Here’s a thought experiment. Imagine 5-19-year-olds going back in time to the early 1990s. How would they feel? As Chuck Klosterman writes in The Nineties: “It’s hard to explain the soft differences between life in the 2020s and life in the 1990s to any person who did not experience both of those periods as an adult—far more difficult than explaining the day-to-day difference between life in 1960 and life in 1990.”
Having lived through both periods, someone like me does know the difference. Back then, time was slow. It wasn’t an era when 20 things demanded your attention simultaneously, like this Monday morning.
I am trying to write this piece against a tight deadline. But I also want some good music playing in the background. My ears have heard enough of Miles Davis and are now demanding good old Altaf Raja. Oh, and while I have a Kindle copy of The Nineties, the book I quoted from, I now want to order a hard copy as well. So, I am on Amazon, ordering the book.
Meanwhile, the water I had put on the stove for my black coffee has come to a boil. In all this, I need to know what time the India versus West Indies T20 cricket match starts today evening. So, I log on to espncricinfo.com and then wonder if the new episode of Only Murders in the Building has dropped on Hotstar. In the few minutes it has taken me to write this, a few pesky calls have also demanded my attention.
The 1990s were different—one did only one thing at a time. I studied (or at least pretended to). I heard the radio. Watched TV. Went out and played. And even waited and waited and waited and waited… for the dull, dreary, long afternoons, when one had to pretend to sleep, so as not to annoy Momzilla, to come to an end.
In her excellent new memoir, the actor Deepti Naval has a perfect paragraph on the feeling I am trying to describe.
As she writes in A Country Called Childhood: “In the house next door, there were other ways of dealing with the breezeless nights. Munni’s mother would say, ‘Pur gino, pur! (Name the towns ending with ‘pur’). So, the kids would start counting, Gurdaspur, Kanpur, Jabalpur, Saharanpur, Ferozepur, Rampur, Sultanpur, Hoshiarpur, Lyallpur—and sure enough, twenty-one purs would bring in the breeze.”
Naval is talking about the late 1950s and not the early 1990s, but the sentiment is the same, where parents had to make up things to keep the children busy, like my mother’s insistence on a post-lunch nap on all holiday afternoons. (The after-effect is that I still need to take my post-lunch nap to function in the evenings).
The difference between Naval’s childhood of the 1950s and mine was that TV had entered our drawing rooms by that time. And given that evenings post a game of cricket weren’t as dull as the holiday afternoons and mornings tended to be.
Of course, there wasn’t much of a choice even on TV. Just one channel broadcasted a few hours of programming daily. And it wasn’t all entertainment—a lot of it was educational content (at least those producing it thought it was).
In all this, anything produced by Jaspal Bhatti was a must-watch. Full Tension was one such serial. In one episode, Bhatti satirized the entire process of an initial public offering (IPO) of a company’s stock.
But why was Bhatti talking about an IPO in the 1990s? Well, Full Tension was broadcast in 1994, and this was a time when many unscrupulous promoters were launching IPOs, collecting money from investors and disappearing.
The vanishing companies scam remains India’s biggest stock market scandal though it is the least talked about, with the scams of Harshad Mehta and Ketan Parekh being bigger in the public eye.
So, here’s the gist of the IPO episode of Full Tension. (You can see the episode on YouTube or read the next few paragraphs).
Bhatti is shown to be a chartered accountant in the episode. He and a friend are out eating golgappas (also known as paanipuri, phucka, batashe etc., in different parts of the country). The friend tells Bhatti he is thinking of buying 1,000 shares each of Hindustan Fever and Crooke Bond. Yes, you read that right. Those were fairly innocent days.
Please don’t try pulling off such a stunt today. It will get corporate communications professionals and their public relations agencies in trying to justify their salaries mode.
So back to the story. Bhatti tells his friend that the days of buying shares are over. It’s time to launch IPOs, collect money from the public and run your own business. His friend replies, “not every golgappa seller can come up with an IPO”. To this, Bhatti, looking at the golgappa seller, says: “If he wants, he can start a public limited company tomorrow morning and garner Rs 1 crore.”
This interests the golgappa seller, and he lands at Bhatti’s office the next day. Bhatti then unveils the full plan. The company will be called PP Waterballs (where PP stands for Prem Prakash, the name of the golgappa seller, and I don’t need to explain what water balls mean here).
Prem Prakash has a doubt: “Why would anyone invest in the golgappa business?” he asks Bhatti innocently. Bhatti explains this by saying that he will write such a report on the business of golgappas that people will think it’s a big food industry unit. (You see where this is going).
Bhatti then tells Prem Prakash that he would need around Rs 10-15 lakh to get the entire IPO going. Prem Prakash says he can borrow this money from his uncle Lal Singh who has a golgappa business in Southall, London. Bhatti turns this into another marketing stunt, where he says that PP Waterballs has a collaboration with Red Lion (Lal Singh in English) of London.
The IPO is successfully launched. Then comes an expert named Prasad, who keeps projecting the stock to retail investors and says it will only keep going up. Meanwhile, Bhatti, along with his Mumbai stock-broker (shown to be a peon at some firm), buys up the stocks of PP Waterballs, thus creating an artificial shortage and sending the stock price soaring.
After it has crossed Rs 100, they gradually start selling the shares and make huge profits, while retail investors are left holding on to nothing but a piece of paper (this was before the demat era came in).
Of course, this was a satire, and like any good satire, things were exaggerated to drive home the points that Bhatti was trying to make. But nearly three decades later, this excellent piece of satire remains as relevant as it was back then. Let’s try and understand why.
1) Last year saw a whole host of IPOs. In fact, data from the National Stock Exchange tells us that there were 63 equity IPOs during the year. Of these, quite a few IPOs were of loss-making companies or barely profitable companies engaged in the e-commerce business. The shares were priced at nosebleed valuations, with the companies seeking a huge amount of money from retail investors for a stake in their business.
Then, a huge amount of marketing was carried out to get investors interested. This included analysts and experts writing reports that these companies were god’s gift to humankind. One analyst projected earnings until 2041 to justify the high price of Zomato (Exactly as Bhatti did with PP Waterballs). What do they say about being able to justify anything on an excel sheet?
2) Of course, given the huge demand, everyone couldn’t buy the stocks through the IPO. Hence, many retail investors bought post the IPO, driving the price even higher in most cases. The experts and the analysts kept up the hype around such stocks, even after the IPO (like the expert named Prasad did with PP Waterballs).
3) In the case of PP Waterballs, Bhatti and his broker created an artificial shortage and thus fooled the retail investors. Nothing of that sort happened in the case of IPOs of loss-making companies. Nonetheless, like in the case of PP Waterballs, the entire system around the IPO is structured against the retail investors.
As I had written in a recent Mark to Market piece titled Zomato’s flop show raises many important questions: “At the heart of the current financial system are largely financial services groups which run investment banks managing IPOs, stock brokerages which help investors buy shares in an IPO, mutual funds and insurance companies which help investors buy shares in an IPO indirectly and finally, banks and non-banking financial companies, which are ready to lend money to investors looking to borrow and invest in IPOs.”
So, the system is so structured that it makes sense for insiders to drum up the price of an IPO. Of course, the outsiders (read the retail investors), who come to the party late, end up paying the price for it.
In that sense, the system continues to favour the insiders as it was in the 1990s, though things are nowhere as bad as they used to be.
4) In the case of PP Waterballs, the expert Prasad kept recommending that the stock would only go higher, which it did until it didn’t. In July 2021, analysts at a stock brokerage projected that the Zomato stock would touch Rs 255. A year later, when it was closer to Rs 40, they put out another report saying that it would now touch Rs 100.
The point is that the stock price of Zomato may or may not touch Rs 100, but the investors at least deserved an explanation on the previous forecast.
The job of stock market analysts is to drum up business for their brokerages. This can only be done by putting out buy ratings. A sell rating, by its very definition, limits the business to investors already with the brokerage. On the other hand, a buy rating can be used to get new investors to trade with the brokerage.
5) In Bhatti’s serial, once the stock price starts falling, there is a scene in which a few retail investors are talking. One of them says to the other, the price of PP Waterballs has started to fall; shouldn’t we sell it? To this, the other investor replies that he has bought the shares at a premium (that is, at a price higher than the IPO issue price) and will face a loss.
This is classic loss aversion at work. As Richard Thaler writes in Misbehaving: “Roughly speaking, losses hurt about twice as much as gains make you feel good…The fact that a loss hurts more than an equivalent gain gives pleasure is called loss aversion.” This explains why investors keep buying a dud stock to lower their average purchase cost, leading to an escalation of commitment. Bhatti was doing behavioural economics, for which Thaler got a Nobel Prize in 2017, in the 1990s.
Naturally-occurring Ponzi scheme
Before we define what a naturally-occurring Ponzi scheme is, we need to describe what a Ponzi scheme is.
A Ponzi scheme is a fraudulent investment scheme in which older investors are paid using money brought in by newer ones. It keeps running as long as the money brought in by the newer investors is greater than the money paid to the older ones. Once this reverses, the scheme collapses.
Or the scammer running the scheme runs away with the money before it collapses.
The scheme is named after an Italian-American, Charles Ponzi, who tried running such an investment scheme in Boston in 1920. He had promised to double investors’ money in 90 days. At its peak, 40,000 investors invested $15 million in Ponzi’s scheme. Not surprisingly, the scheme collapsed in less than a year under its own weight. All Ponzi did was take money from newer investors and pay off the older ones.
The dynamic at the heart of a Ponzi scheme is the money being brought in by the newer investors driving returns for the earlier ones. This dynamic is at the heart of a naturally-occurring Ponzi scheme as well, without the financial fraud part.
Robert Shiller defines this in his book Irrational Exuberance as follows: “Naturally-occurring Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere.”
This is precisely what happens at the time of an IPO, particularly when the company isn’t making any money. The lesser the prospects of earnings, the more the talk. The more the talk, the more the demand for the stock during the IPO and after it lists (hopefully). The greater the demand, the greater the price rise on listing on exchanges.
As Shiller writes: “When prices go up a number of times, investors are rewarded sequentially by price movements in these markets, just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the market [in case of an IPO, the specific stock] will go up further.”
Of course, there is no fraud happening here like it is in the case of a Ponzi scheme. Nonetheless, the system is rigged against the retail investor, especially in the case of loss-making companies where promoters are allowed to sell a part of their stake through the IPO.
The IPO is not gathering capital from investors to expand. It is just allowing the promoter of a loss-making company to exit. This exit resembles “a Ponzi scheme when it is supported by naturally-occurring stories.”
The broader conclusion here is that the stock market regulator needs to look at the process of allowing loss-making company IPOs in the future, especially letting promoters of such companies dump their shares on the public.
On the flip side, retail investors have something to learn all over again. As Aswath Damodaran recently wrote: “No matter how tempted you are to blame the financial news, journalists, equity research analysts and others for your decision to buy Zomato at its heights, that decision was ultimate yours, and the first step in becoming a good investor is taking ownership of your decisions. Put bluntly; if you live by momentum, you die by it.”
This happens primarily because most retail investors invest on hearsay. They invest in something because their friends, family, colleagues or social media influencers they follow are already doing something similar. This may work briefly but over a reasonably long period of time is a recipe for disaster.
As a retail investor, it’s better to buy a broad bouquet of large-cap stocks or simply invest in an exchange-traded fund or an index fund if you don’t have the time, inclination, mental bandwidth and smarts required to figure out which stocks to invest in and the ones to avoid.
Since we started with the 1990s, let’s end with that as well. Your investment strategy should be like the old Hero-Honda advertisement, fill it, shut it, forget it. Chasing the hottest new IPO in town isn’t going to get you anywhere. I guess many people must have already learnt that over the past year.
PS: I am taking a two-week break from writing. The next issue of Easynomics will be on 24 August. See you then!