Reading Time: 4 minutes
Delhi-based Tarun takes a hard look at the dynamics of equity price in the markets, in the weekly column, exclusively in Different Truths.
There are great stories of wealth creation through equity markets. Often, we hear of celebrities like Warren Buffet, who is followed the world over for his stock investment abilities, or even our own Rakesh Jhunjhunwala. Most of the people still frown on equity markets as being a waste of time and resources, or even being harmful. I try to explore a bit more on this aspect.
The companies’ stocks are listed on stock exchanges, like, the Bombay Stock Exchange, or National Stock Exchange in India. They can be sold and bought there, subject to the Exchange rules. Now, notice that the companies’ products and services are not sold on the stock exchanges. Only their ownership in terms of equity units of small denomination, changes. That means the people dealing in the products and services of the companies are different than the people dealing in the shares of the companies.
The price of a stock depends on two factors – the earnings of a company, and the investible funds of the
A company increases its earnings in many ways. Some of the factors that increase them are the right management, a great product, a great business plan, competitive advantages along with supportive government policies. Now, judging whether a company would be able to increase earnings over the years sustainably, is not an ability for an average investor. One needs to have either a natural flair for it or one has to acquire it studiously. A person like Warren Buffet has said that he doesn’t buy shares, but businesses. That is, he doesn’t buy shares to trade them, but buys running businesses, which look promising to him, and holds them for a very long period of time.
So, if an investor has to judge so many things-the management quality, the product, the business plan, the liquidity, and then invest, is it easy? The simple answer is no. Still, there are so many people indulging in stock investing. There are newspapers devoted to their coverage, there are business channels that continuously beam tips to buy and sell stocks. There are occasional headlines of a black day in stock markets when markets crash. This is all an unreal kind of world, one created by the modern-day industrial revolution. The financial markets are divorced from real economies, as we are seeing worldwide, at least in the short run. India’s GDP growth may be coming out less, yet, because of the wonders of liquidity, the stock markets continue to go up. Similarly, in the USA, or other countries, the GDP growth can’t be directly linked to the stock market growth, because of the liquidity factor.
A word about psychology is very important here. There are statistical tools to analyse stock prices. There
Let me give you an example. In the 1990s, LTCM was a fund formed with two Nobel Prize winners as directors, and lots of toppers of USA universities. It managed to earn above-average returns on investments for three years, prompting it to take more and more risk, and eventually, it earned a loss so huge, that the Federal Reserve Bank had to step in to save it. That happened probably because the earned profit made the company so overconfident, that it overshot the risk mandate it originally had.
So, should we disregard stock markets altogether? This is an important question, which I shall answer in my next column.
©Tarun Gupta
Photos from the Internet
#WarrenBuffet #BombayStockExchange #NationalStockExchangeinIndia #NobelPrize #Mortgage #Investment #TheBarefootEconomist #DifferentTruths