Want to be stock market boss? Try this

[K.Karthik Raja]

Want to be stock market boss? Try this

Cautious investors should consider a number of strategies that are
formulated to enter and exit the market in a predetermined manner.

First, by buying shares on a periodic basis, it is possible to
accumulate more low-priced shares. This dollar cost averaging requires
constant purchasing with a fixed sum for a year or two to be
effective.

Second, consider balancing your portfolio between stocks and other
fixed-income securities. Whatever ratio you decide on, the success of
the plan rests on your ability to monitor and act on imbalances.

Third, reinvest your dividends to purchase new shares. This is a
painless way (if you do not need the dividend income) to increase your
stake in the company. Remember that in the long run, a stock's value
is a reflection of its dividend stream.

Earnings and projected future earnings are all important in the stock
market. Get the consensus earnings estimate before you buy a company,
and then monitor those earnings (and future earnings) to see that
there are no surprises.

Averaging up

Paying attention to the business cycle is a classic approach to the
key problem of timing purchases and sales. However, there are other
equally successful ways to invest that rely on different techniques
and philosophies. Some investors use one method, some another, but
there is no reason not to mix them.

One truism that appears valid in the investment world is the simple
observation that no one technique works all the time. Just as you
diversify a portfolio with 8, 10 or 15 companies in order to eliminate
company risk, it is wise to consider and implement different
approaches.

One answer to the problem of timing is to pass: It is too difficult
and too tenuous to place much faith in it in the view of some. Ignore
timing and implement a strategy that does not rely on the vagaries of
the business cycle and a host of sometimes confusing leading
indicators. By using a fixed formula, the issue of when to buy and
when to sell is not subject to a judgment call.

Dollar cost averaging is perhaps the most popular of these plans. By
regularly purchasing the same dollar amount of securities over a long
period, it is possible to buy more shares at low prices than at high
prices. Thus the investor accumulates more low-priced shares than high
priced shares. This is a systematic method of buying shares at an
average cost that is lower than the average price of those shares.

For example, an investor decides to buy $ 1,000 of stock each quarter
of the ABC Company. Its shares are $50 each at the start of his dollar
cost averaging. His program might look like the one in Table 1.

Table 1: Dollar Cost Averaging for the ABC Company


Quarter
Price per share
No. of shares
Share cost

1st $50.00 20 $1,000

2nd $43.00 23 $1,000

3rd $55.00 18 $1,000

4th $66.66 15 $1,000

5th $70.00 14 $1,000

6th $80.00 12 $1,000

7th $85.00 12 $1,000

8th $90.00 11 $1,000

Total $539.66 125 $8,000

Average Price
Average cost per share

$539.66 � 8 = $67.46
$8,000 � 125 = $64

At the end of two years, the investor spent $8,000 for 125 shares
worth (@$90) $11,250. With $8,000 he or she could have bought 160
shares at $50 initially (if the money had been available), which would
have been worth $14,400.

At the other extreme, an investor could have bought 89 shares for
$8,000 at the end of the period, Clearly, low stock prices, are better
than high stock prices since more shares will be accumulated. This
form of investing also works best when there is predictable growth and
a real likelihood of higher prices. It works best with volatile issues
and it can be used easily with mutual funds in order to provide
diversity.

This system ensures that the investor will not load up with high-
priced issues. When prices decline, the damage to the portfolio will
not be as great as it otherwise might have been.

There are some disadvantages as well: Commission charges for odd lots
(less than a hundred shares) can be high; there is a natural
reluctance to buy when prices are high; there is also a natural sense
to sell out when prices are depressed rather than maintain the
program; and dedication to constant buying of a company's shares may
blind one to problems that develop within that firm over time.

Other formula plans

Other formulas are also useful to the passive investor. The constant
ratio plan is a simple way to keep equilibrium between common stock
and fixed-income investments.

You could start a program by dividing your portfolio (or intended
portfolio) in half: 50 per cent of the value in common stock and 50
per cent in bonds. The holdings are evaluated on a regular basis, say,
every three or six months.

If the stock side increases beyond a given point, say, 60 per cent,
some stocks are sold. If it declines below 40 per cent, some stocks
are bought. As prices rise, the profit from the sold stocks is
converted into bonds. As stock prices fall, some bonds are sold to buy
more shares.

This system keeps the investor balanced and allows for profitable,
programmed trading. Obviously a judgment on asset allocation has to be
made as to whether 50-50 is appropriate or 90-10 would better serve.

This judgment must also be made by employee-shareholders of company
pension plans. Many company income-sharing plans require or request
the participants to select how their retirement funds are to be
balanced for the forthcoming year.

Another variation of a passive investment program is the constant
dollar plan. An investor establishes a safety point in dollar terms
above which he or she will not venture any further funds in common
stock. Whether it be $20,000 or $100,000, the safety point is one that
keeps his or her portfolio from experiencing too much exposure.

The portfolio sells shares if that point is crossed, reinvesting in
the more conservative fixed-income side. On the other hand, the
portfolio sells bonds and buys shares when the stock side is
substantially below the safety point.

Dividend reinvestment plans

Dividend reinvestment plans, under which dividends are used to
purchase additional shares of stock, are a convenient and inexpensive
way to add to holdings. The vast majority of companies do not charge
fees for joining the plans; some even offer a discount from the market
price.

Dividends reinvested through these plans are taxable to the
participant (unless they are in tax-deferred accounts), as is the
difference between the fair market price and the discounted price. For
more information about these plans, contact the company's shareholder
relations department for a copy of the plan's prospectus.

Timing in these formula plans is predetermined by the market's
actions. It removes the possibility of active intervention on a whim
if the plan is rigorously followed. Critics object to the mechanical
artificiality of these schemes.

They keep investors from fully participating in long and sustained
trends in a business cycle. But then, investors wish to be protected
from such participation by definition. They wish to make progress
slowly and methodically: the tortoise, after all, did beat the hare.