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The folly of targets

Investors yearn for price targets to know when to book profits, but having a price target in mind is often self-defeating

The folly of targets

Value Research Stock Advisor is now about four years old. By all measures - those that matter to us as well as those that matter to our members - it's a successful service that has delivered on its promise. With every month that passes, more people join in and I'm sure that among the readers of this column too, there are many who are already members and others who are on their way to becoming members.

From the public at large, one of the most common queries that we come across is that we do not provide a 'target price'. It seems that a target price is considered to be de rigueur for stock-recommendation services. People feel that if you do not have a target price, you cannot recommend stocks.

When people say this to us, they kind of imply - and sometimes explicitly state - that we have a target price in mind but we are not revealing it to them. It seems inexplicable to the trader that one would buy a stock without having in mind what the stock price should be. The logic seems unassailable. Current price: X. Target Price: Y. If Y is sufficiently greater than X, then buy. Could the algorithm of equity investing get any better than that? Surely not.

The problem is that we have no clue what the target price is. NO CLUE AT ALL. All we know is that over a sufficiently long time, Y will be a lot more than X. Why is that? Why are we clueless about the target price? The reason is simple: this number is basically fictional. If you want a target price for a bank fixed deposit, I'll give you one, no problem. For a liquid fund or an ultra-short-term fund, it's a little bit uncertain but sure, I could oblige you. But for a stock, I have no idea myself.

Not just that, I consider the very idea to be disastrous for getting good returns. The idea of having a target price is closely associated with the greatest myths of stock investing: profit-booking. People buy a stock with a target in mind, the stock does well and when that target is reached, they book a profit and then look for the next one. It is a common saying among equity investors that no one ever lost money by booking a profit. That statement sounds like a clincher, and makes profit booking a no-brainer. Sometimes I get the feeling that no-brainer means a decision taken without using brains. The problem is that this kind of attitude leads to this typical query: I was invested in XYZ stock and have reached my target price. Now I have booked profits, so where should I invest next? The right answer is probably the same XYZ stock!

Booking profits means that you think that an investment has reached a point when it has nothing further to offer in your time frame, and you would need to move the money to some other stock. It doesn't mean that just because a certain amount of profit has been made, you must 'book' it. If you immediately move the money to another investment, then you've unbooked the profit. This makes sense only if, for some strange reason, it's important for you to count your profitability of each stock separately.

The reality is that this target-price mentality will permanently reduce your stake in a great long-term investment. Stock prices of the best companies double, then double again, and again and again over time. We all know which stocks these are. The passion for reaching the target price and then booking profits that many Indian investors display is quite counter-productive. Basically, it forces you to sell your winners and by implication, hold on to your losers, which is the other half of the tragedy.

If you have a bunch of stocks on which you have a target price, and you believe in this whole concept, then you will very predictably sell your good ones (because they have hit the target) and hang on to the duds (because they have not hit the target). That's what I call a no-brainer.

The real goal of investing is to ride the winners - for years, maybe decades. If you do that, the few duds will not matter. For example, in the stocks that we have recommended on Value Research Stock Advisor, a majority are average, about the same as the market, five-six are real winners and three-four are doing poorly. This is what an actual, practical winning portfolio looks like. The five-six winners have won so massively that the three-four do not matter. Even one of the winners can compensate enough for those.

But the key is that you have to hang on to the winners. None of this target-price business is permissible. For a stock that is now 5x, it could be 10x down the road or maybe 20x one day. If you knew the target, it would not make sense.