Sensex, Nifty charts (Feb 16, 2018): bears remain on top

In a holiday-curtailed trading week, FIIs were net sellers of equity worth Rs 28.5 Billion, as per provisional figures. DIIs were net buyers of equity worth Rs 23.7 Billion.

For the second week in a row, Sensex and Nifty traded below the downward 'gaps' formed on Feb 5, but didn't lose much ground on a weekly closing basis.

India's wholesale inflation rose slower than expected in Jan '18. WPI eased to 2.84% YoY compared to 3.58% in Dec '17 due to lower food prices.

BSE Sensex index chart pattern

The daily bar chart pattern of Sensex consolidated sideways during the week. The failure to close above the 50 day EMA despite intra-day breaches three days in a row was a sign that bears are continuing to 'sell on rise'.

The fact that Sensex didn't fall inside the 'support/resistance zone' between 32550 and 33800 may provide some solace to bulls, but not for long.

Market sentiment shifted from extremely bullish to bearish due to re-introduction of LTCG tax. FIIs have voted with their feet. The PNB scam has further exacerbated bearish sentiment.

Technically, the 132 points 'gap' will be a tough resistance to overcome in the near-term. Even if the 'gap' gets filled (partly or fully), the down move should resume thereafter.

Support from the 33800 level has been tested twice already. A support (or resistance) level gets weakened by each subsequent test. That increases the probability of a fall inside the 'support/resistance zone' and a test of support from the 200 day EMA.

Daily technical indicators are looking bearish and a bit oversold. But don't expect any significant recovery before Apr '18, as investors are going to book profits till Mar 31 '18 to lock-in tax-free LTCG.

There are technical reasons for not being bullish in the near-term. The sideways consolidation during the past two weeks (below the 'gap') appears to be forming either a 'triangle' or a 'rectangle' pattern. Both patterns are typically continuation patterns. So, the more likely breakout is downwards.

Also, the huge Rs 128 Billion Tata Steel rights issue - at a discount to CMP - will remain open from Feb 14 to 28. That will squeeze out a lot of cash from the secondary market.

The long-term trend remains bullish, as the 200 day EMA is still rising and the index is trading above it. The correction is providing an opportunity for booking profits in small/mid-cap stocks and selectively entering large-caps. 

NSE Nifty index chart pattern

For the second straight week, the weekly bar chart pattern of Nifty traded below the 33 points downward 'gap' formed on Feb 5, and closed below the support level of 10490.

While that clearly shows bear domination, the index managed to close just above its 20 week EMA and well above its rising 50 week EMA in a long-term bull market.

Despite strong bearish sentiment and heavy selling by FIIs, the index has managed to hold ground because of steady inflows into domestic mutual funds.

Weekly technical indicators are beginning to turn bearish. MACD has crossed below its signal line and fallen from its overbought zone. ROC has crossed below its 10 week MA and is poised to enter bearish zone. RSI and Slow stochastic are seeking support from their respective 50% levels.

A fall below the 20 week EMA and a possible test of support from the 50 week EMA seems likely. Any attempt by the index to rally and close the 'gap' will bring bears to the fore.

Nifty's TTM P/E is at 25.32 - well above its long-term average. The breadth indicator NSE TRIN (not shown) is oscillating about the edge of its oversold zone, as bulls and bears have battled each other to a temporary stalemate. 

Bottomline? Sensex and Nifty charts are undergoing corrections after 13 months long bull rallies. The downward 'gaps' formed on Mon. Feb 5 are acting as resistance zones. Any pullbacks towards the 'gaps' may induce more selling and likely lower levels in both indices. Avoid bottom fishing.

Nifty chart: a midweek technical update (Sep 20 ‘17)

FIIs were net sellers of equity worth Rs 30 Billion during the first three days of trading this week. DIIs were net buyers of equity worth Rs 16.4 Billion, as per provisional figures. Nifty touched a new closing high of 10153 on Mon. Sep 18 and a new intra-day high of 10179 on Tue. Sep 19.

After the fiasco of demonetisation, GST implementation is turning out to be another thorn in the flesh for the NDA government. The balloon of July's tax collection of Rs 950 Billion was punctured by input tax credit claims of Rs 650 Billion.

Tata Steel has announced a 50-50 joint venture in Europe with Thyssenkrupp. The JV is expected to absorb a large portion of Tata Steel Europe's debt (which was used to acquire Corus 9 years ago).

The daily bar chart pattern of Nifty touched a new high of 10179 on Sep 19, but formed a 'reversal day' bar (higher high, lower close) that often marks an intermediate top.

Despite strong selling by FIIs, large inflows into domestic mutual funds and the consequent buying by DIIs propelled the index to a new high. The index is trading well above its three rising EMAs in a bull market.

Daily technical indicators are in bullish zones. But caution is advised because MACD and RSI are showing negative divergences by touching lower tops while the index rose higher. Some correction or consolidation may follow.

The entire 7 weeks' trading from Aug '17 onward has formed a large 'rising wedge' pattern, which has bearish implications. Bulls are struggling to move the index above its Aug 2 top of 10138 in a convincing manner.

Nifty's TTM P/E is at 26.39 - much higher than its long-term average. The breadth indicator NSE TRIN (not shown) is hovering just above its overbought zone, and can limit index upside.

Small investors may be feeling confused about what to do. Confusion comes from lack of a plan for long-term investing. As has been repeated ad nauseam in this blog, your asset allocation plan should decide what needs to be done regardless of the state of the market.

A bull market is supposed to climb a wall of worries. If you are tired of waiting for a correction and can't stop the urge to jump in to the market, select your stocks very carefully, and use a strict 'stop-loss' every time you buy a stock.

Technical updates – Tata Chemicals and Tata Steel

The Tata Group hasn't been the quite the same after Ratan Tata decided to hang-up his boots. Cyrus Mistry ruffled feathers of the Tata Sons board, and his short tenure ended in litigation and acrimony. N. Chandrasekaran's tenure has started off more cautiously.

Low inflation and oil prices, and a stronger Rupee has helped keep India's current account deficit in control. Demonetisation and GST implementation led to a slowdown in growth. 

A slew of reforms introduced by the NDA government is likely to bring economic growth back on track from FY 2018-19. The stock market has been rallying in anticipation. The stock prices of Tata Chemicals and Tata Steel have benefitted from the rally.

Tata Chemicals

The stock price of Tata Chemicals touched a 2 yr low in Feb '16 and has been in an up trend since then. The 'golden cross' (of the 50 day EMA above the 200 day EMA) in May '16 technically confirmed a return to a bull market.

Note the consolidation within 'Rectangle 1' during Aug-Nov '16. A 'rectangle' is usually a continuation pattern - so the eventual breakout should have been upwards.

Negative divergences (marked by blue arrows) visible on all four technical indicators led to a breakdown below the 'rectangle'. However, the up trend resumed thereafter.

A breakdown below 'Rectangle 2' has now occurred - triggered by weak Q1 (Jun '17) results. Note that the stock had already corrected below its 20 day and 50 day EMAs following negative divergences visible on three of the four technical indicators. 

All four indicators are looking oversold. The up move is likely to resume after some consolidation around current levels.

Tata Steel

Tata Steel's stock was trading in a bear market below its falling 200 day EMA till
Feb '16. The 'golden cross' (of the 50 day EMA above the 200 day EMA) in Mar '16 technically confirmed a return to a bull market.

The stock price has tested support from, but not fallen below, its rising 200 day EMA since then. The company is gradually extricating itself from the leveraged mess created by its Corus acquisition back in 2008.

Daily technical indicators are looking overbought. The stock can correct some more. The dip is providing an adding opportunity. The stock may have 20-25% more upside left in the current rally.

Technical updates – Tata Chemicals and Tata Steel

Many companies in the Tata group have been undergoing restructuring and consolidation after the change of guard. Cyrus Mistry has focussed on cutting flab and exploiting synergies within group companies. Results are beginning to show. Return of bullish sentiment in the stock market following BJP’s majority in the general election has helped.

Inflation has been moderating. Low oil prices contributed to lowering inflation and the current account deficit. Recent raising of excise duty on petrol and diesel will reduce the fiscal deficit. Labour reforms announced in Rajasthan may gradually be introduced across the country. FIIs are encouraged by the calculated and deliberate way in which the government is introducing reform measures – but a lot still needs to be done.

After hitting 2 year lows during Aug-Sep ‘13, the stock prices of Tata Chemicals and Tata Steel are back in bull markets. That makes them good candidates for adding on dips.

Tata Chemicals



The stock price of Tata Chemicals formed a small ‘double bottom’ reversal pattern in Sep ‘13 that ended a 9 months long bear phase. In a classic ‘trend change’ move, the stock quickly rose on surging volumes but faced resistance from its 200 day EMA in Nov ‘13; the subsequent correction dropped the stock to a higher bottom in Jan ‘14 – providing an opportunity to enter for those who may have missed out earlier.

The stock price climbed sharply above its 200 day EMA on a volume spurt, pulled back to provide another buying opportunity, and then soared away past its Jan ‘13 top. The stock closed at a 2 yr high of 424.70, but all four technical indicators are looking overbought and are showing negative divergences by failing to touch new highs.

Expect some consolidation or correction before the next leg of the up move. The stock has gained 77% from its Sep ‘13 low (66% on an annualised basis) – not bad for a large-cap stock.

Tata Steel



Tata Steel’s stock ended a 7 months long bear phase by closing below the 200 level in early Aug ‘13. A ‘V’ shaped recovery, backed by high volumes, gained 50% within a month, but faced resistance from its 200 day EMA. After a brief correction down to its rising 50 day EMA, the stock crossed above its 200 day EMA into bull territory on a volume surge.

A pull back to the 200 day EMA gave another entry opportunity. The stock rose to form a small ‘double top’ reversal pattern in Dec ‘13 that initiated a 10 weeks long correction that dropped briefly below the 200 day EMA. The next rally rose to touch a 2 yr high of 560.25 in early Jun ‘14 – gaining a huge 182% in 10 months (almost 220% annualised). Cyclical large-cap metal stocks some times provide such spectacular gains – but one has to be nimble-footed to benefit from them.

The stock has been in a corrective phase for more than 5 months, but appears to have found support, and is looking poised to move up again. (Note how the 440 level has acted as a long-term support/resistance level.) Technical indicators have corrected overbought conditions. Some more correction or consolidation can’t be ruled out.

A look at Cap Goods and Infra sectors – a guest post

After rallying from their Dec ‘11 lows to their Jan ‘13 tops, both Sensex and Nifty indices have been undergoing corrective moves. While both indices are within 10% of their Jan ‘13 tops, some sectors have done much worse than the indices.

In this month’s guest post, Nishit takes a look at two such beaten down sectors – Capital Goods and Infrastructure, and builds a case for investing in stocks from these sectors with a long-term point of view.

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The Markets are going down every day and several sectors are being beaten out of shape. Capital Goods and Infrastructure are two such sectors. Fresh orders have dried up and stocks from these sectors are at multi-year lows. Let us try and examine these sectors.

Capital Goods and Infrastructure are the heart of any country’s economy. If infrastructure is not built well, no country can expect to do well. These sectors typically work in about 8 year cycles. They see a boom phase for a long time and then an equally long downturn as well.

The last cycle of investments stopped around 2008-2010 period. Hardly any new orders are being booked by most of the companies. The expansion of industry has also halted, and hence the Capital Goods sector is doing horribly.

Now, there will be two factors at play here. First, the existing infrastructure - specially the power plants and manufacturing industry - is getting old. This will lead to replacement demand. Second, as India grows there will be demand for additional power plants and machinery. More interior areas will get developed and become urbanised. This will lead to a lot of work for the Infrastructure companies.

There have been several companies both in the Capital Goods and the Infrastructure space which have been around for decades and have seen several business cycles and have returned stronger. Siemens, L&T, Bharat Bijlee, HCC to name a few.

We do not know how long the current downturn will last. It may well go on for a couple of years more. A smart way of playing this is by doing Systematic Investment in these companies. Most of them are at around 40-50 % from their peak valuations. Investments may be divided into 4 lot sizes. Add one lot now and then add another lot at about 15% higher or lower than the current valuation.

Metals is another sector where valuations have been beaten down. Remember no country can ever expect to grow without Steel being produced. Tata Steel and SAIL have been beaten badly out of shape and these companies have been around for several decades now. They certainly merit a look.

The downturn can go on for some time to come and all investments in such sectors need to be done with a time horizon of at least 3 – 5 years. It is a tough task for most of us but only by investing on such larger time frames can real money be made in the equity markets. The Benchmark Nifty may be down only around 10–12% from its peak in January ‘13 but Steel, Capital Goods and Infra stocks are down almost 40-50%. In every fresh leg of down move, different sectors get beaten down. Banks are currently facing the music. Information Technology Sector could be the next one.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Stock Chart Pattern - Tata Steel (An Update)

The stock chart pattern of Tata Steel has been in a prolonged bear phase ever since reaching a closing high of 703 in Jan ‘11. Shortly after posting the previous update on Aug 4 ‘11 (marked by grey vertical line in the middle of the chart below), the stock price dropped like a stone below the support level of 500 on a volume spurt.

A fall below a support level on strong volumes usually means that the support level will turn into a strong resistance level during subsequent up moves. That is precisely what happened to the 500 level on the closing chart pattern of Tata Steel.

The first attempt at a pullback towards the 500 level in Sep ‘11 faced strong resistance and the stock fell to a lower bottom. The second attempt in Oct ‘11 managed to climb above the falling 50 day EMA, but stopped short at 480. The stock price continued to fall – forming a bearish pattern of lower tops and lower bottoms – till it touched a closing low of 335 in Dec ‘11.

The subsequent rally coincided with the rally in the broader market. Aided by a couple of strong volume spurts, the stock price rose sharply above all three EMAs and touched a closing high of 495 on Feb 15 ‘12. But resistance from the 500 level was overwhelming.

During Mar ‘12 and Apr ‘12, the stock price consolidated within a bearish ‘rising wedge’ pattern, from which the expected downward break out occurred in early May ‘12. The stock made a ‘U turn’ but could not climb past its falling 200 day EMA. The stock price dropped below all three EMAs but recovered after touching a slightly higher bottom at 350 in Sep ‘12.

So, has the stock formed a bullish double-bottom pattern? The volume action doesn’t suggest that. There should have been a pick-up in volumes after the stock bounced up from the second (higher) bottom. Instead, volumes have slipped, and so has the stock’s price after it faced resistance from the 200 day EMA.

Technical indicators are looking bearish. MACD is still positive, but is falling below its signal line. ROC has crossed below its 10 day MA into negative territory. RSI has dropped below its 50% level. Slow stochastic has entered oversold territory. The stock may move down to test support from the blue line connecting the two previous bottoms.

An upward bounce from the blue trend line, supported by increase in volumes will be bullish. A drop below the blue trend line will be bearish.

Bottomline? The bear phase in the stock chart pattern of Tata Steel is not over yet. Accumulate slowly with a stop-loss at 355. Alternatively, wait for a convincing move above the 200 day EMA to add. Either way, one has to remain patient for the next couple of years to get good returns.

Do investors have the ‘if-its-free-I’ll-take-two’ syndrome?

Before I can answer the question, I need to tell the story about the syndrome.

A young boy was being taught by his father about prudence in handling money. Here are the three important guidelines provided by the father:

• Live within your means and try to save money from whatever little you may have
• Always ask the price of anything you wish to buy, and then decide if you can afford to buy it
• Don’t blindly accept a quoted price; try to bargain and buy at a lower price

Well-versed in the guidelines, the young boy went to the local ‘paanwala’ to buy some candy. On being told that the candy cost a Rupee, he promptly started to bargain. Despite repeated pleas by the ‘paanwala’ that there was no discount on a candy costing a Rupee, the boy would not relent. A small crowd had gathered on hearing the commotion, and potential customers were walking away. In desperation, the ‘paanwala’ handed over a candy to the boy, saying: “Take this. It’s free. Now please leave.” The boy was delighted, but refused to budge. “It’s free? Then I’ll take two!”

That boy must have grown up to be a stock investor. He also must have told all his friends – who also became stock investors. How do I know this? Because of the proliferation of web sites offering “sure-shot free stock tips” and “99.9% success guaranteed Nifty tips”.

There was a time when I used to go out of my way to provide free advice to young investors about what stocks to pick and how to build a portfolio. But I no longer give free advice – except in my blog posts. Why? Because I found out that most investors were not following my advice at all. In fact, they were doing just the opposite. They would not buy the stocks I’d recommend, and would go right ahead and buy the stocks I suggested that they avoid!

Then a wise reader related the story of a doctor in a small town who decided to treat patients for free after his retirement. Hardly any one showed up at his chamber. Then he decided to charge a reasonable fee. Soon, he had several patients visiting his chamber every day. The moral of the story is: No one respects free advice.

The other day, I received an email: “Can you please suggest one multibagger stock?” Usually, I ignore such emails, or answer back: “I don’t provide free stock advice.” But I was in a genial mood that day, and wrote back: “Buy Tata Steel.” The response floored me completely. Let alone thank me, this smart fellow came back with: “Any penny-stock multibagger?” This is what I meant by ‘if-it-is-free-I’ll-take-two’ syndrome!

A more dangerous affliction is the ‘if-it-is-free-I’ll-take-as many-as-possible’ syndrome. I got this email from such an investor: “I would like to buy some fundamentally strong stocks in this bear market. Please send me a list of such stocks.” I answered: “I don’t give individual stock advice for free. But you can take a look at some of the beaten down stocks in the Sensex and Nifty indices.”  Back came a response: “OK, I promise to send your fee, but send me the list of stocks now.” I didn’t bother to reply, only to receive this reminder: “I still haven’t received the list of stocks.” Later, I found out that this freeloader was regularly providing free stock tips in one of the investor forums!

The answer to the original question is: Many investors do. I think it is part of the human psyche that we get swayed by products that are offered ‘free’. That is why retailers periodically offer “Buy-1-get-1-free” deals to get rid of unsold or unfashionable or oversized/undersized stock. Shops tend to be overcrowded during such offers.

When it comes to stock advice, ‘free’ usually means ‘not good’. Investors need to appreciate that. If some one really knew which stocks will become multibaggers in future, he would not tell a soul and buy as many of those stocks he could afford before the stock market got wind of it. 

The Sensex Fool’s Four stocks

This is a sequel to last Thursday’s post: Fool’s Four stock investment strategy. Before proceeding further, let me thank readers Googol, Purnendu and Rishi for providing me with their lists.

There are a few stocks common in their lists with mine, but there are differences due to changes in current market prices, adjustments for split/bonus and calculation of dividends. I have checked the list to the extent possible, without turning it into a research project. But there may be errors in my list as well.

The point to note is that the stocks that make the list – with one notable exception – have under-performed the Sensex by various degrees. That is the whole idea behind the Fool’s Four strategy. Without further ado, here are the Sensex Fool’s Four stocks:

1. NTPC
2. Jaiprakash Associates
3. ITC
4. ONGC
5. Wipro
6. Tata Steel

Why 6 stocks? Well, if you read the previous post, you will know that the stock ranked 1 – viz. NTPC - is supposed to be dropped from the list. That leaves 5 stocks. Regular readers may be aware that I am biased against PSU stocks because the government treats them as ‘free ATMs’ and run them to the ground. That eliminates ONGC from my list.

Given below are the one year closing charts of the remaining four – compared with the Sensex (in green):-

Jaiprakash Associates

Jaiprakash Associates has been a significant underperformer for the past one year, and it isn’t a surprise that it is at the top of the list. The company’s ambitions have far exceeded its execution capabilities. The huge debt burden is a millstone around its neck. Since it has fallen so much, the chances are better for a higher percentage gain when the market eventually turns around.

ITC

ITC is the odd-one-out of this list. It was a market performer till Feb ‘11, but has significantly outperformed the Sensex from Mar ‘11 onwards. The special centenary dividend boosted the dividend yield. The dividend is unlikely to be repeated next year. But this is a great stock to own – even if it wasn’t on the list.

Wipro

Wipro had outperformed the Sensex till mid-Jul ‘11. It is the last two months that haven’t gone well. There are management issues that haven’t yet been sorted out to the market’s satisfaction. Of late, it has fallen behind aggressive competitors like Cognizant and HCL Tech. But it is a good company and may fight back.

Tata Steel

Like Wipro, Tata Steel has underperformed the Sensex in the last two months. It is the lowest cost integrated steel maker in India and extremely well-managed. The Corus integration is still a work-in-progress, and the real benefits of the acquisition may be a couple of years away. But I have no doubts that the current problems in Europe will be overcome, and the company’s bottom line will significantly improve.

The Fool’s Four strategy suggests that you invest equal amounts of money in all four stocks, and make any adjustments only after one year. Will the strategy work? There is only one way to find out – by investing. Or, you can opt out by only investing ‘on paper’ and check back after one year.

Stock Chart Pattern - Tata Steel (An Update)

The previous update to the technical analysis of the stock chart pattern of Tata Steel was posted a year back. The stock rallied strongly from its Mar ‘09 low of 150 to its Apr ‘10 peak of 694, followed by a correction down to 450, and was struggling to escape the clutches of the bears at 520.

Let us have a look at the one year closing chart pattern of Tata Steel, to find out what kind of progress it has made in the past 12 months:

I had recommended that investors use a drop below 500 to enter the stock. An entry opportunity presented itself when the stock closed just below the 500 level on Aug 25 ‘10. The next leg of the up move started almost immediately, and the stock quickly rose to close at 678 on Oct 6 ‘10 – falling short of its previous closing high of 694.

A correction ensued, during which the stock price fell below the 50 day EMA on several occasions, and in the process, formed a bullish rounding bottom pattern that propelled the stock to a new closing high of 703 on Jan 3 ‘11.

Note that while the stock managed to reach a higher top, all four technical indicators failed to follow suit. The MACD and the RSI touched lower tops, and the ROC and the slow stochastic reached flat tops (marked by blue arrows). The combined negative divergences pushed the stock price into a down trend that has lasted more than 7 months, and has formed a bearish descending triangle pattern.

The closing level of 559 on May 23 ‘11 meant a more than 20% drop from the peak, and the ‘death cross’ (marked by the light blue oval) on May 24 ‘11 confirmed a bear market.

The Tata Steel stock is a component of both the Sensex and the Nifty indices. So it isn’t a great surprise that the stock has formed a descending triangle pattern similar to the ones formed on the Sensex and Nifty charts. The difference is that the price peaked two months later – in Jan ‘11 instead of in Nov ‘10 – so the duration of the triangle is two months less.

Will the stock bounce up from the long-term support of 557, or will it break down below the descending triangle? All four technical indicators are looking bearish, so any bounce up is likely to be temporary. The MACD and ROC are negative. The RSI is below its 50% level. The slow stochastic is in its oversold zone, where it may remain for a while.

The height of the descending triangle from the peak of 703 to the support level of 557 is 146 points. On a break down below the triangle, the stock price can fall to (557 – 146 =) 411. However, there are long-term supports at 500 and 450 levels, and the stock price may turn back from one of those two supports.

Bottomline? The stock chart pattern of Tata Steel is trading below all three EMAs and looks all set to drop below the support level of 557. This is the best stock to own in the steel sector. Any drop below 500 can be a good opportunity to start accumulating again. 

Why building a stock portfolio is like buying a car

One of the requests I receive most often from blog readers and newsletter subscribers is to help them in building a ‘good’ stock portfolio. Many think that this is a trivial task. All they need is a list of ‘good’ stocks to buy. It is not that simple. A portfolio is not a ‘T’ shirt with a ‘L’ written on its label that will fit 90% of investors. It needs to be custom-tailored for a near perfect fit, to suit each individual investor’s background, experience, financial commitments, risk tolerance, and future plans.

But the real problem lies elsewhere. Most young investors can spare Rs 1 - 2 lakhs. Some have recently started earning and can only spare Rs 3000 – 5000 per month. These are insufficient amounts for building a ‘good’ stock portfolio. So, I use the analogy of buying a car.

One doesn’t go out and buy a car – specially if they have just started earning. Some prior planning is required. (Car loans are readily available nowadays, but the EMIs can burn a big hole in your pocket.) A better option may be to buy a scooter or motor cycle for immediate transportation needs. Even then, you need to learn the rules of the road, and get a driver’s licence before you buy anything.

Unfortunately, there is no licence required to invest in the stock market. Most small investors jump into the market without any knowledge of the basic rules of investing. No wonder their stocks crash and they suffer heavy injuries (to their savings). Grow your capital by regularly investing in fixed deposits, recurring deposits, PO MIS, ETFs, mutual fund units till you have sufficient capital to buy a ‘good’ car.

Can’t you buy Rs 3000 – 5000 worth of stocks every month? Yes, but which stocks? You can’t even buy 10 shares of Tata Steel. So you’ll probably buy 100 shares of Suzlon instead, or worse still, 800 shares of Cranes Software! Your risk of loss will increase proportionately. You are far better off investing that amount of money every month in a ‘good’ fund like DSPBR Top 100 or HDFC Prudence. After 5 or 6 years of regular savings, you may have sufficient capital for a ‘good’ portfolio.

How much is sufficient capital? I suggest Rs 5 lakhs as a bare minimum. Rs 10 lakhs is a more reasonable figure. Can’t cars be bought for Rs 1 - 2 lakhs? Yes, they can. But they won’t be ‘good’ cars. How about a used car? That may work, but is likely to require regular trips to the service centre for repairs. And you really can’t be sure if a used car is really a ‘good’ car. The previous owner may not have driven or maintained it properly.

Even with Rs 5 lakhs, you will only be able to buy a decent entry-level car. But if you are ready to spend Rs 10 lakhs, then your choice of ‘good’ cars increases significantly. And if you own a Rs 10 lakh car, chances are that you will take good care of it by following scheduled maintenance procedures, getting repairs done promptly, adding accessories that will enhance your driving comfort and experience.

A ‘good’ stock portfolio needs sufficient capital, and has to be nurtured and maintained as well – by keeping track of market happenings, individual stock results, using opportunities to book part profits or add more on dips. The emphasis should be on safety, and not about driving/investing recklessly.

The state of the stock market – a broker’s views

I cornered my erudite stock broker friend just after he had finished his morning round of golf, and asked him about the current state of the stock market. Here, in no particular order, is the gist of his uncensored views during a freewheeling discussion:-

1. The Sensex is very likely to test its recent low of 17300. It may even go down to 16000, but the probability is low.

2. The market is likely to trade in a range for another 3 months, or even longer. With high oil prices further messing up India’s fiscal deficit, markets won’t be able to move much higher.

3. The second half of the year should be ‘technically’ better. That is when the ‘big players’ have decided to sit down together with the Udayan Mukherjees of the business channels to decide (and announce) where they are going to push up the stock market.

4. Oil prices won’t come down any time soon. The turmoil in the Middle East and North Africa will be fomented by the USA for two main reasons. The first is their insatiable desire to corner oil resources, which was the main reason for their invasion of Iraq. Every one knew that there were no ‘weapons of mass destruction’ in Saddam Hussein’s armoury.

The second reason is the dismal state of the US economy. All the dollar printing hasn’t improved anything. The US economy thrives after wars. A Republican president would have used the Tunisia and Egypt uprisings as excuses to send troops. The Democrat president is pussy-footing around. But he will soon have no choice but to start a war by sending in the US marines. There is already talk of enforcing a no-fly zone in Libya.

5. The talk of ‘valuation difference’ between developed and emerging markets being the reason for the recent correction is all hogwash. Valuation differences were there a year back, when FIIs were pouring money into emerging markets.

6. The export lobby has been moaning and groaning about the rupee appreciation against the dollar hurting the country’s exports. There is not a peep from the import lobby because none exists. The government is the biggest importer. They should ignore the exporters and let the rupee appreciate against the dollar. That is the only way to cushion the rising cost of oil imports. Imports far exceed exports anyway.

7. There is no greed and fear in the Indian stock market. There is only more greed and less greed. Nothing else explains the paltry cash volumes compared to the huge F&O volumes of trade every day.

8. Small individual investors in the more evolved and sophisticated US market invest mainly through mutual funds. In India, any one who has Rs 5000 to spare wants to invest in equity shares. Since he doesn’t have enough money to buy even 10 TISCO shares, he goes out and buys 15000 shares of Cals Refineries. How smart is that?!

Part of the blame lies with us brokers, who want investors to regularly buy and sell stocks, because our livelihoods depend on that. But, small investors will be far better off investing regularly in an index fund or a balanced fund.

Should investors join the ‘Bollinger Bands’ wagon?

Bollinger Bands are a technical analysis tool, developed about 30 years ago by John Bollinger. Before we get into the nitty-gritty of what these bands are and why investors might find them to be a useful tool, a few words about a statistical concept called ‘standard deviation’.

Standard deviation, in layman’s language, means the amount by which a series of measurements vary from the average value of the measurements. Let us say, we are measuring each day’s maximum temperature, and the figures for 5 days are 24, 25, 25, 26, 30. That gives an average value of (24+25+25+26+30)/5 = 26. The absolute variations from the average are –2, –1, –1, 0, 4 respectively for the 5 days. A series of arithmetical manipulations are done on these variation data (squaring, adding, averaging and taking the square root of the average) to arrive at the standard deviation.

Investors need not be math wizards to understand and apply the Bollinger Bands tool - thanks to readily available charting software. But it is always good to know the concept behind the tool. So, what are Bollinger Bands?

It is a technical tool to measure the volatility in prices of a stock or commodity. It consists of a band with three lines. The one in the middle is a 20 period simple moving average (SMA) of the price. The two other lines – one 2 standard deviations above and the other 2 standard deviations below the 20 period SMA – complete the band.

Volatility is measured by standard deviation. As volatility increases, the Bollinger Bands automatically widen. When volatility decreases, the bands contract. Since standard deviation is calculated using a 20 day SMA, a 20 day SMA is also used as the middle line in the daily price charts.

The 20 day SMA with the upper and lower bands 2 standard deviations away is the most commonly used set-up in Bollinger Bands. But other combinations can also be used, depending on price volatility and investment styles. Standard deviation values are higher for stocks (or commodities) trading at higher prices than those trading at lower prices. A higher value of standard deviation doesn’t necessarily mean higher volatility.

Now let us take a look at Bollinger Bands drawn on the 1 year bar chart pattern of Tata Steel:

How do we interpret Bollinger Bands? They do not give ‘buy’ or ‘sell’ indications by themselves, but are used together with other technical indicators to confirm a ‘buy’ or ‘sell’ decision. A contraction of the bands can be used as an early indication of a price rise. Note the contractions in Jun ‘10, Aug ‘10 and Nov ‘10, which were followed by sharp up moves.

If prices keep touching the upper band on a regular basis, it is a sign of ‘overbought’ conditions, usually followed by a correction. Sep ‘10 and Dec ‘10 show such overbought conditions. If prices keep touching the lower band regularly, it is a sign of ‘oversold’ situation, usually followed by a rally. May ‘10 and Jun ‘10 are examples of oversold situation.

Note that the RSI and slow stochastic also confirmed the overbought and oversold conditions on the stock chart. Charts can remain overbought or oversold for long periods. So, selling when the price touches the upper band or buying when price touches the lower band may not be a good idea. A useful strategy when the chart is overbought is to maintain the 20 day SMA (middle line) as a trailing stop-loss. (If you have read my eBook, you will know what a trailing stop-loss is used for. If you haven’t read my eBook yet, why not? It is FREE.)

Some times the price moves above the upper band, or below the lower band. That doesn’t mean that these are sell or buy signals. It gives an indication of relatively higher or lower prices. Note that in Feb ‘11, the stock reached a lower bottom (below the lower band) while the RSI made a higher bottom. This positive divergence gave a ‘buy’ signal.

In Jun ‘10, the stock also reached a lower bottom, but failed to even touch the lower band. This was an early sign of a possible trend reversal. A ‘buy’ signal was generated because the RSI made a higher bottom.

Why do retail investors fall prey to the ‘get rich quick’ syndrome?

Most retail investors enter the stock market for the first time near a peak, after hearing about their friends or relatives who became rich overnight by investing in stocks. They think – like many poor souls before them – that getting rich quickly from the stock market is the best idea since sliced bread.

In a country with a large number of educated youth and inadequate employment opportunities, there are enough con-men and charlatans trying to make a quick buck by promising jobs. They usually lure unemployed youth with guaranteed jobs – even overseas jobs - if they can first cough up a sufficiently large amount of money.

One can appreciate and understand why an unemployed person may get tricked by such scams. He has a genuine need of money to sustain himself and his family. But it is really shocking that young people who are not just well-educated but also well-employed falling prey to the ‘get rich quick’ syndrome.

After announcing the re-opening of subscriptions to my Monthly Investment Newsletter in a recent post, I received an email that went something like this:

‘I lost a large sum trading intra-day. I went long in Nifty futures. The spate of scams made the market tank. Booked heavy loss. Then went short in Nifty futures, but the market moved up. Again booked heavy loss. Now my only hope is your investment calls will not only help me to recover my losses but make some profit also.’

I was at a loss as well – for words. He was expecting more than a 150% gain to cover his losses and make some profit. Why did he get into this mess in the first place? He thought making money in the stock market was a piece of cake. In other words, he had fallen prey to the ‘get rich quick’ syndrome.

Any long-term investor will say with confidence that if one buys good blue chip stocks at reasonable prices and holds on for 3 to 5 years, one can easily make 15-20% per annum returns on investment. Those returns adequately cover the risk-free bank interest and the prevailing rate of inflation.

But one should not expect higher returns over the long-term. Higher returns may happen in a particular year. Not over several years. Rome wasn’t built in a day. A portfolio of strong stocks that provide steady returns year after year also takes time and patience to build.

Unfortunately, today’s generation prefers instant noodles, 20-20 cricket, and paying by plastic cards. ‘Patience’, ‘discipline’ and ‘long-term’ are replaced by ‘I want it now’ in the dictionary. No wonder young investors find Tata Steel and Colgate boring, and run after Suzlon and Bartronics in the hope of getting rich quick.

Stock Index Chart Patterns - BSE Sectoral Indices, Dec 23, '10

I had taken a look at the chart patterns of the BSE Sectoral Indices two months back, when the Sensex was heading towards its new high. Not surprisingly, many of the sectoral indices reached their new highs simultaneously. But some had already started to correct.

Time to take another look after the corrective move of the past two months to check where the strengths and weaknesses lie for investing in 2011.

BSE Auto Index

The BSE Auto index continues its strong performance, consolidating sideways rather than correcting down too much. Note that the RSI failed to make a new high with the index in Nov ‘10, and has dropped below the 50% level. As long as the index stays above the support level of 9670 and the rising 100 day EMA, the bull market will be under no threat.

BSE Bankex

The BSE Bankex has taken quite a knock on the chin – thanks to the bribe-for-loan scam, and is trying to cling on to the support level of 12640. The RSI is on the verge of dropping back into the oversold zone. The correction may continue for a while longer. Investors need to be very stock specific.

BSE Capital Goods Index

The BSE Capital Goods index corrected all the way down to the 200 day EMA, and is struggling to stay above its long-term moving average. The RSI has dropped below the 50% level and is hinting at another test of support from the 200 day EMA. Rising interest rates and tightening liquidity situation may be hurting profitability.

BSE Consumer Durables Index

The BSE Consumer Durables index has corrected nearly 25% from its peak, underperforming the Sensex. High input costs have started affecting wafer thin margins in spite of good sales. The RSI is at the edge of the oversold zone, indicating that there may be another drop towards the 200 day EMA.

BSE FMCG Index

The FMCG index formed a bearish double-top pattern, but the correction has received good support from the rising 100 day EMA. But up moves are finding resistance from the sliding 20 day and 50 day EMAs. The RSI is below the 50% level. The index may consolidate sideways for some time. The index corrected 8% from its top and marginally outperformed the Sensex during the recent correction.

This is my favourite sector because of its strong cash flows, good dividends and low volatility.

BSE Healthcare Index

The BSE Healthcare index also formed a bearish double-top pattern but found support at its rising 50 day EMA. It has barely corrected 5% from its peak and has outperformed the Sensex. No wonder the sector is called ‘defensive’.

BSE IT Index

The BSE IT index has been a spectacular outperformer, though the RSI is indicating an overbought situation. The gradual economic recovery in USA and Europe have boosted sentiments. Investors would do well to stick to frontline stocks. Employee attrition has become a problem that affects the small and mid-cap IT companies a lot more.

BSE Metal Index

The BSE Metal index hasn’t made any progress in the past two months. The bullish pattern failed to play out, and the index continues to oscillate around its 100 day EMA. Unless it clears its Apr ‘10 top, investors may not reap much gains. However, Tata Steel and Hindalco looks good and may be bought on dips.

BSE Oil & Gas Index

The BSE Oil & Gas index fell steeply below its 200 day EMA after reaching a new peak in Nov ‘10, but has recovered quickly above all four EMAs. Note that the RSI made a lower top in Nov ‘10, heralding the correction. This time around it has made a higher top while the index made a lower one – which is a bullish sign. Investors can look at Indraprastha Gas on dips.

BSE Power Index

The BSE Power index corrected steeply to its 52 week low within two months of hitting its 52 week high in Oct ‘10, and hasn’t been able to recover much at all. The sector has been overhyped and it is finally dawning on investors that most of the expansion projects are behind schedule, and profits are likely to be muted. The sector has dropped into a bear market. Avoid.

BSE Realty Index

The less said about the BSE Realty index the better. This darling of the previous bull market is down where it belongs – in the dumps. Prices were artificially boosted through cartelisation and hoarding of commercial and residential inventory. The time for reckoning has arrived. Stay far away.

3 year charts of some Sensex 30 stocks trading below all-time highs

The BSE Sensex is trading near its all-time high. That doesn’t mean all the 30 stocks that comprise the Sensex index are trading near their all-time highs. Here are the charts of some of the Sensex stocks that are trading below their earlier peaks:

BHEL is a PSU star and a leader of the infrastructure pack. Despite power being a priority sector and BHEL being the major supplier of large capacity steam turbines and boilers that form the heart of thermal power stations, the stock is yet to reach its 2007 peak.

The 200 day EMA is rising and the stock is trading above it, which is a bullish sign. But volumes have trailed off as the stock is trying to move higher, which is not so encouraging. Add on dips.

The realty sector was most favoured by investors in the previous bull market, with DLF being the undisputed king. Questionable business practices and opaque financial statements had a disastrous effect on the stock’s fortunes. Though it is trading above its 200 day EMA, it has failed to regain even 50% of its bear market fall. Avoid.

NTPC is one of the better managed PSUs and the largest power generation company in India. But that hasn’t translated into superior stock performance. Despite all the hype surrounding the power sector – specially during the previous bull market – most power generation companies are not highly profitable. One of the major reasons being that growth in power generation is dependent upon frequent and huge capital expenditure.

The stock is trading below the 200 day EMA and falling. Avoid.

Jaiprakash Associates is one of the leading companies undertaking large infrastructure and real estate projects that require massive capital outlays, which have been mainly financed through debt. The huge interest burden has proved a detriment to the stock’s performance. After retracing 50% of its bear market fall, the stock has been making a bearish pattern of lower tops and bottoms. Avoid.

Tata Steel’s large debt burden caused by the Corus acquisition was compounded by the economic slowdown in Europe (where Corus sells most of its output). The stock is trading well below its Jan ‘08 peak, but has formed a bullish cup-and-handle continuation pattern. It is trading above its rising 200 day EMA and can be added on dips.

How to identify a truly great company from a merely good company

In a post back in Dec. ‘09, I had mentioned that the great companies can be distinguished from the good companies by how efficiently they use the money invested in the business to generate higher profits. The post was an introduction to a short series of articles on financial efficiency and profitability ratios.

At that point of time, I had not heard of, or read anything by Jim Collins – the former award-winning teacher at the Stanford Graduate School of Business. In his 2001 book, titled “Good to Great”, Collins has distilled and analysed the results of a 5 years long research project undertaken to identify how merely good companies become truly great companies.

Collins and his team of research associates sorted through all the published information available on more than 1400 US companies, and held countless interviews and discussions to come up with a short-list of 11 truly great companies.

These companies were merely good for many years before they were able to produce sustained great results over a period of 15 years, and significantly outperformed bigger and better known competitors in terms of stock market returns.

The outperformance period of 15 years occurred during the 1970s, 1980s and 1990s – just prior to the dot.com boom and bust. Some of the companies are no longer great companies, and some are almost down and out.

The book is a good read nevertheless, and reveals some universal and timeless principles that can help us to identify (and invest in) the truly great companies in the Indian stock markets. Here is a gist of the principles:

1. The transformation from good to great doesn’t happen suddenly. It is a process of a gradual build-up followed by a breakthrough.

2. Unlike the popular perception of how companies are turned around by high-profile leaders with rockstar-like personalities and egos, the good-to-great leaders are self-effacing, quiet, reserved, and have strong personal integrity. Such leaders ‘are a paradoxical blend of personal humility and professional will. They are more like Lincoln and Socrates than Patton or Caesar.’

3. Good-to-great leaders make sure that they select the right people for the right jobs, and spend most of their time on team building and succession planning. They don’t take the credit for the outperformance of their companies. They give the credit to their team.

4. Once the entire team is on board and the vision and strategy have been agreed upon, there is complete faith in the eventual success – and at the same time, the discipline to confront and overcome adversity and changes in current reality.

5. The good-to-great companies have a culture of discipline – disciplined people, disciplined thought, disciplined action. The culture of discipline combined with an ethic of entrepreneurship produces great sustained performance.

As I was reading the book, the first name that flashed across my mind was ‘Narayanmurthy’. He epitomises all the principles mentioned about good-to-great leaders, and led Infosys to become one of the truly great companies. The succession planning in the company has been an example that others should emulate.

Ratan Tata (Tata Steel, Tata Motors), Anand Mahindra (M&M), Yogi Deveshwar (ITC) are some of the names that also come to mind. Disciplined investing in these companies can generate enormous wealth over the long-term.

I am sure there are several other names that readers may know of.

Why has the Sensex remained rangebound for 10 months?

Many small investors are perplexed about the rangebound Sensex over the past 10 months – trading between 15300 and 18300 in a slightly upward sloping channel.

Of late, the Sensex has been trying to break above the trend line connecting the tops. But every time it has fallen back into the trading range, despite continuous buying by the FIIs.

So what gives? There could be two possible reasons. The first is that most of the Sensex stocks appear fully valued or even over-valued, so action has shifted to the mid and small-cap stocks. The second is that some Sensex-constituent stocks are performing very well, while others have lagged the Sensex.

Trying to analyse the possible first reason would require access to FII buying and selling data that I do not have. It is based on anecdotal evidence. But the second reason can be verified more easily with a quick, back-of-the-envelop calculation.

Here is what I gathered, by comparing the closing prices 10 months ago with that of today’s prices:

Sensex stocks	Price on 12.10.09	Price on 12.08.10	% Gain/ (Loss) in 10 months
ACC	796	837	5.1
BHEL	2424	2496	3.0
Bharti Airtel	351	318	(9.4)
Cipla	298	314	5.4
DLF	425	316	(25.6)
Jindal Steel and Power	619	656	6.0
HDFC	2758	2991	8.4
HDFC Bank	1700	2075	22
Hero Honda	1631	1867	14.5
Hindalco	129	167	29.5
HUL	290	266	(8.3)
ICICI Bank	893	964	7.9
Infosys	2240	2779	24.1
ITC	129	153	18.6
Jaiprakash Associates	160	119	(25.6)
Larsen and Toubro	1657	1805	8.9
Mahindra and Mahindra	458	633	38.2
Maruti Suzuki	1516	1226	(19.1)
NTPC	210	195	(7.1)
ONGC	1245	1267	1.8
Reliance Comm	248	173	(30.2)
RIL	1084	972	(10.3)
Reliance Infra	1357	1095	(19.3)
SBI	2173	2784	28.1
Sterlite	170	168	(0.01)
TCS	581	855	47.2
Tata Motors	550	1024	86.2
Tata Power	1319	1329	0.01
Tata Steel	546	520	(4.8)
Wipro	344	413	20
SENSEX	17027	18074	6.1

Only 13 stocks have outperformed the Sensex in the past 10 months. 1 stock was an equal performer. The balance 16 underperformed the Sensex. Not a very scientific experiment, but one that may give us clues for taking investment decisions.

1. The IT pack – Infosys, TCS, Wipro have outperformed

2. SBI and HDFC Bank have outperformed; HDFC and ICICI Bank have marginally outperformed the Sensex

3. Hindalco has outperformed, but Sterlite and Tata Steel have underperformed

4. Hero Honda, M&M and Tata Motors have outperformed; Maruti Suzuki has underperformed

5. Tata Power and NTPC have underperformed; Jindal Steel and Power have given equal performance with the Sensex

6. Bharti Airtel and Reliance Comm have underperformed

7. ITC has outperformed but HUL has underperformed

8. ONGC and RIL have underperformed

9. ACC, BHEL, DLF, Jaiprakash Assoc, Reliance Infra have underperformed; L&T has marginally outperformed

10. Cipla has underperformed

One school of thought says: Tend the flowers and pull out the weeds. Translated into English, it means hold the outperformers and get rid of the underperformers.

While that may be sound logic, it may not necessarily make good investment strategy. If the Sensex has to move above the trading range, the outperformers have to keep performing, but the underperformers need to pick up the baton and start running.

In other words, if you believe that the Sensex is going to move higher, a contrarian bet on the underperformers is likely to provide good gains. That is not a blanket permit to buy all the underperformers. One still has to do due diligence.

This may not be a bad time to pick up Tata Steel, RIL, Sterlite and, on dips, HUL, NTPC, BHEL. The telecomm sector is best avoided.

Stock Chart Pattern - Tata Steel (An Update)

A detailed technical analysis of the stock chart pattern of Tata Steel in Sep ‘09 showed two tops just short of the 500 mark in Jun ‘09 and Aug ‘09 and a correction down to 416. I had expected the correction to continue based on the weakness in the technical indicators.

The stock did just the opposite. It reversed directions well before it could drop to the 200 DMA, made a series of higher tops and higher bottoms till it closed at 694 in Apr ‘10. A spectacular 544 points (363%) rise from the low of 150 in Mar ‘09.

The not-so-great performance of the company in 2009-10 – thanks to the huge debt burden of the Corus acquisition - weighed on the stock price. A swift plummet below the 200 DMA was finally halted at the long-term support level of 450 – correcting 45% (in 2 months) of the previous (13 months) rise.

A look at the one year closing chart pattern of Tata Steel may explain why the Sensex hasn’t been able to make much headway of late:

One of the better traded, Sensex constituent stock has grossly underperformed in the past 4 months. After rising above the 20 and 50 DMAs, as well as a long-term support-resistance level of 528 the stock made an attempt to clear the 200 DMA and another long-term support-resistance level at 562.

All it managed was a small, head-and-shoulders pattern from which it broke downwards today (Aug 11 ‘10). The strong volumes reflected market expectation of poor Q1 results (to be announced tomorrow). If the results are disappointing, the stock may drop to the 50 DMA (at 503) and further to the support level of 450.

Any fall below the 500 level can be used for entering this bellwether stock, as domestic operations are doing well and large cash inflows are likely to kick-in due to substantial revival of the Corus operations in Europe.

The technical indicators are looking somewhat bearish. The slow stochastic has dropped below the overbought zone. The MACD is positive but has crossed below the signal line. The RSI has fallen sharply below the 50% level towards the oversold zone. The consolation for the bulls is that the RSI rarely spends much time inside the oversold zone.

Bottomline? The stock chart pattern of Tata Steel has stayed below the 200 DMA for the past 3 months. If you believe in the long-term growth story of the Indian economy, the lowest cost steel producer in the country can’t remain stagnant for long. Use dips to accumulate.

Does the Dogs of the Dow theory also apply to the Sensex stocks?

What on earth is the Dogs of the Dow theory? Why would any one want to apply the Dogs of the Dow theory to the Sensex stocks? What if the theory does apply, and what if it doesn't? Let me try and answer those questions one by one.

What motivated me to even discuss such a topic? Too many new investors wanting to enter the stock market without a clear idea about what to do. Many don't even realise that making money in the stock market is a full time activity.

I have advised investors to buy index funds or index ETFs, and balanced funds - but to stay away from buying individual stocks unless they have the time and knowledge to pick their own stocks. But I know that many think I'm plain old-fashioned and prefer to enjoy the thrill of losing money quickly!

Now here is a stock investing plan that is so mechanical that it can run on auto-pilot with a maximum input of two hours effort once a year. Sounds too good to be true? It almost is - but it does seem to work.

Postulated by Michael O'Higgins in his book 'Beating the Dow', the Dogs of the Dow theory goes like this:

Every year pick 10 stocks that form the Dow Jones (DJIA) index and that have the highest dividend yield (i.e. dividend per share to price per share ratio). Allocate equal amounts of money for buying each of the 10 shares. Then sit tight for a year without even looking at your portfolio.

After one year, repeat the process by adding and deleting stocks from your portfolio in such a manner that equal amounts of money are allocated to those 10 stocks that have the highest dividend yield after one year.

Go on repeating the process for a few years - otherwise the benefits of this mechanical investing strategy may not bear fruit. Back-testing the theory with older data have apparently shown the efficacy of the theory.

From 1957 to 2003, the Dogs outperformed the Dow by about 3%, averaging a return rate of 14.3% annually whereas the Dow averaged 11%. The performance between 1973 and 1996 was even more impressive, as the Dogs returned 20.3% annually, whereas the Dow averaged 15.8%.

Why or how does the theory work? The simple assumptions are:-

1. If a stock constitutes the Dow Jones index, then it must be a 'good' stock to own;

2. If a stock is trading at a high dividend yield, then it's price may have been beaten down for some reason, or it may have substantially increased dividends (may be due to some one-off reason - like a big capital gain, or a special anniversary dividend);

3. Either way, the market will eventually recognise that a 'good' stock is going abegging and the price will rise substantially.

The problem with any mechanical or automated investing strategy is that eventually every one starts following it (if it works), and the likelihood of outperforming the Dow Jones index recedes.

So, will the Dogs of the Dow theory work for Sensex stocks? There is no reason why it shouldn't. Just flash back to 2007, near the peak of the bull market. Tata Steel acquired the much bigger Corus. The stock market gave the acquisition a big thumbs down and the stock was beaten out of shape.

Did it substantially reduce dividends? Not at all. It ended up trading at a high dividend yield, and was a prime candidate for any one choosing a Dogs of the Sensex theory.

Question for readers: Do you know of other such Sensex dogs? Do you own them? Will you buy them after reading this post?

How to use Financial News - revisited

With results season upon us, financial news is flooding the airwaves and the pink sheets. Some companies are declaring better than expected results - like Tata Motors and ITC. Others are disappointing the market with poor Q2 '09 shows - like Punj Lloyd and Tata Steel. A few had so-so results - like L&T.

I had written an earlier post on this subject when the market was down in the dumps. At that time, my suggestion was to categorise each item of financial news into 'great news', 'good news', 'bad news' and 'worse news'.

The stock market is in a much healthier state now, but is in the throes of a good correction. Does that put a spin on the decision making process? Not really. The same categorisation principle applies.

Let us take the examples of the companies mentioned above.

Tata Motors and ITC pleasantly surprised the market. The Jaguar-Land Rover deal was supposed to weigh down the former, and the bad monsoon was expected to affect the FMCG sector. The Tata group's huge resource raising capability helped to manage the large debt; plus the pick-up in commercial vehicle sales was 'good news'. So was ITC's considerable profits from cigarettes and reduced losses from FMCG.

What happens with such 'good news'? Stock prices usually perk up, which is used by smart investors to sell. Within a few days, the stocks tend to trade near their earlier range.

Punj Lloyd and Tata Steel declared results that were way below consensus estimates. Tata Steel's Corus debt hangover and poor offtake of steel in Europe wasn't entirely unexpected. But it is a fundamentally strong and well-managed company. The selling pressure on 'bad news' can provide re-entry points for smart investors.

Punj Lloyd's is a case of 'worse news'. Why? The management had given the impression that the Simon Carves UK penalty issue was not a big problem and will get resolved soon. Far from it. On top of their singular inability to generate cash from their core operations which led to their huge debt burden, the effort at hoodwinking investors have not gone down well at all.

The stock is falling off a cliff but still trading at a P/E of 19 at today's closing price of 202. Investors should not make the mistake of using this fall as a buying opportunity. Instead, sell at every rise. I won't be surprised if it revisits its March '09 low. A stock to avoid.

L&T's case is a little strange. While their results were not a major disappointment, the low rate of conversion from their huge order book is a concern for the market. This is not a buy on 'bad news' yet, because of the valuations. Patient investors should wait before re-entering.

The 'bad news' about Idea's results could be a harbinger of the overall derating of telecom stocks. Bharti's stock price got battered by 7% in anticipation of similar 'bad news'.

There has been no 'great news' among the financial news in the results season so far. The economy is still recovering, and unless the export-import business picks up to its earlier glory, the stock market may fail to reach greater heights.

Related post

Should Indian investors switch out of Telecom Sector stocks?