Sunday, April 30, 2006

When to Buy

Making a decision on purchase of a stock, which you have singled out
for investment based on your research, presents difficulties for most
investors. More often than not people try to time their purchases.
They want to buy the stock but hesitate to pay the current price. The
market analysts of CNBC add even more confusion by claiming that the
stock has gone too high and buy at correction.

My answer to the question is an emphatic NO. Market timing may have
worked in their case but it never worked in my 10 year investing
career. In the investment philosophy which I have developed, this
decision is very simple for me. When I evaluate the prospects of the
company I generally decide a price band for purchase, based on my
valuation. Please understand that the intrinsic value is not a pointed
value. Suppose a company has chances of 10-25% growth in next 10 years
with different probabilities. The intrinsic value calculated based on
10% growth will be vastly different from the once at 20% growth. So
all we can calculate is a price band where each point has associated
probabilities.

Thus when there are no specific values why do investors decide that
they will buy only when the stock falls 20% from current value. Most
people do this because they have no knowledge of valuation and they
think that market is efficiently pricing the stock. They think that if
the current price is correct and they are able to buy at 20% below
this they would make gains.

So what is the alternative? I can tell once which I follow (quite
successfully). I decide at which price band I'm comfortable and start
buying at that. I make periodic investments subsequently based on
renewed information about the company. For instance 4 years ago my
research showed that M&M is a company worthy of investment. Based on
different growth estimates the valuations suggested a price band of
400-600. I made the first investment of only Rs 15000 at Rs. 315. In
next 3 years I made 25 additional investments in M&M whenever it fell.
The last and the biggest investment I made was at Rs 52. My average
worked out to Rs 87 and current price of Rs 440 is almost 5 times
high. You could argue that if I had made all the investment at Rs 52
my gains would have been higher but these things work only in the
hindsight. You can never predict movement of stock prices in short
term and I know my limitations.

Please note here that the original investment at Rs 325 too has
provided me a gain of 40%. So I think that the best way is to start
with small investment and increase it as the .....Price falls....
No. As you get to know more about he company and are more comfortable
about its value in relation to current price.

Price in itself does not matter. In J&K bank I made similar series of
investments starting at Rs. 26 and continuing till Rs. 120 as the bank
grew in strength and profits.

Here is the bottom line. Start with small investment. Get to know more
about the company. Do a periodic review. Every time the decision has
to be made considering the current price in relation to its current
prospects.

In case of M&M the prospects worsened(with tractor market degrowth)
but price fell even more sharply. That's why I invested more. In case
of J&K bank the price rose by 200% but the bank business and its value
in the eyes of the financial community grew more. So I made more
purchases at prices twice high as the initial one.

You can develop your own investment styles and take more risk by
commiting all your funds at once if you are dead sure about your
valuation. In my case though I'm dead sure about my valuation I'm
never sure about valuation of Mr. Market

Posted: Sep 5, 2004
http://in.groups.yahoo.com/group/lawarrenbuffet/message/877

1 comment:

Amit K Gupta said...

Hey buddy. I am impressed. I went through all your articles. And concepts mentioned by you match a lot with my thinking. I also picked up my some of the concepts from one of the Benjamin's book and investing in US market since last 3 years with good enough success and ofcourse with some failures and learnings along the way. I also do a blog out of hobby...check out at "http://www.stocksconsulting.blogspot.com/".