Irrational behaviour is dominating the Stock market

Irrational behavior is dominating the Stock market

Stock market touching indices new heights every day. Sensex touched 46000 a all time high level. People are very happy at the gains they are making. Many experts and analysts  in various business channels are  projected as a life time opportunity.  No one is talking of risk which many investors might face at some stage.

Let me explain you with a very logical and practical example.

Whenever you buy anything you pay a price. Two things you always evaluate. Price and Benefit. If you are buying anything at Rs 100 you know what benefit you are getting. Tomorrow if someone comes and ask you to pay Rs 150 will you pay? The first thing you will ask what benefit you have added that you are asking for higher price. If more benefit is explained that justify the higher price you might pay but if you feel benefit is not justifying the increased price you might not pay Rs 150. We prefer to pay only that price which is worth the benefit. We have this psychology in all our buying process but found missing when we are investing in stocks. We question for increase in price when we buy anything in the consumer market. We ask, “why you have increased the price” but how many of us have tried to find the answer in case of equity? How many of us have valid reason to believe that market upward movement is fully justified?

What is the benefit we get for which we are buying a particular stock or share of a company? It is the net profit (PAT) or earning per share (EPS). EPS is Profit after Tax/Nos of outstanding share. Are we aware what earnings we are going to get for the price which we are paying? Suppose there is a stock which was bought at a price of Rs.225 and gave an EPS (Earning per share) of say Rs.13. The historical Price Earning (PE) ratio is 17.30 (225/13). PE ratio means for every 1 rupee earning that person paid 17.30. Now if it is trading 277 how will you know it is worth buying at this price? It is worth buying only when you know it’s worth the benefit (earnings which you will get in future). Looking at Mr X purchased at 225 and got earning of 13 if you buy at 277 that does not mean you will also get earning of 13. You might get less or same or more. But do you know that? So what for you buying at 277?

We all know financial numbers of most businesses are very low due to lockdown and almost every reputed research company have predicted a gloomy picture for current year 2020-21. All are hoping numbers to be much better in 2020-21. But that is almost 6 months to a year from now ( if it happens). Are we ready to believe that market will keep moving upward till that results (growing earnings) are seen? What if the earning numbers fall below expectation? Will the market still move upward? Following anything blindly is the biggest risk.  

Why then market and stock prices are moving up now? Let me again explain with an example. There is a stock A.  It is trading at say 33 and at that time may be 500 people have interest in it. With bull run the prices moves up and becomes 45 in 1 month. it has given 33% return in 1 month (may be one of the best in that period). Now the number of people showing interest for that stock grows from 500 to 2000. As demand grows for that stock ( more people are chasing it) its market price goes up again. One action (price increase and higher return) catalyses another action (number of investors interest increases) which further leads to more demand of that stock and the cycle continues. Everyone investing looking at how in short term people who invested have got very high return. But people have forgotten that for all things their natural behavior is to pay the price which is worth the benefit.

Let me put one more word of caution. Historically whenever stock prices have jumped abnormally high in very short term then corrections have happened. Sometimes the corrections have been so massive that it has taken some years to bounce up. I don’t remember anytime in past when economic realities, business numbers are low and still market just shooting up.

This irrational behavior is beyond any logic. Hope after few months we don’t have many people repenting about losses than some who are rejoicing now at abnormal gain in short term.