Don't buy stocks on rumours, do careful research

A Turkish gentleman Tamer Ozel wrote a letter to the editor of Businessweek on the Istanbul stock market and I cannot but remark on how similar our markets are. He stated, "The Istanbul stock market is like an auction at which ignorant buyers judgements are not based on the success of companies for better and new products and services or for promising inventions.

The rise in stock is not due to value added by stock issuers, which normally would be reflected to shareholders as a high yield on dividends. Yields indeed are very low with respect to the inflation rate in Turkey. The rise in market is due to the rise in the number of buyers competing to buy the same number of stocks available in the market. For the local residents, the Istanbul stock market is a kind of lottery."

Another business magazine reports of a young man who by investing or rather speculating in the East European Stock exchanges was able to turn an investment of $10,000 to $150,000 in 13 months.

Sounds familiar? our market is very similar. It is also a lottery driven by greed and fed by rumours- a market where investors buy shares spurred by the hope that it will double in three months even though the yield may be and usually is less than 2% per annum. I remember a friend once advising me to buy the shares of a particular company. Being fairly innocent I asked him who controls the company, what was its profits and what does it do? He dismissed these concerns with disdain – "My broker says it will double," he said. "Who cares what it does? Why indeed!"

Bernard Baruch the multimillionaire stockbroker and investor once while staying at the St Regis Hotel in New York had a number of friends and relatives over for dinner. While he was entertaining them he received a call and his part of the conversation was, "Consolidated Gas. Yes, yes that's good." A few weeks later, a relative of his dropped in, in tears. She had lost a lot of her money. "You too must have lost a great deal in Consolidated Gas", she mentioned.

"Lost a great deal in Consolidated Gas", repeated Baruch in amazement. "Yes", she replied.

She then told him she had been guilty of eavesdropping and had brought the shares on his "tip" or recommendation as she had heard him say "good". The truth was quite different. Baruch had suspected that Consolidated Gas would fall and had therefore commissioned an individual to procure some information for him. The telephone call was from this person confirming Baruch's belief, and Baruch was merely acknowledging the confirmation that he had received.

Consequently, he began to sell his holdings.

Prices rise based on the rumours and expectations. The market is like a drug, it's addictive. De La Vega commented on this in the 17th century. "You cannot leave the market once you have tasted the honey". The recent rise in prices have been largely on account of financial institutions and foreign funds buying shares of those companies they fancied. A classic case of tons of money chasing a few shares. If one checked one would have noticed that only a few doubled and trebled. Many remained at the same levels. And as this was the cause for the rise--the moment these entities withdraw from the market the price will fall.

This strengthens my belief and my submission that the market (particularly in India) is for traders. If you wish to make a profit buy and sell as soon as the price rises. You can always buy again when the market falls and it will. The problem with most people is that they are impatient.

They feel that they stand to miss the bus if they do not buy now. Just before the fall in 2008 I remember my broker (during those days I was a lone wolf yelling caution) exhorting people to buy. And people were buying at that time as if there as not tomorrow. With the hope of acche dins are here again, people are once again buying.

I believe that, at this time, it would be a good idea to be careful while buying. Buy only after careful research. All companies are not doing well. And if you feel or your research suggests that a company is well priced, sell the share.

The writer is MD Cortlandt Rand and an author