What is CMP in the Stock Market?
In previous times, the stock market was a physical space that traders set up offices and desks at, and stocks, shares and bonds were traded in physic…
03 Dec, 2021
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A beginner investor's guide to stock split, the headline-making IRCTC stock split and its dramatic stock price spike and dip.
When you receive a piece of mithai or a single pastry in the office for someone's birthday or some such, you usually eat it yourself. However, when you receive a box of mithai for Diwali or a whole cake for New Year from clients and associates, you typically share these with your family or partner or loved ones.
An amateur investor's synopsis/ quick guide into what exactly happened: what is the IRCTC stock split and how has it panned out?
Something similar took place in the case of the IRCTC stock split. The share prices reached an excellent share price of over Rs 1200 around the middle of October this year. At this point, IRCTC decided to go for a stock split with the aim of increasing liquidity and reducing the stock price, making the stock a viable purchase for a larger cross section of potential shareholders
Just like your a whole mithai box is a challenge to finish independently (maybe not for your taste buds, but certainly for your insulin) a single IRCTC share, priced at over Rs 1200 might present a challenge because a lot of potential buyers might find this too expensive, especially because shares are purchased in lots. Meanwhile, the IRCTC share split is aimed at reducing the per-share price by dividing it by the ratio of the split, in this case, 1:5. What happened in the interim has been a little unprecedented, however, because share prices rose by nearly 150% following the announcement, to unsustainable levels of over Rs 6,000. Of course, this was possibly the result of knee-jerk reactions and the price has drastically rationalised since the IRCTC share split date on October 29. At the time of typing this post, the share price stands at a little over Rs 850.
How a stock split works:
A stock split divides the number of shares as decided by the company. If you own 100 shares and the company does a 1:5 split, as IRCTC did, then you will own 500 shares. Each share might reduce in its individual value, but the underlying value of the investment will not change.
The company will usually announce the share split a few days or weeks in advance of what is known as the record date, which is the day that the actual split occurs.
In the case of IRCTC, the announcement was made on July 3o, 2021 and the record date was October 29, 2021. This 3 month period gave the market sufficient time to go completely out of control and drive the stock price up over the moon to completely unrealistic levels.
The biggest losers and winners:
Of course, this bodes very well for shareholders who already held the stock who would have achieved much more than their target price in a much shorter time.
Similarly, investors who bought shares at the start of the uptrend following the IRCTC stock split announcement and sold before prices rationalised to normalcy after the IRCTC share split date could potentially have also taken home potentially high earnings depending on where on the uptrend they bought and at which point during rationalisation they sold.
Investors who held on to shares unnecessarily during the peak out of greed might have missed the bus on these larger than usual gains because now that the hype has died, nearly no market expert seems to think that stock prices will reach such peaks that were experienced during prior to the IRCTC share split date.
It might be interesting to note how different categories of investors behaved during the July to September period:
- AMCs reduced their holdings
- Foreign portfolio investors also reduced their holdings
- Individual investors increased their holdings
- Retail investors drastically increase their holdings
Any learnings to be taken from this episode?
Are you a thinking investor who is wondering, "Why did stock prices surge through the roof and then fall so horribly?"
If you are, you are on the right track because you are trying to understand the nature of Mr Market, as the father of investing Benjamin Graham (and Warren Buffet's mentor) would refer to the stock market. The market, Graham always underlined, behaves very emotionally. Stock prices, he indicated, do not necessarily say anything about the actual worth of the stock price and can be driven up and down by fearful or greedy investors and countless other forces. He said that investors should use financial data and certain metrics - like price to earnings ratio, price to sales ratio and price to book ratio - to decide the actual value of a stock.
It would appear like that's not what investors did here: instead, driven by hype, investors bought and bought shares even while the prices rose to unrealistic levels, apparently hoping that the prices would continue to rise. Some probably even used logic and arrived at the conclusion that IRCTC would be a good investment because the Indian Railways seem to be doing good business. They might not have been wrong but they forgot to ask one fundamental question: what is a good entry price?
So the lesson to be learned here is to always evaluate a stock by value investing methods. Learn to use value metrics - like PE ratio, to begin with. This will tell you how a stock's price compares to its actual earnings. If the earnings outweigh the price, value investors typically hold on to the stock or might choose to buy in, if other factors are in line. Alternatively, the stock price outweighs the earnings, the price is seen as inflated by value investors. They usually predict the price is due for a correction (or price drop) soon and will usually sell the price before - or as soon as - the downtrend begins.
Of course, investors who sold at the peak clearly played their cards right.
Conclusion:
Value investing and careful research can help you avoid hype, fear and greed that cause poor decision making when buying, holding and selling stocks.
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