoid the folly of being misled by the powerful irrational movement caused by social proof. This predictable irrationality is almost ubiquitous. I’ve known investors from all over the world and we exchange ideas on a regular basis.

For a while I was befuddled by the following behavioral pattern: I would receive congratulatory emails from my friends because the stock I wrote about moved up but very few of them wrote me congratulatory emails when the thesis of my investment was gradually holding water yet the stock price remained tamed.

How Do You Judge Your Investing Success?
Warren Buffett says…

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.

For all the reasons we love Buffett and his teachings, how many of us would apply this thought in our investing process?

A lot of people are asking me these days if they should sell their stocks because the prices have risen sharply over the past few months and they don’t want to miss out on profit taking.

These people seemingly assume that they would be able to deploy their profits as successfully – read, in stocks that would rise in prices – as they did the last time.

If you are also thinking on these lines, I will repeat what I wrote in one of my recent posts –

If you own good quality stocks and want to book profits after last few months’ rally, don’t! Think in terms of the wealth these can help you create over the next 15-20 years, instead of short term profits you have earned from them in recent times.

Stop taking cues from the stock prices. Start focusing on business fundamentals.

Ask yourself this question – How do I judge the success or failure of my investment decision making?

If the answer is “stock prices”, yours is a wrong yardstick of performance, my dear friend.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Hi Vishal,

    If I remember correctly, in the book The Intelligent Investor, even Mr. Graham has “given permission” to do some amount of speculation. I think he recognized this as typical human behavior in a situation similar to now. 🙂
    And honestly I also think it is doable as long as I limit the gambling amount small and strictly stick to my limit come what may.
    I’ve tracked recommendations on a couple of sites for quite some time and regardless of how bad the financials are the stock reaches UC for a few days after recommendation. And then continues upward journey for a few months.
    I have made money in this way, got back my small capital and now enjoying the game with the profits only.
    This does not interfere with my long-term investments.
    Am I going wrong here? Would appreciate any feedback.
    Thanks
    Roshni

    • hi roshni,

      only issue with that approach is how much capital you can allocate to this short term ‘tips’. in the end it doesn’t add much to your gains apart from giving you a ‘kick’. also its important to add the profits from these tips to long term investments

  2. Nelson Christian says:

    Hi Vishal,

    I read Rohit Chauhan’s post recently.

    In this post he talks about missing out on a potential ten bagger in Mayur Uniquoters because of some corporate governance issue: issue of warrants to promoter at below market price.

    This post of yours made me rethink about Rohit’s post. Does the fact that the stock went on to become a 10 bagger excuse the fact that on principle there were doubts about integrity of promoters. I do not know but there may be other examples where stocks with dubious promoter credentials may go on to become multibaggers particularly in such euphoric times. I know Rohit is a very senior and astute investor and when he indirectly says that the end justifies the means, what are retail investors like us to do. It certainly takes lot of guts to say that even if the stock turned out to be a ten bagger I should not have touched it because of its promoters. I am extremely curious to know your thoughts on this particularly after this perfectly timed post.

    Kind Regards,
    Nelson

    • Dinesh Agrawal says:

      Hi Nelson,
      I have read Rohit’s post and its excellent. He never intends to say end justifies the mean but to follow the process. If process is good than overtime outcome will take care of itself.

      But the question is, is process good and how can it be improved. This requires constant checking and re-checking of the process, analyzing your failures and missed opportunities.

      Regards,
      Dinesh

      • Nelson Christian says:

        Hi Dinesh,

        Thanks for the answer. I agree that we should analyze our mistakes to learn from them. I also agree on the stress on solid reliable processes. But I remember Prof. Bakshi in one of the blog posts had written about how the problem in MCX could have been identified earlier by investors by looking at a document posted by SEBI a few years back. Going by the same reasoning, when there is some questionable action taken by the promoters, even if they have not done something bad again in the next few years, does that exonerate them. The reason it is being discussed is that the stock went on to be a ten bagger. Rohit is terming it as a mistake because of its 10 ten fold returns. If it would have lost 90% of its value due to another corporate governance issue, he would be glad he identified the promoter integrity issue well in advance. Now since we cannot predict the future or predict how promoters or managements are likely to behave, these actions (warrants issue) guide us regarding the intention and the integrity of the promoters. This is the reason I asked this question. I may be wrong in asking this question but I just described my understanding of the situation.

    • Hi nelson
      Let me clarify the thought behind the post and I plan to write more on it subsequently. Its called Bayesian reasoning.
      Lets say you are analyzing a stock and give it a pass because the promoter’s integrity is suspect. that is a hypothesis which has a certain level of probability. if evidence is strong it can be 90% (never 100% though) or 50% if evidence is less.
      In my case I assigned a high probability. Now a year later you check the evidence again ..is there is any new evidence to support the hypothesis or disprove it. if there is new evidence for the hypothesis (promoter is doing some more hanky panky) ..then the probability goes up. you don’t invest. but what if the evidence is that the promoter has been quite decent and proshareholder..then the probability goes down. maybe after watching for some year, the probability that the management is dishonest, is low that one can take a chance.

      my main argument is that one should revise the opinion based on new evidence. I did not ..I just stuck to my earlier view and have done for a lot others. Its just that this one stood out so starkly, that I realized what I was doing.

      so its not that the 10 bagger justified investing, but that one should revise assumptions based on evidence to avoid missing 10 baggers

      rgds
      rohit

      • Nelson Christian says:

        Hi Rohit,

        Thanks for the reply. I misunderstood your post and hence the comments. Thanks for clearing my misunderstanding.

        Kind regards,
        Nelson

  3. ……and yesterday I read this, after reading this.

  4. vijayakumar r yadav says:

    Not necessarily. We are right as long as the businesses we have invested in are of strong fundamentals and bought at reasonable prices and the businesses are doing fine. In a rational market, the increase in the stock prices should be a reflection of the improvements / growth in the businesses. In a irrational market, anything can happen.

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