The market euphoria can lead to poor decision-making, where investors ignore fundamental analysis and chase momentum

In this heated stock market, take great care to differentiate between the ‘monkeys’ and the ‘goats’ in your portfolio They may overlook company financials or governance red flags, blinded by the allure of quick gains. Moreover, even mediocre companies stock prices soar during these times, creating a false sense of security

Dhirendra Kumar

CEO, Value Research

Do you remember the equity markets towards the end of 2007? The Sensex had been up about five times over the previous five years and there was madness in the air. There seemed to be no end to how high and how fast stocks could rise. We all remember how it ended, but that’s not the point I’m trying to make. The point is not what happened to the markets when they crashed, but to individual companies when they recovered.

Whenever the markets rise as they did then, they eventually crash. It was inevitable then, and it’s inevitable now. There may be some doubt about when it will happen and by how much, but it will definitely happen. To a seasoned equity investor, this is nothing unexpected. Ups and downs are a part of the game.

The part that few investors appreciate is that these are dangerous times. Over the next few years, when the dust settles in the next market cycle, you will find that these weren’t great times as far as buying stocks was concerned. You might think I’m saying this because during bull runs valuations are high and stocks are expensive. You would be right, but that’s not the only reason. The biggest reason is psychological. When anything you buy makes money, the constant scepticism that investors need disappears from their minds.

This euphoria can lead to poor decision-making, where investors ignore fundamental analysis and chase momentum. They may overlook company financials or governance red flags, blinded by the allure of quick gains. Moreover, even mediocre companies’ stock prices soar during these times, creating a false sense of security. It’s crucial to remember that when the tide eventually turns, the quality of the underlying business, not just the market sentiment, will determine which stocks survive and thrive.

In 2007, just before the market’s peak, I wrote a newspaper column with this amusing story: ‘One day, a man appeared in a village and offered to buy all the monkeys that the villagers could supply for Rs.1,000 each. The villagers caught all the monkeys and sold them. Soon, another man appeared and offered Rs.2,000 for each monkey. However, there weren’t any more monkeys around, so the villagers couldn’t sell any to the man. However, they figured that, for some reason, the demand for monkeys was going up, so they looked for the first man and bought back all the monkeys for Rs.3,000 each, which was the least the man was willing to take. Unfortunately, this stratagem failed, and the buyer never reappeared, leaving the villagers stuck with the animals.

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Nearby, there was another village, where the same story was repeated, except it was about goats. The final buyer also never appeared, and the villagers were stuck with goats. However, there was a big difference. The monkeys were a nuisance. They were noisy, troublesome and dangerous, and they stole food all the time. So the villagers eventually abandoned them in the forest. The goats, however, were easy to keep, grazed on grass and provided milk. When they grew older, the villagers slaughtered them for meat. All in all, buying goats was not as bad a deal as it seemed initially.’

For investors in today’s raging bull market, the moral of the story should be obvious. In this heated market, take great care to differentiate between the ‘monkeys’ and the ‘goats’ in your portfolio. The ‘monkeys’ are the speculative stocks, hyped up by market sentiment, but lacking fundamental value. When the market inevitably corrects, these stocks may prove to be not just worthless, but actively detrimental to your financial health. The ‘goats’, on the other hand, represent companies with solid fundamentals, strong business models, and the ability to generate real value over time.

The goats are expensive, too, but at least they will deliver value even after the buyers disappear.

(The author is CEO, VALUE RESEARCH.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

This story originally appeared on: India Times - Author:Faqs of Insurances