The Hindu Business Line : A sense of history helps

Stock exchanges, growth versus value, blue chips, fundamental analysis, leverage, and arbitrage. For a discussion of these, and nearly fifty other topics, here is from Barron's Keys to Investing in Common Stocks, as a new Westland edition. "A successful investor should possess a sense of history, which tends to repeat itself, although not exactly in the same form," advise the authors Barbara and Nicholas Apostolou, both from Louisiana State University. "Looking at past trends in the markets assists in maintaining objectivity and a sense of perspective."

An early lesson in the book is about inflation, because it impacts investment decisions. "An asset that rises in price as fast or faster than the general level of prices is a good inflation hedge, or protection against loss due to the effects of inflation." Research has shown, one learns, that `a worse than expected inflation report pushes up interest rates and depresses stock prices.' And conversely, when inflation is better than expected, you can expect `higher returns on stocks and bonds.'

Another useful counsel is to `keep it simple.' The book cites Peter Lynch to emphasise how `the individual investor actually has key advantages over profession investors.' According to Lynch, institutional investors suffer from two disadvantages: One, "They waste time justifying their decisions to their bosses. As a result, they tend to follow the herd."

Keep your eyes open

And two, "A stock is not attractive until several large institutions recognise it. As a result, professional investors jump in after a stock has had a run-up in price." Keep your eyes open `at work, at the shopping mall, and on the road,' as Lynch says, to `uncover interesting stories to exploit.' Invest only in companies `with products and services that are easily understandable.' Most important: "After a stock is purchased, it should be held for as long as the `story' that drew an investor to it in the first place is still valid."

A chapter on ratio analysis uses `the Enron case' to highlight how `an analysis of the financial statements using basic ratio analysis techniques should have disclosed to investors Enron's deteriorating financial results and inspired some scepticism about the price of its common stock.'

Accounting data, though, are of little use to `technicians,' as the authors explain in a chapter on `technical analysis.' Technicians find that it takes time to process and evaluate accounting data, while `technical analysis leads to much quicker decisions.' So, which is better, fundamental or technical?

"No technical indicator has proven to be an infallible predictor of future stock prices," notes the book. "There is no sure and easy road to stock market riches." The successful investors are those `who have pursued a sound investment strategy geared to making profits over the long term.'

Takeover terminology

In the prevailing M&A (merger and acquisition) buoyancy, it should be useful to pick up `takeover terminology.' The book describes many `colourful' phrases, about how companies fend off corporate raiders. Such as, poison pill, white knight, golden parachute, greenmail, shark repellent, and pacman defence.

Useful read is a chapter on `investment strategies,' with findings from research studies, for example: Low P/E (price earnings) stocks consistently produce larger long-term returns than high P/E stocks; earnings of smaller companies can grow faster than those of larger companies; the best time to buy a stock is before the institutions become attracted to it and run up the price; and companies that report a high level of insiders' purchases perform better than companies reporting heavy sales by insiders.

When planning for retirement, a rule that may come handy is the `100 minus the investor's age' formula. "The amount represents the percentage of the portfolio that should be invested in stocks," explain the authors. For example, if you are 40 years old, you can think of putting 60 per cent of your holdings in stocks.

Nice starter read.

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