In my last post I had talked of Need vs Greed. I shall this time, write about the primordial basic instinct of flight vs fight. In times of financial crises, the common investor also has a similar dilemma. Unfortunately 95% of the so-called-investors, flee the markets when any bubble bursts. Take the sub-prime crisis which had its fall out on stock markets , the world over. The sensex came down a cliff from a high of 21000 to 8500 levels and Nifty had rolled down from 6100 to 2000 levels. How many of us bought stocks during those months of 2008-2009? Very few. Those of us who fought the markets and stayed put or invested, came out victors. Stocks like JSW Steel, Tata Steel to name a few were available at Rs 170/-. The business was still intact. It was still making profits. They were not lending money to house owners and except for being part of the global economy, they had no other connection.
The prices were ridiculous because 95% of investors including the “haloed” FIIs and MFs were dumping the stock as if the world would end tomorrow. If you have read Benjamin Graham or Buffet, it was a “bargain basement sale” going on. One should have backed the truck and loaded it fully with those dirt cheap stocks. And those who remained in the battle-field saw the valuations go through the roof within two years. JSW Steel crossed Rs 900/- and Tata Steel Rs 700/- within 24 months. Too fast a rise, but then when have the markets been rational. Markets hover between extreme pessimism and irrational exuberance.
The investor (it is a euphemism, for most of the people who put their money in stocks invariably are traders and gamblers who equate the daily activity of buying and selling with investing) faces two major behavioural dilemmas in taking any financial decision in the stock markets. They are to fight the market, i.e keep investing when the going gets bad or flight from the market i.e keep away from the market when the going gets tough or the markets take a down turn. The investors who flee the market, in down times, rarely make big money from stocks because when a L & T share is available at half the price, one is not buying. It is like you want to buy a pair of Levi’s jeans. The market price of the pair is Rs 3000/-. Suddenly one fine day, due to over inventory in the showroom, there is a sale and the same jeans is available for Rs 1000/-. Wouldn’t you like to buy a pair for yourself as well as your wife on that day? The offer is as good as buy-one-get-one-free. But we do not exhibit similar behavior in stock markets. We run away and sit tight on our money when the markets are falling on a daily basis rather than invest in fundamentally sound businesses because of a fear of loss. As the Nobel prize winning economist, Kahneman proved in an empirical study, a person feels twice the amount of sadness at a sudden loss of Rs 1000/- as he would feel happiness at an impromptu gain of Rs 1000/-. Thus, loss aversion is a part of our psyche. But “Intelligent investors” make their purchase of a business at such an attractive price that they do not suffer a major downside and are therefore, out of the loss-aversion-syndrome.
Risk, which is inherent in stock market investments, becomes lesser as prices go down. Let me illustrate it with an example. The price of a stock can theoretically become zero. If I buy one share of SBI at a price of Rs 3200/- my theoretical downside is a loss of Rs 3200/- whereas the same share when I buy at Rs 1600/- my risk is only Rs 1600/-. I have thus, halved my risk at a purchase price of Rs 1600/- But the market hoopla is so much that the investor feels that being part of the mob is better rather than sticking your neck out. As a result excellent businesses available at cheap valuations are given the go by and with your flight from the markets, you miss the flight of seeing your stock valuations rise after the pessimism and pain is over.
Right now, it is again an opportune moment to invest fresh capital into building a good quality portfolio for the long haul. Why do I say it may be a good time to start cherry picking some stocks? For that, wait for the next issue where in I shall discuss, when is the right time to enter and exit from the stock markets. Till then read about mean, median and mode from the text books of your child in VIII standard, they will come in handy.