Financial Times

Stocks - is there wealth for the small investor?
By Ravi Mahendra
Fundamental analysis is a concept where the market values a security based purely on the fundamentals or the underlying potential of the firm. It considers factors such as current earnings and potential earnings, which would be reflected in the form of business confidence or PER (Price Earnings Ratio) multiple. If a firm's earnings are high, the company would be valued highly. Share prices of development banks such as NDB and DFCC rose significantly after the Tokyo donor conference because the prospect of their involvement in the disbursement of aid money improved the level of confidence investors had in these institutions.

In the speculative bubble concept, the market can be influenced by the activities of speculators who are usually gamblers operating in the market with the objective of making short-term gains. They hold securities for a short period of time with the hope of making a gain if their prices rise. When there are many such speculators in the market, their activities tend to push prices upwards, even though there aren't stable economic fundamentals to support such an increase in value.

This creates what is known as a 'bubble', which is capable of reaching massive proportions, but also has a risk of vanishing without a trace. As long as speculators are confident that there is potential for more gain, the value keeps on increasing, until a point is reached where a sudden shock may cause the bubble to burst. That's when share prices come crashing down, causing distress and dismay to investors. In the 1987 share market crash in the UK, speculators were blamed for it.

Which concept is valid in the CSE?
This question is rather difficult to answer because the CSE has been quite active during the past few months. The elections in 2001 brought to power what was regarded a pro-business government. The peace process, which was also brought about by this government, resulted in a ceasefire. Strong economic confidence as well as the prevalence of peace led to an upward movement of the bourse. When these factors are considered, the market seems to be working on the basis of Fundamental Analysis.

However, stability was not present always, since Executive and Legislative power were in the hands of two different political parties which were at loggerheads with each other concerning the management of the economy as well as the peace process. The takeover of three ministries should not have been too surprising to any investor familiar with Sri Lankan politics. Furthermore, since no firm peace deals have been struck yet, the peace process is still very fragile. When these factors are also considered, one wonders whether speculators play a significant role in the market. On November 3, the market crashed on news about the takeover of the three ministries, as well as the proclamation of emergency and suspension of parliament.

This may be because investors may have feared a slowdown in the economy, an imminent election and a delay in the budget, which was expected to address many economic issues. These events would have affected fundamentals of corporate performance, and there were sound reasons for the market to move down. However, despite the downward move, there were investors who bought shares, which were trading high previously, at lower prices. The Prime Minister's return to the country on November 7 saw an upward movement in the market. This was a rather speculative move, because there was actually no change in the country's situation, and as per the Constitution, the President is vested with the powers to allocate ministries, or even dissolve parliament. When the share prices went up, many individuals would have made money by cashing in on the shares they bought during that three-day period.

The small investor
Is there potential for small investors to invest and generate long-term wealth in the CSE? In my opinion this would be difficult, since the market is rather volatile and often driven by the activities of large local as well as foreign speculators who work with their own interests of short-term gain in mind.

If economic and political stability is achieved, and the market consists of more fundamental investors rather than speculators, then it may become a place where a significant investment can be made with confidence. Till then, it is advisable not to keep all your eggs in the CSE basket.

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