A discussion with Mr. Stoploss, Millionnaire, on his views on investing in the stock market.
“So, you are a new entrant to the stock market. Perhaps you got some hot tips from a friend of a friend and want to cash in on the latest surge in the bourses, right? Or perhaps your retirement fund is not looking attractive enough as the D-day approaches, eh? Great, you are just the person I am looking for to offload my tale of woe” said Mr. Stoploss, MBA, pausing to light a cigarette.
“A few years back when I was fresh out of a reputed B-school, I had ventured into this terribly fascinating world of punters, armed with all the information and technical jargon pumped into me by our revered professor Mr. Bullbear. I had just been offered a very high paying job by M/s Buyhigh, Byebye & Selllow as a stock market trader, and with all the glitz and the glamor that my degree had coated me with, I knew that I was out to shine; rather, in our language, to outperform.”
“Things went on well for a while. The markets were on the rise, and I could buy a two-dime worth of stock at a dollar, and offload it the very next day for two. Having made a few million for the company in a short span of six months, I had already started counting the fat bonus that I knew I was about to get, come year-end. I needed the money, you see. There was this condo that I had been dreaming about since my B-school days, and while I had already made the down payment on my Jaguar, I still hadn’t saved up enough to look at the condo, except with a sidelong glance. But the year-end would take care of it all, of that I was pretty much confident.” Stoploss took another puff at the foul-smelling tobacco-stick.
“So what happened then?” I asked, curious.
“The market crashed” said Stoploss, “The market crashed, and crashed miserably. It was not just the stocks that fell, entire corporations were wiped out. You must have read in the newspapers then about the lay-offs and pay-cuts…” his voice trailed for a while “… but that is another story. Back at M/s Buyhigh, Byebye & Selllow, I was facing a peculiar problem – for the first time in my career I could not decide whether to sell or to hold. If my boss said sell, Mr Redspan, the economist, said hold. If Mr Redspan wished to sell, someone else suggested that I buy even more. They used phrases like ‘this is just a correction in the market’ or ‘the next surge will see the Plow-Bones Index shoot up even higher’. And I was almost fresh out of campus. What could I do but to knit my brow and wait for them to come to a consensus? After all, these were the heavyweights of the industry – who was I to dispute the judgment of even one of them? So I just sat their, watching my stocks dissolve. The two-dime scrips that I had picked up at a dollar fifty were now going for a half a dime, and I could only watch – selling then would have wiped out my entire net worth.”
“Net worth?” I interjected.
“Ah, yes, I forget that you are a layman. Simply put, Net worth is the actual amount of capital that you are holding after paying off all your liabilities. And at that point of time, had I sold, I would have been left with a negative net worth with no hope of recovering the capital eroded, even if the market were to go on an upswing.”
“So what did you do?” I asked
“I quit my job,” he replied, “I quit my job before they could lay me off and with what little money I had, I started building my own portfolio. I told myself that this time I was not going to listen to anyone but myself. And that was exactly what I did.”
“And you were successful, right?”
“Wrong. I failed again. This time the markets did not crash – they just refused to operate according to the guide books. You see, all the theories that I had studied were contradicting each other. Dow-Jones said Buy Low and Sell High, but I had no means for predicting which high meant high for share prices, and so I would hold on to stocks which were not really worth anything. And when the prices would start coming down, I would be at a loss to locate the point at which the prices were the lowest, and would start buying at prices which would eventually slide even further. They had taught us things like Trend Analysis in our finishing school, but… to no avail.”
“Well, it is the analysis of past trends to predict the price movements in the future. There is this theory which says that the stock markets behave in a cyclical fashion – one has only to study the past to understand and predict the future. But for all my knowledge and sophisticated tools for analysis, I realized that the markets rarely follow a long term trend, and if they do, be assured that they never will when you have decided to enter the market. In the end to make things worse, as an uneducated investor, you probably would walk right in when the market is the most volatile. So trends would not help you. If anything can help you at all, it is the grapevine – the tips that keep going back and forth in the market. But even then it becomes a punter’s ball – how do you know which tip is true and which baseless?”
“But all that education, all the technical knowledge that you had gathered in your B-School…”
“You have not been following what I am saying. Technical knowledge counts nada (North American DataCom, Inc) in the stock market. With technical knowledge all you can do is determine whether the scrip you have set your eyes on has a strong earning potential. You can look at the net assets position, which is broadly the difference between the assets and liabilities of a company on a given date. You can also look at the P/E multiple, which in your limited vocabulary would translate to the ratio between the price per share and the net profit per share after taxes. If you are expecting the earnings of the company to go up in future, you would want to pay more than the current earnings per share for the scrip. But tell me, if the earning of a $10 share for the year is $ 10, and you expect the earnings to go up by say 30 % every year, and you are thinking of holding the share for say two years, how much would you be willing to pay for it?” he threw the question at me, a malevolent smile spreading across his face. I did some quick mental arithmetic.
“$26.90, of course. If I want to hold it for one year, I’ll pay $23.00, which is 30% above the current earnings added to the current price, and if it is for two years I’ll settle for a price less than or equal to $26.90”, I beamed, feeling pleased with myself.
“And that, my dear friend, will ensure that you never enter the stock market,” said Mr. Stoploss, smacking his lips in satisfaction, “You see, contrary to what is taught in B-Schools, the market does not run on future expectations based on current price and business trends. It runs entirely on two factors – the expectation of the market that there is some person who is willing to pay a higher price, and more importantly, on whispers.”
“Yes, whispers. Loose rumors, bits of inside information, lucky tips from the gut – these all constitute the whispers that make the market run. To go back to our example, in an upward market you’ll probably see the scrip that you think is worth less than $27 going for a price like $127. And don’t be shocked, my friend, in my days I have seen stocks trading at P/E ratios of 100 and more. And do you have any idea what that means? It means that if the company does not grow but maintains its current rate of earnings, and if it pays out all its earnings as dividend, the price you paid for the scrip would come back to you in a hundred years, give or take a few. Now tell me who expects to live that long except for the analysts and brokers?!”
“But does that mean an ordinary person such as me should not venture into the stock market at all?” I ask.
“Of course not! The market is there, and people do make money out there. But you must remember certain basic facts. First, do a thorough study of the company. Look at its net worth and gauge that against the current market price. If you feel that it is overvalued, don’t buy. Look at the P/E ratio, and if your gut tries to tell you that it is abnormally high, please listen with an attentive ear. Look at other financial aspects like whether the future earnings of the company are hinged on the success or failure of some major project or the like. For example, there may be a situation where the media or the grapevine will tell you that a company is about to make a major breakthrough in a particular area of pharmaceutical research and is, therefore, a good buy. Don’t. With your small capital base, you really cannot take the chance of buying a stock at an astronomical price and then watch it tumble when the research team says ‘we can’t’.”
“But you said financial indicators do not matter,” I quipped, thinking I had caught him on the wrong foot.
“They don’t. Not when you are playing with millions of dollars. But with the measly few thousands that you want to multiply, the financials do give an indication that at worst, you may still have an opportunity to walk out with your capital intact in the short run. In the long run it might even fetch you reasonable returns. Good financials mean that in all probability the company will not wind up in the next five years, and the longer a company is likely to stick around, the better are your chances of finding a buoyant market to earn some money on your investment,” Mr. Stoploss paused, “secondly, check to see if the company has any pending lawsuits against it, like sexual harassment charges”, Mr. Stoploss winked, “Some lawsuits might even liquidate a company, so always check the net effect that a pending suit may have on the company’s assets. Also, never be drawn to what the analysts have to say. Remember, it is their job to ask you to invest. If they paint a bleak picture of the market, the slide will begin automatically since there would be more panic stricken sellers than buyers, which forces them to always try and sound optimistic. So, decide on what kind of profit is decent enough for you, wait for that price, and when you get the price, sell. Do not wait for the pot at the end of the rainbow. One good monsoon in an agricultural economy may push the market up for six months, but always remember that those are the only six months that you might ever get to make a profit. Simply put, try to sell while others are still buying, and buy when others are still selling. That is the one and only way to ensure that you come out of this caper with something to say for your bruises.”
“So is that how you made your money?” I asked, staring at the huge diamond ring that adorned his left index finger.
“That,” said Mr. Stoploss, Millionaire, “is another story.”
This is purely a work of fiction intended to give the reader a basic idea of the author’s perspective of the stock markets. The article does not aim to encourage or discourage new entrants to the stock market, nor does it purport to provide a surefire way of beating the market. Finally, the author proclaims “Invest at your own risk, why drag me into it?!”