The Hindu Business Line : Sensex and the doctrine of <I>caveat emptor</I>

AFTER touching the 6000 mark, the Sensex nose-dived by about 200 points. It is time retail investors became careful, as the market already seems to be over-heated and may go in for correction any time.

Surely March 2001, when the Ketan Parekh effect drove valuations to unjustifiably high levels has not faded from investor memory.

Now is the time for them to practise the doctrine of caveat emptor (buyer beware!), especially when the media and the investing community are continuously harping on the incomparable rate of return offered by the so-called robust capital market. Here is a reality check for the retail investor community:

First, investment in stock market requires careful study of complex factors, such as the financial performance of select companies, their internal rates of return, the past trends, the management, the kind of corporate governance the corporates have in place, the future outlook, particularly in the globalised scenario, the market positioning, the floating stock, the shareholding pattern, and so on.

The best of the yesteryear companies are unable to withstand intense global competition, and are grossly undervalued by the market. In addition, to evaluate the right stocks, there should be constant monitoring to see how the investment grows, if at all. All these are possible only by professional, and not by lay, investors.

Second, experience tells us that the market is not always driven by fundamentals. Most of the hype in valuation is a combination of one or more factors: Sentiments, the overall expectation of the economy, the recent announcements by the board of a particular company, the feel-good factor, the rumours and even the scams.

In fact, the current excessive investment by the FIIs in the Indian market is, among other things, attributable to the overall feel-good factor about India and the absence of a comparable market elsewhere in the region.

Short of attention to these relevant details, the retail investors, most of the time end up buying high and exiting at low valuation — the reverse of what is being advised.

Third, the greed of gullible retail investors seems to have no bounds. Emboldened by the emotions created by the market, with little knowledge of the nuances, they want to double or treble their money quickly. The reality, however, is that while the stock market, considering its risks, may reward higher decent returns, when compared with alternative investment options over a longer term, it is nothing but a gamble to expect to make a killing, merely because a few others are lucky enough to do so.

For instance, in the medium or long term, one should be happy to realise a return of 15 per cent in the stock market, when the interest rates are around 6 per cent.

Four, it is unfair to blame the market regulator, for all faults of the investing community. The regulator can simply not close all the loopholes for scams.

For instance, a few years back, there were a series of police complaints against promoters who promised huge returns on private placements which did not materialise.

Private placement, by definition, is investment on private basis — yet to be listed on a stock exchange — based on trust on relatives, and friends and so on.

The role the regulator can play in such risky investments is minimal. Regulators cannot bring back the lost investments driven by the disappointed expectations of lay investors.

Retail investors, of course, can participate in the stock market, through select mutual funds. Globally, the trend of investment in the stock market is predominantly through institutional investors only, even where technology gives lay investors access to information on a continual basis. Beware, retail investors.

(The author is a Chennai-based Advocate and a Fellow of ICAI.)

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