A lot of investors put money in stocks without knowing the business. Proper business knowledge can help investors understand how earnings can grow with changing business dynamics. For instance, any announcement related to water desalination can impact companies like Va Tech WabagNSE -4.97 %.
Sometimes people invest in the stock of a quality business but at higher valuation. This may lead to losses in the short term. One should always compare the stock valuation with its peers or industry average before investing. Buying a stock at a higher valuation like high price-to-earnings ratio (P/E) can lead to losses even in a bull market.
The price-to-earning (P/E) ratio tells what the market is willing to pay now for anticipated future earnings of the company. The ratio is calculated by dividing the share price of the stock by its earnings per share (EPS). The ratio indicates whether a stock is over-valued or under-valued. Comparing a set of stocks on the parameter of PE ratio, giving investors a fair idea of how expensive or cheap a stock is on a relative basis. This ratio can be regarded as one of the important factors among many others while taking a decision to buy or sell a stock. Buying a quality company at wrong valuation can dampen portfolio return even in a bull market.
Stocks generally trade at lower P/E multiples in relation to historical values in a bear market, and at higher levels in a bull market. Simply put, it would be prudent for an investor to avoid shares that are trading at a significant premium to their historical PE trading range.
Novice investors often get lured by market movement and try to spot penny stocks hoping for multibagger returns in coming years. A stock trading below Rs 10 is normally considered a penny stock. Market mavens believe one should avoid looking for a penny stocks in a bull market, as their valuations do not look cheap. Small companies with unreliable promoter backgrounds should be completely ignored.
Do not invest in a company which is not generating free cash flows. Free cash flow represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base. One should avoid companies that are not able to generate free cash flow.
Selling a quality stock on the smallest of negative news is one of the worst decisions an investor can take. Most investors who have made money in the stock market have worked on ‘buy’ and ‘hold’ strategy. Negative news can increase the volatility in a particular stock in the short run. However, one should not sell a stock in panic.
Never put all your eggs in one basket; invest in a variety of stocks and asset classes. There can be prolonged periods of under performance in a specific sector or asset class. Ensure exposure to fixed income with some portion of your portfolio.
Anil Rego, CEO, Right Horizon, said: “Diversification helps investors in reducing the volatility and protect portfolio with sudden changes in market environment.” While creating a diversified portfolio, one must keep in mind that a large number of securities do not necessarily lead to better diversified portfolio. One can achieve diversification by having a fewer securities from across a large universe.
If there’s one thing every trader needs to know, it’s to trade with a stop loss (SL) in place. Stop loss is the limit at which a losing trade would automatically get closed.
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