FE Report (February 14, 2011)
Much has been written on the recent stock market debacle in Bangladesh. The factors that came up in discussion as being responsible for this market crash are: (a) poor stock market regulation, (b) poor policy decisions by the regulators, and (c) manipulation. While these factors may be responsible for the market crash, a fundamental question remains: Did investors exercise their discretion before investing in stocks?
Investors are assumed to analyse stocks before they make their decisions regarding those stocks. In Bangladesh, most investors do not understand the ABC of accounting and finance. This is true of the millions of faceless investors in other countries. In developed countries, there are an army of securities' analysts who follow stocks. They act as information intermediaries. They collect information on stocks, do fundamental analyses, provide earnings forecasts and render investment advice. Fundamental analysis by these analysts makes the market efficient. It is these analysts on whom many faceless investors rely for investment advice. The Bangladesh stock market suffers from lack of adequate number of well-trained analysts. This situation should be remedied as soon as possible.
However, it is to be noted that relying on analysts is not always a panacea. Prior research documents that these analysts have their own incentives to give particular advice on particular stocks. Thus, there is no alternative to doing one's own analysis and exercising discretion. After all, it is the investors' money that is at stake. Thus, investors should invest some time and resources to learn the basics of fundamental analysis.
Interestingly, many sophisticated investors also did not do the proper homework this time. Rather they relied on the comments of the ministers regarding the state of the health of the stock market. They are now blaming the ministers. But it is not for the ministers to give the stock market a certificate of health. It is the job of the investors and analysts to assess the financial health of the listed companies. Instead of doing their own homework, they have in fact delegated the job of analysis to the ministers.
When optimism runs high in the stock market, it is fashionable to disregard the signals of accounting regarding the financial performance and condition of the companies on the ground that prices lead earnings, suggesting that prices are quicker than earnings in reflecting value-relevant information about the company and prices reflect a richer set of information than does accounting earnings. Further, it is argued that prices are forward-looking while accounting reflects only the past information. These arguments were given during the recent information technology (IT) bubble in the US market. Prices of many IT stocks skyrocketed despite the fact that those companies were in red. Eventually, the bubble burst.
What is missing in the above arguments is the value of accounting information as an alternative source of information. In other words, accounting acts as an alternative source of information that can be used to assess whether the market is out of line. Did the Bangladeshi investors use accounting reports to assess the reasonableness of the stock prices? My personal understanding is that most investors jumped on the bandwagon. This phenomenon is not new in our country. We saw many people, including educated ones, flocking to some financial institutions that gave huge returns overnights despite the fact that those institutions were not approved by relevant regulatory agencies for taking deposits. Thus, as I see it, part of the problem lies with the greed to make money overnight.
While the importance of strict monitoring and enforcement can hardly be overemphasized, it should be noted that the stock market crashed even in the best regulated market in the world. So the upshot is that there is no alternative to doing a bit analysis and exercising discretion.
Investors are assumed to analyse stocks before they make their decisions regarding those stocks. In Bangladesh, most investors do not understand the ABC of accounting and finance. This is true of the millions of faceless investors in other countries. In developed countries, there are an army of securities' analysts who follow stocks. They act as information intermediaries. They collect information on stocks, do fundamental analyses, provide earnings forecasts and render investment advice. Fundamental analysis by these analysts makes the market efficient. It is these analysts on whom many faceless investors rely for investment advice. The Bangladesh stock market suffers from lack of adequate number of well-trained analysts. This situation should be remedied as soon as possible.
However, it is to be noted that relying on analysts is not always a panacea. Prior research documents that these analysts have their own incentives to give particular advice on particular stocks. Thus, there is no alternative to doing one's own analysis and exercising discretion. After all, it is the investors' money that is at stake. Thus, investors should invest some time and resources to learn the basics of fundamental analysis.
Interestingly, many sophisticated investors also did not do the proper homework this time. Rather they relied on the comments of the ministers regarding the state of the health of the stock market. They are now blaming the ministers. But it is not for the ministers to give the stock market a certificate of health. It is the job of the investors and analysts to assess the financial health of the listed companies. Instead of doing their own homework, they have in fact delegated the job of analysis to the ministers.
When optimism runs high in the stock market, it is fashionable to disregard the signals of accounting regarding the financial performance and condition of the companies on the ground that prices lead earnings, suggesting that prices are quicker than earnings in reflecting value-relevant information about the company and prices reflect a richer set of information than does accounting earnings. Further, it is argued that prices are forward-looking while accounting reflects only the past information. These arguments were given during the recent information technology (IT) bubble in the US market. Prices of many IT stocks skyrocketed despite the fact that those companies were in red. Eventually, the bubble burst.
What is missing in the above arguments is the value of accounting information as an alternative source of information. In other words, accounting acts as an alternative source of information that can be used to assess whether the market is out of line. Did the Bangladeshi investors use accounting reports to assess the reasonableness of the stock prices? My personal understanding is that most investors jumped on the bandwagon. This phenomenon is not new in our country. We saw many people, including educated ones, flocking to some financial institutions that gave huge returns overnights despite the fact that those institutions were not approved by relevant regulatory agencies for taking deposits. Thus, as I see it, part of the problem lies with the greed to make money overnight.
While the importance of strict monitoring and enforcement can hardly be overemphasized, it should be noted that the stock market crashed even in the best regulated market in the world. So the upshot is that there is no alternative to doing a bit analysis and exercising discretion.
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