Maybe, it's about time to flush out the newbies from the stock market?

Read an interesting posting from Channel NewsAsia forums about this topic. It's really amusing.

Bullish sentiment

Volatile market

Due to the US sub-prime mortgage crisis this year, the market turned bearish for a while. And then the Fed decided to cut interest rates to try to remedy the market causing investors to turn bullish for a moment. Thinking that it's all over? The media decided to add in some bad news and occasionally some good news to enlighten the market of their current situation(it stimulates their income as they sell more papers too!). This brings investors on a roller coaster ride. Weeee! Woooo! Ahhhh...............!

Bearish sentiment

Newbie

In terms of experience, I'm still a newbie as I have only started investing early this year with real cash. However, my investing mindset does not put me in a newbie position. I'm value orientated while most are in it for a quick profit. I've been eagerly reading up investment books for the past 2 years which taught me to invest for the long term and not speculate. I also learnt to analyse financial statements to make good investment decisions.

If you noticed, most decent company stocks especially small caps increased 1-2 times from the start of the year. Some stocks have even rose 6 times their initial price! No wonder those aunties, uncles and Ah Dis(young boy, like me) are bragging about their investment profits. It is easy to make money in a bull market as most stocks will rise(like how hot air rises) and not much skill is required. One can make some profit by throwing darts to pick stocks. However when you are in a bear market, its a different story. Newbies will panic when prices start to drop fast. One of the irrational things they do would be to follow the herd and sell at a loss. Worst still if they used leverage like contra or margin, their losses would be higher.

The bull climbs up the stairs of the building while the bear jumps out of the window.

As a value investor, if the fundamentals of the company does not change and the price is cheaper now, I would increase my positions.

Conclusion

It's time that newbies learn a lesson not to speculate and look for hot stock tips. They should do their own research before buying. In the long run, they would do reasonably well provided that they don't buy at rocket prices. Whether they can beat the market in the long run is another story.

Chapter 3: The Behaviour of the Security Markets

The price to be paid or received for a security is an integral part of any complete analysis. We do not believe that short-run price movements--the day-to-day or month-to-month variations--are a valid or profitable concern. But the broader concept of business cycles should not be left out.

The relationship between Intrinsic Value and Market Price

The chart above traces various factors like speculation and valuation which contributes to the market price. Rather we should say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Undervalued Situations When The Market Appears High

When the general market is high there are always a number of individual issues that appear undervalued. One maybe tempted to buy these issues. But that is a time that calls for especial caution. Not only may the 'neglected issue' continue neglected for the remainder of the bull market, but when the downturn comes it is likely to decline in price along with the general market and to fully as great as an extent.

In a word, beware of 'bargains' when most stocks seem very high.

The Factor Of Marketability

The speculator or market trader has a real need for marketability because he may want to buy or sell in a few minutes' time. The typical investor has no similar requirement. It is better to sacrifice quick marketability to attract value rather than vice versa. For every point lost in the spread between bids and offers, the buyers of a true bargain issue may expect to gain perhaps 10 points in increased dividend returns plus ultimate improvement in selling price.

Much of the emphasis on marketability comes from the stock-brokerage business. Brokers are in business to earn commissions. It is easier for them to get orders in active than in inactive stocks. Hence, they are likely to overemphasize the popular and active issues in their work. This attitude tends to create something of a vicious cycle, since it makes active issues more active and inactive ones more inactive.

Summary

The security analyst should be concerned with those fluctuations in security prices which tend to create opportunities to buy at less than indicated value and to sell at more than such value.

Chapter 2: The Scope & Limitations of Security Analysis

'Analysis' connotes the careful study of available facts with the attempt to draw conclusions therefrom based on established principles and sound logic. It is part of the scientific method. But in applying analysis to the field of securities we encounter the serious obstacle that investment is by nature not an exact science. Individual skill (art) and chance are important factors in determining success or failure. Nevertheless, analysis is not only useful but indispensable in the field of investment and possible in that of speculation.

Three functions of security analysis:

Descriptive function- Make adjustments in the financial figures to bring out the true operating results in the period covered, and particularly in order to place the data of a number of companies on a fairly comparable plane. Evaluation of favorable and unfavorable factors in the position of the issue compared with others in the same field, also projections of earning power on various assumptions as to future conditions.

Selective function- Pass judgment on the merits of securities.

1) Bonds and preferred stocks- Make sure that interest payments will be met in the future without difficulty or doubt through an ample margin of safety in the past to protect against possible adverse developments that lie ahead.

2) Common stock- Selecting those that will pay a good return or increase in price or both. There are 2 approaches. The older approach places its chief emphasis on anticipation of an increase in price of the stock in the longer term, whereby, the present market is by and large an appropriate reflection of the present situation of the stock. The newer approach attempts to value a common stock independently of its market price. If the 'intrinsic value' found is substantially above or below the current price, the analyst concludes that the issue should be bought or sold.

A general definition of intrinsic value would be 'that value which is justified by assets, earnings, dividends, definite prospects'. The most important single factor determining value is now held to be the indicated average future earning power. Intrinsic value would then be found by first estimating this earning power, and then multiplying that estimate by an appropriate 'capitalisation factor' or multiplier.

"Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised." --Warren Buffett

Critical function- Security analysis may be competent to express critical judgments, looking to the avoidance of mistakes, to the correction of abuses, and to the better protection of those owning bonds or stocks. Questions largely dependent upon the act of management include capitalisation setup, dividend and expansion policies, managerial competence and compensation, and even continuing or liquidating an unprofitable business.