What's the Scoop

Sowmya Kamath   Delhi     Print Edition: November 2011

Dealing with stock market rumours
The Earl of Oxford set up the South Sea Company (SSC) in 1711 to pay off 10 million pounds in national debt. In return for taking over the debt, the SSC was granted sole rights to trade in the South Seas. Insiders soon spread rumours that Spain would give the UK free-trade access to four of its ports, resulting in frenzied trading of SSC shares. However, King Philip V never had any intention of doing so. By the latter half of 1720, share prices of SSC, once at 1,000 pounds, was reduced to nothing, resulting in the British government outlawing stock certificates until 1825.

Today, the stakes are even higher with rumour mills working overtime and markets reacting instantly. The media and market are quick to spot changes before a firm makes a formal announcement. Your reactions to such unconfirmed news or rumours can make or break your investments. So, how must one react?

To get it right, you must first understand the difference between rumours and unconfirmed news. Rumours cannot be verified and can emanate from sources such as friends and family, ministry officials and even the media.

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However, unconfirmed stories that appear in the media do have a source (often undisclosed) but there are chances that the move may not happen as reported. Whatever the news, understanding its effect on the movement of share prices is crucial, say experts. Prices react swiftly and investors hardly get a chance to take stock of the situation.


4% was the rise in share price of Hotel Leela on 18 July 2011, the same day reports of the company raising up to Rs 1,000 crore came out.


"Look at the stock price and determine whether the news has followed the price or the price has hatched the news," said Ajay Parmar, head (research), Emkay Global Shares and Services. If the market has a negative breadth, positive news may not prop up share prices, but negative news in a weak market could lead to the shares overreacting to it, adds Parmar. Let's look at some common market rumours and how to tackle them.

SALE OF UNIT, M&As
Rumours that a company could sell its stake in a division or that a foreign firm might buy a stake in a domestic company should push up share prices. The idea is that a company selling its unit at a premium will leave the shareholders with a higher share value. But should you buy stocks on such rumours? If the share price had reacted before the news about the sale of a unit was out, heed caution.

K Ramanathan, CIO, ING Investment Management India says, "We value companies based on SoTP (sum-of-the-parts-valuation). We then compare the movement of prices before and after the news came out. If the price has moved irrationally, we sell."

CORPORATE GOVERNANCE
News such as promoter involvement in a scam or misuse of company funds will hammer down stock prices. However, getting a confirmation on such involvement is very difficult. So, judgment plays a crucial role. In a market that has an overall negative sentiment, such rumours can have a domino effect on stock prices. Hence, it's better to sell.

"We would get out of the stock immediately because fundamental assessment will not work in such cases, however attractive a stock looks," says David Pezarkar, head (equities), Daiwa Asset Management.

PLANS FOR RAISING FUNDS
News of fund raising will push up prices, but from a long-term investment perspective, a fresh investment would hardly make sense if the market has already reacted. Any fund raised by a company through equity dilution at a premium to the current market rate will benefit current shareholders.

"Suppose the current market price of a company's share is Rs 400 and you're buying the share through private placement at Rs 460, then the dilution is less. This will benefit the shareholder," adds ING's Ramanathan.

But, it's hard to know at what rate a company will raise funds. It may also decide to raise money through debt instruments rather than a private placement of equity shares. Knowing the price at which the company's competitor or peer has raised money, and the premium, could give you an idea.

SHARES TO BE PLEDGED
This will have a negative impact on share prices. Companies usually pledge shares with banks or financial institutions to have easy access to funds, but investors are often wary of such news. It has to be tackled on a case-to-case basis.

In a scenario of rising stock prices, there is no concern. But, if the price of the stock declines to a certain level, promoters are required to make a payment or pledge more shares. If the promoter defaults or is unable to provide further shares as margin, then the lender has a right to sell the shares in the open market.


"While positive news may not prop up share prices in a weak market, negative news could lead to the shares overreacting to it."
K Ramanathan | CIO, ING Investment Management India


Usually the quantity of shares pledged by lenders is large resulting in an erosion of stock price. According to a ICICI Securities research report, companies with a high proportion of pledged promoter holding are susceptible to such erosion in prices. If you get a sense that the company is finding it difficult to raise money and meet its funding needs, you can exit the shares and enter at a later time.

DELISTING OF SHARES
Rumours on de-listing should not be a trigger to take action on a stock for long-term investors. The uncertainty and the tax implications argue against buying the firm's shares. However, you can invest in companies with good fundamentals if there is a possibility of de-listing.

While rumours may have an impact on share prices, long-term investors should evaluate its effect on the fundamentals of the company. If the news can have an adverse impact on company fundamentals, it is better to exit the stock.

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