FORECASTS

Sunday, November 15, 2009

All investment decisions are based on forecasts of the future. No investor would ever incur stock market losses if he could accurately predict the future. A bull something today with the expectation that it will be more valuable tomorrow. A bear, on the other hand, sells because he thinks the value of what he sells is likely to decline in the future. If both the bull and the bear knew what tomorrow would bring, their chances of going wrong and whether the future is predictable or not is a purely academic question insofar as the stock market investor is concerned. He really has no option but to try and predict it, otherwise he would not be able to function at all.

The finance minister frequently makes major policy announcements based on his forecasts of the economy’s future. A whole group of institutions such as the Planning Commission, National Council of Applied Economic Research, Center for Monitoring the Indian Economy and the Reserve Bank of India periodically publish reports giving future projections on the rate of growth of the GDP, industrial production, inflation and agricultural output. In fact, all our thoughts and actions are based on the underlying premise that the future is predictable. Civilized life, as we know it, would not be possible in the absence of a strongly entrenched belief that events succeed each other according to a pattern that can be discovered and understood.

All forecasting depends upon a sound understanding of reality. In the stock markets, the realities are the pace and direction of economic change, corporate strengths and weaknesses, capabilities of corporate managements, shifting perceptions of investors, potential power struggles, market psychology, impact of technology is devoted to an understanding of these realities.

SHARE PRICES AND FACTS

Friday, November 13, 2009

Share prices are determined by investor perceptions of value. There is no such thing as the intrinsic value of a share. There is also no objective yardstick for measuring the value, or price, of a particular share. All perceptions of value are subjective in nature. They reflect what investors, in their collective judgment, perceive the value of a particular share to be at a particular time. And, what is more, there is not stability about either the individual investor's perception or the market's collective perception of value. Both are subject to frequent, and often unpredictable, changes. This is the main reason behind the high volatility observed in daily share price quotations. By and large, an investor's perception of value is determined by his expectation of how a share will perform in the future. This expectation is, turn, strongly influenced by numerous factors, some of them factual and others purely psychological, like prevailing market sentiment, current market behavior, economic and corporate news, views of widely followed analysts, dividends, bonus and rights issues, the international exchange rate of the rupee, threat of war, monsoons, rate of inflation, interest rates, fears of political instability.

In the short run there is often little connection between the success of a company's operations and the performance of its share on the stock markets. In the long run, however, there is a strong, an almost hundred percent, correlation between the performance of the company and the movement of the market price of its share. In the long run, share prices must move to reflect the strengths and weaknesses of their underlying companies. This short-term divergence between the company's operational success and the market performance of its share provides an opportunity to make money. However, this opportunity can only be exploited by investors who know that this diverseness is short-lived and will narrow down over a period of time. The key to making money on the stock market is to look for successful companies whose current share prices, because of negative or lagging investor perceptions, do not reflect the fact they are successful.