The Hindu Business Line : Value and performance

There could have been no better demonstration of the truth that value is almost a mythical phenomenon, than what happened to the stock markets last fortnight. Investors, small or large, who put in money in tens of thousands, see the market as a place to buy a `share' or part-ownership of a company, which is equally hypothetical for all practical purposes. The same `share' is then used by the traders (or the punters if you want to be blunt) as a chip to denominate the millions of dollars they play with, on behalf of the faceless millions of investors from anywhere in the world, or corporations. It is like using the same piece on the Monopoly game, for different values by different players. One set, the trader can move his paper around the world at the click of a mouse and so the value denoted by the price of the entire Indian stock market can decline by a mammoth Rs 100,000 crore in a few hours. And the Finance Minister, whom one either pities or envies, is in the position of saying in the same breath "everything has been taken care of, we have all the controls in place; there is nothing to worry; the economic fundamentals are very strong" and have the chutzpah to add with a superior look, "but markets will behave this way, we must not be surprised". If an undergraduate student submitted an essay with these sentences he would be given a big zero, because the first is a total contradiction of the second.

What is not being said is: No single party has any idea why this is happening. There is a great deal of panic behaviour, irrationality, emotion and contradictory advice. All of this is set against the background of a potentially violent world political scene, with skyrocketing energy prices. However, let us return to the two categories of players. Neither of them has a major influence in the management or interest in the real goods and services produced by the company. Recalling the dual characteristics — of a market place for exchange of real value and a casino — notice a difference. In all casinos, the bank always wins; by design odds are stacked in its favour. On the other hand, a retail investor in a stock market, barring World War and like calamities, always has a good chance of winning — that is, earning a reasonable return well above the normal safe return of government bonds — but only in the long run. This is the reality of stockholder capitalism and one rupee-one-vote. Though Leftist commentators see this as the massacre of innocents, the message of the fortnight is simple: small players must not gamble unless they are willing to lose or gain equally big. If this does not suit us, then there is always the RBI bond or Post Office for a steady 6-7 per cent a year!

The price of a stock on the market is always a conundrum. It is the intersection of the two sets of forces outlined plus another factor altogether. It is also a signal for how well the company behind it is expected to perform over say, the next year. The discounted value of the future earnings is expected to be reflected in the multiple of the stock price over the earning per share, the classical P/E ratio or multiple in the market lingo.

However this does not vary from minute to minute, yet the stock price does.

Herein lies the root cause and danger of treating the stock market as a gambling den. Consider this: if you can buy a notional part ownership of a paper entity such as a corporate body through a virtual transaction online and could also escape bearing the full pain of parting with the price from your own pocket, then is such trading any different from throwing dice? In fact, this is exactly what the regular traders (as opposed to investors) in the market can and actually do. They only settle the differences on a net basis of all sales and purchases after a day or two as the case may be. Imagine if the rules also allowed them to do this on borrowed funds. Then they are simply playing a game — and what is more managing to raise the funds by pledging the shares already bought by them. In a rising market, it is easy to see how this is a licence to print money. But it is an invitation to disaster if one is recklessly hoping to make up one day.

The reason is the ebb and flow of the other kind of money (let's call it trading money as opposed to the investor money) is based on so many imponderables: the tide of sentiment about an economy, the market for goods, the government and attractiveness of other places to invest in — all of these dictate how billions of dollars are shifted around electronically. The truth of the matter is that the competitive gambler makes his margins by the way he guesses how others will move. This is nothing peculiar to stocks, of course — a fact that we forget sometimes. This is true of the price of almost any commodity, currencies, gold and other assets auctioned. The only differences are that the stock market has far larger number of participants and is eventually a notional commodity. When you own gold bought yesterday you take delivery of it and can do something with it as indeed with tea or coffee even in bulk.

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