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B for Bubble?

May 11, 1997

Suddenly, there is a new-found craze for the B-word: the B1 and B2 shares. These B group shareswere so badly mauled in the last bear market that, as far as I was concerned, B meant bust, brokeand other such words that depict the act of seeing a share I purchased for Rs 10 trade at Rs 3 - andthat too only 100 shares a month!

But, recently, the brokers and the media have started playing on this new word and are now toutingthis B group to lead the way in the next wave of the bull run. In fact, so enamoured are we fundmanagers with our B-group shareholding that we were suckered into buying in the mania days of1994, that we have begun to mislead our investors and clients about how this class of shares haveperformed.

To give you a quote from a report by a fund manager to his shareholders, published before thebudget when the B word was still deep down in the toilet bowl flushed out of existence. "An upsurgein interest from domestic investors stimulated significant appreciation among smallest stocks and theFund comfortably beat the Dollar in the fourth quarter (meaning October to December 1996)".

Imagine, this fund management group had the audacity to tell its shareholders that the rubbish sittingin the portfolio between December and February actually rose faster than the good, solid stuff asrepresented by the BSE-30 Index. They also made a very questionable statement that "domesticinvestors stimulated" this rise: I guess if you call a dozen sattavallas "domestic investors" you aretechnically correct although it is a little distant from the vision of thousands of eager investors rushinginto their brokers' offices that most readers may have when they read such a statement.

And this fund management group does not seem to be the only one to subscribe to the theory that, ifyou believe in something so much, it may actually come out to be true. Another fund report, writingabout the identical 3-month time period between December 1996 and February 1997 also claimedthat the small cap stocks did a lot better than the bigger guys. To quote: "In January 1997, themarket is already up 25% from its lowest level. Penny stocks and mid-cap companies are theoutperformers in this move". Many of our fund managers seem to have taken this poetic licence a bittoo far in describing the movement of shares in the market!

And now you have the press joining this bandwagon of chanting "B, B1, B2 - just be there." Whilenot denying the movement in a select group of shares that can be classified as mid-cap stocks in theB1 category, I think it is important to put these events and price movements into perspective. Manymarketmen, fund managers, and brokers believe that share prices are going to hit the 4,500 levelwithin the next few months. If this were to happen, then the large market cap stocks (represented byHDFC, Hindustan Lever, MTNL, State Bank, and Telco) would become a little on the expensiveside with their PERs looking a little stretched and certainly without any further immediate upwardmovement. An Index of 4,500 would suggest a price of Rs 3,800 for HDFC, Rs 1,300 forHindustan Lever, Rs 350 for MTNL, Rs 375 for State Bank, and Rs 450 for Telco - prices whichFIIs are unlikely to buy more shares at. So, since the FII will not buy these larger market cap stocks,they will turn their attention to the more reasonably priced mid-cap stocks: the B word, the B1shares!

This argument goes on to say that, given this scenario of a 4,500 Index and fully-priced "A" groupshares and having turned his attention to the B1 shares, the FII will be all set to buy the B1 sharestomorrow but, being a smart FII, rather than buy the mid- cap stocks tomorrow - which anyway theFII was going to do - the FII will buy the mid-cap stocks today! So, what has to go up tomorrowwill start going up today! There is absolutely nothing wrong with this logic. And I subscribe to theflow of thoughts. The problem in this argument lies in its timing.

What if I assume that the Index is going to go the other way: southwards, to the 3,500 level? Whatwill the FII do in this scenario? Looking for value and good liquidity he can actually buy all the bluechips at lower prices: about Rs 2,900 for HDFC, Rs 1,000 for Hindustan Lever, Rs 270 forMTNL, Rs 280 for State Bank, and Rs 350 for Telco. If he does that, he can make a good profitwhenever the Index turns up again to the 4,500 level. A 30% profit from liquid shares which you cansell and book profits from seems a lot better than a book profit of 20% on a B1 share where youseem to be the only buyer or seller on any given day!

Also, if the market turns down instead of up over the next one month, guess what will happen to theshare prices of the mid-cap stocks? With no FII to buy them, their prices will fall even further thanthe big caps - just as they did in the last bear market between 1994 and 1996. None of the reportsto buy mid-cap is based on the argument that the company is doing better than expectations - no, allthe arguments to buy B1 is based on the demand factor; the potential FII demand, the promise ofmore money coming in. And, put the Index down to 3,500 and see how quickly that potentialdemand disappears.

None of this is to suggest that B is ugly. As we all know, small is beautiful but it may not be the righttime to think that way. The B1 stocks will flourish when the big market caps are expensive andgetting more expensive each day - in a northward bound market. And, based on a sideways tosouthward market, the time for mid and small-cap may not yet have come.

India will take its place as an economic power house side by side with China and the OECDcountries but the time for that is a little far away: that is a long view thought process. The B1 storywill happen much before India emerges as an economic giant and the B2 story (which will benefit allthe rubbish I have in my portfolio) will also happen a little before India's economic dominance but,meanwhile, stick to the tried and tested - it should be a little more profitable.

So if your broker calls and says how FIIs are about to unleash their power on the B group,remember the little sentence at the bottom of your bill: Buyer B-ware.

Big Stocks did 40% better than small ones! Dec 4, 1996 March 9, 1997 % ChargeBSE - 30 Index 2,745 3,944 +43.6BSE - 100 1,217 1,711 +40.5*BSE - 70 +31.2CRISIL - 500 530 730 +37.7*CRISIL - 470 +30.4* Excluding BSE 30 Companies

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