(3) Stock Picking: Good Company v/s Bad Company: Finance Trading Times

(3) Stock Picking: Good Company v/s Bad Company

The so called “Blue-Chip Companies” – what exactly do they mean?
Basically, this term indicates a company which is well established in the market, has a well trusted management, is listed in the main stock indicator index (like Sensex/Nifty), has been giving good profits since last few years and has the potential for further growth (atleast that’s what the majority of the investors in the market should believe). In essence, a blue-chip company is considered to be a “Good” Company.

Now, a few of the questions that come are as follows:
• Is it really worth investing in a so called blue-chip company?
• Can you really differentiate a “Good” company with a “bad” Company with regard to investments?
• Can the experts giving recommendations on various business channels for stock picking really trust-worthy?

I will be taking some specific names of companies here, but that does not mean that these companies are good or bad. It is just quoted for a particular example and for a particular period. Let’s look at some of the examples.

TATA group is one of the highly reputed & well established business groups in India. It has a track record with decades of success. TCS or TATA CONSULTANCY SERVICES, a group company within TATA group brought it’s IPO in 2004. The IPO was offered in price-band of 775 to 900 and finally the price for allotment of shares was fixed at 850. This IPO had all the good things and good indications:
• People subscribed to this IPO in large numbers.
• Banks like PNB and IDBI were offering “IPO loans” to individuals to subscribe to this IPO.
• This IPO also initiated the so called “black market trading” (trading in shares between 2 individuals, even before the listing of the company), which was an indicator of the investor confidence in this particular company.

Now, my questions start here:
• If this IPO was so good, why is it that the price was fixed only between 775 to 900? Why not 1000, Why not above 1200 (and the list can continue)
• Why wasn’t the final price for allotment of shares fixed on the higher price of 900, why was it priced at an intermediate 850?
• Why didn’t the TCS stock, after listing on the exchange immediately made a nice handsome profit? Instead, what had happened, it was listed at an opening price of almost 1200 Rs., but the same day, it came down to close at 988 Rs. If it was a “good” stock, why there was straight fall of 18% on the first day of listing itself between the opening and closing prices?

A few of these questions can be justified by mentioning that it was the trading activities that led to the price fluctuations in the short term. Very true, but don’t these trading activities affect what you are holding??

The actual answer to the above questions lies in what is called “The Market Perception” and is affected by the fundamental question of “Demand and Supply”. The first question, regarding the price band of 775-900, and not a higher value relates to the market perception of the value of the company. It is the market that decides what should be the FAIR value of this stock, not the company (both TCS and Book running lead managers –who brought the shares to the market). When I say MARKET, it means all the market participants (individual traders, fund managers, market-makers, foreign investors and Individuals, who trade or invest in the market). If the company had over-priced the issue, there was a danger of under-subscription of shares – meaning all the shares being offered will not be sold through IPO.
The same reason continues for the final allotment price of 850 (Q2). The majority of bids that were received were probably valuing the share at a max of 850. Hence, the IPO was priced at 850, not on the higher side. Again, it’s the market valuation that decided the price.
Third question – on the listing day, individuals started trading enthusiastically. The opening trade is 1 single trade, it can be for 1 single share or for a hundred thousand shares. So if someone was highly bullish on this stock, he started the trade at 1200. However, ultimately it’s the market that finally decide the fair value of the stock – so by the closing time, it was down 18% (988) and stayed there for a long period.

The market is HUGE – millions of market participants (individual traders, fund managers, market-makers, foreign investors and Individuals) trade and invest in the market. Trying to guess what the majority of them will do is nothing better than fooling yourself, as the size of the market is huge. Ultimately, the market price finally settles at the so called fair value as perceived by the majority of market participants. When you say XYZ is a good company and you will invest in it, it means that you believe that the majority of the market participants will also think the same way. Whether you are right or wrong, it’s a different issue altogether and comes as a later result.

Another example, Reliance stock was trading at a lowest level of 220 in September 2001. Today it has touched the highs of 1700, a straight profit of 675% over 6 year period. There were hundred of individuals, who bought this stock at 220 to 250 levels in 2001. However, majority of them sold their holdings in 2003, when the stock price touched 400 and above, making above 100% profit. The belief was that the stock will not appreciate further. However, the stock continued its run, and today it is at 675% profits. There were many individuals who booked profits halfway thinking that it was the highest price the stock could touch - just to notice that the stock has continued its bull run further. Despite the battle between Ambani Brothers, where the stock took severe hits, it managed to keep up the pace.
The question is: How many of the investors managed to benefit from the continuous profit from this stock? How many could perceive that this stock would give 675% returns despite the brother’s battle for control? The fact is, no body can predict anything. All people do is they take a bet in the market when they INVEST in a stock. If it goes well, they happily book profits – that too indecisive of the profit levels; otherwise the famous reason – “I am a long term investor, I invest for long term” – basically meaning I’m sitting on loss for my investment.

Looking at the above 2 examples, can we conclude that TCS is a Bad company for the initial period and Reliance is a Good company for the 2001-2007 period? Definitely Not. We have NO IDEA how a particular stock will perform – today, tomorrow, in one year, in 5 years, in 30 years, nobody is confident about anything. All people do it make BETS – nothing better than a monkey throwing several darts on a dartboard – occasionally, 1 or 2 darts hit the bulls-eye and the monkey feels happy. What it ignores is that there were many more no. of darts that missed the bulls-eye by a distance.

Let’s take this discussion further:
Can you name the first 3 companies in the following industries?
• Radio
• Television
• Rail
• Computer
• Airplane
• Internet
• Mobile

OK, may be naming first 3 is difficult, so can you try to name the first company of each of the above industry? Probably not.
The reason is that the pioneer companies for almost all the above industries did not survive for long. Either they collapsed due to mis-management or due to competition or due to other factors. Innovation CANNOT guarantee any success for anytime. Interestingly, all the above industries are the once which have transformed our lifestyles significantly – but yet, the pioneers inventing the technology, or trying to make business out of it, failed miserably.

If it was so easy to make 10/15/20% returns in the stock market, why is it that the Mutual Fund Managers don’t guarantee even a 1% return? Why is it that every advertisement for a Fund or investment comes with the tagline: “Mutual Fund investment are subject to market risks, please read the offer documents carefully before investing.”

The fact is that things work randomly, and in the investment industry – the word RANDOMNESS rules. We all become victims of RANDOMNESS, looking only at the success and survivors like the monkey mentioned above. One of my favourite expressions is “Everything is Random”. Right from the job that you’re doing, to the salary that you draw, to the money you spend, to the money you save – things happen randomly. You have very little control over how things will proceed in your own life – especially with respect to your success/failure and more particularly with respect to the finances that you have. More on randomness in a later article.

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8 Comments: Post your Comments

Unknown said...(on 31 May 2007 at 19:49 )  


A said...(on 31 May 2007 at 23:26 )  

great articles!!! i've been doing a lot of reading the last few weeks on investment, stocks and all the mumbo jumbo. But u've laid it out in fairly simple terms and thats what is appealing!
i'm 26 and just now exploring possibilities about financial planning. any wise suggestions/tips?

Mahen said...(on 5 June 2007 at 04:44 )  

"Everything is Random" Very true and very much applicable in todays world.

My favourite statement is "It depends"

Bala said...(on 14 June 2007 at 02:35 )  

Really very nice article about truths of investing in equity market. Keep blogging.

Balakrishnan K

Kalyan said...(on 14 June 2007 at 11:50 )  
This comment has been removed by the author.
Kalyan said...(on 14 June 2007 at 11:58 )  

'Everything is random', so very true. But does that mean that Stocks dont really give high returns? I have seen many people making good amount of money since ages in stocks. (Though larger number of people loose their shirts, but this happens in every industry, right? From textiles, automobiles, manufacturing, to services et al. There is an element of uncertainity in everything and the fun lies in making your way out of that randomness). And all of them tell the same thing "Calculated risks pay-out" and "Dont be greedy in stock-market. Get out when you reach stop-loss or the target price".


Anonymous said...(on 24 July 2007 at 09:57 )  


Anonymous said...(on 7 September 2007 at 07:32 )  

Please change the black background as it portends eye-ache. I couldn't continue any line more than 3.

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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