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B. Venkatesh

ALL of us are familiar with buy and sell recommendations given by equity analysts. Often, we come across a "hold" recommendation. Some argue that such a recommendation goes against the opportunity-cost principle in economics. Why?

Suppose you decide to invest Rs 1 lakh in Bata India at Rs 100 per share. The brokerage-house through which you trade gives a "hold" recommendation on the stock. It essentially means that the stock is not worth buying now. Perhaps, the analyst believes that the stock may not move up substantially from the current level.

Economists argue that if you will not buy a good now because of its price, you should also be prepared to sell if you own the good.

Assume that you bought Bata India at Rs 70 per share. Suppose the analyst expects the stock to move to Rs 125. If you sell now, you will forego a likely gain of Rs 25 per share (Rs 125 minus Rs 100).

But selling now fetches Rs 1 lakh that you can invest in another stock. Suppose you invest in Archies Greetings at Rs 100 per share, and the stock moves to Rs 140. The additional profit that you gain (Rs 40 less Rs 25) is the opportunity cost of holding Bata at the current level.

Is this argument not powerful? Of course, it assumes that you have invested all your money. Otherwise, a "hold" recommendation may still be valid. Why?

Suppose you also have Rs 1 lakh in your savings account. You might as well use that cash to buy another stock. For, interest on savings account will be lower than the return you can earn by holding Bata. Either way, it is clear that opportunity cost is important to manage your portfolio.

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