June 2005
Stock Taking

Good Time to Buy

By Rabindra Bhattarai

The Nepse index in May registered a considerable decrease. The investors should rejoice and capitalise on this opportunity.

There are good stocks available at reduced prices now (see table). If one buys them at the current price, he/she can expect to sell them in a few weeks at much higher prices thus making a handsome gain.

Many investors, however, still seem confused about it and they are not buying the shares. Here is the explanation why this is a good opportunity to buy:

The latest decline in the Nepse index and the prices of individual shares is not because of any manipulation by anyone or due to any negative developments in the economy, or any important policy change announced by the government. Yes, the large investors who used to play in the stock exchange are now dormant and there was an order by the Nepal Rastra Bank to the commercial banks to reduce the interest spread. These facts too may have affected the market a bit but the more important reason was the right share issue by Nepal Investment Bank Ltd. (NIBL) early May. Though one important development before the market tumble was the lifting of the emergency, this development took place much earlier than the day of index tumble. Hence this factor cannot be regarded to have played a significant role in this.

The Nepse index had gone up to 298.78 on 4 May 2005, but it lost 9.89 points the following day, which was the book closure day for the 1:1 right issue by NIBL. Anyone who bought NIBL shares before the book closure day (also known as ex-right day) would have gained as he could have the opportunity to buy the right shares at par value (Rs. 100) and sell them after some weeks at a higher price. But that opportunity would not be there for shares bought on or after the book-closure day.

This was the reason why the price of NIBL shares declined on May 5 and the subsequent days. This naturally reduced the Nepse index, but the market took it as a negative signal and prices tumbled in the other scrips as well—a phenomenon known as the signalling effect.

Such phenomenon is very common in the Nepali share market. Every time there is a right issue coming, the index initially moves up till the book closure day and drastically declines the next day.

The confusion among the investors is caused by the method followed by the Nepal Stock Exchange in calculating the index. Under this method, the right shares being issued are not taken into consideration till they are listed. But the buyer of the shares has to take these forthcoming into consideration while making the purchase or sell decision. One share on the right-on day (the day before the book closure for the right issue) is equal to two shares on the following day (ex-right day) from the investor’s perspective. But from the perspective of the stock exchange, the number of shares in the stock exchange is the same on both the right-on day and the ex-right day. This is so till the right shares are not listed in the stock exchange. This is the only reason why the Nepse index had gone down by so many points on May 5.

If a mechanism to adjust the forthcoming right shares in the index calculation were present, this sort of confusion could have been avoided. Nepse follows value-weighted method while in the price-weighted method this problem may not arise; though price-weighted method too has its own drawbacks in other counts.

Thus it is clear that as the current decline in the index is due to only the NIBL right shares, the shares (particularly those in the table) will sell at a higher price in the near future once the market adjusts to this phenomenon. Hence the advice to buy.

This analysis again shows that the Nepali stock market is primarily guided by whims and not by new information. This is a sign of market inefficiency, but investors can earn handsome gains from this if they try to understand such underlying causes of the market movement and act accordingly.