Invent a theory, and let investors follow

Vivek Kaul
Friday, March 03, 2006 21:37 IST


Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. — John Maynard Keynes, the greatest economist of the twentieth century
MUMBAI: Every bull market has a theory behind it. The theory puts across the “reasons for investing in the stock market”. At other times, it explains why the market is rightly valued when evidence suggests otherwise.
Even at times when an individual or a group is rigging the stock market, it helps convince investors to come and join the party.
The theory is essentially used to influence the investor’s perception of the stock market. As Harshad Mehta, the original big bull, remarked in an interview to a business magazine, “The crucial thing about stock markets is that they are primarily driven by perceptions, not performance. That’s unlike the commodity markets, which are more performance-oriented.”
Mehta had his favourite theory, too, — the replacement cost theory. When he rigged up stocks like ACC, he justified the inflated price using this theory. And what did the theory say? “The market capitalisation of ACC (as well as the other stocks that were rigged) should be at least equal to the money required to create another ACC.”
He backed up this theory with some really media-friendly comments, “I thought I’d be like Pied Pier. I thought I can sell dreams... that asset-creation is not a crime, that if you wanted to be Harshad Mehta, come to the stock market.”
After Mehta’s downfall, this theory has been confined to the dustbins of history, at least, as far as the Indian stock markets are concerned.
The next big bull was Ketan Parekh. Parekh was not as media- friendly as Mehta was. But stock market experts picked up on his investment style and justified it by saying that the companies he has invested in have been selected for investment with help from his research team.
The research team, they said, had listed out stocks with a low capital base and a low liquidity. And this convinced not only ordinary investors, but also foreign institutional investors and mutual funds. The FIIs and funds bought stocks Parekh had invested in, even after he had more or less exited them.
Another theory that has gained currency among analysts in recent times is the ‘sum of the parts theory’. This is applied in case of companies which are in multiple businesses. The profits of such a company are essentially made up of profits through its multiple businesses. But the stock price at a given point of time may not have captured the right value of the various businesses.
Thus the logic: stock is cheap. Using this theory, analysts remained gung-ho on Reliance even after its recent demerger. Most analysts expected the price of the Reliance stock in the range of Rs 700-800, post-demerger. They used the sum of the parts analysis to justify the price.
The price of the Reliance stock before the demerger, they felt, did not rightly value its investments in financial services, power and telecom.
Since so much information is available these days, something insightful can always be said about each and every market event. And this makes truly random happenings in the market look like they happened due to some reason.
Also, a lot of stock market experts are very intuitive. But intuition cannot serve an investment argument. Thus, a theory through which one can convince the investors to invest.