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Rules to make stock market investment safer

By Ashish Pai in Mumbai
April 05, 2010 11:04 IST
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The thought of investing in equity and safety sounds contradictory. Conventional wisdom says investing in equity is the riskiest. How does one make such investment safer?

Although it is impossible to eliminate the market risk in equity investing, you can make your investment process sound by following some simple techniques.

Keep in mind that the purpose is to generate wealth over a period of time and not overnight or in a fortnight. Let's now look at some methods to make your investment safer:

Go for higher dividend yield stocks: Stocks with high dividend yield are preferable. Dividend yield is calculated as a percentage by dividing the dividend by price e.g, the dividend paid by Indian Overseas Bank for 2008-09 was Rs. 4.5 per share and its current share price is Rs 92.

The dividend yield is about five per cent. Since the dividend you get is a tax-free amount, it compares better than the return from a bank fixed deposit. At times, when not able to sell your stocks due to the market condition, there can be cash flow in the form of final dividend and, at times, interim dividend.

Some of the stocks with high dividend yield are GNFC, Andhra Bank, Vijaya Bank, Castrol and Hindustan Unilever. A word of caution: the amount of dividend declared varies by financial performance and cash requirement.

Look for shares with lower Price to Book Value (PBV) ratio: Book value is computed by dividing the equity share capital and reserves & surplus by the number of equity shares outstanding. PBV is market price divided by the book value. Generally, high-growth companies have a higher PBV.

However, at times there are some fundamentally good companies with a low PBV. If PBV for a company is less than one, it means the market capitalisation is lower than the net worth. Meaning, in normal circumstances there is intrinsic value in the stock. Some of the companies with low PBV currently are Federal Bank, Syndicate Bank, Karnataka Bank, GSFC, Gujarat Alkali and Shipping Corporation.

Investors should generally avoid stocks with a very high PBV ratio, as it means their market capitalisation is far more than the net worth.

Don't put money in stock at a 52-week high or all-time low: A time-tested rule is not to buy stocks at a 52-week high or low. A stock at a high price may start dropping after reaching the peak. Also, there may be limited upside from these levels. Similarly, when the stock price is bottoming out, you don't know how much more it will fall.

Buy companies with good management: At times, out of greed, investors invest in companies with shady management. It is advisable to buy in stocks of companies with good management, even at the cost of lower returns.

Here, the safety of your capital investment is more or less assured. Examples are HDFC, Infosys, Wipro, NTPC, Mahindra & Mahindra, State Bank of India, etc.

Monitor your investment: A common tendency is to forget the investment after it is made. You have to periodically evaluate the performance and take corrective steps. Investing does not mean buying and forgetting. It requires constant evaluation and corrective action.

Have a profit-booking and stop-loss policy: If the stock you invest in gives you the anticipated capital appreciation in a specified time period, it is advisable to book profits either partially or fully. Similarly, if the price of the stock that you invested starts drifting down, it is advisable to have a stop-loss limit. By doing so, you will be able to preserve your capital to a considerable extent.

Diversify your pie: Always diversify your investment in different sectors, asset classes and time horizons, as it will enable you to lower your risk. By investing in only one asset class or sector, you may lose out on the opportunities in others.

Investing is like driving a vehicle. It is similarly important to avoid potholes, follow traffic discipline and keep your vehicle in proper condition. Investing requires avoiding unnecessary risk, having proper strategy and evaluating your investment decisions.

If you follow some basic rules properly and have a disciplined approach, you can drive your equity investments safely!

The author is a freelance writer.
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Ashish Pai in Mumbai
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