Personal Finance Solutions for India

Looking beyond purchase price of your share
Shiv N. Majumdar

Defined Tag: Stock Market.

Your purchase price or entry point is the base from which the results of your investment in shares are derived. However, over-emphasis on the entry price can blind you from a great investment or deprive you from getting the best out of your investment pick.

At the transaction level, purchasing and selling of shares is a zero-sum game. Buyers and sellers of a particular share have diametrically opposite views about its price at that point of time. However, in course of time, sometimes within a short period, the buyer or the seller is proved wrong regarding the contracted price.

Even if we are alive to the fact that it is impossible to buy cheapest or sell dearest, an exorbitant purchase price or a dirt-cheap selling price will have compelling discomfort.

An investor will get overjoyed at a low purchase price and a less-than-satisfactory purchase price will continue to haunt the investor and may eat into his confidence. Similar will be for a seller, except that the buyer is burdened with a high acquisition cost and will not be able to shake off the prick of conscience as long as he holds these shares.

There are cases of people who try to get rid of an exceptionally great acquisition just because his trade while buying was less than satisfactory to him. Because, he wishes to forget the inglorious episode.

Best results from shares come primarily from long-term holdings, which get the best of low transaction costs, compounding of rates of growth and low taxation. A good pick and good entry and exit prices would certainly improve your returns further. Thus, all is not always lost due to a higher purchase price.

But, forgetting the exact purchase price has its advantages. Unlike a mutual fund, an individual investor will, however, need to keep note of purchase price for tax computations. Barring this aspect of tax computation, an investor will do well to concentrate on Market Value of his portfolio (even if it means a hefty write-down from acquisition price) till the time he holds the shares.

Pradip has an interesting risk management method. Whenever, his shares make a certain level of gains, he partly divests his holdings in the scrip so that he has no net investment and the number of shares in hand represent gains only. His list of shares has a sub-heading 'Shares with Zero Investment'. Needless to say, market value of these shares does not bother him or the growth potential of these shares, the percentage returns in any case being infinite!

Gautam is a typical investor who lost a lot in the bear market. He is waiting for the time when the half-a-dozen scrips he is holding will fetch his purchase prices. He does not differentiate between the market value of his holdings and the comparatively high purchase cost he incurred. Till he recognises Market Value of his holdings only and actively manages his portfolio he may rue his misadventure into the stock market. If by any chance any of his holdings gets re-rated by the market and on the upswing recover purchase cost, Gautam is likely to sell without waiting for any further improvement in prices.

Devashish subscribed to IDBI shares during the public issue and had been repenting his action. Now he has gathered that IDBI shares may see better days. He has decided to buy further IDBI shares to cut his losses through averaging of costs. The average enamours the Cost Accountant in him, but he misses the point that he is investing more money to recover a loss already incurred and that there may be a better investment option for this fresh investment contemplated.

Pradip, Gautam and Devashish are all not recognising Market Value of their investments and are suffering from the same 'Acquisition Cost Syndrome'.

It is important to demarcate past, present and future. If a business writes off non-recoverables or diminution in value of assets, an investor should also adopt the same. He should carry his portfolio at the current Market Value and decide on the future. He can look at the efficiency or otherwise of his trades in isolation, to hone his trading skills.

In business, decisions are based on action-oriented focused Management Information Systems. From this angle, your purchase price is a given and something that cannot be undone. Therefore, basing portfolio management decisions on Market Value will rid us the pangs of conscience arising from a bad trade and result in better decisions through a sharper investor focus. Pradip will devote the right resources to all his investments on the basis of market values, Gautam can attach due importance to his locked invested amounts and Devashish can decide on his IDBI shares based on the present.

Isolating trading inefficiencies and other aspects of your investments based on the principle of demarcating past, present and future can only improve your skills and results.