Why do some stocks behave the way they do?

Everyone who has traded in the Indian Stock Market must have wondered why some stocks are so weird. Why do they keep hitting upper circuit filters day after day and then suddenly plummet to the bottom taking away all the investors' wealth away.

Briefly stating, these stocks are manipulated by operators who try to take advantage of two factors: fear of losing money, greed to gain more money.

A good example is of Teledata Informatics which was a well performing stock in 2005. It started its fall like a knife and became the second most undervalued stock in the whole index in 2006. Recently, it started its uptrend again and now has jumped almost five times its low of 9Rs in June, 2006. You must be wondering why it behaved the way it did.

To begin, Teledata looked like a good company posting excellent results quarter after quarter. It caught investor's fancy and stock moved up rapidly.

It reached its peak in April 2005 and started going down. Nobody had a clue why a company with good results and good growth in revenues as well as net income is going down. Investors started to panic and searched a lot on moneycontrol message boards. Since nobody was explaining, people started to come out on research of their own. Finally, some reported that common equity of the company has swelled to almost double of its initial value because investors have exercised their option to convert huge number of preferred stock into common equity.

It was speculated that the company stock should trade at half the value of what it traded previously. So the fair value should have been around 20 Rs. The people, who calculated this value sold the shared till the stock's value reached around 25. Remember that no mutual fund or institutional investor will sell the shares below 25Rs if its fair value is 20 Rs at present but there is an increasing growth potential in future. Similarly, they will not buy the share above 20 Rs if the fair value is 20 Rs. Increasing growth potential means that company grew its topline by 30% this year, then it is expected to grow 35% next year and by 40% the second year and continue for sometime.

Notice that valuation of a company's share price is seldom done on increasing expected growth. Instead, it is commonly assumed that the most recent growth is the best that company will have starting today. So fair price comes out to be lesser than what may actually happen.

Simple retail investors thought that fair value is 20 so they kept selling, but the share was in no man's land from its journey from Rs 25 to around Rs 18. At Rs 18, the sellers turned into buyers even though common investors kept thinking that company is in bad shape and in hands of fraud management and the share is subject to high manipulation.

Meanwhile, Teledata kept posting good results quarter after quarter and fair value of the price increased significantly even accounting for increased common equity. One should also notice that no company will post consistently good results for an extended period of time. To analyze results, no way is better than to look at annual report and look at various numbers. History has showed again and again that accounting manipulation of results is not possible for an long period of time.

You should note that in the period where investors are losing money, there is very little information and people are left to pure speculation. This only makes people believe in incomplete information and grapevine, fueling fears and uncertainty. The only way that you can find inside out of the company is to look at annual report. These days, annual reports are available for downloading as PDF format on company's websites. I would suggest that you should not trade in stocks who have suspicious movements and for whom you do not have access to annual reports.