Thursday, November 6, 2014

How the stock market acts like a voting machine in the short term – an example

“In the short run the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.” – Benjamin Graham

Value investing guru Graham’s oft-quoted statement is best validated by an example. With Q2 (Sep ‘14) results hitting the market thick and fast, results from two companies - and the subsequent contrasting market behaviour of their stocks - caught the eye.

Let us call the companies Company ‘A’ and Company ‘B’, and look at their Q2 Sep ‘14 results and compare them with their Q2 Sep ‘13 results in the table below (figures in Rs. Crores).

Company A Q2 (Sep ‘14) Q2 (Sep ‘13) Company B Q2 (Sep ‘14) Q2 (Sep ‘13)
Sales 7639.33 6892.64 Sales 207.45 225.03
Net Profit 988.16 913.80 Net Profit - 1.21 1.52

Company ‘A’ increased its sales by Rs. 746.69 Crores (10.8%) over the same quarter in the previous year. Its net profit increased by Rs. 74.36 Crores (8.1%).

Company ‘B’ had sales lower by Rs. 17.58 Crores (7.8%) than the same quarter in the previous year. Its net profit turned negative. The loss would have been much higher except for a forex gain of Rs 3.89 Crores and gain on sale of subsidiary of Rs. 6.69 Crores.

You will not be faulted for concluding that the stock market should have given a ‘thumbs up’ to Company ‘A’ and trashed the shares of Company ‘B’. But the exact opposite happened!

The stock price of Company ‘A’ fell almost 8% after announcement of results – though it has recovered a substantial portion of its losses since then. The stock of Company ‘B’ rose a whopping 54% – thanks to three ‘upper circuits’ – after results announcement!

So, are investors completely irrational? Not completely. The Q2 ‘14 sales and net profit of Company ‘A’ were lower by 10% and 6.5% respectively than Q1 ‘14. These figures disappointed the market. The high stock price of Company ‘A’ may have led to profit booking.

Company ‘B’ increased sales by 4.4% and reduced losses by 95% over its Q1 ‘14 numbers. The fact that the stock price of Company ‘B’ is low may have something to do with investor enthusiasm about the reduced losses and the three upper circuits.

In the longer term, the stock market will act like a weighing machine, and sanity will prevail. That doesn’t mean the stock price of Company ‘B’ will not rise even higher.


Rajasekharan N. said...

Had we known the real names of the companies, it would have been further amusing and realistic!

Subhankar said...

Here is a broad hint:

Company 'A' is a MNC in the FMCG sector. Company 'B' is a VAS software company in the Telecom sector.