Dear Friends,
Several of my friends, relatives and well-wishers have been asking this question on Direct Equity Investment and I though I will publish my Point of View on this topic.
My answer to whether a normal investor can do direct stock market investing for wealth building is a resounding “No”and here is why I say so:
Each one of us is busy with multiple things and the time we get to track the stock performance is very less. Investors like Warren Buffet (Oracle of Omaha), Prem Watsa (Canada’s Warren Buffet) or our own Rakesh Jhunjunwala (supposed to be the most savvy Stock Investor in India) spend full-time on analysing the companies, researching them before they buy. They also have huge analyst teams who research the stock, rip them apart and provide inputs to these big ticket investors. Not to say that they sit on the boards of the companies and are privy to the direction that the company takes.
Typically, the so called stock pickers among us, watch NDTV Profit, Money Control, read Economic Times, Mint, discuss with friends and colleagues over a cup of coffee or during lunch and based on inputs that we get, take a position in stock – buy or sell. The information obtained and decisions made using such inputs is very subjective and speculative in nature without sound logic. Compare this with the Mutual fund houses who have dozens of Fund Managers (invariably these fund managers are from premier B Schools and have a solid Finance background), similar or more research analysts who track the stock market full-time and take calls based on established processes (that is why they charge us the expenses). The question is can someone who does it part time without a proper infrastructure in place can excel the experts? The answer is “Yes”, at very few times but mostly “No”
Now let me share my own personal experience to further strengthen my argument. I have dabbled with stocks directly using ICICI direct, talking to my friends and colleagues and have also made money. Let me say with absolute conviction that people who directly trade in stocks enjoy the associated thrills. The question is whether they have been able to build wealth through direct equity investment like the Warren Buffets and Vatsa’s. What I realized after several years is that a normal investor trying to do direct stock picking is nothing more than “Intelligent Gambling”.
I had worked in Cognizant for close to 15 years and can say that I know quite a lot on how it operates and can sense the outcomes (quarterly results), being part of it. We have a 90 day period before which the employees who resign have to exit their ESOP (Employee stock options). I had a few left and was selling it in tranches, the last one was planned after the June results (Cognizant announces the quarterly results 5 weeks after the close). Seeing the positive results from the Indian behemoths like TCS, I was holding my ESOPs in Cognizant thinking it will go up (I had no reason to feel why our performance would be poor). Finally when the results came out, I lost a couple of lakhs in a single day (CTSH tanked 15% after results were announced due to revised guidance). I see no way to recoup my losses as there are no more triggers before the next results which will come out in Nov 1st week, whereas my ESOP expiry is 30 Sep 2014. If I can’t predict what is happening in my own company then on what basis or better knowledge will I have on other companies to buy or sell them?
Let me quote the famous words of Warren Buffer which I use it many times:
“Only when the tide goes out do you discover who’s been swimming naked”
People who have invested in stocks and made money should realize that when the going is good everyone is an expert stock investor (as in the past 4 months due to Modi Euphoria). Another interesting quote that I use often is
“If you are a good stock investor, then you are in the wrong profession”. Remember that for small ailments like headache or common cold you can pick up an OTC drug but beyond that you need to seek professional medical advice and that is where the doctors and similarly professional fund managers (for wealth building through equity investments) come to play
Now let me share another interesting example. I have my cousins who is a doctor couple (Husband is a Radiologist and Wife is a General Practioner) and live in UK. When they came home with their 2 kids, we were having a causal dinner conversation and my cousin said that one of their kids fell ill and was taken to a doctor. I was shocked to hear that as both parents were doctors and why would the kid be taken to another doctor. Apparently the answer is as per UK medical Ethics you are not supposed to treat your blood relatives due to the emotional attachment as the decision making will suffer.
I can see similar thing happening when we do direct stock investing. Let’s say I invest in a stock now after all the so called research (News Papers, radio, TV, friends etc.) and the stock tanks by 10% in a week; typical human psychology is I can’t be wrong so let me buy some more to average the same (have personally done many like Reliance Power, Reliance Communications, DLF) or let me hold for further period as it’s just a short term trend and the fundamentals are very strong. How can Reliance group fail to deliver? – in the past 7 years this group has really failed to deliver when compared to the broader markets, whether it’s the Mukesh’s group or Anil’s group. But Mutual funds don’t get influenced by emotions and have solid processes in place. If the stock has not performed or if the fund manager realizes that he/she has entered a wrong stock they come out of it or cut their exposure. It is not that only when a stock does not perform do the MFs sell them, but they also have price targets and on achieving the same they sell it (and maybe buy at a later point in time for based on their research forecast).
Agreed, MFs can’t give phenomenal returns like a concentrated portfolio of half a dozen stocks can give. But the question is ‘which half a dozen?” and how would we get to know them? I got this wisdom after 8 years of direct stock market investing and now reconciled to the fact that the only option to build long wealth for ordinary investors is through Mutual Funds.
Nowadays I tell people that you have a separate allocation of say 5 to 10% max if you want to really play in stock market directly for the thrill of it (don’t we pay huge money to take some theme park rides knowing very well that we would be tormented for a few minutes and its really scary!) which you won’t get in Mutual Funds. Atleast that way you can appease your ego and also ensure that you are building enough wealth by investing the rest through Mutual Funds!!!
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Very thoughtful. Thanks Sendhil
Excellent write up. Cognizant Q2 example may not be apt because may be, you can’t predict performance on short term but am sure you are better in predicting cognizant stocks on long term and usually, stocks are long term.
You are absolutely correct Anbu when you say that stocks are for long haul. But the point that I was trying to drive with the example is the limited amount of insight that we have on companies, which makes it difficult to take a judicious call on the stock.
Good article Sendhil. I like the idea of allocating 5-10% of funds in which we can directly dabble in stocks. Especially for people who like to be more active in their investing. Rest can be in the hands of professional managers who do this on whole-time basis. Even within those 5-10% of direct investing in stocks, I think a person should either stick to sectors where he himself works or which are connected to it. The chances of making a better stock-pick is more.
Also when we use mutual funds to invest I think a parameter we should check is whether the fund manager is himself invested in the fund or not. Basically whether he has his own skin in the game. I believe it improves the chances of the fund performing better than otherwise.
You are right Jyoti. We should understand the business of the companies that we invest in so that the chances of getting it the pick right is more. Even Buffet has mentioned this in his speeches and articles that he publishes, saying that he prefers to stay out of businesses that he does not understand