The period between 1993 and 2002 has gone down in the history of the Indian stock market as one of the longest and the most painful one with the 30-share sensitive index of the Bombay Stock Exchange gaining precisely zero per cent.

The Harshad Mehta scam in 1992 saw the sensex tumble by over 40 per cent in just three months followed by a nine-year slump on the bourses.

Going by the current market trend, the bear hug this time may last even longer. The sensex has fallen more than 50 per cent from its peak of 21206.77 in January this year. It is currently trading at the level of January 2006 wiping out gains of two-and-a-half years.

While no one knows where or when the mayhem will end, it will be wrong to think that bear markets are a bad time to invest.

Gloom is boom

A bear market is a boon and not a bane. In fact, bear markets can generate profits twice as fast as bull markets, if you get your basics right. Shelby C. Davis, the investor who turned a paltry $50,000 into a fortune of $800 million to become one of the 400 richest men in the US, once said, “You make most of your money in a bear market; you just don’t realise it at that time.”

Davis made most of his money between 1959 and 1974, which is recorded in the US economic history as the longest ever bear market till date.

Amid the global financial turmoil, Warren Buffett, the world’s richest man, has been buying American stocks. “A simple rule dictates my buying; Be fearful when others are greedy, and be greedy when others are fearful,” Buffet recently wrote in The New York Times.

Following Buffet’s example, investors can buy more shares with a given amount of money when the sensex is at the 9000-level than when it was hovering around 20000. However, the irony is investors are more willing to buy equities at higher prices. In 2002, when the sensex was around 3200, inflows into equity schemes of mutual funds were at Rs 4,517 crore. In 2007, when the sensex topped 15000, the inflows increased to Rs 1,07,189 crore.

Stocks to watch

How can investors make money in a bear market on the same stocks that they had bought in a bull market?

When the tide turns, not all stocks will be able to bounce back. When markets rebound, some companies will perform better than the others if:

1) They belong to sectors that offer long-term prospects.

2) They have long-term focused and outstanding management teams.

3) They have proven track records with solid financial fundamentals.

4) They have strong competitive advantages in the form of popular trusted brands, wide distribution networks and good order book positions.

With investors turning pessimistic, they are willing to pay less premium for earnings per share of companies. This may be because of a general slowdown in economic activity, though the financials of companies may not have changed drastically.

For example, investors now are not willing to pay more than Rs 12.50 on an average for sensex stocks for an earning of Re 1 per share. In January this year, they were willing to pay Rs 28.50 for the same earning per share.

Investors were not so negative even in the last bear market in 2000-2003 after the Asian currency crisis and the dotcom bubble.

The sensex traded at a price-earning ratio of 12.5 in late 1998. This signifies that stock prices have been hammered quite a lot and there is not much room for them to go down further.

The basic strategy of making money in the stock markets is buy cheap and sell when they are dearer. But while the “buy and hold” strategy works fine in a bullish market, it doesn’t hold good when the bear goes wild.

Thumb rule

In a bear market, one can make profits in two ways.

First, sell at a loss to buy stocks cheaper.

If one has bought shares at high prices and the markets start declining after that, one is most likely to hold on to the stocks till the prices shoot up and exceed the purchase price.

However, in such a situation, one should sell shares with a stop-loss instruction.

Let us assume that Ashok had bought 100 shares of Company A in January for Rs 50 a share. After the recent market crash, the share is now trading at Rs 40 apiece.

Ashok should sell 100 shares for Rs 40 with a stop-loss instruction at Rs 41. In case, the share price bounces back after the sale order is executed, the broker will buy it back at Rs 41. So, Ashok’s loss will be restricted to Rs 100.

If the markets fall further, he should give delivery of the sold shares and wait for some days. He can buy the same share for Rs 30, say. By doing so, he would actually be making a profit of Rs 1,000.

Moreover, in his income tax return, Ashok can show this transaction as a short-term loss of Rs 1,000 — hundred shares bought at Rs 50 and sold at Rs 40.

This short-term capital loss can be set off against any short-term capital gain. In case, one doesn’t have any short-term capital gains, one can carry forward this loss for three successive years in the income tax return.

Another way to make profit in a bear market is by averaging of cost.

Cost averaging means consistent buying of shares with every dip in prices so that the average cost of purchase comes down. This means one has to make systematic investments in shares of the same company as the price falls. As the average cost comes down, one’s investments will turn profitable with a slight upside in the markets.

While adopting this strategy, one should be confident about the company’s future profitability. One could be in trouble if he/she does cost averaging in shares of a company that is fundamentally weak. This is because, when the markets take a U-turn, shares of such companies may not appreciate to the extent they did last time.

A bear market is, therefore, not so scary as one may think. The key lies in proper stock selection, correct timing and a brave heart.