It’s the end of the world as I’ve known it, but I feel fine

By the end of October, our landlord would come visiting every Saturday morning, knowing that I would go to the office late over the weekend. And every time he visited he wanted a ’tip’, or as he put it, a ’teep’.

Being new to the city and its investing culture, the first few times I had no idea of what he was asking for and I turned the conversation to other topics of mutual interest, like the weather, the maid, the state of the city, and the state of the nation.  

Eventually I did figure out that he was asking for stock market tips: basically, recommendations of stocks, in particular stocks that the punters were planning to run up. The way it would work is that some stockbrokers would come together and decide to drive up the price of what was usually a penny stock by buying and selling the stock among themselves. This was referred to as circular trading, or more popularly as a “chakri" in the kya lagta hai stock market lingo.  

Given the low volumes of such stocks, as soon as this pre-agreed buying and selling would come in, the price of the stock would start to go up. Once the price went up regularly for a few days, it would appear on the radar of retail investors looking to make a quick buck. Once retail buying started to come in, the chakri operators would sell and quickly exit the stock.  

Like in any Ponzi scheme, the sooner you entered such a stock, the more money you made. But by the time the retail investors would enter such a stock, its price had already been run up as much as the operators wanted it, and it was time for them to sell. This would lead to the stock price falling, with retail investors usually losing money in such situations. As is the case with almost every financial market, the insiders took the outsiders for a ride.  

My landlord thought that as I worked for a newspaper I would have access to insider information on such setups and be able to share some ’tips’ with him. Now, as it turned out, I had no access to such information. The landlord equated the lack of tips from me to the absence of a quid pro quo. So, before I could scratch his back, he decided to scratch mine, and started giving me tips. These would typically be penny stocks.  

Dear reader, we are in 2024, and close to two decades have passed, so you might be wondering what triggered this memory. Well, in the recent months, I have been asked for stock tips after many years: investors want tips on which small cap stocks they should put their money in. They also want to know which initial public offerings, especially those of small firms that list on the small and medium enterprises platform of stock exchanges, they should invest in, and how long after listing should they hold on to the stock.  

Like I had no information to offer in 2005, I have no information to offer even now. But what I do have to share is some information regarding IPOs that the Securities and Exchange Board of India (Sebi) recently shared.  

1. Individual investors sold 50.2% shares (in value terms) allotted to them within a week after listing. Basically, on average, half of the shares allotted to individual investors in an IPO were sold within the first week of listing of the stock on the exchange.  

2. Like my Gujarati landlord’s love for tips, Gujaratis on the whole love the idea of investing in IPOs. As Sebi points out 39.3% of retail investors in IPOs were from Gujarat, followed by those from Maharashtra (13.5%) and Rajasthan (10.5%). In fact, given that many Gujaratis live in Mumbai, the Maharashtra number must also be primarily made up of them.  

3. When returns were more than 20%, individual investors sold 67.6% shares by value allotted to them within a week of the stock listing. In comparison, they sold 23.3% shares by value, when returns after listing were negative, meaning that the market price of the stock was lower than its issue price. 

This basically implies that when the stock price goes up after listing, and investors are sitting on profits, they tend to sell too quickly and book profits, whereas when the stock lists at a price lower than the price it was issued at, investors tend to hold on to the stock and not sell it immediately. 

This tendency has been widely studied by economists and is referred to as loss-aversion. 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. So, we experience life in terms of changes… and losses sting more than equivalently-sized gains feel good."  

The concept of loss aversion was introduced by renowned Israel-American psychologists Daniel Kahneman, who won the Nobel Prize in Economics in 2002, and Amos Tversky, who would have shared the award had he not passed away in 1996.  

As mentioned earlier, loss aversion refers to the tendency for people to prefer avoiding losses over acquiring equivalent gains. This idea stems from Prospect Theory, developed by Kahneman and Tversky, which suggests that individuals are more influenced by potential losses than gains because losses evoke stronger emotional reactions. 

Research in behavioural economics consistently shows that people feel about twice as much pain from a loss as they experience pleasure from a gain. For example, the excitement of a rising stock market index doesn’t match the emotional distress felt when it plunges, which is why these days the term ’stock market crash’ starts trending on social media even when the broader indices fall by as little as 1%.  

Another reason people stick with losing investments is their difficulty in admitting their mistakes. They often hold on, hoping to recover their losses. As Jason Zweig writes in Your Money and Your Brain, quoting Kahneman: “When you sell a loser… you don’t just take a financial loss; you take a psychological loss from admitting you made a mistake. You are punishing yourself when you sell… On the other hand… selling a winner is a form of rewarding yourself."   

This tendency to sell winners early and hold on to losers is one of the many problems I have had with the fascination of individual investors with IPOs.  Here are a few others.  

1. The demand for an IPO doesn’t always guarantee long-term gains. As a Bloomberg newsreport published in January pointed out: “Indian IPOs have failed miserably at generating additional returns for investors over what they would have earned passively from just owning a broad benchmark. 

About 77% have underperformed the NSE 500 Index over a 10-year period, with average underperformance of more than 14% annually." But just owning stocks that make up for an index that already exists and hoping to make money from it is an extremely boring idea. In comparison, chasing the mirage of IPO returns is fun. It gets the adrenaline going. It creates talking points.  

2. While strong demand can lead to impressive percentage gains on listing day, the limited chances of getting an allocation mean the potential for absolute gains is reduced. 

3. An IPO isn’t the only opportunity for retail investors to invest in a company’s stock; shares can be purchased at any time after the listing.  

4. If retail investors believe a stock has strong potential, they should consider gradually accumulating it over time. This is particularly important for those whose financial situation may not allow large one-time purchases. In fact, true wealth creation for retail investors often comes from post-IPO investments or by simply sticking to regular investing through equity mutual funds.  

5. Building wealth over the long term can seem unexciting. The thrill of securing an allocation in an oversubscribed IPO, talking to others who did not get allocation about it, and enjoying listing day gains is hard to beat. However, keep in mind that these gains are significant mainly in percentage terms and not much money is made in absolute terms. It’s possibly a part of the icing on the cake that will never be built. Getting rich is all about making money in absolute terms.  

6. There is a tendency amongst retail investors to want to speed up the process. They have come to a realisation that investing in the stock market is the way to riches. And now that they know that they want to speed up this process by actively and continuously managing the little money that they have. Investing in IPOs is a part of that thinking.  

As Morgan Housel writes in Same As Ever—Timeless Lessons on Risk, Opportunity and Living a Good Life: “Whenever people discover something valuable— valuable—particularly a lucrative investment or a special skill—there is a tendency to ask, Great, but can I have it all faster? Can we push it twice as hard? Can we make it twice the size? Can we squeeze some more juice out of it?" Nonetheless, it is worth remembering that “most things have a natural size and speed and backfire quickly when you push them beyond that".  

Indeed, even Warren Buffett, whose name keeps getting dropped in the world of people managing other people’s money, made much of his wealth after he turned 50, and he did that by staying invested for the long-term. As Housel writes: “Warren Buffett once joked that you can’t make a baby in one month by getting nine women pregnant." 

But this isn’t the world in which talking about such things makes much sense. Over the last few years, many individual investors have moved on from one bubble to another. First came the fascination for investing in cryptos. It was followed by punting in small cap stocks. Then came public sector stocks and stocks across several sectors, driving up their prices to astonishing levels.  

As Pankaj Tibrewal, founder and CIO of IKIGAI Asset Manager, had tweeted in July, quoting data from Bloomberg Intelligence: “India’s industrial sector (construction and machinery) has almost touched more than $425 billion in market capitalization, surpassing Germany’s and Korea’s, but India’s aggregate sales and EBDITA (earnings before interest, taxes, depreciation, and amortization) are just one third of those countries, though with similar growth profiles. Total market capitalization of shipbuilders in India is now 75% of Korean shipbuilding sector with sales 5% of Korea’s."   

This does not mean that many retail investors haven’t made money. They have. But clearly there is a problem on the valuation front. Many stocks that retail investors are invested in and are still investing in are priced much higher than what their earnings justify.  

We are busy punting IPOs of small firms listing on the small and medium enterprises platforms of the stock exchanges. IPOs of firms wanting to raise a few crore rupees have been subscribed hundreds of times over.   

Amid all this, trading in financial derivatives, primarily options, where 90% of the traders lose money, has gone through the roof. Further, 71% of the investors carrying out intraday trading also lose money.  

But that doesn’t seem to be stopping most from betting, and betting big. With due apologies to the American rock band R.E.M., I guess this is the end of the world as I have known it, but I largely feel fine, of course, on most days.   

In the end there are two kinds of investors in this world, those who invest like my former landlord and those who invest like my former landlord. As Zweig puts it: “Holding losers too long and selling winners too soon is no way to get rich, but it’s how nearly everyone invests."