The Hindu Business Line : The long and short of it

“Don’t worry about market fluctuations. Think long term.” Now that’s something that investors, young and old alike, would have been told repeatedly while their equity investments yo-yoed with the ups and down in the stock market in the last two years.

But what exactly is long term? Is it a year or two or is it, like, forever? And should you really just take a nap while the market is battering your portfolio with its wild swings? Here’s more on the subject.

Defining tenures

Though investment gurus often ask us to hold for the “long term”, did you know that “long term” actually means different things to different people? Investment advisors such as Warren Buffet, who buy stocks on the strength of the underlying business, have been known to stick to their choices as the business grows and matures; for them, long term is a holding period of ten to fifteen years!

But investors in the Indian context tend to be a bit more impatient and even fund managers typically ask investors to take a “three-five year view”.

The definition of long term or short term can also differ based on who is talking about the investment. When a fundamental analyst recommends a stock on the basis of a company’s business, he would generally advise a holding period of at least three years. On the other hand, a technical analyst may peg short-term calls to between ten and twelve trading sessions, while their long-term calls take up to a year to deliver.

Taxmen too have a different definition of long term. Here, short-term investments indicate a holding period of less than a year. Any security held for a year or more becomes a long-term investment.

Why define tenure

The risk involved in investing for the short or long term varies much as how a stock behaves in a day or a week can radically differ from how it performs over a number of years.

While there are some stocks on which you can build gains only if you hold them for a few years and watch the business grow — such stocks move gradually and will provide rather meagre returns even over a few months — there are others you can only rely on for quick gains.

Most seasoned market players will be able to reel out a string of stocks that head for the stratosphere in every bull phase; but sink into oblivion when the markets aren’t scaling new highs every day.

Defining your investment period, therefore, assumes significance because the stocks you choose will have to fit into one of the above slots. The risk and returns involved too depend on how long you are willing to hold that stock.

As a rule, short-term investments hold greater risks, but may deliver higher returns (or losses), whereas for long-dated investments, there is enough time for the stock price to capture the growth of the underlying business.

If you’ve done a good job of identifying a growing business, the stock price will eventually catch up.

How to select

Well, so much for the risk. But how do you go about selecting stocks? Remember short and long-term investments are to be made with different returns perspectives in mind. The key in a long-term call lies first in the industry selection because some industries, such as sugar and pharma, are cyclical and may not deliver.

So, you’ve first got to study the prospects of the sector, and how it may develop over the next few years. In addition, study the fortunes of related key industries. Later on, a fundamental analysis of the company will give you the prospects of that company within the industry. On the other hand, short-term stock picks — primarily trading picks — must be based on analyses of charts and price patterns, immediate market outlook, tips and news flows.

Is there a ‘best option’?

Lesson one: Simply buying and holding stocks does not necessarily guarantee substantial returns, or even returns at all. Here’s why.

Had you bought the stock of textile company Arvind Mills back in July 2004, you would be sitting on a loss of 66 per cent per share today. Or if we take the Sensex itself, the five-year absolute returns (from July 2004 to July 2009) is a neat 200 per cent. But had you exited in December 2007, your returns would have been higher at 302 per cent.

Lesson two: However, holding a stock merely for a long period isn’t enough. Constant monitoring of investments is a must.

Consider the case of Gillette India. In the period between January 2000 and July 2009, the stock has lost 63 per cent of its price. Similarly, the stock of Sonata Software erased away 95 per cent of price in the last nine years.

Lesson three: Avoid the temptation to convert your bad short-term investments into your long term “portfolio”. That’s a good way to ensure that your portfolio is made up of stocks that you wouldn’t particularly like to own.

Suppose you bought the stock of Entertainment Network from a short-term perspective at, say, Rs 261 in end September ’08. In hindsight we know that the stock took a downward turn and hasn’t touched your expected sell price since. What should you do then? Investments marked for the short-term are best for the short-term only.

Converting them into a long term one may not be the wisest choice, even if you were sitting on losses on the stock. Continuing with Entertainment Network, had you held on to the stock, you would still be at a 26 per cent loss, which could have been less than 10 per cent had if you exited the stock in the beginning of October.

Standing by decisions

So, the point to note is that whatever your investment decision is, the key is discipline. Stick to your investment period, and your targeted return.

A short-term call isn’t likely to behave in the manner you wish in the long term. Losses you may be sitting on now may worsen in the long term if the industry or the company itself is on a downswing or if its business or operating capabilities are questionable.

In a long-term investment, don’t simply put your money in and then entirely ignore it and look at it after a good many years.

Keep a watch on the price from time to time, and if you are of the opinion that the price has run up from when you got it, or your stock has hit your expected sell price, cash in your profits while keeping your capital in. That way, you make a profit, but will still be able to benefit from a further price rise.

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The long and short of it