My friend Rohan visited me on the weekend, and here is how our discussion went. Rohan’s comments are in red.
“Hey Vishal, did you notice the crash last week? I am pained to see my portfolio again and again!”
“Stop fooling dude! You know I am talking about the stock market and the crash in the Sensex!”
“Oh that! No, I was busy somewhere else, so didn’t notice that!”
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“How could you miss a 1,200 points crash in the last 8 days? And you seem to be writing an investment blog, huh!”
“Rohan, I avoid looking at these daily and weekly rises and crashes in the stock market. I have better, more exciting things to do in life!”
“But doesn’t this hurt your investments as well? I’m sure your stocks must be down as well!”
“Oh, even I’m sure!”
“Wow! So how could you be so careless to just ignore these crashes?”
“Okay Rohan, let me ask you a question. You love those fatty burgers at McDonald’s right?”
“Oh yeah, I just had them for dinner last night! But why are you asking this?”
“Well, if you plan to eat those burgers throughout your life and are not a potato farmer, should you wish for higher or lower prices for potatoes?”
“Of course, lower!”
“In the same way, if you are going to buy a car from time to time but are not a car manufacturer, should you prefer higher or lower car prices?”
“Hey, of course I will wish for lower car prices! But what’s the point of asking these questions? Don’t they answer themselves?”
“Indeed Rohan! Anyways, now for your final question – If you expect to be a net saver during the next 15-20 years, should you hope for a higher or lower stock prices during that period?”
“I always want higher stock prices!”
“Great! So like many investors, even you have got this one wrong. Just think again. Even though you are going to be a net buyer of stocks – you will be buying more stocks than you will be selling – for many years to come, why will you be elated when stock prices rise and depressed when they fall? In effect, you are saying that you will be happy when prices will rise for the burgers or cars you will be buying!”
“You see Rohan, this reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. But if you are a prospective purchaser, you should much prefer sinking prices.”
“Yeah, that makes sense. How in the world I never thought about that?”
“It happens dear.”
“So, Vishal, is this the right time to be buying stocks given that the Sensex has already crashed by 1,200 points in 8 days?”
“Sensex is nonsense, Rohan! Its rise and fall doesn’t tell you whether you should be buying or selling stocks.”
“Now, why do you say that?”
“Because most great businesses of the future have a high probability of lying outside the Sensex, which is built up of companies that are already bloated in terms of sales, profits, employees, market capitalization. Plus, the very fact these are in the Sensex suggests that they are among the most expensive stocks out there.”
“Okay, so are stocks looking cheap outside the Sensex?”
“Look at this chart, Rohan. It shows the price-to-earnings or P/E of BSE-100 companies. P/E suggests how cheap or expensive stocks are compared to corporate earnings. So you can note that the BSE-100 P/E – which is the average P/E of all the 100 stocks listed in this index – has fallen to around 16x as of now, from around 20x same time last year.”
Data Source: BSE’s Website
“Which means stocks have become cheaper, right? And thus a great time to buy them, right?”
“Yes and no! Yes, they have gotten cheaper compared to last year, but this doesn’t suggest in isolation that you must go and blindly buy any stock.”
“So Vishal, you think stocks can fall further from here on?”
“I don’t know!”
“What do you mean you don’t know? You are an analyst and you must know where the stock market is headed!”
“Being an analyst does not give me any power to predict, especially the future! All I know is that, as an investor, you must be prepared for big volatility in your returns over the next few years.”
“Hey, why do you say so? I’m already frightened seeing the current volatility!”
“My simple reasoning is that the stock market, as I see it now, is simply behaving like a drunkard who is high on an overdose of alcohol (easy and cheap money).
“So while it continues to move up and down the stairs in this heavily drunken state, I am fearful that it will take a deep dive. As for the exact timing of this dive, I won’t pretend to be sure of that. My simple premise for caution is – that which cannot be sustained will not be sustained.
“As an investor, it is important for you to understand that we live in a world that is based on economic structures that are now unsustainable. We are passing through the biggest bubble (call it a grand Ponzi scheme) in the history of the world – a bubble in government debt, asset prices, and promises.
“These bubbles are all going to going to collapse, in one way or another.
“The negative side of this is that you may be so terrified of all this that you may quit investing in stocks. The positive side is that you will get a lot of chances to buy stocks at cheap valuations.”
“Great! But what should I do now? Now as in NOW!”
“Keep playing the game. Keep investing in sustainable, growing, profitable businesses that you can get at reasonable valuations. If you don’t get them now, wait!”
“But how do I take care of so many ups and downs in stock prices? It’s so frightening!”
“You see Rohan, we’re all so encouraged by the 24/7 news cycle to focus on the short term, it’s too easy to panic when what we thought was attractive gets 20% cheaper.
“But please don’t get bogged down by such short-term volatility. Be worried only of permanent loss of capital. If you can do that, you need no bubble to retire wealthy with your stocks.
“This will help you keep your head when all about you are losing their…in bull or bear markets.”
“It’s easier said than done! How do I really get my eyes off those falling stock prices in my portfolio?”
“Simple, close your eyes…and breathe!”
By the way, do you want to test how you behave as an investor? Take Safal Niveshak’s Investor Psychology Survey. I will announce the results soon.