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What Retail Investors can Learn from the HDFC Saga

Apr 21, 2022

An average American has an IQ of 98.

Anyone with an IQ more than 130 is considered very intelligent as per psychologists around the world.

Now imagine if you knew someone with an IQ of 200. Yes, you read it right. An almost double century IQ

An IQ of 200 = 'Genius'.

Sir Isaac Newton had an IQ of 200. Undoubtedly was one of the smartest people to have walked on this planet. The man who found the 3 basic laws of physics on which the modern world operates was indeed a genius.

However, there is one thing which even Sir Isaac Newton failed at miserably - The stock market.

In fact, Newton lost his entire fortune in the stock market.

Newton was one of the early investors in South Sea Company, which was founded in 1711 to trade with Spanish America. In 1720, the company bagged a deal to manage British government debt. As soon as the news spread, the price of the South Sea stock started soaring.Newton, who was then the warden of the Royal Mint in London, wisely chose to book profits and pocketed a handsome gain of about £20,000, a princely sum in those years.

As the euphoria around the stock kept on inching higher with every passing day, Newton could not resist the temptation of buying the hottest stock in town once again. He invested nearly all his money into the venture.

The man, who developed the calculus and formulated the laws of motion, ended up buying the stock almost at the peak of the bubble.

The stock collapsed, most likely because investors began to realise their profit expectations were unrealistic.

In less than a month, the stock was worth less than a quarter of its peak price. Newton's net worth was down to about £20,000; he had lost all his early profits and a good bit more besides.

How on earth does the smartest person in his times lose a fortune in stock market?

No wonder every time the market turns irrational, we are reminded of what Sir Isaac Newton stated during the bubble, "I can calculate the movement of the stars but not the madness of men".

I'm sure the merger news of HDFC and HDFC bank was widely tracked by almost everyone in the market.

After all it was a big moment in the banking industry. The markets gave it a thump up. Both HDFC and HDFC bank hit 15% upper circuits during the day.

The merger would make HDFC bank the second largest company by market capitalisation surpassing TCS and only second to Reliance Industries.

Unfortunately, as we know the merger turned out to be the biggest anti-climax for the HDFC group in terms of stock price reaction the following week. HDFC and HDFC Bank stocks declined by 20% and 15% from the highs post the merger news.

While enough has been written on merger synergies, let me focus on the price action and how retail investors get trapped when a corporate event happens.

The first and foremost rule in stock market when a corporate event happens is 'Sell on News'.

The logic is simple.

There are people much smarter than you and I combined who know of developments already happening in the company.

And that is precisely what happened with the HDCF twins. It was a perfect exit for FIIs at the expense of retail investors. Foreign investors who owned a high percentage of the float of the HDFC twins got a brilliant opportunity to exit the stocks at much higher prices.

While retail investors got trapped in the momentum created by news flow, foreign funds trimmed their positions.

Isn't a 15% up move in companies with Rs 4-5 trillion marketcap abnormal? Nothing is as good or as bad as it seems.

This sums up the euphoria on the merger day. The way the stock prices reacted was as if the market share post-merger will double.

The question which retail investors should ask themselves is, what changed that warranted a massive 15% move in stocks which are considered defensive?

I mean whatever the synergies are, wont they take time to play out? Mind you, the merger will be completed in FY24.

So why the euphoria?

Markets always have a knee jerk reaction to everything. Both on the upside as well as the downside.

If you see the FII selling figure in both the HDFC and HDFC bank, they have been selling shares worth Rs 20-30 bn almost every day since the past 5-7 days.

That is huge.

Even if you look at fundamental reasons, the premium valuation which HDFC bank has compared to peers like ICICI Bank and Axis Bank isn't justified.

On a lighter note, HDFC bank stock hit a 52-week high and IS approaching a 52-week low, both in the same month. If this is not a case of both euphoria and 'sell on news', then what is?

My suggest avoiding a stock during such euphoria as 99% of the time, the euphoria dies down.

Unfortunately, in the case of HDFC twins the fall was excessive.

From a long-term perspective, people who invested at peak prices on the merger news may not incur a loss. But my point is different. The question here is, will HDFC Bank outperform other banking and NBFC stocks?

What is the opportunity cost of the waiting period to find out? To recover 15%-20% just to reach the cost price is an opportunity lost.

Warm regards,

Aditya Vora
Research Analyst, Hidden Treasure

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