Don’t follow, find your way to the market
When Mark Twain said this, he was probably referring to investors who tend to follow the herd, lose money and then blame the stock market for it. Experts have time and again warned the investors on this.
Benjamin Graham and David Dodd in their all-time classic, Security Analysis, explain the way a stock market works. They say, "The market is not a weighing machine on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather, should we say that the market is a voting machine, where countless individuals register choices which are partly a product of reason and partly of emotion." Given this, at times the market moves like a herd. The interesting question is, "Why does this happen?"
Robert Shiller in his book, Irrational Exuberance, says, "A fundamental observation about human society is that people who communicate regularly with one another think similarly. There is at any place and in any time a zeitgeist, a spirit of times". Marketing research has shown that a typical Indian's decision is heavily influenced by the actions of his acquaintances, neighbours or relatives.
Psychologically, the desire to conform to the behaviour and opinions of others, a fundamental human trait, is what drives such buying behaviour.
So if everybody around is investing in a particular manner, the tendency for potential investors is to do the same is more likely. Like sheep in a herd, investors find it cosy to be inside the herd rather than outside it.
Another interesting observation is the order in which investors take decisions. Ants, when they get separated from their colony, obey a simple rule: follow the ant in front of them. Much like the circular mills of ants, investor decisions are made in a sequence. This does not always work out to their good as investors who put money in IT stocks in 2000 might have found out.
A wealth creation study by Mumbai-based broking firm Motilal Oswal for 2000-2005 clearly bear this out. The study identified the 100 top wealth creators during 2000-2005 in the Indian stock market.
These companies have added at least Rs 100 crore to their market capitalisation for the period, after adjusting for dilution. Out of the 100 companies that made it to the list, there was only one IT company — Infosys.
As the study rightly points out, "Fad investing at exorbitant valuations took a toll". Investors who bought at high valuations in 2000 clearly lost out. They thought that they were safe being a part of the herd, but it clearly did not work out well for them.
A disciplined investor does not blindly follow the herd. He searches for stocks whose true value has not been recognised by the stock market, buys them and then waits for the stock market to recognise the right value and correct the disparity.
Easier said than done, for, being a disciplined investor requires time and hard work. Most investors in the market operate on hearsay or on supposedly insider information. Some of them even try to time the market. They tend to forget the golden rule of the stock markets — time in the market is more important than timing the market. And time in the market comes from a thorough understanding of the company's business.
