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Where Everyday Is An April Fool's Day

Investors as a class, love making fools of themselves For many investors, April fool's day is a day when they should think about what they do in the remaining 364 days of the year. That's because for these people everyday in the stockmarket is an April fool's day. Barring lotteries and casinos, to my mind, there is no other institution in the world which regularly makes a fool out of millions of people on a daily basis. For fools, the stockmarket is a casino or a lottery, where, if they hang around for too long, they are certain to lose money. And the sad fact for most fools is that they simply love the action of the stockmarket too much. So much, that even though they are net losers, they keep coming back for more. Persistent failure seems to go to their heads. On the other hand, for intelligent investors, the stockmarket is neither a casino nor a lottery. In fact, it's a place where many manic-depressive people create manic depressive prices offering intelligent investors enticing opportunities of making money off the fools. It's important to know what constitutes foolish behaviour in the stockmarket. Here are a few pointers: The Most Popular Game In Town There are times when one particular game becomes the most popular game in town. At those times almost everyone wants to play this game called the primary market. There are three players in this game - the promoters, the investors and the intermediaries. Let me first mention the primary market investors, which are of three types - fools, greater fools and even greater fools. Fools are those who apply for, and get, shares in hot new issues because they are sure to sell, on listing, at prices well above their cost. Greater fools are those unlucky fools who apply for, but do not get, shares in hot new issues. Because these greater fools really want those shares badly because they are sure to go up quickly, they buy them from fools, soon after listing, at prices well above those paid by the original fools. Greater fools then look out for even greater fools to materialise who will pay even higher prices for the merchandise in their hands. And so on and so forth . . . The situation is identical to what happens in other similar games such as Snap, Old Maid and Musical Chairs. This splendid comparison is not mine. It was originally made in 1930s by the great economist and investor, John Maynard Keynes. Here's what he wrote: "For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs - a pastime in which he is victor who says snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated." The music in the Indian primary market stopped sometime in 1995 when the supply of even greater fools evaporated. Since then, the fools and the greater fools, after having opened their merchandise have found, to their horror, that what they bought for Rs 100 or higher in 1993 and 1994 is worth no more than Rs 20 today.
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If most investors are destined to lose money in IPOs (Initial Public Offerings), who do they lose it to? In other words, who are the people who really make money in the primary market? There are three primary categories. First, are the promoters who create and sell small pieces of companies in the primary market. Even though these pieces may be worth Rs 10 or less, during big bull markets (identical to the ones India experienced in 1994), they can be sold at Rs 50 or even higher. It's no wonder that most new issues are made in bull markets. Ralph Wanger, an eminent mutual fund manager recently wrote these words which explain vividly the motives behind the issuers of most new offerings: "New companies will be invented to meet investor demand. The securities industry, you know, is not a service industry. It is a manufacturing industry. If you want a stock Wall Street will make it for you. Any business, any kind you want. Recently the internet being the rage, the investment bankers have worked overtime creating a stream of IPOs to meet the demand. And people love them, to judge by their P/Es, some of which have soared into triple-digit stratosphere. Remember back in the early '80's when the hard disk drive for computers was invented? It was an important, crucial invention, and investors were eager to be part of this technology. More than 70 disk drive companies were formed and their stocks were sold to the public. Each company had to get 20 percent of the market share to survive. For some reason they didn't all do it . . ." While on the subject of promoters of new issues, let me give you another immoral quote from an immortal investor - Warren Buffett. "Promoters have, throughout time, exercised the same judgement and restraint in accepting money that alcoholics have exercised in accepting liquor." The second category of people who make money in the primary market are the financial intermediaries, that is, the merchant bankers and underwriters who sell issues to the public. As Wanger has pointed out, in the securities business, whatever can be created and sold, will be created and sold. Selling new issues during bull markets is a very lucrative business. Unfortunately, as pointed out above, the new issue industry is a cyclical industry and no one has predictive powers good enough to correctly predict the cyclical turns. Consequently, most investment bankers who find that money is rolling in during bull markets, suddenly find themselves with nothing to do in bear markets. The third category of people who make money in the primary market are fools and greater fools who become smart. Fools profit by selling to greater fools, which, in turn, profit by selling to even greater fools. Unfortunately, profits made are rarely kept. Most people who make money in a hot new issue will, most likely, reinvest their money in more new issues and will eventually lose, not only all the profits made in successful ventures but also a good part of their original principal. A useful, though cynical, principle to remember about the primary market is this: Money will be made and kept by promoters; Money will be made by intermediaries, some of which will be kept; Finally, money will be made initially by most investors, but almost the whole of it, if not all, will eventually be lost. Put another way, the primary market is a vacuum machine which, over time, sucks money out of the investors' pockets and transfers most of it into the pockets of the promoters and the remainder of it into the pockets of the intermediaries. Is the primary market the only fool's game in town? Not at all. In fact, the secondary market offers even more enticing opportunities for acting foolishly. Peter Lynch, a highly successful mutual fund manager,
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after years of careful observation of foolish behaviour in the stockmarket, made a list of the Twelve Most Foolish Things People Say About Stock Prices. Here's a list of seven of those things: Foolish Thing # 1 If It's Gone Down This Much Already, It Can't Go Much Lower Some investors foolishly believe that a steep fall in the price of a stock automatically turns it into a bargain. They forget that the intrinsic value of a stock is not a constant, unchanging number. On frequent occasions, the price of a stock falls for very good reason. The management of the company may have made stupid mistakes threatening its future profitability. The company may be highly leveraged and interest rates may have surged. The price level from which the stock has fallen may have been too high in the first place. And so on. Buying a stock while focusing only on its price while ignoring its value is a sure way to lose money in the long run. Foolish Thing # 2 You Can Always Tell When A Stock's Hit Bottom As Peter Lynch puts it, "Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It's normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it. Grabbing a rapidly falling stock results in painful surprises, because inevitably you grab it in the wrong place." Again, you need to focus more on value than on price. If the economics of the business is really bad, and the company has taken a lot of debt, the stock can go all the way down to zero. People, however, think that they always tell when a stock hits the bottom. Usually they do this by looking at previous bottoms ("support levels") achieved by the stock and then they project a trend line into the future. If the future was as clear as a trendline, then chartists would be the richest people on earth. Foolish Thing # 3 If It's Gone This High Already, How Can It Possibly Go Higher? Most stockmarket investors sell their stocks simply because their prices have gone up a lot. In many cases, the rise in price is irrational and is not justified by the underlying fundamentals. In such a situation, it's usually a good idea to sell the stock and look for better bargains available elsewhere. But, that's not what most people do. Instead, they fix a mental price target. If a stock reaches that target, they quickly sell and realise their profits. This is one of the most foolish things to do in the stockmarket. The stockmarket is full of people who bought shares in outstanding companies several years ago but sold them as soon as the prices of those shares reached their mental targets. Now I find them grumbling, "I sold Colgate at Rs 100 per share. Kick me! Kick me!" The fact is that by setting mental targets, investors ensure that they will never make a really huge profit on an investment. If you find someone who has made lots of money in the stockmarket, ask him how he did it? Chances are that he made his money by buying at reasonable prices shares in exceptionally well managed companies, and then by refusing to sell those shares whenever their prices reached the next high. Stocks are not like footballs which after being kicked up in the air, always come down. If the business is sound and the management of the company remains focused on wealth creation for shareholders, then you can be sure that the price of the stock will continue to rise over the years. If you hold on to such a stock,
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for a very long time, you will be glad you didn't sell it soon after a significant price rise. Foolish Thing # 4 It's Only Rs 5 a Share: What Can I lose? This is another crazy notion that many investors have. They believe that a Rs 500 stock is far more risky than a Rs 5 stock and consequently they buy the "cheaper" Rs 5 stocks while ignoring the "prohibitively expensive" Rs 500 stocks. They forget that stocks are not like bananas, the prices of which can be compared by using the yardsticks of number or weight. Given similar quality, bananas costing Rs 20 per dozen are cheaper than those costing Rs 40 per dozen. The same rule does not apply to shares. A share is nothing but a piece of a business. That's why it's called a "share." Take two identical companies with the same assets, liabilities, earnings, prospects and cash flows. Logically, both should be valued at the same price in the marketplace, say Rs 100 crore. Assume company A has 1 crore shares outstanding. Each share of Company A, therefore, should sell for Rs 100. Assume company B has only 10 lac shares outstanding. In this case, each share should sell for Rs 1,000. Is it really less risky to buy shares of company A at Rs 100 than those of company B at Rs 1,000? Looked at this way, most investors will correctly answer no. But most investors do not look at the problem this way. Rather they look at absolute prices. They forget one simple fact of investing life: Whether they buy a share at Rs 1,000 or Rs 100, if it goes to zero, they will lose 100 percent of their investment. If only investors would learn to look at stock prices, not in isolation, but always in comparison with their intrinsic values, they would find that a stock which is selling at Rs 500 per share often turns out to be far cheaper than a stock selling for Rs 5 per share. Foolish Thing # 5 Eventually They Always Come Back There are millions of these type, who are holding on to their losers in the hope that eventually their prices will rise. Buyers of IPOs (the fools and the greater fools) as well as buyers of overpriced stocks in the secondary market come in this category. Maybe the prices of such stocks will rise. Maybe they won't. The fact is that one can never be sure. But there is one thing one can be sure of which is this: stock prices of well managed companies will eventually rise. If this is true then it must also be true that investors who are hanging on to their losers in the hope of making up their losses, will be eventually much better off if they switched from their lousy stocks into good stocks immediately. This will be true even if the prices of the lousy stocks rose because, by then the prices of good stocks would have risen much more in percentage terms. Sometimes, while trying to avoid accounting losses, investors willingly suffer from huge economic losses. Such behaviour can only be called foolish. Foolish Thing # 6 It's Always Darkest Before The Dawn It's a common tendency of many investors to believe that things that have become bad can't get any worse. Such investors look for poorly performing industries and on the basis of their assumption that the worst will get over sooner or later, they buy stocks in companies of such industries. Such a strategy may work for a while but will eventually produce mediocre or even disastrous results. Today's prosperous companies could be tomorrow's dogs. Ten years ago, Tisco was a true blue chip company operating in a protected environment. Today's Tisco is far inferior to the earlier Tisco, but it will take many years for some investors to figure that one out.
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Foolish Thing # 7 It's Taking Too Long For Anything To Happen It's not uncommon to find investors who buy sound stocks, but get tired of waiting for their prices to rise. As a result they sell and guess what happens? Soon after they sell the shares, their price surges, leaving those who sold exclaiming, "I sold too soon. Kick me! Kick me!" Again, the mistake these investors are making is that they are focusing on price not value. If the company chosen in the right one, then its earnings will rise very significantly over they years, making the stock worth a lot more than the price paid. But there is no law which requires annual increases in intrinsic values to be reflected in stock prices on an annual basis. The fundamental point to remember is this: There will be always be years when intrinsic values rise significantly accompanied by little change in stock prices. The reverse is also true: In some years, the market price of the shares will rise much more than the rise in their intrinsic values. But over the long run, you can be sure that market prices will track intrinsic values. If the long-term intrinsic value of the shares is rising, the stock price will rise eventually. Investors forget this simple fact that in some years the stocks will outperform the underlying businesses, while in other years, the reverse will happen, but, over the long run, intrinsic values and stock prices will reach the same destination. Selling out simply because the price has not risen, even though the intrinsic value of the shares have been rising is foolish. In fact, when you find that the prices of good stocks in your portfolio are not rising, even though the companies are doing well, then you should add to your holdings i.e. you should make money off the fools who are selling out because they got tired of waiting. The above list is only a small number of foolish things many investors indulge in, while thinking about their investments. There are plenty of other ways of acting foolishly. Do You Seriously Want to be Rich? By the way, do you seriously want to be rich? Do you want to have more money than you ever imagined? Do you want to earn a guaranteed minimum return of more than 650 percent in less than 3 weeks? Do you want to know which stock that is currently selling under Rs 20 is sure to jump to more than Rs 150 within the next three weeks? To find out the name of this secret stock, you must subscribe to my Special Five-Star Flash. Merely clip and fill out the coupon, enclose a cheque for Rs 200 and send it to me and the name of this stock will be rushed to you in a plain envelope. Remember, it's in your own interest not to reveal this name to anyone. (You don't want others to profit at your cost, do you?) Not even your spouse! The best investment ideas are not for sharing! Also remember that this is a once in a lifetime opportunity! You may never get another chance simply because such opportunities do not come by everyday. So get up right now and write that cheque for Rs 200 and you will receive through our special courier a plain brown envelope with only one name inside it. That name will be the source of immense riches for you. And that's guaranteed. YES! HURRY YOUR SPECIAL FIVE STAR FLASH TO ME TODAY! Name: ___________________________________________________________ Company Name: ___________________________________________________ Address: _________________________________________________________
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Enclosed is a cheque* for Rs 200/-. Cheque No: _____________ Dated ______ Drawn On ____________________ I understand that your Special Five Star Flash will tell me how to get rich quickly by revealing the name of the stock which is certain to rise from less than Rs 20 per share currently to more than Rs 150 within three weeks! I hereby promise not to reveal the contents of your Special Five Star Flash to anyone. Mail to: Intelligent Investor, 114, 1st Floor, Motlibai Wadia Building, 22-D, S.A. Brelvi Road, Fort, Mumbai - 400 001.
* Please draw all cheques in favour of Intelligent Investor April Fool's Offer.

Note

This article is submitted by Sanjay Bakshi who is the Chief Executive Officer of a New Delhi based company called Corporate Investment Research Private Limited. Sanjay Bakshi. 1997.

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