dimpledbrain

The conceptual framework for a man's search for meaning

dimpledbrain header image 2

Show me the money

December 27th, 2011 by dimpledbrain

Academic definition:

A capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. In the secondary markets, existing securities are sold and bought among investors or traders, usually on a securities exchange, over-the-counter, or elsewhere. [source Wikipedia].

The truth:

  1. Stock market is a prime example of how capitalism works. It’s an inevitable rule that the rich gets richer. A price to earning ratio (PE ratio) of 10 means for every RM1 that the listed company is capable of earning, the company will be traded at 10 times its intrinsic value. That is to say if I were a rich man (you can’t list the assets of a company below certain threshold e.g. you can’t list your pasar malam store despite the good business model) and lists a business (called assets) that can generate an earning of RM10m per year, a PE ratio of 10 will suddenly increase my net worth by 10 folds.
    • Why do rich men privatize gems (i.e. good companies) and list dogs (bad companies)?

There are broadly three parties interested in the welfare of a company listed on the stock exchange.

  1. The first group includes the owner(s) and some long term institutional investors. These people generally do not trade (i.e. buy and sell) their shares frequently. The major shareholders typically maintain > 50% of the shares to control the company through an elected board of directors.
  2. The remaining stocks is called the ‘balance float’ i.e. the ones we can buy and sell over any stock exchange.
  3. The second group called Syndicates or Smart Money trade and control the balance float. If you think the share price follows the rules of supply and demand, think again.
  4. The last and the third group is called the public or the herd.

You have probably heard of Fundamental Analysis (think the first group) and Technical Analysis (think the second group aka the Smart Money). The Public is always fooled.

The first group makes money via the long run, i.e. they are interested in the long term prospects of the companies. The long run direction of the stock market is always upward. (In general, inflation, increasing employment rates, and population growth will fuel gross domestic product (GDP) and in return grow profits, and thus shares.)

The second group makes money via a cycle of:

(a)    Accumulation – generally no news about the companies while the Smart Money buys the floating shares from the market. Typically, bad news about the target company is released to deter the Public from buying the shares.

(b)   Mark up – when Smart Money has enough shares in its inventory, they will mark up the share price. They can do this because they have purchased most of the remaining floating shares from the first stage (accumulation).

(c)    Distribution – Smart Money starts selling the shares. This is where good news about the companies are published in the media. Stock recommendations etc. The public gets excited and is drawn into it.

(d)   Mark down – when Smart Money has sold most of their shares, they will mark down the share price. The public would have been trapped into holding these dead ducks as they call it or selling the shares for a loss.

The cycle repeats.

90% of the public loses money from the stock market even though you have fewer Smart Money than the Public and if aggregated, the Public holds more money compared to the Smart Money.

There is more than one Smart Money group by the way. The fiercer, built to destroy Smart Money will devour the weaker Smart Money carnivorously, together with the Public, in the quiet Sahara of stock exchange.

If you can’t beat them, join ’em.

  1. Always go for counters with fundamentals. Recall tulip mania. (Wikipedia: At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman)
  2. There are so many financial analysis ratios that one can rely on. Choose a few that are relevant to the target industry. Some of the ratios I personally like include return on equity (ROE), cash per share, debt to equity ratio, profit margin percentage and earning per share (EPS) percentage. There are also some industries (e.g.the steel industry, construction etc) that I’m not very fond of due to their fluctuating and unpredictable nature).
  3. Ignore media recommendations. Think about the cycle above. One should aim to buy during Accumulation/Mark Up and not during Distribution/Mark Down.
  4. Technical indicators that make sense must have both components of (a) price and (b) volume
  5. Expert opinion differs but I personally prefer small to medium companies with good dividend payout (vs large companies). On the selected few, not only is dividend payout comparable if not better. With lower P/E ratio, small to medium companies are frequently on the buyout target menu too.

p/s:

  • ‘There is of course more than one way to skin the cat- the point is to stick with something you are familiar with. I’ m totally/almost clueless about (setting up) businesses, property, foreign currencies and gold.
  • It’s on my wishlist to meet someone from the Syndicate/ Smart Money. It intrigues me on how the entire operation takes place. You almost don’t hear anything about them and yet their action unmistakably makes their presence felt, like wind only seen in the things it blows through…

I end this posting with a quote from the legendary investor Philip Fisher, “I have already made up my mind, don’t confuse me with facts.”

Tags:   · · · · · · · · · · · · · No Comments

Leave a Comment

0 responses so far ↓

There are no comments yet...Kick things off by filling out the form below.

button-canoe
button-canoe
button-canoe
button-canoe