When bad news is good news

May 17, 2004, Black Monday, the day when the Sensex fell by more than a tenth in just one day, for instance, was not a reason to panic; it was a cause for celebration – it’s not every day that you get an opportunity to buy value worth Rs 5,000 for Rs 4,500. Had you bought the market that day (through an index fund), today, after merely 12 months, your money would have grown by 45 per cent to Rs 6,500.

And if you thought this was an anomaly, think again. If you had cashed in on the five biggest single-day crashes in the past decade, you would have gained in four of them in a year. The 7.2 per cent fall on October 5, 1998 was followed by a rise of 62 per cent in the next year; the 6.9 per cent, April 17, 1999 fall saw a rise of 47 per cent the next year; the 8.3 per cent fall on March 31, 1997 saw a 16 per cent rise. The sole exception: the 7.2 per cent fall on April 4, 2000 – the market fell further by 23 per cent in a year (See chart: Every Fall has a Rise – Almost).

But what did we do on May 17, 2004? I remember receiving calls from all kinds of people all across the country – analysts, commentators, friends, even heads of asset management companies – wondering what to do. As if the political tail (A B Bardhan dismissing the market on TV) that had begun to wag the financial dog will collect enough centrifugal force to throw the industry, the stocks, the analyses and the people associated with it into nothingness.

Over the next one week, panic selling was the norm. Newspaper headlines, in 72 points, screamed ‘Crash!’ TV channels got ‘experts’ to analyse the event and highlighted the ‘political risk’ invading an already risky stockmarket. Investors, small and large, consumed these packages and sweated their way to sell counters.
Big mistake.

Of the 460 stocks with market capitalisation greater than Rs 100 crore on May 17, 2004, more than four out of five stocks rose by more than 25 per cent; 71 per cent rose more than 50 per cent and more than two out of five stocks doubled. And while seven stocks rose by more than 500 per cent, just 18 stocks gave negative returns.

We had said it then – in this newspaper (See box: Chronicle of a Prophesy Foretold) – and we say it again: every fall in the market is an opportunity to buy, not a reason to sell. You need a lot of psychological strength to ride against the tide, but if you just bite the bullet and take the plunge, this contrarian approach is the road to riches.

Of course, this generalised, optimistic, definitive statement comes with a ‘conditions apply’ bold print: if you can’t digest the risk that accompanies stock investing, either buy index or managed equity funds to ride the market, or simply stay away and park your money in lower risk instruments like sovereign debt or the good old provident fund.

What to do
Unfortunately, these crashes don’t come every other month. You have to be lucky if they come once a year as they did between 1997 and 2000. But often there’s a lull, like it was between 2000 and May 11, 2004. Whatever the case, here go my five bits about how to benefit from the Bardhans, make money from the Mehtas, profit from political uncertainties.

One, identify one to five industries that you’re naturally conversant with. For instance, if you’re working in a bank’s call centre, you would be clued into what consumers are doing, what they’re buying, how many are paying how much interest on their credit card debt and so on. That’s an insight into where the profits are. Or when you shop in malls, you know just which ones are selling and which are the ‘hang outs’. And so on.

Two, learn how to read a balance sheet and a profit and loss statement. It’s not difficult – but not easy either. There is enough literature around, but the best book I’d recommend to get started with is undoubtedly One Up on Wall Street by Peter Lynch. Buffett’s letters to his shareholders (www.berkshirehathaway.com) is the next stop.

Three, within a sector, find out which companies are leaders – and whether they are listed. If yes, see if their leadership translates into profits and evaluate if they will continue to grow. Check out its competitors. Talk to people in the industry – your B-school friends, now working for MNCs, banks, infotech companies and so on.

Four, make a list of five to 10 companies and watch their performance – quarterly results, news, ads. Keep an eye on any new information (the websites of BSE and NSE provide good information feeds) and evaluate its importance. You could also build a mock portfolio on these sites and watch how the share prices fluctuate so you can buy them at attractive prices (that is, when they crash).

Finally, wait for the bad news.