Volatility or not, essence of investing is to look for mismatches

Written by Saikat Neogi | Updated: Aug 7 2012, 09:43am hrs
Regarded as a guru on valuation and applied corporate finance, Aswath Damodaran, professor of finance at the Stern School of Business, New York University, says before buying the shares of a company, an investor must look at the various facets of cash flows that are the drivers of value cash flows that the business is generating from its operations, the expected growth in these cash flows and the risk in these cash flows. Damodaran, in an interview to Saikat Neogi, also says gold does not have an intrinsic value; it is a substitute for financial assets and if one loses trust in financial assets, then one will invest in gold.

Given the volatility in the equity markets, what are the parameters a retail investor should look at before picking stocks for the long term

With or without the volatility in equity markets, my answer would be exactly the same. An investor, and it is irrelevant whether the investor is retail or institutional, has to look at the fundamentals of the business he or she is buying a share of. In particular, he should think about the cash flows that the business is generating from its operations (higher is better than lower), the expected growth in these cash flows (higher again is better) and the risk in these cash flows. These are the drivers of value. You have to make an assessment of the price you are paying for the same company and you are looking for a good company at a low price. That is the essence of investing look for mismatches.

If an investor is willing to bear the paper losses in equities in the short term, what strategy should one adopt and what kind of companies should one look at with a longer time horizon

A company that has strong competitive advantages and a good business model that is going through tough times. Investors may have sold off on the stock as a result and you may be able to get it a bargain. Secondly, badly managed companies where you see the potential for management change (and the possibility of a turnaround)

Apart from various analyst reports and advice, what are the various valuation tools an investor should use to pick up stocks and decide the portfolio

Don't use analyst reports and advice. In fact, avoid them like the plague. Understand basic accounting, learn how to read financial statements and get a handle on the basics of valuation.

The valuation of the Sensex is at a 10-year low. Also, some stocks remain undervalued or overvalued for a considerably long period of time. How should investors look at stock picking

You may be getting stocks at a bargain, but I am not a market timer. When you see a drop as you have seen in the Sensex, you are seeing a reaction to some very real macro problems. Is the market wrong I don't know and I won't try to make that assessment. Do your homework and analyse individual companies. If you can get them cheap, then invest in them.

In medium term, do you think investors in India will go for more risk-averse instruments like bonds and by doing so, will it give some depth to the bond market, especially the corporate bond market

Investors go in cycles. After periods of stock market turmoil, they do look for safer investments. It is entirely possible that they will turn to bonds, but I think that it is far more likely that they will flee financial asset markets into real assets (real estate, gold, etc.)

How does one do a value judgment on the price of gold and time the investment in the yellow metal

You don't. Gold does not have an intrinsic value. It is a substitute for financial assets and if you lose trust in financial assets, you will invest in gold.

What is an ideal portfolio mix and how should one make sure that it is diversified sufficiently

There is no one ideal mix. It depends on how risk averse you are. If you want to diversify, invest in mutual funds (rather than stocks) and across sectors. A diversified portfolio will have different asset classes (stocks, bonds, real estate) and have global exposure (for example, you can buy Indian companies like Infosys and TCS that have revenues globally).