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Why stock tips are dangerous

Badari Ramesh | August 24, 2005

The stock market is no different from horse racing," warned my dad with years of experience -- a few good, mostly bad.

I naturally disregarded his advice when making a foray into the world of stocks with my meager allowance.

In fact, I told him there are experts who follow the market every minute and give advice to lay investors like me, telling us which stocks to buy and which to sell -- the embodiment of modern day crystal gazers!

After all, how many analysts follow the races like they do the market?

Buying shares for the first time?
The heady days

When I started to invest, it was during days of the ICE (Information, Communications and Entertainment stocks) and TMT frenzy (Technology, Media and Telecom stocks). Not only in India, but across the world.

Almost every stock one bought (with or without the advice of the gurus on the Dalal street) gave a 10% to 20% return within a fortnight.

What I did not realise was that most of these 'experts' and many pink papers (finance and business newspapers are called pink papers because of the colour of their pages) were as ill-informed as I was. Subsequently, I realised many of their recommendations carried little justification other than satisfying vested interests.

I still remember 'analysts' recommending Silverline Technologies at Rs 1,500 a share (I don't know if it even trades today), Pentamedia Graphics at Rs 2,000 a share, Sonata Software at Rs 2,300 a share, all backed by rosy sounding jargon. Today, Sonata Software is selling at around Rs 30 a share.

At that time, the P/E ratio of many of these companies was quoting at as absurd a figure as 60 or 70. Let me explain.

The Price to Earnings ratio tells us the price you are willing to pay for every rupee you may earn in the future.

In mathematical terms, P/E is the market price divided by the Earnings Per Share.

EPS = Net profit / Number of shares

P/E = Market price/ EPS

Common sense dictates we would like to pay a lesser price for every rupee we earn in the future. Hence, investors should look for stocks with a low P/E.

I again distinctly remember these 'experts' asking investors to stay away from Subex Technologies which came with its Initial Public Offering at Rs 70 a share. Those who did follow their advice will be dismayed to note that the stock is today selling at Rs 500 a share.

A pink paper gave a 5-star rating (it used to rate the IPOs with stars) to the Padmalaya Telefilms IPO. The stock underperformed from day one and is languishing way below its issue price (price at which the share is bought during the IPO) today.

How to sell shares at the right time
History proves them wrong again

A few years ago, many of these experts had given 'avoid' calls on the IPOs of Allahabad Bank (Rs 10) and Union Bank (Rs 16). They ignored the fact that these were decades old, well-run banks with a strong regional presence and poised for strong growth because of the booming Indian economy.

Look where they are four years down the line -- Rs 85 and Rs 105 respectively.

There were 'strong buy' recommendations from many brokerage houses on Sterlite Opticals at around Rs 500. At that time, there was an imminent optic fibre glut in the world and the production overcapacity has still not been absorbed today. This led to the crash of the stock price to Rs 50.

3 stock market mistakes to avoid
Cut to recent times

There were hardly any 'buy' recommendations in the media for the IPOs of Crew B O S (stock price more than doubled in a year), Ramkrishna Forgings (more than doubled in one year's time), India Bulls (many brokerages had lukewarm recommendations at Rs 19. In less than a year, the stock is selling at Rs 130 a share).

Take any of the recent stocks whose prices have soared -- BEML, Nagarjuna Constructions, Siemens, ABB, Aban Lloyd, Mercator Lines, Pantaloon...

How many of these figured in the 'buy' recommendations over the last year? How many even figured in the top holdings of the best performing mutual funds handled by the wizards of Dalal Street?

But then hindsight is always 20/20...

4 great stock buying tips
Back to my father's advice

Today, I reluctantly agree my father was right.

Shares are as risky and unpredictable as horse racing.

I remember, at one time, a bigwig dumped large chunks of Digital shares when it was about to be merged with HP and small fish like me saw an overnight 30% erosion in the stock price.

The market watchdog, the Securities and Exchange Board of India, did make some noise but he is back in the ring once again.

Often brokers and their coterie buy a particular stock and begin to spread the word around about it being a good buy. Sometimes, even the company promoters are in the game.

When this 'hot tip' begins to do the rounds, others start to pick it up.

Day traders find such tips irresistible. Day traders buy/ sell stocks during the day and square up their position by the end of trading that day, when they either book a profit or a loss by selling the shares.

The retail investor is sometimes the last to get wind of it but he too hops onto the bandwagon.

This causes the price to steadily climb upwards. When the price climbs to a substantial level, the brokers sell.

That is when the price begins to tumble and the poor (or rather nave) retail investor is left with the dud stock.

I'm not for a moment saying all analysts are bad or just try to push up obscure scrips to provide attractive exit routes to their customers. All I am saying is that I seem to be witnessing the same trend these days in the media; it's a sense of dj vu, many times over.

If it were the ICE scrips then, it's the mid-cap mania now.

I have analysts recommending unheard-of scrips with P/E ratios as high as 15-16 throughout the day.

Why mid-caps are hot!
And so dear reader...

If you invest based on the advice you get in the media or because of some tips you heard from your neighbour, you invest at your own risk.

Instead, do your homework.

If you see the stocks go up by 10% to 15% in the short term, take your money and don't look back.

And, whatever you do, please don't get greedy.

Happy investing!

Badari Ramesh is an avid Get Ahead reader and dabbles in the stock market now and then. The view expressed here are solely his own.

Illustration: Dominic Xavier

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Number of User Comments: 3

Sub: Well said

The closing line was bull's eye. "Dont Get Greedy". Infact this should be the first principle to enter the market. This is a view held ...

Posted by Mayank

Sub: Quantifying speculation

You may want to follow these speculation guidelines Ask price <= 5 x BPS (Book Value per Share) Market Cap <= 10 x Revenue of ...

Posted by Anonymous Coward

Sub: Why do they give tips?

Let us think logically. Anyone who buys and sells stocks is doing it only to make money. If I know a good buy, what would ...

Posted by Cautious investor


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Hello friend ,

Thanx for this fantastic lines . i really appriciate your for sending this which help the new commers like me .

with regards
vamshi krishna .

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