Greed = Loss at the stock market

ou win some. You lose a lot.

This epigram is the perfect explanation for my pitiful experience as a day trader.

Let's bust the jargon

Before I start my saga, let me explain some of the terms I will be using.

Day traders are those who buy/ sell stocks during the day and square up their position by the end of the day. Which means they either book a profit or a loss.

This breed traditionally likes a volatile market; it helps them rake in the moolah. And to say the markets were volatile those days would be an understatement.

K-10 refers to infamous broker Ketan Parekh's favourite stocks.

They spanned a spectrum that included software, media, banks and pharmaceuticals. To name a few: Silverline Technologies, Aftek, Infosys, Pentamedia Graphics, HFCL, Global Telesytems, Zee Telefilms, Global Trust Bank and Ranbaxy.

Buying into any of the K-10 stocks in the morning and selling them by evening (with the sole intention of making a huge profit) was how day traders like me evolved and finally perished.

Those who buy first and sell later are said to go long on that particular stock. They expect the share price to rise. So they buy shares at a low rate, hope the price will rise and sell when it does.

Those who sell first (without owning the shares) and buy later are said to go short on that stock. They expect the share price to fall. So they sell at the current rate, expect the price to fall, and buy them again at the lower rate.

The day begins

Now, that we have the jargon clear, let's flashback to my very first day as a day trader.

I went short on (sold) five shares of Infosys when it was worth some Rs 6,000, hoping to cover (buy) them at a lower price by the time the market closed for trading at 3.30 pm. I did this after a pink daily (a business newspaper) recommended going short on Infosys at that particular level.

Back then, the market regulator, the Securities and Exchange Board of India, was rather smug and complacent; most pink journals (business newspapers and magazines) offered their own recommendations on what to buy and what to sell.

After an initial nervousness following the earthquake, the market resumed its upward journey catching short sellers like me on the wrong foot. The stock closed higher than what I had sold it for.

Never one to accept defeat -- and to proclaim my fortitude to my peers -- I decided to wait until Friday to close my position (decide what I finally wanted to do).

Here I would like to remind you, dear reader, that you did not have settle your trade at the end of the week (pay for what you bought and take money for what you sold). All you had to do was pay a small amount (a margin) and you could settle it the next week. I did this hoping the price would fall the next week. This was called badla financing.

Finally, though, I reluctantly booked my losses (and there were many more that followed) on Friday as the stock did not come under selling pressure (nobody was interested in selling so the price remained high).

My first debit came to around Rs 1,200 (5 shares x the difference of Rs 240 at which I bought those shares to cover my position).

Got the picture?

I sold the shares at around Rs 6,000 and instead of buying them later at a lower rate (I had betted on the rates falling), I ended up buying them at a higher rate.

Thankfully, at the cost of snubbing my own ego, I'd decided not to go for badla financing. The stock climbed further the following week and my losses would also have climbed accordingly.

The sins of a day trader

Smarting from my first loss and determined to make up for it (the most unforgiving sin I ever committed in retrospect), I decided to go long on GTL and HFCL the next week at a very high price.

As luck would have it, the prices of both the stocks did increase and I would have definitely made up for my losses if I had the sanity to sell them. But then I remembered Gordon Gekko and his dictum: Greed is good. In fact, I went a step further and declared: Greed is God (another sin that a day trader should never commit).

No points for guessing right. I lost again. Lost in the sense that the prices fell down from their stratospheric levels and I had to sell them at a small profit (remember a bird in the hand is worth two in the bush; likewise book your profits when you see them. Don't be greedy).

I -- and many like me -- failed to read the coming correction.

I made a neat profit of some Rs 700 after paying brokerage and service tax: my first profit after the initial loss. My happiness knew no bounds that day and my chest grew an inch wider.

Thenceforth, I learned a lot of lessons in day trading from my peers who'd visit the same trading terminal, but never put them into practice. I went on making one mistake after another (always thinking that I knew better), kept losing money week after week until 9/11 happened (I had also lost a fortune following the Ketan Parekh scam, but that's another story).

Not that I made money after that devastating attack on the World Trade Centre.

What I did was to make up was my mind to finally quit day trading, but not before my losses had reached almost Rs 2,00,000 (I have preserved my final debit bill like a souvenir). Then, I knew I had only one option left. It was a wise one; I decided to put an end to my crazy punting ways.

This is what happened...

Reality hit home

A few days before 9/11, I had gone short on (an addiction I picked from my sub-broker, who went short on any stock that took his fancy) Aurobindo Pharma, Infosys (yet again), Moser Baer, Digital Equipment (now Digital Globalsoft), Ranbaxy and what have you...

I had made (notionally) a tremendous profit on Moser Baer itself, on which I had gone Rs 275 short. The price now was Rs 240. In the next few days, MBIL's market price plummeted to Rs 179.80 but, once again, I was possessed by Gordon Gekko and did not cover my position by buying the stock.

As my misfortune would have it -- though I think it was a blessing in disguise -- the stock started rising, as quickly as it had plummeted. I ended up covering my position at a marginal loss.

Even though I made profit on other stocks that I'd gone short on, the entire episode diminished my appetite for day trading.

Also, realisation had sunk in -- a day trader always wins some and loses a lot. I know of many punters who'd agree with me.

PS: Not satisfied with my own losses in Silverline Technologies -- of which I bought 50 shares at Rs 380 -- I convinced my aunt to buy 50 more at Rs 185. I told her what a value buy it was at that level and promised her that she would be soon selling it at double the price. Even as I write this piece the stock's quoting at Rs 4.05. Not to mention the fact that it is still languishing in my portfolio!

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Make money with shares

ood question indeed. Why do people buy shares?

In a line: Because they can make big money on it.

There's a huge difference between the gains and losses you can make by investing in the stock market as compared to your returns from bank fixed deposits.

In stocks, you can make unbelievable money -- it's not uncommon for people to have doubled their money in the last one year.

On the flip side (there is always one), when the markets crashed in May, many people lost more than a quarter of their investment.

Compare this with your bank fixed deposit. Your FD will only fetch you around five to six percent per annum, but you can be sure of getting your money back.

When you put your money in a bank deposit, you loan the money to a bank for a fixed return (rate of interest) and a fixed tenure (number of months or years). At the end, you get back your original amount and you are paid interest on the same.

When you invest in stocks, you do not invest in the market (despite what you think). You invest in the equity shares of a company. That makes you a shareholder or part-owner in the company.

The good news is that since you own a part of the assets of the company, you are entitled to a share in the profits those assets generate.

The bad news is that you are also expected to bear the losses, if any.

Now, if you are a shareholder, there are two ways you can benefit from the profits of the company: capital appreciation or dividend.

Dividend

Usually, a company distributes a part of the profit it earns as dividend.

For example: A company may have earned a profit of Rs 1 crore in 2003-04. It keeps half that amount within the company. This will be utilised on buying new machinery or more raw materials or even to reduce its borrowing from the bank. It distributes the other half as dividend.

Assume that the capital of this company is divided into 10,000 shares. That would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 10,000 shares; each share would earn Rs 500. The dividend would then be Rs 500 per share. If you own 100 shares of the company, you will get a cheque of Rs 50,000 (100 shares x Rs 500) from the company.

Sometimes, the dividend is given as a percentage -- i e the company says it has declared a dividend of 50 percent. It's important to remember that this dividend is a percentage of the share's face value. This means, if the face value of your share is Rs 10, a 50 percent dividend will mean a dividend of Rs 5 per share.

However, chances are you would not have paid Rs 10 (the face value) for the share.

Let's say you paid Rs 100 (the then market value). Yet, you will only get Rs 5 as your dividend for every share you own. That, in percentage terms, means you got just five percent as your dividend and not the 50 percent the company announced.

Or, let's say, you paid Rs 9 (the then market value). You will still get Rs 5 per share as dividend. That means, in percentage terms, you got just 55.55 percent as dividend yield and not the 50 percent the company announced.

Capital Gain

As the company expands and grows, acquires more assets and makes more profit, the value of its business increases. This, in turn, drives up the value of the stock. So, when you sell, you will receive a premium over (more than) what you paid.

This is known as capital gain and this is the main reason why people invest in stocks. They want to make money by selling the stock at a profit.

It is not as easy as it sounds. A stock's price is always on the move. It could either appreciate (increase in value) or depreciate (decrease in value) with respect to the price at which you purchased it.

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Or, if you buy a stock for Rs 10 and sell it for Rs 9, you lose Rs 1, or your loss is 10 percent.

Now look at both: Dividend and Capital Gain

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Add the Rs 5 per share you have received as dividend, and your total return will be Rs 10 plus Rs 5 = Rs 15 or 150 percent (Rs 15 divided by Rs 10 multiplied by 100).

If you buy a stock for Rs 10 and sell it for Rs 9 after a year, you would lose Rs 1 per share.

However, you would have got Rs 5 as dividend. So you would net Rs 4 as earnings from the company.

In percentage terms, your return would be 40 percent (Rs 4 divided by Rs 10 multiplied by 100).

Tax

One last point.

If you are a tax payer, the finance minister has made it very easy for you to invest in the stock market. There is no tax on dividend. Neither will you be taxed on long-term capital gains. This means, if you buy a share, hold it for at least a year and sell it at a profit, you don't have to pay any tax on the profit your make. If you sell it within a year, the short-term capital gains tax is only 10 percent.

Contrast this with fixed deposits, where you have to pay tax on the interest at your marginal tax rate. This means that, if you are in the 30 percent tax bracket and your interest income exceeds Rs 12,000 in a year, you'll have to pay tax on your interest income at that rate (including the surcharge, the cess, etc, the rate works out to almost 35 percent).

Investing in stocks may be more risky, but it is more tax-friendly. Besides, there is the potential to get a higher return on your investment.

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Want to buy a stock? Read this first

eciding you want to invest in the stock market and deciding which stocks to buy are two very different decisions.

The first is easy.

The second is not so easy.

A smart investor should never invest in (buy stocks of) companies he doesn't know much about. Relying on 'advice' from friends is not always a great idea. Do some groundwork yourself.

Where does one begin?

The best place to get information about a company is from the horse's mouth: the company -- especially if an expert certifies what the company management is telling you is true.

We are talking here about the company's annual report or its profit and loss statement and balance sheet, which have been audited by chartered accountants.

There is a wealth of information in a company's annual report.

• The chairman's statement will tell you about the management's future plans.
• The directors' report will tell you how the company performed in the preceding year.
• For a personal analysis of the company's earnings and profits (or lack of them), there is no substitute to the profit and loss account and the balance sheet.

What is a P&L account?

Simply put, it gives the company's performance over a period of time, usually a year. It tells you whether the company made a profit or loss over the period.

How does a business make a profit? Well, its income needs to be more than its expenses. If its expenditure is more than its income, then the company is running on a loss.

You don't have to be an accountant or have a degree in commerce to read a company's financials. It is quite easy to grasp the basics.

A sample P&L account

Profit and Loss Account for the year ended March 31. All figures in Rs/lakh.

	2004	2003
Income
Sales	110	80
Less: Excise Duty	10	8
Net Sales	100	72
Other Income	20	18
	120	90
Expenditure
Materials	50	40
Other Expenses	30	25
Interest	5	10
Depreciation	10	10
	95	85
Compensation paid under VRS	20	-
	115	85
Profit for the year before tax	5	5
Tax	2	2
Profit for the year	3	3

Income

Under this heading, you will find that sales are the biggest item. Sometimes, people talk about gross sales and net sales.

Gross sales = Total sales including excise duty.

Net sales = Total sales - excise duty.

'Other income' refers to all those items that contribute to income but do not form a part of the company's sales. This could include dividends or interest income from the company's investments, profits from sale of assets or investments, sale of scrap items, income from services and so on.

The point to remember is that, usually, most items in 'other income' are items not directly related to the company's business. For instance, a manufacturing company may earn income from some smart investments.

In other words, 'other income' may not necessarily recur every year.

Expenditure

Expenditure is the expense on raw materials, wages, salaries, administrative expenses, advertisements and publicity, charges for power consumption and so on.

The item 'interest' refers to the interest the company pays on its loans.

Depreciation refers to the wear and tear of the equipment used by the company (this is just a notional estimate). The need to provide for depreciation arises because a company needs to set aside a sum every year so that it can buy new machinery when needed.

Exceptional items

In the above example, we have another item: Compensation paid for VRS in 2004. This is reported separately from other items of expenditure because it is an 'exceptional item'. Which means, it does not occur every year.

For instance, in the example, it didn't occur in 2003.

Profit

Deducting expenditure from income gives the profit.

In the example, profit before exceptional items is Rs 15 lakh (120 - 95) in 2004, while it is Rs 5 lakh (90 - 85) in 2003. Despite the fact that profits before tax are the same in both 2003 and 2004, it is only because of the lump sum VRS payments made in 2004; otherwise, the profit this year would have Rs 20 lakh.

If this payment is left out of the picture (as it should be, because a VRS payments means the wage bill in succeeding years will decrease), the company has performed much better in 2004 than in 2003.

Please remember that profits by themselves carry little meaning. You will always have to compare profit in a particular period with those in the preceding period to arrive at any conclusions.

In the above example, we can see the company has done better in 2004. Sales have gone up by 38.8%, while profit before exceptional items has gone up by 200%.

• How to invest in an IPO

You can now analyse a company's P&L account.

1. Did sales increase?
2. Did it result in higher profits?
3. Have profits been artificially boosted by higher 'other income'?
4. Have exceptional items led to lower profits?
5. Have interest costs gone up?
6. Have raw material costs been contained?

What are quarterly earnings?

The quarterly earnings reports are nothing but the P&L account for a particular quarter (three months).

Also read the 'Notes to the Accounts' at the end of the P&L account or quarterly earnings reports. These tell you whether the company has changed its methods of accounting, or other material factors that have affected the profits of the company.

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Spot a good stock. Win big!

etween MTV and Channel [V], you might have sometimes come across, say, CNBC.

You might have noticed a band that runs at the bottom of the screen containing the stock prices.

This is called the ticker.

Watch this ticker for some time, and you will find that stock prices are constantly going up or down. Rarely do they stay put.

Which brings you to the common question: when should you buy stocks?

Pose this question to any stock market guru (even someone who falsely professes to be one), and you will get this answer: Buy Low. Sell High.

That means you should buy stocks at a low price and sell them at a high price.

Easier said than actually done, of course.

Which brings us to the next question: how do you know if a stock is worth buying?

One, look at the 'fundamentals' of the stock: check the underlying factors behind the stock price.

In other words, find out what it is about this stock that makes it hot.

Let me introduce you to three ways by which you can figure that out.

1. Earnings per Share (EPS): How well the company is doing

Company XYZ Ltd.

Capital: Rs 100 crore (Rs 1 billion).

Capital is the amount the owner has in the business.

As the business grows and makes profits, it adds to its capital.

This capital is subdivided into shares (or stocks).

For a clearer understanding of capital, read What's in a share? Money!

The capital is divided into 100 million shares of Rs 10 each.

Net Profit in 2003-04: Rs 20 crore (Rs 200 million).

EPS is the net profit divided by the total number of shares.

EPS = net profit/ number of shares
EPS = Rs 20 crore (Rs 200 million)/ 10 crore (100 million) shares = Rs 2 per share

Lesson to be learnt

• If a company's EPS has grown over the years, it means the company is doing well, and the price of the share will go up. If the EPS declines, that's a bad sign, and the stock price falls.
• Companies are required to publish their quarterly results. Keep an eye out for these results; check for the trend in their EPS.

2. Price earnings ratio (PE ratio): How other investors view this share

Two stocks may have the same EPS. But they may have different market prices.

That's because, for some reason, the market places a greater value on that stock.

PE ratio is the market price of the stock divided by its EPS.

PE = market price/ EPS

Let's take an example of two companies.

Company XYZ Ltd
Market price = Rs 100
EPS = Rs 2
PE ratio = 100/ 2 = 50

Company ABC Ltd
Market price = Rs 200
EPS = Rs 2
PE ratio = 200/ 2 = 100

In the above cases, both companies have the same EPS.

But because their market price is different, the PE ratio is different.

Lesson to be learnt

• In the case of EPS, it is not so much a high or low EPS that matters as the growth in the EPS. The company's PE reflects investors' expectations of future growth in the EPS. A high PE company is one where investors have hopes that earnings will rise, which is why they buy the share.

3. Forward PE: Looking ahead

The stock market is not nostalgic. It is forward looking.

For instance, it sometimes happens that a sick company, that has made losses for several years, gets a rehabilitation package from its bank and a new CEO.

As a consequence, the company's stock shoots up.

Why? Because investors think the company will do better in the future because of the package and new leadership, and its earnings will go up.

And they think it is a good time to buy the shares of the company now.

Suddenly, the demand for the shares have gone up.

Because stock prices are based on expectations of future earnings, analysts usually estimate the future earnings per share of a company. This is known as the forward PE.

Forward PE is the current market price divided by the estimated EPS, usually for the next financial year.
Forward PE = Current market price/ estimate EPS for the next financial year.

To illustrate what we��ve been talking about, let's take the example of Infosys Technologies.

Trailing 12-month EPS = Rs 56.82 (EPS of the last four quarters)
Closing price on January 6 = Rs 2043.15
PE = Price/EPS = 2043.15/ 56.82 = 35.95
The PE of Infosys [Get Quote] as on January 6 = 35.95

Clear? Now be alert:

Estimated EPS for 2004-05 = Rs 67
Estimated EPS for 2005-06 = Rs 90
These figures are according to brokers' consensus estimates (you can find those in the business daily, Economic Times).

Forward PE = current market price/ esimated EPS for next financial year
Forward PE for 2004-05 = 2043.15/ 67 = 30.49
Forward PE for 2005-06 = 2043.15/ 90 = 22.70

With an EPS growth of over 30%, a forward PE of 22.7 is not high, indicating that there is scope to be optimistic about the stock's price.

Lesson to be learnt

• Sometimes, investors look out for a low PE stock, expecting that its price will rise in the future. But sometimes, low PE stocks may remain low PE stocks for ages, because the market doesn't fancy them.
• Keep tab on the business news to check out the company's prospects in the future.

That was the basics of fundamental analysis. Not too mind boggling, is it?

Next time you want to buy the shares of a company, at least do this groundwork.

Please watch out for ratios and how to calculate shares in the coming pieces.

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Should I buy shares now?

hen I read how investors are reacting to the current market trend, there is only word that comes to mind: bewilderment.

Some are laughing all the way to the bank, others are falling over each other as they scramble to buy more mutual fund units.

A newspaper article said that in November mutual fund investors in Mumbai withdrew huge amounts from their equity mutual funds. Almost Rs 4,000 crore went out from the fund houses.

Those investors were smart. They sold their mutual fund units back to the fund houses, booked profits and deposited the moolah in the bank.

But the mutual fund companies still had reason to smile. Even as they bid goodbye to a few investors, they were busy saying hello to many more.

The article went on to explain that, in cities other than Mumbai, the inflow (fresh investments into mutual funds) was Rs 2,228 crore.

Who are the wise men?

The ones entering the market or the exiting it?

Quite a few are echoing the sentiment that it is not a good idea to book profits (to sell your mutual fund units/ shares). They believe the markets will stay strong for a while and the Sensex will rise even higher.

• Sensex? What's that?

Others are saying the situation is shaky and it's a smart idea to exit now.

That brings us to you. What must you do with your shares?

You have three options

1. Get rid of the junk now

This would be the wisest move you could make.

In hindsight, a lot of our decisions appear rather unappropriate or downright stupid. This applies to investments too.

So, if you have stocks that cause you tremendous embarrassment, it is a good time to sell now.

For the sake of an example, let's say you have shares of Videocon Appliances.

In May 1995, the price was around Rs 92. The price has consistently fallen over the years and in May, this year, it touched Rs 15.

Well, the good news is that it has crept up to Rs 25. So, even if you are making a loss, it is a good time to sell now.

This is a good time to book profits or even minimise your loss if the price of your shares has not risen sufficiently to give you a profit. But, just because the price has risen, don't change your mind about selling your shares if you have already decided you don't want them.

2. Sell and make a profit

This would be the safest move.

And, if the mutual fund numbers in Mumbai are to be believed, that seems to be what a fair number of people are doing.

The temptation to stay invested in a bull run is high. Many find this temptation too strong to resist. There is always the possibility that the Sensex may climb higher and one would rake in better returns (make more money).

On December 22, the Sensex touched a high of 6480. Predictions abound that it will touch 6500 by the end of this month or early January.

While it could very well be true, it's better to be pragmatic. You never know how high the market will rise, so you might as well enjoy the going while it is good. This, in simple words, means: Sell those shares.

3. Sell some, hold on to some

How about the best of both worlds?

If you own some stocks that promise to rise in value in the future, hold on to them. You then have the option of selling them if the Sensex rises even more.

If you really want them to be part of your investments for a long time, then be prepared to ignore the highs and lows of the market over the next few years.

Now that you've selected your chosen few, sell the rest and make a profit.

What you can also do is sell portions of your portfolio at various stages.

Say you have shares of 10 companies. Sell the shares of three companies now and hold on to seven.

If the Sensex continue to rise, sell another three and hold onto four.

This way, you can take part in the rally without selling at one go. It also means you don't miss out completely if the Sensex continues to climb.

Should you buy?

You do like to live dangerously, don't you?

Before you actually go and buy some more shares, let me throw you a few questions.

1. Why do you want to buy shares now?

If the answer is that you don't want to feel left out or want to brag to your in-laws that you 'play the market', steer clear. You are not thinking logically.

If you think you can make a fast buck in no time, you are kidding yourself. To make a quick buck, you need a lot going in your favour.

For starters, you need to invest huge amounts for even a small price rise to give you a good return.

Otherwise you need the price to move up drastically. This is something you have no control over.

Thirdly, you must be willing to take the risk of making a loss (something everyone chooses to ignore).

2. Will you be willing to hold on to your shares if the market comes tumbling down?

Okay, that was an exaggeration. No one really believes that will happen.

Right now, as the bulls and bears fight it out, there is a lot of dust being kicked up. And the bulls clearly winning. When the dust settles, it would be safe to pick up some shares.

In technical terms: The correction (a short-term drop in stock market prices) is bound to come but the market will bounce back. And, if predictions are to be believed, the Sensex should touch 6,700 by December 2005.

What you can do is wait for the correction to buy shares. Alternatively, you could pick them up now if you are prepared to hold onto them and sell them maybe a year later, when the Sensex rises to a level higher than what it is today.

Learning from history

Interestingly, have you noticed we are entering 2005 on the same note on which we entered this year?

On January 1, the Sensex touched a high of 5936 and climbed up to 6249 on January 9. By May 31, it dropped to 4830 and began picking up in July. On November 12, it touched 6001 and, on December 22, it was 6480.

(Note: The above levels are the highest the Sensex reached on that particular day.)

If you expect the trend to repeat itself this year and foresee the Sensex touching a higher level next December, then you can probably go share shopping for Christmas.

A word of caution: Don't try to imitate the savvy trader. Select your stocks carefully. Avoid rumours or you could get slaughtered in the market.

On a closing note, I have to make mention of what a friend once told me, "The moment the grocer or the panwallah asks you about the booming stock market, sell your shares and book profits."

He was not being biased against any socio-economic class when he said that. All he meant was that when it reaches that stage, it is a good indication the bull run has peaked.

So, what has your grocer being saying to you lately?

Illustration: Dominic Xavier

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