As pointed out in a previous article there is a big difference between investing in shares and trading in them. When investing people consider what return they will get. In the case of trading the returns to the investor arise from the short term gain n the price of a particular share. Shares have a habit of going up either because they are undervalued or because of speculation about some likely event such as the transfer of the controlling interest in a company. Generally the net asset value of a company has little bearing on the price of a share unless the controlling interest is being sold. In such an event the book value of the share will be multiplied by twice or more since the book value does not reflect the market value of the assets owned by the company even if the assets are periodically re-valued. But ignorant investors can be misled by Investment advisers who seek to justify an unusual increase in the price of a given share. Last week saw the price of East West shooting through the roof because of the news that a subsidiary had entered into a transaction to set up a new hotel on land which belonged to its subsidiary. But the project has not even started and any returns from such a project are a matter for the future. Why then should the price of its share climb to such dizzy heights?
High net worth individuals willing to spend a large amount of money on a share can push up its price since he merely has to keep on buying. The herd mentality will induce others to follow him thinking there is gold at the end of the trail. Meanwhile the high net worth individual whose average cost is below the price that his action has caused it to rise to, will liquidate his holdings and the herd will continue to buy. If he unloads too many shares at a time the price will collapse and hence he has to be careful. To achieve his objective other people must continue to buy and for this purpose circulating a half truth as a rumor will help. The insiders in the brokering industry, the very Investment Advisers who buy the share on its upward journey, continue to circulate rumors that the price would go still higher and they even give a target price it would reach. If the retail investors swallow the rumor hook line and sinker then it becomes a self fulfilling prophecy. Retail investors are surprised when the prediction is fulfilled. The return on trading depends on buying early when a share is rising and selling at the right time.
Investing is quite a different game altogether. Investors for the long term expect a return by way of dividends and a capital gain which they may choose to realize or carry as a paper gain. But to invest in a particular share the investor will have some idea of the future prospects of such company. The dividend yield shows what he can expect at the going market price and assuming that the dividends will be the same as previously. But the earnings may grow faster than in the past and the company may then distribute higher dividends or put more into Reserves and the price of the share may rise promising a capital gain on top of the dividend. Presently the dividend yield is very low for the market as a whole being a mere 1.5%. This is unusually low when compared to long term Treasury bonds. A 5 year bond now gives a yield of 8- 8.5%. The return on stocks must be greater than the return on bonds or bond yields. Investments in stocks should provide even more to compensate for the risk in equities- the risk premium which in developed countries is 5%. In Sri Lanka the historical average is 6.6% according to the calculations of Prof Lalith Samarakoon This means that an investor in the stock market must get 14-15% return. At the present prices of equities he cannot get such a return.
The writer is an economist and is the General Manager of a Colombo based stock brokering firm. You can reach him via firstname.lastname@example.org