The Hindu Business Line : Stock market is like the Rorschach inkblot test

Like the majority, you perhaps rely on your broker's recommendations and pick up stocks to buy and sell. If so, it pays to know that the recommendations can be untrustworthy, as Clifford Pistolese writes in Select Winning Stocks Using Technical Analysis, from Tata McGraw-Hill (www.tatamcgrawhill.com).

The broker may be pressured to sell underwritten or sponsored stocks the firm has in inventory, explains Pistolese. "Also, when a broker is trying to achieve a monthly sales quota, he or she may urge you to act too hastily."

Mismatch of interests happens when `the broker's primary objective is to earn commissions and finding the most appropriate investment for you is a secondary consideration'.

Instead, you can be a self-directed investor, urges the author.

And, to help you take control in your hands, he discusses techniques for selecting stocks that can make large capital gains. Begin from the basics, therefore, and know that `the stock market is like the Rorschach inkblot test in which people see what they are inclined to see'. Rather than engage in such subjective exercises, review the market status using technical analysis, guides Pistolese.

He concedes that some people may prefer to invest for high-income flow. "Holding investments that pay high dividends or interest is especially appropriate in a range-bound market when stocks that make large capital gains are harder to find," notes Pistolese.

He then goes on to describe an example of investment that can yield high returns, thus: "Huge deposits of oil, oil sands, and natural gas exist in Canada.

As long as the price of oil and natural gas remain high, there will be strong incentives for companies to develop these deposits. Much of the development of these resources is financed by royalty trusts.

These trusts pay out most of their income in the form of dividend disbursements."

Another example is of REITs or real-estate investment trusts, which are required to pay out 90 per cent of their earnings, at times, on a monthly basis.

"They get much of their revenue from leasing rental properties. Some of these leases run for 10 years, which provides for a very reliable flow of income."

Essential read is the chapter on `pitfalls to avoid'.

Hopefulness is a positive influence as long as expectations are reasonable, advises Pistolese. "A low level of greed is motivational and can serve to keep investors participating actively and with enjoyment. But when greed gets out of control... "

Useful lessons.

Academic inputs plus practical illustrations

"Steve buys 200 shares of IBM at $120 each, by borrowing $12,000. How long can the price of IBM fall, before it would trigger off a margin call, if the maintenance margin is 25 per cent?" Thus reads one of the many examples in Sunil K. Parameswaran's Equity Shares, Preferred Shares and Stock Market Indices (www.tatamcgrawhill.com). The book, which is the fourth in a series on the securities market, blends academic inputs with practical illustrations.

Such as this example, in a chapter on dividend discount models: "Flextronics has just paid a dividend of Rs 2.50 per share. The required rate of return on the stock is 10 per cent per annum, and dividends are expected to grow at the rate of 6 per cent per annum. What should be the stock price?"

The first chapter introduces readers to many elementary concepts, including voting rights, proxies and par value.

Written in a simple style, the book explains terms and phrases of importance. "A stock dividend (called a bonus share in India) is one that is distributed in the form of shares of stock rather than as cash... This is known as capitalisation of reserves," educates Parameswaran.

In a section on stock splits, he notes that while stock dividends entail the capitalisation of reserves, stock splits do not. Only the par value of the existing shares gets reduced. "A company which perceives its stock price to be too low can go in for a reverse split."

A 4:5 reverse split, for instance, means that a holder of 500 shares will have 400 shares after the exercise.

An elaborate chapter on stock market indices deals with sub-topics including value weighted indices, changing the divisor, changing the base period capitalisation, rebalancing a tracking portfolio, and free floating methodology.

Educative material.

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