About Quality and Price in Stock Investing

Proponents of Efficient Market Theory (EMT) believe that it is impossible to 'beat the market' because prices of stocks (and other securities) discount all available information at any time due to the efficient dissemination of information in the stock market.

Most small investors would benefit by believing in EMT. Instead of losing their shirt trying to 'beat the market' by buying 'cheap' stocks in large quantities, they should just buy index funds or index ETFs from their monthly savings. The stock index will provide them long-term returns.

Hasn't Buffett become an investing legend by doing just the opposite? Isn't he the one who thinks that EMT is meant for academicians? Doesn't the stock market periodically mis-price stocks, allowing savvy investors to 'buy low and sell high'? Yes, to all three questions. 

You can get market-beating returns if you buy stocks of quality companies at fair prices, and sell them at a profit a few years later. But do you know which are 'quality companies' and what are 'fair prices' for their stocks?

Wikipedia provides the following definition of Quality Investing: "..an investment strategy based on a set of clearly defined fundamental criteria that seeks to identify companies with outstanding quality characteristics. The quality assessment is made based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability)." 

In a recent article, Ben Johnson of Morningstar.com discussed 'The What, Why and How of Quality', where he makes the following remarks: "The importance of assessing the price paid for high-quality stocks cannot be understated. While quality matters, price arguably matters more."

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Some strategies about selling stocks

Why discuss stock selling strategies just when the Sensex is showing some signs of life after an 8 months long corrective move? Isn’t this a good time to buy and make some money?

The answer depends on what type of investor you are. If you want to play the momentum in the short-term, by all means buy and book profits after a gain of 3 or 5 points. May be even 8 or 10 points. Which isn’t bad at all – if you are trading thousands of shares. Such a strategy can be followed at any time.

But many small investors don’t have big money at their disposal. They can buy 200 or 500 shares at a time (I’m not talking about penny stocks here). A 5 or 10 point gain is neither here nor there – compared to the risks involved. May be this isn’t such a great time to buy after all – since the index is just about 10% below its all-time high.

Instead of having an ad-hoc hit-and-miss strategy, have a plan. For buying, holding and selling. The ‘Margin of Safety’ concept works well for buying. P/E bands work well too – for buying, holding and selling. I prefer to use an asset allocation plan for timing buy-sell-hold decisions.

Today, I want to discuss a few selling strategies. Before you buy any stock, decide on a selling plan – based on your risk tolerance, time horizon and individual preference. As a long-term investor, I prefer to have a three years time horizon for any stock to perform. You can just as well choose a one year or two years time frame. Anything less than a year, and you will be treading the fine line between an investor and a speculator.

Once you decide on a time frame, pick a realistic price point. 100% gain in 1 year may happen once or twice, but is not a realistic goal. But a 50% gain in two years, or a 100% gain in three years may be more achievable. When the price target is reached, it is best to sell out entirely. But if you feel that more upside is left, book partial profits, and hold on to the rest with a trailing stop-loss. If the price target is not reached, don’t hold on with the hope that it will be reached ‘some day’. Just sell.

If by partial profit booking you have withdrawn your original investment, don’t ever think that the balance holding is ‘free’. It isn’t. It has an opportunity cost. If the market dives and your balance holdings drop by 50%, you have lost real money. A trailing stop-loss will save you from such a calamity.

Supposing you have a two years time frame with a 50% appreciation target. After six months, the stock suddenly starts to flare up and gains 50%. What should you do? Wait for your two years time frame, or sell now? Sudden flare-ups in stock prices occur for different reasons - insider buying, some company-specific news that you may not have heard yet, a fundamental change in the sector, a merger or acquisition.

Why bother with reasons? If your target is reached, sell – even if it means paying short-term capital gains tax. After all, tax is paid from profits – so you are still ahead.

So far, I have discussed selling strategies when your stock is in profit. What if you buy a stock and it keeps falling down? Have a strict selling strategy – a 3% or a 8% or a 15% stop-loss, depending on the type of stock and the planned period of holding. Have the discipline to sell as soon as the stop-loss is hit on a closing basis.

Learn to be unemotional and unexcited about your buy-sell-hold decisions. Treat them like any monetary transaction – like buying a cup of coffee or getting a hair-cut.

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Some do's and don'ts about Cost Averaging

One of the most common problems that many investors face is whether to sell or to resort to cost averaging when the price of a stock, or the NAV of a mutual fund, drops just after a purchase is made.

A typical question I face goes something like this: "I bought a stock at 80, and when it dropped to 40 I bought some more to bring my average cost price down to 60. Now the stock has dropped below 30. Should I sell to reduce further losses, or buy some more to bring the average cost down further, or just hold on till I get back my average cost price of 60?"

There are no easy answers to such a question. The answers will depend on the type of stock, the investor's risk tolerance and holding period. So, instead of providing answers, let me try to list out some do's and don'ts that can better prepare investors to face a similar situation.

Do's about Cost Averaging

1. Before you pick any stock or fund, do a due-diligence. Find out as much as you can about the track record of the promoter or fund manager and the performance of the stock or fund through bull and bear periods
2. Learn the rudiments of reading a price chart, or at the very least find out about the 52 week high and low values of the stock/fund; try to buy at, or near, a 52 week low
3. Decide whether you will indulge in short-term trading or long-term investing
4. Accordingly, set either a tight stop-loss or a wider stop-loss
5. If the stop-loss is hit, be ruthless about selling the stock/fund
6. If steps 4 and 5 are followed, the need for cost averaging won't arise if the price falls after purchase
7. If the price rises after purchase and you are convinced about the future of the stock/fund, buy more. In other words, average your cost upwards.

Don'ts about Cost Averaging

1. Don't ever buy a stock/fund just because a friend or colleague or TV analyst has suggested a 'buy'; learn to take responsibility and decide for yourself
2. Don't buy a stock/fund trading at or near a 52 week high
3. Don't be overconfident of your stock-picking skills just because you've tasted a few successes; always remember to set a stop-loss - whether you wish to trade or invest
4. Don't become a long-term investor by default because your trade failed and the loss became too large, and you hesitated about selling at your stop-loss
5. Never cost average downwards, as a general rule and particularly for mid-cap/small-cap stocks/funds (which tend to fall the most during bear markets)

Please remember that your cost price is known only to you. The market doesn't care two hoots about whether you are making a loss or a profit. So you need to develop an investment style that can minimise loss and maximise profit.

A related problem, though not quite as nerve-wracking, is when the price of a stock (or the NAV of a mutual fund) which hardly moves up or down for a prolonged period starts to move up as soon as an investor gets rid of it!

This problem is quite easily solved if you learn the art of partial profit booking.

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Does the Price of a Stock reflect its Value?

"Price is what you pay. Value is what you get." - Warren Buffett

Many small investors face a problem with stocks that have a 'high price'. They don't want to buy them, because they feel they can't afford them. They prefer to buy stocks that have a 'low price', because they appear more affordable and capable of giving high returns.

Last weekend, I was discussing the state of the markets with a friend and inevitably the discussion veered towards what stocks are worth buying now. I suggested that he look at a medical devices stock trading at 200 or a hospitality stock trading at 80.

His response was typical. He wanted to buy the 'cheaper' stock. I pointed out that the cheaper stock was actually more expensive on several counts - it had a Re 1 face value (vs. Rs 10 for the other), its net profit margin was less than half, and its Return on Equity (RoE) was just about a fifth.

What he said next left me speechless: 'When I can buy 1250 shares with Rs 1 Lakh, why should I buy only 500?' 

Such an approach to investments is illogical. This fixation on price and affordability is one of the prime reasons why small investors do not become successful investors. It is like saying: 'I can't afford the price of gold, so I'll buy some brass instead.'

The 'Efficient Market' theory was postulated by French mathematician Louis Bachelier in 1900 and developed further by Eugene Fama in his PhD thesis at the University of Chicago in the 1960s. It states that stock prices reflect all available information and adjusts to any new information as and when it becomes known.

It is very unlikely that an individual investor can consistently outperform the market indices because the financial news and information he uses for his stock selections is already available to every one else. Any future information will only be available on a random basis, and will affect stock prices randomly. Therefore, investors will be better off investing their money in a good index fund.

The Efficient Market theory anticipates rational behaviour from investors. But by nature, human beings tend to be irrational. And nowhere more so than in the stock market. Otherwise, why would they enter when the market has already gone up, and refrain from buying at the depths of a bear market?

Experienced investors learn to pick up value-stocks that may appear expensive but are cheap on a valuation basis - at or near market bottoms. Inexperienced investors chase after cheaper growth-stocks that are actually more expensive value-wise.

To answer the question: a stock's price tends to reflect its underlying value in the longer term. In the shorter-term, price and value mismatches do happen, that allow smart investors to build wealth.

1:1 Bonus announcement by Reliance Industries - is it good news for investors?

Reliance Industries made the bonus announcement after the Indian stock markets closed for trading on Oct 7 '09. Today (Oct 8 '09), the stock closed up by less than 1% at 2120 - still more than 15% below its high of 2490 on May 19 '09.

A 1:1 bonus - particularly when announced after 12 years in the midst of a strong bull rally - should have elicited joy and buying euphoria among market participants. Why? Because bonus shares are considered to be beneficial to shareholders. From Reliance, the 'gift' should have appeared an extra special one.

In reality, it should make no difference to a shareholder's wealth. No doubt bonus issues offer 'free' shares on which dividends are paid in the future. But the share price is adjusted downwards depending on the bonus ratio. In the case of a 1:1 bonus, 100 shares will become 200 shares, but the share price prevailing on the record date will get halved after the bonus issue.

A shareholder's wealth remains the same - double the shares at half the price. What can happen after the bonus issue? One year later, dividends are likely to be paid on the enhanced quantity of shares, but the dividend payout ratio is usually maintained by reducing the dividend percentage. The total dividend received by the shareholder remains the same.

There is a downside as well. After receiving the bonus shares, many shareholders sell the original quantity - specially if bought less than a year back - to book a short-term loss and get a tax break by adjusting the loss against short-term profits. This selling pressure pushes the stock price below the already halved ex-bonus price. So the actual wealth of shareholders, who do not avail the tax break, may go down after the bonus shares are issued.

But there are long term benefits if the company continues to perform well in the future - and Reliance should do so. (A bonus announcement is management's way of communicating a bright future to shareholders.) The dividend payments gradually increase, and the investor receives a higher amount each subsequent year.

Why the muted buying? Several reasons. The company's performance over the next few quarters are not likely to be exciting. The KG basin gas selling fiasco and the ongoing public feud amongst the Ambani siblings is creating negative ripples in Government circles, and uncertainty among large shareholders.

Reliance had out-performed the Sensex by gaining 167% from its Oct 27 '08 low of 930 to its May 19 high of 2490. Subsequently, the stock has under-performed by going through a 4 months long sideways consolidation.

If 'good news' doesn't move a stock up sufficiently, it is an indication that there is no longer enough buying interest in the stock. The fact that the Sensex is in some sort of a topping formation is also restricting the bulls at the Reliance counter.

Existing investors may continue to hold. New entrants can make a token purchase at current price, and buy more on dips. (I stay far away from any stock with the 'Reliance' name in it.)

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Stock Chart Pattern - 3i Infotech Ltd

The stock chart pattern of 3i Infotech Ltd looks a little different from other stocks that have been analysed recently. It made a high of 165 back in May '07 (actually 330, but adjusted for the subsequent 1:1 bonus). The bears attacked almost immediately, and the stock gradually slid down to 115 in Sep '08, before it fell off a cliff.

It finally bottomed at 25 in Mar '09 - dropping 85% from its peak. A swift 3 months rally took the stock to 95 in Jun '09 - an exact 50% Fibonacci retracement of the entire Rs 140 fall over 2 years. Thereafter, the stock has been in a consolidation phase within an 'ascending triangle'.

Let us have a look at the 1 year bar chart pattern of 3i Infotech Ltd:-

 

The RSI has moved above the 50% level. The MACD is positive, but marginally below the signal line. The slow stochastic is below the 50% level but the %K line has just crossed above the %D. All three are indicating mild bullishness. The OBV is providing the real clue to the underlying strength - the gradual rise indicates 'accumulation'.

3i Infotech is part-owned (39.5%) by ICICI Bank, and its revenues are a 50-50 split between software products and services. Its product portfolio - mainly targeted at banks and financial institutions - helps to generate a high net margin of close to 30%.

A low P/E of 6.25 means an earnings yield (E/P) of 16% - which is double the current fixed deposit rates in banks, leaving a good 'margin of safety'. Solid top and bottom line growth and strong cash flows from operations make this an ideal portfolio candidate.

Then why is the stock under-performing the Sensex (which has already retraced 70% of its bear market fall)? The company has been aggressively pursuing growth through the inorganic route. That means, it has been acquiring a number of software companies and businesses in India and overseas.

The danger of such a strategy - when leveraged through debt - is that the interest payments become due sooner than later, whether there is a global economic downturn or not.

3i Infotech is less reliant on clients in US and Europe (where the financial services outsourcing business has been hit the hardest) than most Indian software services companies. But the bears have mauled it just the same. And there lies an opportunity for smart investors.

Bottomline? The stock chart pattern of 3i Infotech is indicating that the smart money has been accumulating the stock, and an upward break from the ascending triangle may be imminent. Enter, or add more, on a close above 95. Keep a stop-loss at 70.

(Some questions: Why is the stop-loss set at 70? If you enter now, should you set a tighter stop-loss? At what price?)

Stock Chart Pattern - Suzlon Energy Ltd (An update)

The previous analysis of the stock chart pattern of Suzlon Energy was done more than 6 months ago when the stock market was near its nadir. It is time for an update - more so because the stock is back in the news, thanks to a 5% sale of the promoter's stake.

My bias against Tulsi Tanti and his faulty wind mills was laid bare, including a nonsense rhyme from 'Abol Tabol' by Sukumar Ray, in the earlier post. So I will try to refrain from adding insult to injury. But I can't stop myself from asking this question:

'Why and when does a person sell his wife's jewellery?'

If I was a scriptwriter of Hindi movies, I would perhaps come up with a lofty answer - like 'for building low-cost housing for the down-trodden', or, 'for setting up a well-appointed old folks home'. But the logical answer would be:

'When he exhausts all other options to raise money for survival.'

Let us take a look at the 1 year bar chart pattern of Suzlon Energy and find out how the stock has fared in the bull rally:-

The stock was decimated by the bears, falling all the way from a peak of 460 in Jan '08 (adjusted for a 5:1 stock split that changed the face value from Rs 10 to Rs 2) to a low of 33 in Mar '09. A massive 93% fall, that few stocks can survive.

The subsequent sharp rally took the stock up above the 200 day EMA to 146 in Jun '09 - retracing about 26% of the entire bear market fall. A reader had questioned my recommendation to not go anywhere near the stock (though I had suggested that adventurous traders could make a punt, because the 50 day EMA had gone far below the 200 day EMA, indicating oversold conditions).

Smart investors were not fooled by the whopping 340% gain in 3 months from the Mar '09 low, and started booking profits. After managing to keep its head above the long-term average for most of Jun '09, the stock slipped below it in Jul '09. The 200 day EMA has since provided strong resistance to further up moves.

What is more remarkable? Despite the sharp rally, the 50 day EMA - which had moved below the 200 day EMA way back in Mar '08 - has not been able to move above the long-term average. That means, technically, the stock failed to enter a bull market.

Today's (Wed, Sep 23 '09) news about the 5% stake sale has not been well-received by investors. The stock slipped by more than 6%, and closed below both the 20 day and 50 day EMAs. The bears are in control. Every rise can be used to sell.

The technical indicator's are reflecting the weakness in the stock. The RSI is below the 50% level and moving down. The MACD is barely positive, and below its signal line. The OBV is slipping, indicating 'distribution'. The slow stochastic is getting ready to enter the oversold region.

Bottomline? The stock is at a level nearly 3 times higher than where it was 6 months back. But the chart pattern of Suzlon Energy is uninspiring - particularly the volume spikes on down days. A drop to the 75-80 level could be in the offing. A stock every one should avoid.

Why small investors should avoid small cap stocks

There are several reasons why small cap stocks should not be considered for investment by any investor - new or old, small or large. Before I start to argue my case, let me define what is a small cap stock.

The market capitalisation (or market 'cap') of a stock is the product of a stock's current market price and the total number of equity shares outstanding. In other words, a stock having total outstanding equity shares of 10 Million (1 Crore) and a price of Rs 100 has a market cap of Rs 1 Billion (100 Crore).

The question is: What market cap makes a company a small cap, or a mid cap or a large cap? The short answer is: It depends on whom you ask. There are no precise definitions. The industry norm for a small cap company seems to be a market cap of upto Rs 2500 Crore!

A mid cap company has market cap ranging from Rs 1000 Crore to Rs 13000 Crore. Large caps are those forming part of the Sensex 30 and Nifty 50 stocks. As you can see, the whole thing is pretty confusing.

Small investors get attracted to small caps because of two main reasons - 'affordability' and greed. Most small companies are also small cap companies that trade typically at few tens of Rupees. This price is attractive to small investors with small capital. (Many don't realise that a Rs 30 stock may have a Re 1 face value and may be trading at a P/E of 30.)

Many of today's large caps were small caps 10 or 12 years back. The general assumption is that all small caps have the potential to become large caps and give multibagger returns. But only a small minority out of the thousands traded in the stock market actually make the transition. Most will remain small caps, or disappear into the sunset.

Why are small cap stocks so risky that they are best avoided by small investors?

• lack of transparency of management
• lack of adequate research by fund houses and brokers
• lack of financial muscle
• low liquidity
• high volatility

Management is too busy trying to survive (or siphon off money) to look after investor relations and proper communication of plans. Fund houses shun such stocks, so analysts don't cover them or visit their factories to ask tough questions.

One or two bad quarters can wipe out a small company, who may not have access to big money. Low volume of trading leads to difficulty in getting in or out, and wild price swings if small quantities are traded.

Only those investors with adequate experience and knowledge of fundamental and technical analysis should attempt investing in small cap stocks. That too, with the awareness that the entire investment can go down the drain. Preferably, the investment in small cap stocks should be limited to 10% of total portfolio value, to mitigate the risks involved.

The vast majority of investors should look for more expensive but less risky large cap stocks, or stick to index funds or index ETFs. Always remember Warren Buffet's investment rule: Don't lose money.

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Stock Chart Pattern - Tata Steel

Nearly a year back I had last discussed about Tata Steel (I'm learning not to say TISCO). It wasn't a stock chart pattern analysis, though some investment levels were discussed. The big Corus acquisition, as well as other investments in the Asia-Pacific region, were expected to be shareholder value destructive.

No one, including yours truly, expected a fall from 970 on Oct 29, '07 all the way down to 146 on Nov 26, '08 - a massive 85% drop from the peak. Excessive pessimism often allow smart investors to enter fundamentally strong and proven performers at mouth-watering levels.

The dark cloud of the huge debt for acquiring Corus has been broken some what through debt restructuring. Domestic sales have not been affected much, but Corus is still in dire straits. At 50% production levels currently, the losses continue. 75% production is needed for break-even - which is not likely to be achieved before the end of the year.

So 2009-10 will be a bad year overall. Things are likely to improve from 2010-11 onwards, but it won't be till 2011-12 that huge cash flows from the Corus operation will change the stature of Tata Steel in the global steel market.

We'll now have a look at the one year bar chart pattern of Tata Steel and introduce a new technical tool:-

The Tata Steel chart pattern shows a double bottom at the 146-150 level before the bull rally from Mar '09 took the stock to an intermediate peak of 496 on Jun 3, '09 - correcting 42.5% of the entire bear market fall.

Correction to a low of 330 on Jul 13, '09 broke the trend line marked 'OA'. This was a 47.5% correction of the bull rally rise. Note that both corrections - one upward and the other downward - fell short of the 50% Fibonacci level. Another indication that technical analysis is indicative and approximate - more art than science.

From 330, the Tata Steel stock again moved up to test the previous high, but fell short at 492 made on Aug 4, '09 - forming a double-top in the process. The ongoing correction for the past 4 weeks has broken below the 20 day and 50 day EMAs, as well as the second trend line marked 'OB'.

The third trend line, 'OC', hasn't actually formed yet, but has been drawn to indicate the last support possibility for the bull rally to remain in tact - by making the angle BOC the same as angle AOB. These three trend lines - which together look like a small hand fan - form the basis of the 'Corrective Fan Principle'.

The breaking of the yet-to-be-formed trend line 'OC' will signal the end of the bull rally. Before the stock chart pattern can do that, it will need to test the support of the 200 day EMA (currently at 380).

The trend line 'OC' is now at the 300 level, which also happens to be the previous tops made in Apr & May '09. Previous tops tend to act as support levels. That means a good possibility of the stock halting its fall at 300.

The technical indicators are pointing towards more correction. The MACD has entered negative territory. The RSI is about to enter the oversold zone. The MFI is below the 50% level and moving down. The slow stochastic is well inside the oversold region, where it can remain for a while.

Bottomline? The stock chart pattern of Tata Steel may be giving advance notice of what may happen to the BSE Sensex chart - a 10-15% correction. The zone between 300-380 may provide good opportunities for long term investors to enter, or top up existing holdings.

Stock Chart Pattern - Bilcare Ltd

The stock chart pattern of Bilcare Ltd is almost a mirror-image of the Sesa Goa chart pattern we looked at yesterday. Sesa Goa had moved up to make a new all-time high. Bilcare is struggling to get out of the bear market. Let us find out why.

Bilcare Ltd can best be described as a pharmaceutical ancilliary company. Starting out in medicine packaging, they have now morphed into a clinical trial supplies, services and project management company, with offices in USA, UK and Singapore.

Their related services include solutions for compliance and brand protection issues, as well as educational programmes to create a pool of clinical trial technicians.

Consolidated sales in Mar '09 grew 31.5% to Rs 856 Cr and EBITDA grew 19% to Rs 194 Cr. With good growth, positive cash flows from operations, regular dividends, P/E < 11, P/BV < 2, Debt/Equity < 1 - this is an almost perfect example of Graham's 'value pick' criteria.

So why is the stock languishing? Two words: Rakesh Jhunjhunwala! The big bull, a big shareholder and director, recently resigned from his directorship in the company and sold a part of his stake. That was a trigger for the bears, who had already mauled the stock, to launch a renewed attack.

The 1 year stock chart pattern of Bilcare Ltd is a clear example why a stock chosen on the basis of fundamental analysis alone can become a 'multi-sagger' :-

The stock had made a low of 275 on Jun 14, '06. It then climbed dizzily all the way to a bull market top of 1830 on Jan 1, '08 - only to give up the entire gain as it dropped like a stone to a low of 279 on Mar 9, '09. Such a 'mountain-like' pattern makes it very difficult for any stock to recover its former glory.

The stock rallied with the rest of the market on sharply higher volumes and briefly went above its 200 day EMA, as it made a high of 549 on Jun 4, '09. The correction started almost immediately, and the long-term average quickly turned into a strong resistance level.

The efforts by the stock to remain above its 50 day EMA has also been thwarted, and now the medium-term average has switched from a support level to a resistance level.

The MFI is below the 50% level and moving down. The slow stochastic has just slipped below the 50% level and the %K line is below the %D. Of late, down-day volumes are higher. Looks like the bear grip will remain strong for a while.

Bottomline? The stock chart pattern of Bilcare Ltd is not inspiring confidence. A fall to the 300-350 zone may be a better entry point for bravehearts - but only after thorough homework.

Stock Chart Pattern - Container Corporation of India

Container Corporation is a Govt. of India company, promoted by the Ministry of Railways. Regular readers of this blog may know of my aversion to government-owned companies. So why am I discussing the stock chart pattern of Container Corporation?

A one-word answer: monopoly. I like a company that is well-run, generates cash flows from operations, makes profits, pays dividend and has low debt. If it has a monopoly in its line of business - in this case, storing, handling and transporting of containerised goods through the railway network, a classic play on the India infrastructure story - then it makes the company doubly attractive.

The government holds 63% of the equity. FIIs hold more than 25%. The public holds just about 1%. No wonder it has a high price, but because of its profitability, trades at a P/E of less than 18. If there is one drawback, it is the low volume of trading.

Last year's top line was flat due to the economic down turn that severely affected exports and imports. Still, the company managed to improve its operating and net profit margins.

The one year bar chart pattern of Container Corporation is a clear example of a market favourite that is charting its own course, far removed from the gyrations of the BSE Sensex index:-

The stock made a low of 540 in Nov 21 '08 and a higher low of 610 on Mar 4 '09, before embarking on a bull rally with periodic corrections and consolidations. On Jul 29 '09, the stock hit a high of 1149, a level it had last touched in Sep '07 (adjusted for 1:1 bonus issue).

Thereafter, the stock has started consolidating in a triangle pattern. Of note is the big gaps between the 50 day and 200 day EMAs and between the stock price and the 50 day EMA (marked on the chart with blue arrows).

Does that mean the stock will face a trend reversal? Probably not. But a good correction may take it down to seek support at its 50 day EMA at around 1000, and then to the 200 day EMA at around 850.

The triangle pattern is usually a continuation pattern, so the stock price may very well move further up and try to reach its all time high of 1222, hit on Jun '07, before starting the correction. But triangles are quite unreliable, and the stock may just continue sideways for a while, negating the triangle.

Other than the EMAs, which are moving up strongly, the other technical indicators are showing weakness. Both the RSI and MFI have slipped down from overbought zones. The MACD is positive, but below its signal line. The slow stochastic is dropping towards the 50% level. These are bearish signs, indicating a correction in the near term.

Bottomline? The stock chart pattern of Container Corporation demonstrates that given the proper environment and business model, a government owned company can generate excellent returns. Investors would do well to keep this stock on their 'watch list' and enter on dips.

Stock Chart Pattern - Larsen and Toubro

The stock chart of Larsen and Toubro has been in a consolidation pattern since the election and requires a close look. Before that, a brief peek into history.

Two Danish engineers and school mates, Henning Holck-Larsen and Soren Kristian Toubro, left Europe to set up the company in Bombay back in 1938. Their first office was so small that only one of the partners could use it at a time.

How the company grew to become the largest engineering and construction conglomerate in India is a fascinating story. Interested readers can find out more by visiting the L and T site.

After the passing of Larsen in 2003 (Toubro preceded him in 1982), the company seemed to grow a new set of wings. A solid well-managed and fundamentally strong company with steady growth, cash flows and dividends, its stock was not doing anything exciting.

A futile effort by the Ambanis to wrest control of the company perked things up. The divestment of the cement business, which was like a millstone around its neck, to the Birlas of Grasim came as a real boost to growth.

The global economic boom, the emphasis on infrastructure projects in India, a 5:1 stock split followed by two 1:1 bonus issues acted as rocket fuel that made the company shoot up to the must-buy list of FIIs.

Several subsidiaries and joint ventures including units in finance, electronics, information technology are its hidden assets. An apparently disastrous high cost investment in scam-scarred Satyam is turning out to be a blessing in disguise.

Now the technicals. The one year bar chart pattern of Larsen and Toubro has been in a 'pennant' formation, that opens up a few different possibilities:-

After peaking at 2235 on Oct 30 '07, the L and T stock started falling and dropped by 75% to a low of 557 on Mar 9 '09. The subsequent bull rally seemed to stall at the 1000 level, but post election results, a gap-up move took it all the way to 1800 on Jun 18 '09.

The stock entered a consolidation pattern called a 'pennant'. It is a narrow triangular pattern that usually forms after a sharp up (or down) move. Volumes have steadily receded during the formation of the pattern, which is now 7 weeks old. Ideally, it should have broken out upwards from the pattern by now.

Notice how the technical indicators made lower bottoms while the stock made a higher bottom in Jul '09. A negative divergence. Since then, the stock has made a lower top, but the RSI, MFI and slow stochastic made higher tops. A positive divergence. The conflicting signals indicate indecision among market players.

The MACD is marginally positive. The RSI and slow stochastic are turning down from overbought zones, The MFI turned down before reaching its overbought zone.

If the stock breaks out upwards (as it should for a consolidation pattern in an up move), it should go the same distance as it did from the recent bottom of 557 to the top of 1800 (i.e. to about 2800).

If it breaks downwards, it may get support at the zone between its 200 day EMA and the top of the gap at 1100. It may also close the gap and find support at its previous top at 1000.

There is a third possibility. The stock may continue to consolidate sideways, in which case the 'pennant' formation will fail. Now you know why I keep mentioning that technical analysis is not a science!

Bottomline? The stock chart pattern of Larsen and Toubro is showing indecision. Existing holders should hold with a stop loss of 1350. If you want to add or enter, do so on a break above 1600, or on a correction to 1100-1150.

Stock Chart Pattern - OnMobile Global

Before we take a look at the stock chart pattern of OnMobile Global, here are some fundamental facts:-

Arvind Rao (ex-McKinsey) and Mouli Raman (ex-Infosys) set up the company 7 years back, supported by a private equity fund. They had an IPO in Jan 2008 at a price of Rs 440, and are the leading Indian company in the mobile value-added services space.

Recently, revenue-sharing deals were signed with two large telecom operators - Vodafone, and Telefonica, Spain - that will provide their telecom products access to nearly 35 new global markets.

Top line has grown from Rs 40 Crores to Rs 400 Crores in the last 5 years. By 2012, it is expected to grow to Rs 800 Crores. Profits have kept pace; so have cash flows from operations. Proving that small, fast growing companies can generate positive cash flows if the business model is right and the management is experienced and competent.

Low debt, but no dividend so far. Promoter holding is 57%; FIIs hold another 15%; public holding is less than 12%. No wonder the stock is trading at a P/E of 37. For more details, read this article.

The 2 years bar chart pattern of OnMobile Global seems to be taking a well-deserved rest after a splendid rally:-

The stock saw huge volumes on listing and quickly moved up to 745 in Apr '08 while the Sensex was in the firm grip of bears. It soon succumbed to the bear onslaught and dropped all the way to 200 in Nov '08.

A sideways consolidation concluded with an intra-day low of 185 in Feb 24 '09. A progressive up move with frequent sideways consolidation in a step-like fashion - a sign of a new bull market - took the stock to a high of 682 on July 24 '09.

Here the chart pattern met a resistance zone between 630-690. A small rounding-top bearish formation has brought down the stock to a close of 540 today.

Notice how the stock took support at its 50 day EMA in May '09 and Jul '09? It is likely to find support again at the medium-term moving average. Should it break below it, the 200 day EMA may provide a stronger support.

The current levels of the two moving averages correspond to previous tops made by the stock. Previous tops also tend to act as support levels.

The MACD is still positive, but below its signal line. The technical indicators are saying that the correction may not be over yet.

Volumes have supported the recent up move, though the volume bars are not clearly visible in the chart due to the huge volumes on listing. The RSI, MFI and slow stochastic had all entered overbought zones, and have now dropped down. The slow stochastic is already below the 50% level and the %K line is below the %D line.

The call rates and ARPUs (Average revenue per user) of mobile operators have been going southwards for some time, while the number of users are steadily growing. Mobile value-added services is the next growth area for telecom operators worldwide. OnMobile is perfectly positioned to reap the benefits of this market trend.

Bottomline? The stock of OnMobile Global can be considered for addition in the portfolio of long-term investors. The stock chart pattern shows the zone between 400-500 could provide a better entry point.

Stock Chart Pattern - Exide Industries

The stock chart pattern of Exide Industries has an interesting variation of the cup-and-handle formation, which I will discuss a little later.

It is the strong fundamentals that attracted me to the stock. I'm not particularly fond of the auto-ancilliary sector, which is dependent on the cyclical automobile and commercial vehicles sectors.

There are too many players and too little control over fly-by-night outfits producing spurious parts. To compete, better known names can't afford to sell at prices that will generate better margins.

There are a few notable exceptions that command a leadership position in terms of product quality and management strength. Exide is one. Mico Bosch is another.

Over the years, Exide has become the brand of choice for automotive and industrial storage batteries. Increasing sales and margins, strong cash flows from operations, judicious capacity and market expansions - all point to a suitable stock for a long-term portfolio.

Let us take a look at the 2 years bar chart pattern of Exide Industries:-

 

The pattern in the chart does not have a smooth rounded bottom. Instead it has a double-bottom at 38 in Dec '08 and 35 in Mar '09. Nevertheless, the cup-and-handle pattern is quite apparent.

The more interesting point is that after a brief downward channelled correction that formed the 'handle', the stock not only broke out of the channel on high volume but also managed to move above the 'cup' edge at 80.

The bullish pattern has been completed, and technically the stock should move into a higher orbit. However, there are a few speed-breakers on the way that may slow down the rally.

The RSI and MACD have negative divergences from the stock price. The MFI and slow stochastic haven't shown divergences, but both are in overbought zones.

Then we have to contend with the increasing gaps between the stock price and its 50 day EMA, and between the 50 day and 200 day EMAs. The previous two occasions that this happened - in Jan '08 and Mar '09 - there were trend reversals. I'm not expecting a trend reversal this time, but a deep correction may be in the offing.

Last, but not the least, is the previous high of 90 (for this Re 1 face-value stock), made in Jan '08. Previous highs have a tendency to become resistance levels.

Bottomline? The stock chart pattern of Exide Industries is beginning to look overbought and ripe for a correction. Existing holders can book partial profits. Those wanting to enter may wait to get a better price between 60 and 70.

Stock Chart Pattern - Bharat Bijlee

The stock chart pattern of Bharat Bijlee has an important lesson for small investors who are interested in mid-cap and small-cap stocks. While such stocks can give whopping returns during the later stages of a bull market, they can fall off a cliff when the bears take control.

Bharat Bijlee is not one of many fly-by-night, chameleon-like operations that dot the mid-cap field. It has been around for quite a while. Its supposedly mundane business of manufacturing electrical motors and distribution transformers, with sales to a number of State Electricity Boards with long payment cycles, has still thrown off decent positive cash flows from operations.

This has enabled the company to finance its expansion and growth through internal accruals and debt, leaving the small equity capital of Rs 5.65 Crores intact for the past several years. Last year, both the top line and bottom line were hit by the economic downturn and the increased prices of raw materials.

The 2 year closing chart pattern of Bharat Bijlee shows how badly the bears have mauled this profitable, dividend paying, well-managed small-cap company:

After hitting a high of 3950 in Jan '08, the stock had a one way fall to a low of 301 on Mar 13, '09 - dropping more than 90% from its peak. Such a huge fall is technically very negative, as it may take the stock a long time to retrace even 50% of the fall.

A 'V' shaped recovery, accompanied by heavy volumes, took the stock up to 1015 on June 4, '09 - a rise of about 235% in less than 2 months. After a brief sojourn above the 200 day EMA, the stock has been consolidating in a downward sloping trend channel and has slipped below both the 20 day and 50 day EMAs.

Notice how the 20 day EMA moved down after touching the 200 day EMA. Unless the short-term and mid-term moving averages go above the 200 day EMA, the bull market will remain elusive for Bharat Bijlee.

The RSI, MFI and slow stochastic have bounced off oversold regions. The MACD is negative. Looks like the consolidation in the downward channel may last a while longer.

Bottomline? At today's closing price of 785, the stock is available at a P/E ratio of 9.2. The stock chart pattern of Bharat Bijlee may be providing an entry point for really patient investors. With the current emphasis on building the power infrastructure in India, the stock can hit 1500 in a year's time.

Stock Chart Pattern - Great Eastern Shipping

Before I start discussing about the stock chart pattern of Great Eastern Shipping, I would like to thank reader Abhijit for suggesting this particular stock.

I have long admired the performance of Great Eastern Shipping. Fundamentally strong, with very good profit margins, strong cash flows from operations, low P/E ratio, regular dividends - all the hallmarks of a stock that should adorn any long-term portfolio.

Yet, I never got around to buying the stock. I could never figure out why or when the Baltic Dry freight index would go up or down. What was its exact relationship with the profitability of shipping companies. Whether buying or selling or leasing ships and rigs made more sense at a particular time or not.

In other words, the shipping industry does not fall within my 'circle of competency'. If one doesn't have some knowledge about how an industry or sector works, it is better to avoid investing in that sector. There are plenty of good stocks in a lot of different sectors.

For those who understand - or know some one that understands - the nitty-gritty of the shipping industry, Great Eastern Shipping should be their number one choice.

A look at the one year bar chart pattern of Great Eastern Shipping will indicate that there are a couple of interesting recent formations:-

The stock entered a sideways rectangular consolidation pattern - much like that of the BSE Sensex index - after the low of Rs 139 made on Oct 27, '08. It subsequently made lows of 144 in Dec '08, 142 in Jan '09 and 143 in Mar '09.

The triple bottom was followed by a rally - again tracking the BSE Sensex index - from 143 to 316 in Jun '09, a gain of 120%. But the high of 316 only equalled the high made in Oct 1, '08. The later part of the rally from May '09 onwards was on much higher volumes.

Note how the stock was making new highs right through April, May and early June '09 whereas the RSI remained almost flat around the 70% level. This negative divergence led to a sharp correction, that took the stock down to 212 on July 13, '09 - a correction of 60% of the entire rise from 143 to 316.

The 60% correction is close to the Fibonacci correction level of 61.8%. If the stock went below the 61.8% level, then technically, the it would have re-entered the bear market. Here came another interesting twist to the tale.

While the stock was making lower bottoms of 229 in Jun '09 and 212 in Jul '09, the RSI made higher bottoms - a positive divergence. The up moves of Tuesday (Jul 14) and Wednesday (Jul 15) - again tracking the Sensex - moved the stock up sharply above the confluence point of the 20 day and 50 day EMAs as well as above the down-sloping trend line connecting the lower tops of Jun and Jul '09.

By the smallest of margins, the stock has managed to survive the bear onslaught - at least for the time being. The technical indicators seem to be supporting an up move.

The MACD is negative and below its signal line. But it is turning up and may cross the signal line soon. The slow stochastic has moved up sharply from the oversold region. The OBV is tracking the stock, as it is supposed to do. The volume is also supportive.

Bottomline? The stock chart pattern of Great Eastern Shipping is suggesting that for interested investors, this may be a good time to enter. But buy only a small quantity. Why? The stock has a tendency to track the Sensex - which had a 'pullback' to the neck-line of a bearish head-and-shoulders formation. Should the Sensex crack downwards, the stock may follow suit.

How to Profit from the Cup-and-Handle Chart Pattern

An interesting addition to the technical analysis tool set is the Cup-and-Handle chart pattern. It is very much like a bullish 'saucer' or 'rounding bottom' pattern, but provides additional points of entry.

There is no better way to learn about new stock chart patterns than to look at a practical example. I have chosen the 1 year bar chart pattern of Maharashtra Seamless, because it has made a classic, and clearly identifiable, cup-and-handle pattern:-

The stock made a previous high of Rs 328 in Aug '08 before continuing its bear market down move. It finally made a low of 112 in Mar '09, before embarking on a sharp rally with the rest of the market. In the process, it made a 'rounding bottom' bullish pattern.

The stock went all the way up to Rs 325 in Jun '09 - nearly tripling in value from its Mar '09 low. Not unexpectedly, it faced resistance near its previous high, and the first attempt on Jun 5 '09 failed to go past it. Three subsequent attempts on lower volumes also failed.

The stock then entered a corrective downward sloping channel that has taken it towards its 50 day EMA at Rs 250, where it is currently seeking support.

The horizontal line connecting the two tops of Aug '08 and Jun '09 forms the top rim of the 'cup' at Rs 328. The 'rounding bottom' pattern completes the body of the 'cup'. The downward sloping corrective channel is the 'handle' of the 'cup'.

The progress of the 'handle' needs to be closely observed, because it can provide clues to what might happen next. The depth of the cup is a move of Rs 216 (= Rs 328 - Rs 112).

The 'handle' can retrace between a third and a half of the 'cup' depth. That means a retracement of between Rs 72 (=Rs 216/3) and Rs 108 (=Rs 216/2). So, the correction of the 'handle' should stop in the price zone between Rs 256 (=Rs 328 - Rs 72) and Rs 220 (=Rs 328 - Rs 108).

On completion of this corrective move, the stock price should break up wards again. This provides three possible entry points - should you be interested in entering this stock.

1. The first, and riskiest, point of entry is any time the stock goes below Rs 256 - like it has done now. Why riskiest? Because the 'handle' can go below the Rs 220 level and possibly negate any up move for now.

(There are other reasons why you may want to enter now. Rs 250 is a support/resistance level - as can be observed from the chart patterns made in Jul '08 and Sep '08 (supports) and Oct '08 and May '09 (resistances). The 50 day EMA is another likely support. The RSI has entered oversold region.)

2. The second, and less risky, point of entry will be when the stock breaks out upwards from the downward sloping trend line of the 'handle' formation.

3. The third, and safest point of entry will be when the stock moves above the cup rim level of Rs 328.

The Cup-and-Handle stock chart pattern usually shows up as a continuation pattern in a bull phase. In this case, however, it has formed a bottoming pattern. (There are some other stocks that are also showing a similar formation. Curious readers may want to try and find out some of  these stock charts, as an exercise.)

An inverse Cup-and-Handle can form in bear phases or at market tops - as a variation of the rounding-top bearish pattern.

Here are some questions for my readers. What do you think about the 'handle' formation? Why is it happening? Is it an 'accumulation' or a 'distribution' pattern? (Just use your common sense, and provide your answers in the 'Comments' link, or email me directly.)

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BSE Sensex Index Chart Pattern - Jun 19, '09

Last week's BSE Sensex index chart pattern showed 14 straight weeks of gains on increasing volumes. All the technical indicators were positive and supporting the up move. The economic fundamentals were hinting at signs of improvement. Everything pointed to a continuation of the rally.

However, I did strike the following note of caution:

'But I remain cautious simply because of the continued 14 positive weeks of rally without any meaningful correction. That increases the possibility of a steep fall.'

Prescient? Hardly. Just several years of experience in the stock market and watching chart patterns. In spite of the late pullback on Friday, Jun 19, '09 the Sensex closed lower than the previous week. The incredible bull spell seems to be broken.

This week, we will take a look at the 6 months bar chart pattern of the BSE Sensex index to catch some very interesting formations:-

The long-awaited correction during the week was quite steep and the Sensex pierced through two supports - (i) the 20 day EMA from above, some thing it hasn't done since Feb '09; and, (ii) the up trend line connecting the bottoms made on Mar 9, '09 and May 14, '09.

Friday's pullback took it back to the up trend line and very marginally above the short-term moving average - which means the bulls aren't ready to give up without a fight. The text books on technical analysis say that if you missed selling at the top, sell on the pullback.

Now look at the formation over the last four weeks (the previous 19 trading sessions, to be precise). Do you see a nice semi-circular 'rounding top' formation? Not quite? Then have a look at the signal line of the MACD.

A 'rounding top' is bearish. Since the time spent in the formation has been only 4 weeks, its effect may be weaker. That means, the BSE Sensex index should get support in the region between the previous low of 13480 (made on May 18, '09 when the huge gap-up happened) and the 50 day EMA at 13200.

I've also introduced the Money Flow Index (MFI), a momentum oscillator that is interpreted much like the RSI, but with a difference. The RSI is based on the price alone. The MFI uses price data weighted with the volume of transactions in Rupees.

See how the MFI made a lower top when the Sensex was hitting a new high? This negative divergence is not that clear in the RSI or the slow stochastic indicators. One more reason why you need to look at several indicators for coming to any conclusion.

The best (or worst, depending on your market stance at the moment) has been saved for the last. My favourite indicator, the slow stochastic. After remaining at or in the overbought region for the better part of the past 3 months, it has dived down steeply, and gone below the 50% mark.

The last two times it did that - in Jan '09 and Feb '09 - it went all the way down to the oversold zones, followed by up moves. So watch it closely over the next two weeks.

The big gap (between 11950 and 13480) in the Sensex still remains unfilled, and the very bearish possibility of an 'island reversal' still remains open.

Bottomline? Remain very cautious over the next two weeks, and refrain from making wild bets on unknown stocks. The BSE Sensex index chart pattern is dancing to global money flows. Keep track of the world indices. Fresh investments should be made after the budget.

Stock Chart Pattern - Bartronics India

There is a specific reason for analysing the stock chart pattern of Bartronics India, but I will not divulge it right away. This is one of those much-talked-about-by-analysts-on-Business-TV-channels kind of stock. That means it is well-known among retail investors - particularly those who can't get by without their daily dose of stock tips.

It is funny how these TV stock tips work. By the time an analyst finishes discussing the stock, it spurts in value and some times even hits an upper circuit or two. Retail investors try not to miss the bus. A few fund managers get caught up in the chase. Pretty soon, every one and his brother-in-law owns the stock.

Specially when the company is in so-called 'high-tech' fields - like barcode readers, RFID tags and smart cards - then the exuberance and excitement progresses geometrically. No one doubts the potentially huge market for these 'untapped' technological marvels. More so because they have seen it all in action in one of their '11 days, 10 nights' conducted trips to the USA or Europe.

The positive sentiment is quite apparent from the 1 year bar chart pattern of Bartronics India:-

The stock made a low of Rs 55 on Nov 20 '08, followed by a test of the low on Dec 3, '08. It made another low of Rs 61, three months later on Mar 9, '09 - thereby creating a typical double-bottom chart pattern.

The rally that followed was on expected higher volumes, albeit after the stock cleared the Rs 80 level. Both the RSI and slow stochastic indicators quickly hit overbought zones and then started to decline.

The stock reacted from Rs 115 to Rs 85, where it received support from its 50 day EMA while it consolidated sideways. Note that the on-balance volume (OBV) remained flat when the stock reacted in late April '09. This positive divergence gave an indication that the next move would be a continuation of the up move.

The sharp up-move from May 18, '09 onwards after the election results again took the RSI and slow stochastic to overbought zones. Both indicators have since moved down as the stock reacted from a long-term resistance level of Rs 180.

But observe the MACD, which is flat and the OBV, which has made a new high. These indicate a possible continuation of the rally. Looks like the chart pattern of Bartronics India is suggesting a 'buy-on-dips' strategy.

That's not why I'm writing about this stock. If some thing looks like it is too good to be true, it usually is. So I took a quick peek at the cash flow from operations and the Profit and Loss statement. And guess what? The 'excellent' profits are a big bag of wind!

In the year ending Mar '07, adjusted PAT was Rs 13.4 Crores; cash flow from operations was (-) Rs 75.7 Crores. It got worse in Mar '08. Adjusted PAT was Rs 33.1 Crores, a 'creditable' increase of 147%! But the cash flow from operations? (-) Rs 219 Crores - a fall of 189%. The company actually paid a tax of Rs 8.3 Crores with money it did not have!

How is this company surviving? A look at the balance sheet will reveal all. Almost a doubling of equity capital from Mar '06 to Mar '08; plus a whopping unsecured loan of Rs 253 Crores - at much higher interest rates than that prevailing now. No wonder the Mar '09 Q4 results were awful.

Bottomline? The Bartronics India stock chart pattern looks very encouraging, thanks to the positive sentiment in the markets, but the fundamentals are apalling. Get out before this house-of-cards comes tumbling down.

Stock Chart Pattern - Sintex Industries

The stock chart pattern of Sintex Industries gives clear indication that this fundamentally strong company is coming out of the down turn well. No wonder it has caught the recent attention of the pink papers.

The claim to fame of Sintex was the almost ubiquitous black plastic water storage tanks atop recently constructed houses. The company has moved on to bigger and better products which they sell to the global market place. Their pre-fabricated low-cost housing products order book exceeds their 2008-09 revenues by three times, as per this article.

What I like about the company is the growth in earnings, regular dividends, and positive cash flows from operations. But all is not peaches and cream. The growth in earnings has not been matched by a growth in cash flows from operations. Increasing interest payments is another concern.

Let us take a look at the one year bar chart pattern of Sintex Industries to see what the technicals are indicating:-

After making a low of Rs 70 on Mar 12, '09 the stock reversed trend and made a high of Rs 250 last Friday (Jun 5, '09) - rising more than 2.5 times on higher volumes in less than 3 months. The 'V' shaped bottom formation has been marked on the chart pattern.

After the sharp rise, the stock is consolidating sideways and has taken support from its 20 day EMA. In the process, the technical indicators have dropped from overbought zones.

The %K line of the slow stochastic has slipped below the %D line. The MACD has gone below its signal line. The RSI has moved down to its 50% level. Note how the RSI had reached heavily oversold levels in early March '09 - just before the stock chart pattern reversed direction. The ROC is marginally in the positive zone.

Bottomline? Long-term investors can consider putting Sintex Industries on their watch-list. It is a Rs 2 face-value stock and one should plan to add only on a correction to the Rs 140-150 level. Existing holders can book some partial profits.