Investment in stock market by retail investors - an illusion???

Sometimes a story helps explaining the concept better. So let me start with a fictional story.

There were 3 countries (say A, B & C) in the process of financial evolution. A visionary man in country A wanted to expand his business quickly, but didn’t have enough funds. So he decided to borrow money from his relatives and neighbours. Over time, many people took this route to raise funds to expand their business. And, some people, with plenty of funds available at their disposal, became the lenders to all and sundry. Slowly people realized the importance of this service, and decided to institutionalize the process. Thus, banks came into existence – which started providing a key service to the mankind – getting deposits from people with surplus funds and lending them to the needy.

However, this came with a rider – the inherent business risk always remained with the borrower. There was no sharing of risk. Hence, some businessmen were willing to share both the risks and rewards of their business with partners. Hence, the concept of partnership came into existence. However, this had its limitations, as one could not have 100s and 1000s of partners in the business. To overcome this, some businessmen allowed people at large to take a stake in their business. A process, they termed as Initial Public Offering (IPO).

The industry flourished very quickly. There were many people who wanted to participate in the success story of other big/successful businessmen. Hence, even after the IPO, they started buying and selling the stake in these businesses. The companies then decided to make the process smoother and hence issued shares in their company, each representing a certain amount of stake in the company. This made trading the shares (effectively the stake in the company) lot easier. Over time, brokers evolved, who specialized in trading of these securities. However, scams followed soon. Hence, to restore the lost confidence of public and to regularize the industry – the government of country A set-up a stock exchange. The job of this stock exchange was to ensure smoother deliveries and to prevent scams.

Soon, people set-up specialized desks to do in-depth, detailed, and most importantly fundamental research to identify the promising undervalued stocks. As the industry flourished, people invented new products – derivatives, CDS (for companies) etc.

At this point, people from countries B & C visited country A and were amazed to see the financial evolution that had taken place in country A. So they decided to copy this business model. However, as they did not want to be seen copying the entire model directly, the governments of these countries tweaked the business model a bit.

Sports and entertainment were the main industries in country B. The government of country B wanted to promote these industries further. Hence, it decided to regularize a stock exchange for these industries. This way poor and needy sportsmen and struggling actors/actress/directors etc. could come with their IPO to raise funds for their training. Hence, sportsmen from all fields – cricket, basketball, rugby, volleyball, tennis, table tennis, football, chess etc. started coming out with their IPOs. And so did people from media and entertainment industry. Even sports associations came up with IPOs to raise funds to improve training facilities for sportsmen to improve their performance.

Countrymen liked the concept of these shares. They started trading in the shares. The value of these shares used to go up and down based on the performance of sportsmen and associations in tournaments, actors/actress/directors/writers etc. and success of movies/plays. Soon, like country A, people in country B also set up dedicated research desks to do fundamental research to find undervalued stocks. They did detailed research – for eg. For sportsmen, the research would cover the diet of sportsmen, to quality and no. of hours spent on training, environment of tournament, etc. while for entertainment industry, the research used to cover the diets, story of play, dialogues, dialogue delivery, music, etc. etc. Innovative products like derivatives and credit products like CDS followed too.

Country C has a lot of wealthy people, who loved horse races. The king too was a keen follower. So he decided to promote this industry. He then allowed horse owners and jockeys to issue shares to raise funds, so that they can afford better training facilities, diet and can concentrate on better performance during the race. Like the other 2 countries, it picked up quickly and people started trading in the shares. The prices of these shares used to go up and down based on the performance during such races. Research desks were set-up soon and they covered all aspects similar to what research analysts in country B covered sportsmen – diet, training facilities, hours trained, concentration, race atmosphere, etc. Derivatives followed soon. And the owners of horses demanded CDS products to insulate them from risk of untimely death/accident of their horses. And as it happens, where is demand, there is a supply.

Interestingly, while country A legalized and regularized trading in shares of companies, other 2 were considered to be betting and hence, illegal. Similarly, while country B legalized and regularized trading in shares of sportsmen, sports associations and people from entertainment industry, other were considered to be equivalent of betting and hence, banned. No different story for country C.

Well…..the story is over. And, I am sure that most of you would have got the message.

Hence, retail investors, who are investing in stock market, are no different from people betting on sports and horse racing. Just that the world evolved in a certain manner, legalizing and regularizing one while discarding others. Remember, the essence remains the same in all 3 cases.

Yes, I agree, that at the moment, the world has evolved in a certain manner. No offence to people working in this industry. It earns them a livelihood, legally. So carry on guys…

But retail investors…beware!!!

JJJ