Wealth Creation

The amount of wealth a person owns becomes the subject of envy or discussion amongst his peer group, friends and relatives.   There are only a lucky few who have become millionaires overnight or are actually born with a silver spoon. Rest of the affluent lot that we see around us have actually made it big for themselves by working hard and smart. They had plans clear while saving & investing for them over consumption and this is how over the years, they were able to amass wealth and become, what we in common parlance call, ‘Rich and Wealthy’. It is a truth universally acknowledged that wealth cannot be accumulated through addition but is created through multiplication.  This means that you can create wealth by judiciously investing your savings across different asset classes and not by adding cash to your Savings Bank A/c. As you embark on this goal to create wealth, first decide how much amount you want to accumulate and in how many years. Based on these details, calculate the amount that you should be saving / investing periodically and carry out the feasibility analysis of the result so attained. Thereafter, invest the amount in a suitable asset allocation towards the achievement of your goal of wealth creation. As you decide on the avenues to invest in, make sure that you consider the following factors towards making an informed decision:   Time Horizon:  It means the tenure for which you will invest your savings. The time horizon of your investments should match the time horizon of your goal.     Asset Allocation:           Choosing the right mix of asset classes, while keeping in mind your risk appetite is very important.   Power of Compounding:      As you invest systematically and regularly towards the achievement of your goals, you tend to benefit from the Power of Compounding, thereby improving the overall return on your investment.           How it works: By investing Rs.5000 per month for 5 years at an expected return of 15%, you can accumulate a corpus of Rs.4.05 lac and this same amount invested per month at same return expectation will grow to Rs.12.20 lac over a term of 10 years.  Also, the rate of return that you earn has a great bearing on the overall portfolio growth. Simply stated, if your goal is to create a significant amount of wealth, you should start investing for long period of time, in a variety of investment avenues, suiting your risk profile Prudent Asset Allocation is very significant to reach the desired goal.  It involves dividing an investment portfolio across different asset categories, such as stocks, bonds, cash and real estate, gold, etc. The process of determining the correct asset mix is completely dependent on how much risk you are able to take as well as the time horizon that you have in view. By including asset classes that are have low correlation or negative correlation; the investor can stabilize his overall portfolio return, thereby reducing the overall risk.  Historically, the returns of the major asset categories have not moved in the same direction at the same time.  So when equities are not faring well, you can find opportunity in debt instruments and if you have proportionately invested in both these asset classes, you are able to shield yourself against extreme movements in your portfolio. Finally, it is important to assess the performance of the investments at least once a year and if you see one investment option that is consistently under-performing, transfer your money to another one that performs consistently better.  However you must also remember that even the best investment options can sometimes undergo a period of underperformance. So even if you are advised to weed out the under-performers, don’t be too rash in your decisions.  At the least, re-evaluate your portfolio every year or two to give a better picture of their long-term performance and wealth creation. Plan now, before it is too late!

Why do stock reports come free?

There is a beautiful word once I heard at USIS, Delhi- called TINSTAFL (There is no such thing as free lunch). So I tried to find out the answer of this article headline of my own.

The very first question comes in my mind, “Are you the kind of person who relies on research reports brought out by stock broking firms to invest money in the stock market? “

Well, think twice before you do that again.

Things may not be as straight forward as they appear. To know the real story behind the entire business of broking houses bringing out research reports, read on.

What is a research report?

These days most broking firms that serve retail or institutional investors have a research team. This research team mainly tracks stocks and identifies investment opportunities for investors.

Analysts research companies by understanding their business, meeting the company management and running numbers to check if the current price of the stock is justified.

This research is communicated to both existing and prospective investors of the broking firm in the form of a report.

These reports typically carry a recommendation at the start, like buy, hold or sell. If the report flags a buy, the recommendation to the investor is to buy the stock. In case of a sell, the recommendation is exactly the opposite i.e., to sell the stock.

A hold recommendation comes somewhere in between and is meant for those investors who already have the stock. The recommendation to them is to hold on to their current investment and not to buy more.

Why is research reports brought out?

There are various reasons for a broking house to bring out research reports. Whenever a stock brokerage feels a stock is undervalued and clients could benefit by buying that particular stock, the reasons for buying the stock are put together in a research report.

A stock is supposed to be undervalued, when an analyst feels that the current business prospects of the stock are not reflected in the price of the stock.

Given this, they recommend that the stock should be bought because they expect the price of the stock to go up in the days to come.

There are brokers who primarily serve institutional clients. These brokers typically tend to cover large-cap stocks.

They bring out reports to update clients on the impact of recent developments, future concerns or business opportunities.

Stocks like Reliance Industries, Larsen & Toubro, Infosys and TCS are covered regularly by large broking houses.

These, of course, are some of the reasons why research reports are brought out.

Research does not pay always

Bringing out a good report with a compelling investment argument is a time-consuming process. A good analyst need to take anywhere between a week to month for making a research report.

Moreover, setting up a research team is a costly process for any broker. The cost involves buying databases which have the numbers necessary to carry out research.

 Hiring senior research analysts can also cost a bomb. And after incurring all these costs, a research report is given out free.

Brokerage reports are available free in India, so research is a cost centre.

So, why do stock broking firms spend so much money to bring out research reports and then give them away for free?

The real story behind the background

I have seen the genuine reasons why stock broking firms bring out research reports.

But there are other reasons as well.

 As Andy Kessler writes in the book, 'Wall Street Meat', "Companies report earnings once a quarter. But stocks trade around 250 days a year. Something has to make them move up or down the other 246 days.  Analysts fill that role.

They recommend stocks, change recommendations, change earnings estimates, pound the table – whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions."

Reports essentially are a medium which allows the sales force of the stock brokerage to go out in the market and sell stocks. And how does that help?

 For this, investors need to understand the business model of brokers. The prime & only objective of a research report is to induce a transaction.

Every transaction gives broking income to the broker, which are his bread and butter. A report is a tool to sell stocks.

The 'Buy' Recommendation

 In order to sell stocks to investors, it is very important for broking firms to keep coming up with buy recommendations on stocks.

As Mitch Zacks points out in his book 'Ahead of the Market', "A buy recommendation has more value to a brokerage firm because it gets the brokers on the phone selling stocks to new clients and opening new accounts."

A buy report ensures that the broking house has a chance to make far more money than it ever would by putting out a sell report on a stock.

This is because only those investors who have the stock will consider selling it, so the income will be limited to that extent. This, of course, does not hold for a buy report.

Also, at times, owners of stock broking firms own shares or the broking house owns shares for its portfolio management services' (PMS) clients.

 If a particular stock does not do well, it is quite possible that a broking firm may release a 'buy' report on the stock. This may tempt investors to buy the stock, thus boosting the stock price.

This will give the owner or the broking house an opportunity to sell out of the stock.

What investors need to be careful about?

This, of course, does not mean that no research report can be trusted. Over a period of time, savvy investors learn to separate the wheat from the chaff. The brokerage from where the report originates, tells me about the quality.

While seasoned investors may be able to differentiate one report from another, retail investors have to trust their broker.

So, what should a retail investor do?

Some large brokerages these days carry disclosures on whether they own a particular stock, if they are recommending it.

These reports also point out whether a sister firm of the stock brokerage has an investment banking relationship with the company. This is something that retail investors should look out for.

For retail investors, the only way out is to check the past track record of the brokerage house and then decide whether to trust the reports or not.

So, investors should thus be careful and do their own homework on the stock, rather than buy or sell because of an analyst recommendation.

As Zacks says, "One of the biggest and most correctable mistakes you can make using analyst recommendations is to allow the recommendations as a means by which brokers can sell you a stock. You may not fully realise that the more you trade, the more money your brokerage firm makes."

Wish this article will be your cup of tea!