The lurking danger of a small stock bubble

Rex Mathew
28 March 2005

Investors rushing to buy stocks of small companies should remember that their prices may be manipulated and the risks involved are far too high.

As the stock market indices post historic highs, many experienced small investors are asking the same question — when is the next scam going to surface? In the last 15 years, we have seen two unprecedented bull runs before the current one. Both those rallies saw lots of excitement and hype, amidst expectations of retiring rich, before they came crashing down as scams involving reigning market legends surfaced. Is this rally also going to end in a scam? If you put the question to market analysts, they all insist that this time it is different. But that is what they said on both previous occasions as well, this time it is different.

Is it really different this time? The answer is yes, to a great extent. The last two rallies were built up purely on hype. The first one on the expectations raised by the start of the liberalisation process. The second one by the emergence of such significant technologies like the internet. Both rallies ran much ahead of the fundamentals before tangible benefits of the developments were visible in corporate performance.

Many of the lofty projections made during those two rallies have come true now. The country has attained a higher growth momentum and corporate performance is at its best in history. The results are visible on ground and in corporate profits. India is the toast of the world behind China and foreign investors are flocking in. So the current story is less hype and more real.

The Indian stock market is structurally very different from the days of the previous two rallies. Those days regulation was very poor and exchanges were private clubs of brokers who ran them for their interest. Individual brokers could swing market prices and there was no concept of corporate information, only rumours. The only significant institutional investor was UTI, which existed in its own world. Things have changed dramatically since then as foreign investors made their mark and private mutual funds grew in size. SEBI has done a good job of introducing more discipline and order among market operators. The emergence of the professionally managed National Stock Exchange as the premier exchange has forced the clubbish Bombay Stock Exchange to mend its ways.