Honey, Where is the Money Gone?

For those in the investing game, it is not unfamiliar to come across such headlines as "Bloodbath on the Street. Investors lose xxx crore". As a matter of fact, Business Standard (27-Nov-2010) has an article on the first page "Rs. 4.4 lakh crore lost in 4 trading days". Now, that is bigger than the recent 2G scam amount of Rs. 1.76 lakh crore. The question is - who lost this 4.4 lakh crore? And who gained? More so, if you knew where the money was going, can you not make a bundle?

Now, for the explanation. Let us say there is a company ABC Pvt. Ltd. in which there are 10 people each of whom own 1 lakh shares. Let the current market price (CMP) of ABC be Rs. 100. The total market capitalization ("price at which you can purchase the whole company") is Rs. 100 multiplied by 10 people multiplied by 1 lakh shares per person = Rs. 10 crore. Now, your uncle wants to sell his 1 lakh shares at Rs. 100 but there are no buyers at Rs. 100, so he sells at Rs. 90 per share. Next day, in the financial press, ABC's stock price is listed as Rs. 90 - the last sale price on the previous day. The company's market capitalization is now Rs. 90 multiplied by 10 people multiplied by 1 lakh shares per person = Rs 9 crore. This is 10% less than the day before, or a "loss" in market capitalization of Rs 1 crore. Of course, some money has left the market - your uncle made Rs. 9 lakh. What happened to the other Rs. 91 lakh?

My answer - got vanished with people's perception. Meaning that yesterday, the whole community of stock investors perceived that one share of ABC is worth Rs. 100 whereas today they feel it is worth only Rs. 90 per share. I won't be surprised if they all feel tomorrow that is worth Rs. 110 per share. Then, the newspapers will scream that investors dancing with delight as they make xxx crore in one day.

This is a common misconception as people do not easily understand how stocks are priced. Actions of a small number of investors appear like a stampede.


So, what is the message? Keep out the noise - what the stock market thinks or your neighbours think.Instead, focus on the underlying business - what products/services does ABC produce and how good is it doing in this? Is it consistently making money?

Remember - Bulls make money, bears make money, vultures make money, it is only pigs that get slaughtered.

Invictus.

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