Stock  Taking

Brokers or Market Breakers?

by Rabindra Bhattarai

When the Nepse Index tumbled 11.75 points in a single day on March 25, the first impression that it had in the market was of an impending catastrophe. Though the stock exchange explained that it was due to the de-listing of Nepal Bank Ltd. and the stock dividend declared by Himalayan Bank Ltd. (HBL), in reality it was thanks mainly to the manipulation of the market by the brokers. Though such manipulation is allowed under the existing rules of Nepse, it is quite against the principles of the stock market.

When HBL closed its share transfer book from March 2 to March 25, 2004, in preparation for its 11th AGM, the closing price of the bank’s shares in the stock exchange on  March 1 was Rs. 990. March 2 thus became the ex-dividend date, which means that the person who buys shares on this date or later would not receive the dividend that would be approved by the coming AGM. However, there also is another date, called the “holders' of record date” by which the shares purchased earlier than the ex-dividend date must be recorded in the company’s shareholders register. If a person has bought the shares before the ex-dividend date, he will not be entitled for the dividend declared by the AGM in case the broker fails to get the transfer recorded in this book by the “holders' of record date.” Both of these shareholders (who bought the shares on or after the ex-dividend date and who bought them before the ex-dividend date but failed to get it recorded in the company’s books by the “holders' of record date”) do not get the dividend. Such dividend will go to the person whose name is recorded in the books on “holders' of record date.” Elsewhere, the “holders' of record date” is usually four days after the ex-dividend date, but in Nepal it is learnt to be fixed at 5 days after the ex-dividend date. However, even when the company’s share transfer book is closed, the transaction in its shares can continue in the Nepse floor as usual.

And this was the case in HBL shares on March 25.

The price regulation system of Nepal stock exchange explains that the opening price of any day shall not be more or less than 5 percent of the previous transaction day’s closing price. It means the buying broker can quote the price up to 5 percent less than the previous day’s closing price while the selling broker can quote 5 percent above the previous transaction day’s closing price. But this restriction of 5% plus or minus is not applicable for the first transaction on a stock after the book closure date. As the March 25 transaction in HBL shares was such first transaction after the book closure, there was no restriction on quoting any price on HBL shares on March 25. But going by the principle of stock trading, the price quoted for HBL on that day was totally unreasonable.

Theoretically, the share price should fall down after the book closure by an amount equal to the amount of cash dividend, in case the company is going to distribute cash dividend. For example, if the share price of XYZ Company on one day before the book closure was Rs. 300 and the company had declared Rs. 10 per share as cash dividend which was to be formalised in the coming AGM, the price per share in the first transaction after the book closure should be around Rs. 290. In case of stock dividend (bonus share), the price per share in the first transaction after the book closure date should fall by the rate of stock dividend in the previous day’s closing price. In this example of XYZ Company, if it declared to distribute 10 percent stock dividend (instead of cash dividend) the share price in the first transaction after the book closure should fall to around Rs. 272.72 (Rs.300/1.10).

But this principle did not apply in this case of HBL.

The first transaction in HBL shares after the book closure took place at Rs. 600 as compared to the previous closing price of Rs. 990, thus reducing the price by Rs. 390. This was not according to the market rational. As HBL declared 25% stock dividend, the rational reduction in the HBL price should have been only Rs. 198, plus or minus a small percentage, and the HBL shares on that day should have been priced around Rs. 792 (Rs. 990/1.25).

Some time back, the brokers’ association had decided that no broker should quote the price of the stocks unreasonably below or above the rational price. But that long standing understanding among the brokers was broken this time. Though only 52 units of the HBL shares were traded on that day, that was enough to plunge the Nepse index substantially.

Though this price quote was not illegal, this system is not in accordance with the principles of the stock market and it will not improve investor confidence in the secondary market. The price was very good for the buyer, but the seller lost a lot. The brokers, in some further case, may also cause similar irrational gain to the seller and loss to the buyer if this rule continues. Either way, it does not help in enhancing market efficiency.

Will the concerned body take note of such irrational transactions and develop appropriate governing rules?

(Bhattarai teaches Finance to the MBS students)

Evaluate Stocks Don't Pay More

by Jeevan Basnet

Common stock investor holds a piece of paper, an engraved stock certificate, which can be sold in stock market at a price that varies from moment to moment and which is often unreflective of the balance sheet value. But there is a pre-determined price of stock derived from its true and inherent worth. This ‘intrinsic’ price of valuation of the stock generally differs from the market price because no two investors ever agree on what the intrinsic price of a particular stock ought to be.

There are numerous modalities to calculate the buying price of a stock and it has been observed that one methodology applied in a particular scenario may not be a useful guide at others. However, though the price so calculated may not be completely authentic or exact, it will nevertheless be a point towards formulation of a price based on reasonably sound judgment on whether the stock is overpriced or under-priced. Three main criteria are generally regarded as crucial in this context: a satisfactory ratio of earnings to price, a sufficiently strong financial outlay and the prospect of its earnings over the years.

All said and done, we prescribe here a model to detect what price should an investor pay based on the famous price-to-earning (PE) ratio citing Everest Bank stock as the example. Needless to say that this ratio is a numerical shorthand for the relationship between the stock price and the earnings of the company. Since components relative to stocks (earnings, market price, future prospect) are more or less brought to a point (valuation), this simple method is highly practiced everywhere. It is often a useful measure to assert whether a stock is overpriced, fairly priced or under-priced relative to a company’s money making potential.  

Average PE for the last three years:

16.1+13.3+18.9/3 = 16.1

Intrinsic price on the basis of PE ratio:

16.1 x 29.8 = Rs. 479

With this simple calculation investor can at least set his mind with the theme of acquiring and holding suitable stocks at suitable prices. However, one should not forget significant added consideration like measure of managerial competence, progressive dividend history and long range trend of the average market value. A stock combined with these intangible soundness with proper price paid shall never fail you. The intrinsic price of Rs. 479 for EBL stock is only the starting point to get involved in share business. How much money can be made from this start at the end of the nth period is yet to be derived through other mathematical equations.

Stock investment is most intelligent when it is most business like, hence it requires a background of preparation and disciplined capacity and the first lesson is to avoid anything that appears overpriced i.e. stick to valuation, don't pay more.

(Basnet is one of the prominent active participants in Nepali stock market as an investor as well as stock analyst)

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