V I ALUE NVESTING and B EHAVIORAL F INANCE Insights into Indian Stock Market Realities V I ALUE NVESTING and B EHAVIORAL F INANCE Insights into Indian Stock Market Realities Parag Parikh Chairman Parag Parikh Financial Advisory Services Ltd., Mumbai Tata McGraw-Hill Publishing Company Limited NEW DELHI McGraw-Hill Offices New Delhi New York St Louis San Francisco Auckland Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal San Juan Santiago Singapore Sydney Tokyo Toronto TataMcGraw-Hill Published by Tata McGraw-Hill Publishing Company Limited, 7 West Patel Nagar, New Delhi 110 008 Copyright © 2009, by Tata McGraw-Hill Publishing Company Limited. No part of this publication may be reproduced or distributed in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise or stored in a database or retrieval system without the prior written permission of the publishers. The program listings (if any) may be entered, stored and executed in a computer system, but they may not be reproduced for publication. This edition can be exported from India only by the publishers, Tata McGraw-Hill Publishing Company Limited. ISBN 13: 978-0-07-007763-8 ISBN 10: 0-07-007763-0 Managing Director: Ajay Shukla Head—Professional and Healthcare: Roystan La’Porte Publishing Manager—Professional: R Chandra Sekhar Junior Sponsoring Editor—BGR: Dipankar Das Production Executive: Rita Sarkar Manager—Sales and Marketing: S Girish Controller—Production: Rajender P Ghansela Asst. General Manager—Production: B L Dogra Information contained in this work has been obtained by Tata McGraw-Hill, from sources believed to be reliable. However, neither Tata McGraw-Hill nor its authors guarantee the accuracy or completeness of any information published herein, and neither Tata McGraw-Hill nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understanding that Tata McGraw-Hill and its authors are supplying information but are not attempting to render engineering or other professional services. If such services are required, the assistance of an appropriate professional should be sought. Typeset at Bukprint India, B-180A, Guru Nanak Pura, Laxmi Nagar, Delhi 110 092 and printed at Gopsons Papers Ltd., A-2 and 3, Sector 64, NOIDA-201 301 Cover: Kapil K Gupta RAXQCRZFRYXLA To My wife Geeta Praise for Value Investing and Behavioral Finance “Emotions can get in the way of sound investing. This is a universal state of affairs that applies equally to India and America. Parikh’s book will help you understand how vulnerable most investors are to psychological influences, and what they can do to protect their portfolios from the destructive effects of their own emotions. For Indian investors especially, it is a must read!” Hersh Shefrin Author of Beyond Greed and Fear: Understanding Behavioral Finance and The Psychology of Investing “Parag Parikh has taken the best of the recent research in behavioral finance and has successfully applied its models to the Indian stock markets. I recommend this book to all Indian investors.” Sanjay Bakshi Visiting Professor (Behavioral Finance and Business Valuation), Management Development Institute, Gurgaon “If you are looking for stock tips to double your money in these difficult times, don’t read this book. Read it if you want to create wealth in these difficult times and preserve it through the next upturn and downturn that are bound to follow. Parag distills his experience of three decades as one of India’s foremost wealth managers into this book. He viii Praise for Value Investing and Behavioral Finance explains the subject like a wonderful teacher, grounding you in the basics and then helping you easily grasp concepts that some of today’s wealth managers would do well to follow.” Senthil Chengalvarayan President and Group Editorial Director, Television 18 Business Media “Value Investing and Behavioral Finance deals with the quirks of the mind, their impact on making decisions and the consequences of investment performance. Parag is spot on in urging investors to adopt a more empirically skeptical approach based on a clear understanding of one’s own blind spots and biases. The insights from applied psychology in coming to terms with IPOs, index investing and spotting bubbles will save you a lot of pain and money. Every serious investor would do well to have a copy of this fine work on their bookshelves.” Sanjoy Bhattacharyya Partner, Fortuna Capital “Creating wealth from equity investing is not purely a number game. In fact, it is more of a mind game. Each one of us reacts to a financial situation differently. Unless an investor considers psychological angle to investing, wealth creation will always remain an illusion. This book throws light on the psychological aspects of equity investing. It is a must read for all investors.” Gaurav Mashruwala Certified Financial Planner “The wild gyrations of the stock market in the last 12 months have left investors with heavy losses. Many are bewildered and have lost faith in equity investments. Parag Parikh’s timely book offers a pragmatic way of understanding market behavior and facilitating better investment decisions.” Ashok M. Advani Chairman & Managing Director, Blue Star Ltd. Praise for Value Investing and Behavioral Finance ix “All the techniques required to play in the markets are explained by Parag Parikh. His analysis—spanning last three decades—and expert observations provide the reader with the much needed framework to help him carve his way to wealth by investing intelligently.” Harsh C. Mariwala Chairman & Managing Director, Marico Ltd. “Parag Parikh delivers once again. If his first book, Stocks to Riches was a timely offering and a bestseller several times over, his second one, Value Investing and Behavioral Finance is critical. It is a guide on how to retain your cool in times of meltdown, your patience and your investments when everybody is losing all three with disastrous consequences. Parag does not claim to provide a magic bullet to shoot into the heart of the stock market. In fact, he confesses upfront that he is neither an economist nor an academician. But, what he does have is astute common sense, and three decades of experience in studying the market, money management and investor behavior. From this rare armoury, he has forged the essentials of success and failure in investing. The result is a book that helps you understand your own motivations, which is the first step towards understanding investment, and then achieving mastery over the market. Simple without being simplistic, it tells you everything you wanted to know about managing your portfolio, but never thought you’d find someone to explain it all so clearly.” Bachi Karkaria Consulting Editor, The Times of India “Parag Parikh has amply demonstrated by giving real-life situations how lack of understanding of universal principles of life and lack of self- awareness unleash greed and fear, spelling loom and doom as we are witnessing currently. His insights into behavioral finance serve as a lighthouse whose powerful beam illuminates, empowers, enlightens and guides investors to steer their equity portfolio ships safely and rationally x Praise for Value Investing and Behavioral Finance to the shores of gains and profits. Further, this book shows that to be myopic and seek instant gratification is the sure recipe for disaster.” Sudit Parekh Founder Partner, Sudit K Parekh & Co. Chartered Accountants “Investing 101, with a focus on Indian markets.” Abhishek Dalmia Director, Renaissance Group “If one wishes to understand behavioral finance in investment decisions, he will need to spend considerable time and energy in doing so. This book can save a lot of time and effort, by helping one understand the multiple facets of an investor…The book is extremely informative… There are a lot of good pointers to the behavioral anomalies of investors and the crowd psychology that we would have never otherwise thought of or realized…the book is complete in the coverage of all areas of investor behavior and behavioral trends. The author’s readiness to explain every aspect of the theme is also really helpful, which makes both reading and understanding easy…I will recommend it to anyone interested in the subject.” Y.M. Deosthalee Chief Financial Officer & Member of the Board, Larsen & Toubro Ltd.