A robust economy, impressive corporate earnings growth, relatively stable interest rates and the rising recognition of domestic companies in the overseas markets have made India a favourite investment destination for overseas fund managers.This is over and above the increasing interest among domestic institutional and individual investors, alike, for availing themselves of investment opportunities in this fast emerging financial market. Accordingly, the long-term prospects of the Indian stock market, which measures the pulse of the Indian economy, continue to be buoyant as almost all industrial sectors have been benefiting from the country's economic growth.

At a more micro level, you must realize that irrespective of how much you earn and save, the returns that you receive on your savings should outpace inflation by a substantial margin, if you wish to be able to fulfil your dreams and aspirations and build up a corpus for your retirement years. Investing in stocks has time and again proved to be the best way to do so. This is especially true now, with the economy showing so much promise, which in turn is reflected in the stock market. However, you must be ready to stay invested for the long term and ignore temporary ups and down which the market is bound to face on its long term upward climb. In a nutshell, investing in well chosen stocks for the long term is a sure-fire way to build your wealth.

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This is one of the basic principles in investing: Taking reasonable risks could result in higher long-term rates of returns. Equity shares promise higher rates of return over the long term. On the other hand, debt instruments offer more stable but lower returns. As an investor, you should be able to judge whether the perceived risk is worth taking in order to get the expected return and whether a higher return is possible for the same level of risk and vice versa. The only way you can do this is if you are aware of all the risks that you are up against. Here’s a list of the more common risks that are attached to investing in equity.

Market/economy risks
These risks are not unique to any company and affect all stocks. They stem from factors related to the economy such as money supply, the level of government borrowing, the industrial policy, global economic conditions, etc. These are also known as non-diversifiable risks, since investors cannot avoid these risks, however diversified their portfolios may be.

Industry risk
This is the risk that applies to a specific industry and therefore, to stocks of companies belonging to that industry. A large scale shift in demand, a rise in input prices and regulatory changes are factors that augment such a risk. For instance, consumers’ preference for cheaper polyester clothing hampered the demand for cotton fabrics in the 1990s. Another example is the risk borne by Indian tyre companies when international prices of natural rubber rise.

Management risk
It is defined as the inability of the management to take decisions in the larger good of the company and its minority shareholders. Decisions that benefit only the company's directors and its promoters would classify as a management risk. Further, even a shareholder-friendly management can be a risk if it is unable to manage a company's growth in both good and bad times alike, and lacks the necessary dynamism to lead the company.

Business risk
Business risks mainly arise from the fact that a company's earnings before interest and taxes (EBIT) can vary, depending on various factors. Demand is the first among these factors. If the demand for the company's product is not stable or predictable, its revenue won't be stable or predictable either. The company's ability to increase prices or absorb cost increases is another key to its profitability. Companies differentiating their products through branding are better equipped to pass on cost increases and earn above average profits. Thirdly, if fixed costs are a substantial portion of total expenses, business risk is definitely higher (unless such costs also create a strong entry barrier) since the company's earnings then are more susceptible to variations in demand.

Financial risk
Financial risks arise when debt represents a high proportion of the company's capital structure (which comprises net worth and debt). A calling back of debt by the creditors or the company’s inability to secure adequate funds in future could result in a collapse in the operations of the firm whose stock you have invested in.

Exchange-rate risk
This risk arises out of variations in exchange rates of the rupee against the U.S. dollar and other major currencies. Profits of companies who import a relatively large part of their raw materials and those that export a large part of their goods or services are impacted when the rupee depreciates or appreciates, respectively. A weakness in the rupee also prompts foreign investors to withdraw from the stock market by selling their shares and converting those rupees into dollars. While they may re-enter at lower levels, the withdrawal of foreign investors often forces stock indices to tumble in the short-term, posing a big risk for domestic investors.

Inflation risk
Inflation can hit a company's profits badly if it is not able to pass on the effects to consumers. In some cases, even if inflation eases, wage hikes can rarely be rolled back. Worse still, inflation can inflate corporate profits through overvaluation of closing inventory and this can lead to an increased tax burden.

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Top-down and bottom-up approaches
Before trying to understand the differences between top-down and bottom-up investing, remember that both of these approaches have the same goal - to find out great stocks. Top-down investing involves analyzing the ‘big picture’. Investors using this approach look at the economy and try to forecast which industry will generate the best returns. They then look for individual companies within the chosen industry and add the stock to their portfolios. For example, suppose you believe there will be a drop in interest rates. Using the top-down approach, you might determine that the home-building industry would benefit the most from the macroeconomic changes and then limit your search to the top companies in that industry.

Conversely, a bottom-up investor overlooks broad sector and economic conditions and instead focuses on selecting a stock based on the individual attributes of a company. Advocates of the bottom-up approach simply seek strong companies with good prospects, regardless of industry or macroeconomic factors. What constitutes ‘good prospects’, however, is a matter of opinion. Some investors look for earnings growth while others find companies with low P/E ratios attractive. Bottom-up investors will compare companies based on these fundamentals. They feel that as long as the firms are strong, the business cycle or broader industry conditions are of no concern.

The P/E yardstick
One of the key determinants of a good valuation yardstick is its usage. The price to earnings (P/E) multiple wins hands down on that score, being easily one of the most popular valuation tools not only in India but across the globe.

Conceptually, the P/E multiple represents the premium that the market is willing to pay on a company’s earnings, based on its future growth. The ratio is most often used to conclude whether a stock is undervalued or overvalued. The P/E ratio is calculated by dividing a stock's current share price by its earnings per share (EPS) for a 12-month period (mostly the last reported full-year EPS). In effect, the ratio uses the company's earnings as a guide to value it.

While using P/E as a yardstick for measuring stocks, remember that a stock with a lower P/E is not necessarily a better investment than a stock with a higher P/E. Most P/E ratios you see for publicly-traded stocks are an expression of the stocks’ current prices compared to their previous 12-month earnings. A low P/E must be coupled with the company’s ability to grow revenues and earnings at least as quickly as the price in future to remain attractive. It must also be noted that average P/E ratios tend to vary from industry to industry. Typically, companies in very stable, mature industries which have more moderate growth potential have lower P/E ratios than those in relatively young, fast-growing industries with more robust future potential. Thus, when you compare P/E ratios of two companies as potential investments, it is important to compare firms from the same industry with similar characteristics. Otherwise, if you simply purchased stocks with the lowest P/E ratios, you would likely end up with a portfolio full of similar companies, which would leave you poorly diversified and exposed to more risk than if you had diversified into other industries with higher-than-average P/E ratios.

At the same time, stocks with high P/E ratios need not turn out to be good investments.The important thing is that when looking at P/E ratios as part of your stock analysis, consider what premium you are paying for a company's earnings today and determine if the expected growth warrants the premium. Also, compare it to its industry peers to see its relative valuation and try to determine whether the premium is worth the cost of the investment.

Discounted cash flow (DCF) analysis
It can be hard to understand how stock analysts come up with a ‘fair value’ for companies, or why their target price estimates vary so wildly. The answer often lies in how analysts use the valuation method known as discounted cash flow (DCF). In simple terms, DCF tries to work out the value of a company today, based on projections of how much money the firm is going to make in the future. DCF analysis says that a company is worth all of the cash that it could make available to investors in the future. It is described as ‘discounted’ cash flow because cash in the future is worth less than cash today.

DCF serves as a reality check to the fair value prices found in brokers' reports. DCF analysis requires you to think through the factors that affect a company, such as future sales growth and profit margins. It also makes you consider the discount rate, which depends on a risk-free interest rate, the company's costs of capital and the risk its stock faces. All of this will help you understand what drives the value of a company’s stock. This will enable you to put a more realistic price tag on the company's stock.

Using a DCF model probably entails a more in-depth understanding of the company finances than relying on traditional valuation measures such as the P/E ratio. This analysis treats a company as a business rather than just a ticker symbol and a stock.

Economic value added (EVA) is a financial concept that cuts away market chaos to focus on a single investment question: Is a company creating or destroying wealth for shareholders? By trying to answer this question, you will take the first step to pick stocks that outperform the market, which is the dream of every long-term investor.
EVA is defined as the difference between a company's net operating profits (NOPAT) and its total cost of invested capital over a given time period. This capital charge is necessary to compensate the providers of debt and equity for use of their capital investment at a rate adequate for the risk incurred.

EVA = net operating profits after tax - cost of invested capital

If the EVA is positive, the company has created value above the minimum return required by investors, and if it is negative, wealth has been destroyed.Implicit in the EVA calculation is an important concept - equity requires a return. Not only that, but the cost of equity is typically the most expensive form of invested capital and is linked to factors such as prevailing interest rates and corporate risk. Financial statements recognize the cost of debt, identified as interest expense, but not the cost of equity. Calculating a company's profit while leaving out the cost of equity is like playing volleyball without the net.

With the full cost of capital deducted from NOPAT, EVA shows whether capital is being used efficiently in the company, and with further analysis, whether high-return businesses are subsidizing low-return businesses or which geographical regions or business segments of a company's operations add value or destroy value.

Recognizing how, in the long term, the efficiency with which a company uses its capital determines how well its stock performs, EVA can provide valuable predictive insights into the future performance of stocks. To describe how to apply EVA to investment strategies, one additional concept - market value added - is required.Market value added (MVA) is the difference between the total market capitalization of a company's debt and equity and the total invested capital. It represents the market's perception at a point in time of the company's ability to successfully invest its capital in the future. Companies which have demonstrated superior EVA performance are typically accorded a higher MVA, a premium over their current invested capital to recognize their perceived potential to gain wealth. Companies, which have an eroding EVA, may find their MVA languishing or, in fact, negative, reflecting negative sentiments in their stock price.From the company's perspective, the best category is where wealth is being created (high EVA) and the market is rewarding this wealth creation with a high MVA. Growth and momentum investors may find opportunities in this group of companies.

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Managing investments is a serious business. It can be a time-consuming task, because it requires intelligent planning, continuous monitoring and periodic adjustments. And it can be challenging, because it requires expert knowledge and experience. Equity investment does not provide you the luxury of sleeping over your investment just as would be possible in case of fixed income securities. Indian markets no longer work in isolation. You need to be very well aware of not only happenings of national interest but global issues which affect the future prosperity of your investment. Selecting stocks for one’s portfolio is only the beginning of the investment process. You need to review your valuation metrics to determine which stocks remain undervalued and which are approaching or have surpassed their fair value.

If you have invested in the equity markets your investment needs to be continuously monitored. Even if you buy into equity with a long-term view, you still need to assess the performance of your portfolio on a regular basis. To assess the stock performance you need to monitor the performance of the company as well as the industry. You also need to keep in mind the economical, political and global factors affecting the firm. Therefore, take a closer look at the following factors while measuring the performance of stocks:

Assess companies’ quarterly performances You must have noticed that every three months - at the end of June, September, December and March - the newspapers are full of advertisements about the financial results of companies. That's because companies are required by law to publish their financial results every quarter. They must also send the results to the stock exchange where they are listed. Now you can track the performance through the year since the quarterly results show the most recent performance of companies. While glancing through quarterly results, keep a watch on the following numbers:

*Sales growth
Revenues reveal how much the company has sold over a given period. Sales are the direct performance indicators for companies. The rate of growth of sales over the previous years indicates the forward momentum of the firm, which will have a positive impact on the stock's valuation.

*Net profit
The growth in net profit indicates the attractiveness of the stock. The expected growth rate might differ from industry to industry. For instance, the IT sector's growth in bottom-line could be as high as 65-70 per cent from the previous years whereas for the old economy stocks the range could be anywhere between 10 per cent and 15 per cent.

* ROI (return on investment)
ROI in layman terms is the return on capital invested in business. For instance, if you invest Rs 1 crore in men, machines, land and material to generate Rs 25 lakh of net profit, then the ROI is 25 per cent. Again, the expected ROI by market analysts could differ form industry to industry. For the software industry, it could be as high as 35-40 per cent, whereas for a capital-intensive industry it could be just 10-15 per cent.

* PSR (price-to-sales ratio)
This measures a company's stock price against the sales per share. Studies have shown that a PSR above 3 almost guarantees a loss while a PSR below 1 gives you a much better chance of success.

* ROE (return on equity)
Supposedly Warren Buffet's favorite ‘number’, the ROE measures how much your investment is actually earning. Around 20 per cent is considered a good level.

* Debt-to-equity ratio
This measures how much debt a company has compared to the equity. The debt-to-equity ratio is arrived at by dividing the total debt of the company with the equity capital. A D/E ratio of 2 or greater is risky. It means that the company has a high interest burden, which will eventually affect its bottom-line. If the firm is using only a small portion of its revenues to pay off interest, then the company is better off by employing debt to enhance growth. However, note that companies in capital intensive industries have higher debt/equity ratios. Hence, this tool is not the right parameter to assess such firms.

*Beta
The beta factor measures how volatile a stock is when compared with an index. The higher the beta, the more volatile the stock is (a negative beta means that the stock moves inversely to the market so when the index rises the stock goes down and vice versa).

*EPS (earnings per share)
This ratio determines what the company is earning for every share. For many investors, earnings are the most important tool. EPS is calculated by dividing the earnings (net profit) by the total number of equity shares.

* P/E ratio (price/earnings ratio) Earnings per share alone mean absolutely nothing. In order to get a sense of how expensive or cheap a stock is, you have to look at earnings relative to the stock price and hence employ the P/E ratio. The P/E ratio takes the stock price and divides it by the last four quarters' worth of earnings. If AB Ltd. is currently trading at Rs 20 a share with Rs 4 of earnings per share (EPS), it would have a P/E of 5. A significant increase in earnings can enhance share value. When a stock's P/E ratio is high, a majority of the investors consider it as pricey or overvalued. Stocks with low P/Es are typically considered as having good value. However, studies done and past market experience have proved that the higher the P/E, the better the stock.

Just by glancing at the results for the fourth quarter, you can easily conclude whether the company has made a profit or loss. Is that profit high or low? Is it good enough? To answer those questions, you will have to compare the quarterly numbers with those of the same quarter in the previous year. To make comparisons easy, companies provide these numbers, too.

So, you can check out the growth in each item by comparing it with the numbers in the corresponding quarter of the previous year. While going through the results, the extraordinary items and the other income should be excluded as they are not recurring items. All of the above give a fair idea about the stock and its prospects, but you should always take care while comparing a stock with that of peers.

Study overall trends in capital markets and the economy
The return on equity is directly dependent on the situation prevailing in the economy. The government’s policies, budgetary issues, reforms promoting a particular sector and the global impact on the Indian market need to be considered before deciding on a stock. For instance, a government’s decision to allow foreign direct investment in real estate, and remove the multi-fibre agreement in textiles would give an edge to these industries over others. The outlook for the stock market also depends on the outlook for basic economic factors such as:

• The supply of funds coming principally from business and personal savings
• The demand for funds arising from financing expenditure by consumers, business and governments
• The growth rate for real GDP (the total market value of all the goods and services produced within the borders of a nation during a specified period)
• The inflation rate and anticipated inflationary pressures.

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Normally, a stock is bought after going through its fundamentals and its fair value is determined taking into account the investment horizon. So, a sale would be made when the stock approaches its fair value. However, deteriorating business fundamentals or negative earnings revision may also prompt an early exit from the stock. Continuous monitoring and reviewing would enable you to keep track that if the information or expectation does not yield the desired result then you could sell the stock. An investment made with a long-term perspective also needs to be reviewed to check for any unfavourable technical factors, political or economical instability affecting the rationale for holding the stock. On the other hand, improving business conditions, new products or a change in management that might help a company strengthen earnings may require you to increase the holding period for a particular stock. Thus, it might help you to make more returns by reviewing your selling decision.

After you have built a portfolio investment strategy on the basis of your risk-return profile and a time horizon, you have to implement it. Stock trading can be done through two ways, either offline broking or online broking.

To begin trading, you must first find a broker to execute your trades. Of late, most transactions are carried out in the electronic form. For this, you have to open a ‘demat account’ with a depository who should be registered with the regulatory authority. A depository is an organization which holds securities of investors in the electronic form at the request of the investors through a registered depository participant. It also provides services related to transactions in securities. After opening the demat account you should open a trading account with your broker. The broker issues contract notes detailing purchase and sale transactions, bills containing the charges (stamp duty, brokerage, securities transaction tax and service tax) levied on the purchase and sale transactions. SEBI (Securities and Exchange Board of India) prescribes guidelines for the rate at which charges are levied, the frequency of issuing contract notes and also the format.

Paying margins

Let’s say you strongly feel that the price of a stock will go up and so much so that you don't mind taking some extra risk. You can make money by buying the stock now and selling it later when the price increases. But what if you don’t have the money to buy? Well, you could ‘go long’ on that stock; that is, you ask your broker to buy the stock without paying him the full amount now. Instead, you can pay him a token amount called the margin money. When you buy on margin you are actually buying stocks on credit. Your broker will lend you the part money if you have enough collateral in the form of adequate stocks in deposit with the broker. Since it’s a loan the broker is giving you, he will also charge you interest. You could have also borrowed money from some other sources to buy those stocks. But, usually brokers try to offer interest rates lower than other sources. Buying long allows you to buy more shares than you can afford. And, if your hunch about a stock's price rise turns out to be correct, you stand to gain more than what you could have without a margin buy. But, the longer it takes for the stock to rise to the price level you had expected, the less will be your gain. To be safe, the stock price should rise enough to pay off the loan amount, the interest incurred and the transaction cost. Buying long becomes risky if your calculations go wrong. If it takes a much longer time for the stock price to reach the level than what you had estimated, your profits will reduce because by that time the interest cost on the borrowed money would also have risen. And if your estimate completely goes wrong and the stock's price falls, you immediately start making losses. You break even when the stock price rises enough to pay off the loan amount, the interest incurred and the transaction cost.

Cost of investing in equity
You would incur costs when you open demat and trading accounts. Brokers usually have recurring and one-time charges (account opening fees). Recurring charges are the annual maintenance fee and the brokerages on transactions.

Brokerage is usually 0.25-0.85 percent of the transaction value or a flat rate (between Rs 10 and Rs 50) on a per trade basis, whichever is less. Some brokerages charge customers with large accounts less. Annual charges for the demat account can be anything between Rs 250 and Rs 750. The brokerage may or may not include service tax.

• If you are an active investor with a high trading turnover, brokerage charges will leave a dent on the profits. Obviously, the lower the percentage rate, the better.
• If you are a low volume investor — active or passive — a stiff minimum charge will hurt. Therefore, choose a broker or a Web trader who either does not specify a minimum charge or levies a low one.

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Electronic trading (e-trading) connects buyers and sellers in geographically separate locations in a virtual trading platform. Now, you can use your computer via the internet to e-trade. With reference to shares, e-trading means the buying and selling of equity vielectronic means. In practical terms, you must register as a client with an e-broker as you do with a broker and can start trading.

Most banks offer online trading facilities and these are three-in-one accounts – that is, bank, demat and trading accounts. The expenses incurred here are the minimum balance one has to maintain with the bank, and the demat and the trading account opening charges. Normally the following charges are levied.

Account opening charges - Charges for opening an account stand at around Rs 700. This is inclusive of legal documentation charges. This amount will be debited from the customer’s savings account.

Brokerage – Various brokers may charge different rates but they cannot charge beyond that specified by the government and regulatory bodies. You may be charged at the rate of the higher of 0.5% of the transaction value or Rs 25. In case of a square off, brokerage will be charged at the rate of 0.15 per cent of the transaction value on each leg subject to a minimum of Rs 7.50 on each leg of the transaction.

For instance:
If you buy 100 shares of X Ltd. at the rate of Rs 190, brokerage charged will be Rs 95 (0.5 per cent of 19,000).
If you buy 10 shares of Y Ltd. at the rate of Rs 180, the brokerage charged will be Rs 25.
If you buy 100 shares of X Ltd. at the rate of Rs 190 and sell 100 shares of X Ltd at the rate of Rs 200 in the same settlement, brokerage will be charged at the rate of 0.15 per cent of 19,000 + 0.15 per cent of 20,000 = Rs 58.50
If you buy 10 shares of Y Ltd. at the rate of Rs 180 and sell 10 shares of Y Ltd at the rate of Rs 175 in the same settlement, brokerage will be charged at the rate of 7.5 +7.5 = Rs 15.

Bank charges
There are no account opening charges. A quarterly minimum balance will, however, have to be maintained.

Depository participant (DP) charges
There are no account opening charges. However, the DP will levy an annual maintenance charge as well as transaction charges for each trade.

Online trading gives first-time and low-volume investors an edge over physical broker trading in terms of convenience. Also, it is more transparent. Banks that offer trading platforms make for seamless trading and payment options. The entire transaction process — from placing the order to making payments and delivery — takes place seamlessly, and requires minimal follow-up. In addition, the costs are largely the same regardless of whether you are trading offline or online.

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Every person who invests in the market has his individual experiences to share; nevertheless there are few common misconceptions. To become a successful market player one must be well aware of the truth behind these. For instance, very often we hear people saying that the elderly are not supposed to take risks. They must be very conservative because their earnings power is limited. Well, who decided that young people could afford to lose their money? Taking another example, it is easy to say that stocks that go up must come down but laws of physics do not apply in the stock market. There is no gravitational force that pulls stocks back to even. To give you a better understanding, let us go through the widely prevalent myths in the market that one must be beware of.

Myth 1: The market is always right
Most people believe the market is all-knowing and that the current price of a stock reflects all material information about the company, its history and its prospects. This does not hold true always. Often you would have noticed a stock double or triple in the space of a month but this sharp rise is not preceded by any new information about the company. It’s very rare for a company’s fundamentals to change so significantly over a short span of time. So, what’s changing is simply the market’s perception about the stock. Understanding what the market is trying to say is different but to conclude that it’s invincible would be a big mistake. The market will paint a new picture every day so it will be far more useful to consider the market as extremely prone to swinging to extremes, rather than as an all-knowing and all-powerful force that many market watchers assume it to be. For only then can you use the market to your benefit, and buy low and sell high, rather than become its slave and let it affect not only your wealth but also your health.

Myth 2: Price is not an issue while investing in good companies
A large number of investors propound that one cannot go wrong if you buy into good companies, no matter what their share prices are. This philosophy is often ascribed to Warren Buffett, and his so-called followers swear by it. The truth is that, though Buffett believes in buying the best businesses, he acknowledges that if your entry price is unrealistically high, you might have to wait an eternity before you make decent returns from the stock. Usually, in such cases, your patience runs out on you, and you exit at an inappropriate time.

Let us take the example of Wipro, which rose to almost Rs 10,000 in February 2000. This translated into a P/E (price-earnings) ratio of almost 800 on its earnings for the year ended March 2000. Yet, investors continued to buy Wipro as if the sky was the limit. Wipro is a fantastic company, no doubt, but sometimes speculators are able to generate a frenzy that leaves rationality in the dumps, and along with it, the fate of many investors. Those who purchased Wipro at that five-figure price are mostly unlikely to see those levels again. So, the price at which you buy a stock is important.Buffett, in fact, advises investors to answer two questions while searching for investment picks: which company and at what price.

Myth 3: When a stock hits its 52-week low, it’s time to buy
Bottom fishing is a popular investor pastime, but it’s usually the fisherman who get the fish. The 52-week high/low is one of the most widely used parameters by many investors to buy or sell a stock. The logic: all stocks have a 52-week low and 52-week high, and that range is usually at least 100 per cent. So, if you can buy a stock near its low and sell it near its high, you should be able to earn good returns but grabbing a rapidly falling stock results in a lot of surprises, because inevitably you grab it in the wrong place. For instance, attempting this strategy with technology stocks would call for a lot of courage to face up to the consequences. Most technology investors tend to follow ‘momentum investing’ (buy a stock when it starts to gain momentum and sell it when it begins to lose steam). When momentum takes a stock to a new low, there’s no telling where it will eventually end up. Moreover, a rebound does not always take place. On the contrary, the stock might just keep sinking to new lows, till it reaches a point where nobody wants to buy it at all. So, if you are interested in buying a stock, it ought to be for a more sensible reason. An investor needs to research his stocks very well. Zeroing in on the blue chips is not easy, as there are only a handful of companies that follow such a trend. So, before you jump to any conclusions, think really hard.

Myth 4: Rupee cost averaging is always a good defensive stock strategy
Rupee cost averaging advocates buying more of a stock if its price falls in order to average out the purchase price. Say, you bought 100 shares of a company at Rs 100 (total consideration: Rs 10,000), after which it falls to Rs 50. At this price, you should buy 200 more shares (total amount invested remains Rs 10,000) so as to bring down your purchase price.

Sure, you bring down your purchase price, but is it worth it? If you buy something whose intrinsic value is only Rs 10, first at Rs 100 and then at Rs 50, no matter how much you average down, you will still be buying onions at the price of orchids, and sooner or later, either your money will run out or you may be the only investor left in the company!

So, the more important thing to look at is the true worth of your investment. Once you have figured that out, it is much easier to apply theories like rupee cost averaging or buying a stock when it hits its 52-week low.

Myth 5: Penny stocks are great buys, as they have little downside
Is a stock priced at Rs 10 cheaper than another priced at Rs 1,000? Well, some people will tell you it is. Their reasoning: how much lower can the stock priced at Rs 10 go? Chances of price going to zero are more in favour of a penny stock rather than in case of Wipro or Infosys. However, some people may say that all the upside is already factored in the Rs 1,000 stock. The story is already recognised and there is no more to be gained from buying this stock.

But, the truth is that the absolute price of a stock has absolutely nothing to do with its future prospects, and hence, its valuation. A stock issued at Rs 10 (maybe 10 years ago) and now quoting at Rs 1,000 suggests that the company has done well over these last 10 years in terms of earnings and profitability while on the other hand, stocks trading at or below par suggest something drastically wrong with the company and/or its management.

Don’t take any company for granted – whether it is Infosys or just a penny stock. Put their annual reports under the lens every year before taking any investment decision. The price of a stock must be viewed in relation to its earnings, its book value, the dividend per share and revenues per share, rather than on an absolute basis. More importantly, you must also analyze qualitative factors relating to the company’s business, its longevity, profitability and sustainability of those profits.

Myth 6: Fallen angels will all go back up, eventually
Frequently people say that a particular stock has gone down 20 percent or more, so it should not go lower. Shareholders of TV18 would have a good experience of this. The share got listed at Rs 1,450 in the boom of 2000 and with the bear market it went on making new lows and each time the stock continued its southward journey until it reached the price of Rs 36. Taking another hypothetical example suppose you are looking at two stocks:

• XYZ made an all-time high last year around Rs 50 but has since fallen to Rs 10 per share.
• ABC is a smaller company but has recently gone from Rs 5 to Rs 10 per share

Which stock would you buy? Believe it or not, all things being equal, a majority of investors choose the stock that has fallen from Rs 50 because they believe that it will eventually make it back up to those levels again. Thinking this way is a cardinal sin in investing! Price is only one part of the investing equation. The goal is to buy good companies at a reasonable price. Buying companies solely because their market price has fallen will get you nowhere. Make sure you don't confuse this practice with value investing, which is buying high-quality companies that are undervalued by the market.

Myth 7: P/E ratio tells you whether stocks are cheap or expensive
P/E ratios are easy to find. Every newspaper, magazine and stock report publishes P/E ratios. Everybody seems to talk about them when discussing stocks. So, P/E ratios must be a great way to compare stocks.

As an investor if you were told that ABC Ltd had a P/E of 7, and XYZ Ltd had a P/E of 14, would you buy ABC Ltd instead of XYZ Ltd? You might, but you wouldn’t be comfortable making that decision because one needs more information. You’d like to know a whole lot of things before you decide which stock to buy. One of the most important things you’d like to know is the worth of each stock based upon its earnings, profitability and other key financial data. In other words, you would like to have a sense of the stock’s intrinsic value. P/E ratios don’t say anything about a stock’s value!

What investors need is a ‘value-to-price’ ratio. With this ratio, investors would know immediately whether a stock was cheap, expensive or fairly priced. But this means we have to have a way of computing value. Of course, there are theories and formulas for computing intrinsic value. But they are complex, and some sophisticated investors even say they are unfathomable. Consequently, most investors don’t look at stock’s intrinsic value. They resort to trivial devices like comparing P/E ratios.

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What determines stock prices?
Stock prices are driven by market information in the short term. In the long term, dividends, bonus, capital expenditure plans, mergers and acquisitions, and government regulations affecting the sector together add up to impact stock prices.

How much does a share cost?
The market sets the price and it all depends on how many buyers and sellers think the share is worth that much on that day. Some stocks sell for less than Rs 10 a share, others for more than Rs 1,000 a share. But do not be misled that a Rs 10 share is better than a Rs 1,000 share. The market determines the price of each stock, depending on the company’s potential.

What returns can one expect from his/her investments in equity shares? What are the risks?
Equity shares are ‘high-risk, high-return’ investments. The major distinction of equity investment from all other investment avenues is that while the return from many avenues such as bank deposits small saving schemes, debentures, bonds, etc. are fixed and certain, the earnings from equity investments are highly uncertain and varied. A good scrip picked up at the right time could fetch great returns and the return on a mediocre or poor company’s scrip may be meagre or it may even turn negative; that is, the invested fund itself may be eroded. In short, if the investment in fixed income category instruments is secured and risk-free to a large extent, investment in equities and related fields could be termed as risky.

What are market orders, limit orders and stop orders?
There are several types of orders that you can dictate to a broker. The most common type, which is a regular buy or sell order, is called a market order. Another type of order is a limit order wherein you ask the broker to trade only if the price reaches a specific level. In a stop order, you tell the broker to sell your shares if the price drops to a certain level to prevent significant losses because if it drops to that level it is likely to drop further and your losses are likely to increase.

What do bullish and bearish trends mean?
When the market goes up it is called a bullish trend and when the market goes down it is called a bearish trend.

What is ‘taking a position’?
When you act upon a stock and buy into it, you are taking a position. A position is an amount of money committed to an investment in anticipation of favorable price movements.

There are two kinds of positions:

• Long positions are what most people do. When you buy long, that means you are anticipating an upward movement in the price, and that is how you profit. People usually buy stocks expecting to sell them later at higher prices and hence make profits.
• Short positions are the tricky ones. When you buy short, you are anticipating a fall in the price and the fall is the source of your profit. The shares will be sold and when the price falls they will be repurchased and the difference is where the investor profits. Of course, the investor who borrowed the shares carries the risk of not having the price move as anticipated, in which case he may lose money while repurchasing the stocks.

What is a contract note?
It is a statement of confirmation of trade(s) done on a particular day for and on behalf of a client. A contract note is issued in the prescribed format and manner, establishing a legally enforceable relationship between the member and client in respect to the trades stated in that contract note. Contract notes are made in duplicate, where the member and client both keep one copy each.

Stocks often drop excessively on just a little bit of bad news. Why?
If one piece of bad news gets out, investors begin to fear that more bad news is lurking around the corner. Similarly, if one stock in a sector gets into trouble (especially if it is an event that could easily happen to any other company in the same business), there is a suspicion that others, too, will suffer. For instance, investor confidence in Internet companies took a beating after March 2000, when popular Web-based companies in the U.S. faced bankruptcy.

Is it advisable to buy stocks on the basis of information published in newspapers?
You will probably end up being the last in the queue. Everyone reads that news, and the stock price has probably already reflects that news. In fact, stock prices tend to drop on a major news announcements following the old jungle saying: "Buy on rumours, sell on news."

If one invests for the long term, can he/she simply ignore the short term?
If one invests for the long term, can he/she simply ignore the short term? It is true that a 'buy and hold' strategy is superior to one that is based on market timing. But, that does not mean you wait for all negative developments to emerge before reacting. Hence, you need to look for positive or negative signals in the short term. If these continue for some time they may have long-term implications. However, avoid the temptation to profit from short-term price swings. It may happen that you decide to sell stock ABC at a price hoping to cover it later at a lower price. But then if the up-move is happening for some sound fundamental reason, you will end up losing. Similarly, it may also happen that you cover up your position at a lower price only to see the stock price falls further as the share may have been downgraded for a genuine reason. It is important that you do not miss the big picture.

How can one take advantage of general fluctuations in stock prices?
If you think the market is ‘too high’, you might give a stop-loss to preserve profits, liquidate some of your positions to capture profits and reduce your exposure or delay any new purchases. If you think the market is ‘too low’, then you might keep some money aside for fresh purchases or cover your position, if you have sold the stock short before.

What are the four things that a trader fears most?
The four fears are:

• Fear of being wrong
• Fear of losing money
• Fear of missing out
• Fear of leaving money on the table

An opportunity comes every now and then, but these fears do not let us take full advantage of it. For instance, we enter the trade too soon - before the market generates a signal, or too late - long after the market generated the signal.

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