Common Misconceptions related to Equity Shares
The equity share markets in all its wisdom, also has its own share of misconceptions and myths. Myths are the popular beliefs that have come down the years and generations but really have no basis in reality. These myths are dangerous because there is something so axiomatic about it that we have started believing it to be a lot like stock market religious text. Here are 6 such myths that you need to urgently dispel in the share markets.
Growth stocks are better than value stocks
This is particularly the case for companies operating in emerging industries or selling innovative products and services. It appears that growth is a great strategy to buy into. That is because the higher relatively higher growth expectations tend to justify substantially higher P/E Ratios. But, is growth investing always a better bet than value.
That would largely depend on what levels you buy at and at what point you review. If you bought stocks at the bottom of the cycle in India in 2009 or in 2013, then value would have worked wonderfully well. Of course, if you select a high growth phase which is also a high valuation phase then growth may appear to be a better strategy than value. In more matured markets like the US, value stocks have done substantially better than growth stocks. In fact, quite often, value does work better than growth and here is why. Expectations tend to be higher for growth stocks and higher expectations lead to more opportunity for disappointment. When a company is doing well, investors expect it to continue doing well. We saw in the case of Pharma and IT how they lost value, the moment the high growth assumptions were negated.
A good company is a solid equity investment stock too
Again that is more intuitive and hopeful than backed by data. Logic would seem to dictate that good companies should make for good investments, but the two can be very different. A company with a great product but little profitability is not a great stock to invest in. Check the financials to see how fiscally sound the company is and whether profits are growing. Then look at the stock’s valuation to see if it is cheaply valued, fairly valued or expensive. A solid stock is a good company, with good profits and supported by reasonable valuations.
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Penny stocks are great because they can double in not time
You will get to hear this argument quite often, especially if the investor was lucky enough to have bought RCOM at Rs.8 and exited within a few days at Rs.25. But putting Rs.8 in Kingfisher would have made it totally worthless. It is all a matter of perspective. When you adopt this argument you are guilty of forgetting a basic tenet of stock markets that, for the penny stock to double in value, the company’s entire market capitalization also has to double in value. If you really believe that the company is worth twice its price today, then how does it matter if you buy a stock at Rs.2 or at Rs.2000? You should also ask why a stock is trading for less than the price of a basic cup of coffee. Most probably, that is what it is worth.
These are MTM losses and not real losses; so it does not matter
When the share price falls below its purchase price, some investors rationalize to themselves that they haven’t lost anything because they haven’t sold the stock. This line of thinking is wrong because stocks are liquid assets and have to be “marked-to-market”. That means a stock is really worth only what it is trading in the market and not the purchase value. Effectively, you lose purchasing power when a stock falls in value. If you invest Rs.10,00,000 and the value came down to Rs.7 lakhs, then if you go for loan against shares (LAS), you only get Rs.3.50 lakhs as loan considering 50% haircut. The market value of your portfolio is what matters because that is what your portfolio is worth and that is what you will realize when you liquidate your portfolio.
Dividend stocks give lower returns, so dividends don’t matter
Dividend stocks are often seen as boring, dull, stable and slow growth companies. We normally look at them as incapable of generating above market returns. That is not always true. Take the case of the Nifty. It has delivered 12% returns on an average in the last 3 years. A stock like IOCL would have given 14% return on dividend yield itself. The capital appreciation is icing on the cake. In fact, when companies pay dividends, it is an indication that it has sufficient liquidity in the business and that is a good signal. In volatile markets, there is a premium attached to dividend stocks.
Beating the index is so easy, every equity fund seems to be doing it
The first thing you need to understand is that fund returns are not the same as your returns. That is only possible if the fund holding period is the same as your holding period, which is rarely the case. Globally, nearly 70% of the funds fail to beat the market index. In India, there is an illusion of out performance because the index may not be very efficiently designed. Globally, index funds have grown multi-fold only because funds struggle to beat the index. That trend will gradually come to India too. So don’t live under the myth that it is a cakewalk to beat the market. At least, not in the long run!