Yet another investment strategy

Buying at the bottom and selling at the top’ is a universally accepted stock market rule, but few people have the courage or discipline to follow it. The rule becomes all the more important now with the market near its all-time high. Herd mentality is the biggest mistake investors make in bull markets like these.

Since most stocks have already moved up significantly, well above what is warranted by their fundamentals, there’s no point chasing them further. The best strategy right now is to identify sectors and stocks that are yet to participate in the rally in a big way.

Another rule that investors need to keep in mind is about sector rotation. Each bull market rally brings its own sets of favourite sectors and stocks and rarely does a sector or stock, that leads one bull market rally, participates in the next. Why?

First, it can be purely due to "investor folly". Since everyone starts chasing the same sets of sectors/stocks, valuations hit the roof. For instance, Information, Communication and Entertainment sector stocks (popularly known as ICE) were the darlings of 2000 rally with most stocks from this sector quoting at unrealistic valuations.

Once the fancy goes, prices tumble, bringing valuations well below what is warranted. This is another extreme behaviour and it happens because investors, who are still nursing their wounds, totally desert these sectors irrespective of how the sector is or companies are performing.

Though Indian IT companies remained fundamentally strong and continued to show decent growth, their market price rarely went up. For example, Wipro, a fundamentally strong IT major, is still quoting at Rs 430, 56% lower than its adjusted peak of Rs 980 (in February 2000).

Once we consider the rise in markets (Sensex and Nifty trebled from the 2000 peak), we will know the level of underperformance of this stock since the "tech bubble". The comparative price chart of Wipro and Sensex since Feb 2000 will reveal this. This is despite the fact that Wipro outperformed Sensex in the recent rally that started from March 2009.

Secondly, it isn’t just investors' folly. The problem goes beyond overvaluation. Companies themselves get carried away with the hype, and take up projects beyond their means landing themselves into trouble. The problems can be due to over capacity, unrelated diversification, liquidity issues, etc. And since the companies themselves are in trouble, the investor loss can be much steeper than in the first case.

Making the right choice
Investing in stocks that have not participated in the rally is a very small step. The main task is to identify the right sectors and stocks. The first step is to know why these sectors are underperforming the market now. If a sector is only going through a temporary cycle there's isn’t much to worry. But one must avoid those facing fundamental problems.



Original article : click here: http://economictimes.indiatimes.com/markets/analysis/Best-stocks-from-Worst-industries/articleshow/7083519.cms