The problem of choice in the Indian stock market

By Riya Jain & Priya Chetty on June 13, 2022

Over the century, the Indian stock market has fascinated the people by being one of the quickest ways to grow money. However, the volatility in share prices often requires the investor to be cautious about their investment methods.

But, how to make a rational choice among the available large number of alternatives?

Among popular investment instruments such as stocks, bonds, property and cash, stocks are the most preferred due to their higher returns. Different categories of stock i.e. income, growth, and value provide high earning opportunities. However, there are various market risks associated with each. For reducing these risks, there is a need to spread awareness about the means to identify stocks, determine risk-return trade-off with each stock, and predict future movements.

Thus, this study simplifies the investment decision-making process by assessing the movements of different stocks for the period 1st April 2000 to 31st March 2020 and provides an opportunity for the investors by reducing the influence of risk associated with the stock market.

Stock market analysis

In India, the concept of investing in the stock market emerged in 1875 when the first stock market of India i.e. Bombay stock exchange was established.

The emergence of the Indian stock market (SEBI, 2018)
The emergence of the Indian stock market (SEBI, 2018)

Though with the evolution of the financial market, investment in the Indian stock market is increasing but still the existence of problems like lack of knowledge, difficulty in identifying the different forms of stocks, and the examination of past performance have complicated the procedure of investment for the investors

The Indian stock market

The Indian stock market, being the oldest stock exchange in Asia, serves as a yardstick to measure the progress and health of the country. Having the settlement of the first stock exchange in 1875, the Indian stock exchange to date has two major markets i.e. National stock exchange (established in 1992 in Mumbai with trading started in 1994) and the Bombay stock exchange (1875 settlement in Mumbai). Being the market providing trading opportunities at the international and regional level, there were about 30 stocks exchanges in total i.e.

International Stock exchangesRegional stock exchanges
Bombay stock exchange (BSE) – PermanentCalcutta stock exchange Ltd.- Permanent
National stock exchange (NSE) – PermanentMagadh stock exchange association Ltd. (MSEA) – shut down on 3 Sep 2007
Indian international exchange (India INX) – recognised till 28 Dec 2020Trivandrum stock exchange – shut down in 2010
National stock exchange IFSC Limited – recognised till 28 May 2021The Hyderabad Securities and Enterprises Ltd – shut down on 25 January 2013
Indian commodity exchange limited (ICEX) – PermanentCoimbatore Stock Exchange Ltd – shut down on 3 April 2013
National communities and derivatives exchange limited (NCDEX) – permanentSaurashtra Kutch Stock Exchange Ltd – shut down on 5 April 2013
Multi commodity exchange of India Limited (MCX) – PermanentMangalore Stock Exchange – shut down on 3 March 2014
Metropolitan stock exchange of India Limited (MSE) – recognised till 15 September 2021Inter-Connected Stock Exchange of India Ltd – shut down on 8 Dec 2014

Cochin Stock Exchange Ltd- shut down on 23 Dec 2014

Bangalore Stock Exchange Ltd – shut down on 25 Dec 2014

Ludhiana Stock exchange Ltd- shut down on 30 Dec 2014

Gauhati Stock Exchange Ltd- shut down on 27 Jan 2015

Bhubaneswar Stock Exchange Ltd- shut down on 9 Feb 2015

Jaipur Stock Exchange Ltd- shut down on 23 March 2015

OTC Exchange of India – shut down on 31 March 2015

Pune Stock Exchange Ltd- shut down on 13 April 2015

Madras Stock Exchange Ltd- shut down on 14 May 2015

U.P.Stock Exchange Ltd- shut down on 9 June 2015

Madhya Pradesh Stock Exchange Ltd- shut down on 9 Nov 2015

Vadodara Stock Exchange Ltd- shut down on 23 Jan 2017

Ahmedabad stock exchange – shut down in April 2018

Delhi Stock Exchange Ltd – shut down on 2 April 2018
List of stock exchanges in India

But having the shutdown of 21 regional stock exchanges from 22, now there is only one permanently recognized regional stock exchange in India i.e. Calcutta stock exchange. With a listing of 5262 companies in 2018 from 73 sectors, majorly sectors like Banking, IT, Automobile, Real estate, metal, Media & Entertainment, FMCG, Power, Pharmaceutical, and PSU Bank are the source of investments. The trading of Indian stock exchanges usually takes place between IST 9:55 AM to 3:30 PM from Monday to Friday wherein settlement of securities is in the T+2 period. As the market is organized, thus the functioning is regulated by the Securities and Exchange Board of India (SEBI) (Sharma, 2019).

Apart from promoting training and education on stock market intermediaries, SEBI protects investors’ interests by imposing penalties and fines in case of violations. Despite ensuring stability in securities price, forecasting service, transparent and convenient place of investment, funds raise by companies and promoting saving and investment habits, there is a low percentage of household savings of Indians investment in the Indian stock exchange. However, the strengthening of the Indian economy and stable emerging financial market presence always creates the possibility of money joining the market (Singh, 2020).

Investment opportunities

With the availability of different categories of stock i.e. growth, income, or value stocks; an investor often make the choice based on their intensity to risk and the return desirability i.e.

Growth stocksIncome stocksValue stocks
Issued by companies at a growing pace compared to the overall marketIssued by comparatively slower growth but stable companiesIssues by undervalued companies having constant variations
Substantial returns generatedLarge return source in form of dividendCheaply available with moderate return
Highly volatileStable and mature investmentModerated volatility with undervaluation
Source of high riskLow riskAverage risk rate
Possibility of higher returnSecured investment with ensured incomeNo major impact of volatility with the possibility of high future return
Companies- Microsoft or AmazonCompanies- Walt Disney or Tesla MotorsCompanies- Hindustan Unilever or Asian Paints
Differentiation in investment opportunities

Growth stocks are the securities issued by growth-oriented companies having the potential to develop compared to the overall market. Herein, companies with a focus on expansion tend to invest a majority of their profit in growth activities. As the performance of the company creates the possibility of higher return and derives a beneficial return to investors but due to their high-risk association with the market, high volatility is present. Thus, only the risk-lover investors who are ready to bear high risk for better returns tend to invest in these companies.

Value stocks are comparatively less risky than growth stocks as these are the securities issued by mostly the undervalued companies. Though there is a good financial status of companies due to the trading rate at a lower price, the investment in these companies has moderate return generation capacity. However, having less influence on volatility and possibility of high future return as with improvement in performance value of stocks would increase, thus, risk-neutral investors seek for value stocks for investment.

Lastly, as some the investors are very sensitive to risk and tend to opt for the opportunity wherein fix income could be derived, thus income stocks are that defensive form of investment. Being the securities issued by matured companies which remain in existence despite any variation in market conditions i.e. food, natural resources, securities, financial institutions, utilities or real estate investment trusts; these stocks generate guaranteed returns. As most of the profit earned by these companies is distributed in form of dividends, thus the intensity of risk is low herein. Hence, risk-averse investors who opt for trade-offs and want secured investment during distress tend to invest in income stocks.

The problem of identification in Indian stock market

In order to overcome the identification issue, there has been the presence of various financial measures like price-to-earnings ratio, return on assets, dividend yield, earnings per share, or book-to-market ratio. These financial instruments enable the examination of the volatility of stock price and the return which in turn helps in the classification of stocks into income, growth, and value stocks. This leads to the formulation of the first objective for the study.

The objective deals with stating the method that could be used for categorizing and identification of stocks so that investors could become more aware of the different investment opportunities. As sustainable earning possibilities could only be created by having a sound investment as per the need of the investor, thus, classification of the stocks eases up the process of choice by identifying risky (Growth stocks), moderate (Value stocks), and stable (Income stocks) investments.

Lack of knowledge about the stocks

No matter how in tune a decision is with the market, stock market investment does not guarantee income growth. Despite having secured investment, the actual benefit from that stock is based on the worth of that investment. The variation in economic conditions from terrorist attacks or market bust (economic risk), variation in the market conditions (market value risk), and inflation from global recession or massive government borrowings (inflationary risk) tend to affect the return generation capacity of the investment. Thus, constant ups and downs in the stock market, no guarantee of rising prices (return), or the fear of losing all money makes the investment risky.

No matter in what amount or what investment an investor makes with minimal risk possibility, but actually, chances are taken every day. In order to manage the existing risks and raise the probability of return, investors tend to optimize their investments. For this, the examination of associated risk and return with the stock is a must. Being sensitive to risk, investors have the tendency to invest only when an adequate return to compensate for the associated risk is available. This, return generation as per the risk or uncertainty attached to the stock is said to be a risk-return trade-off.

While making an investment decision, investors examine the risk-return trade-off and decide about their investment. Thus, the comparison of risk with the return is an essential part of the decision-making process. Though there are many methods like company-based analysis or industry-based analysis (Fundamental methods), raw data-based analysis, examination of investor sentiments, funds flow-based analysis, momentum-based analysis, graphical assessment by trends, volume-based analysis, or volatility-based analysis (Technical analysis). But this study focuses on having a technical examination of stocks by having the graphical as well as statistical analysis in form of trend, momentum, and CAPM-based analysis.

With the purpose of deriving more information and resolving the issue of lack of knowledge, the investor tends to examine the nature of stock prices and have the assessment of risk-return trade-off. This led to a statement of the second objective of the study wherein targeting the lack of knowledge problem the assessment is done to analyze and compare the risk-return trade-off of income, growth, and income stocks. Under this objective, the below-stated aspects are targeted i.e.

  • Nature of income, growth, and value stock returns.
  • Trend-based assessment of the stock’s performance during the global recession and BSE market crashes
  • Comparison of BSE stock’s performance
  • Short-term movements of income, growth and value stocks tracking
  • Medium-term movement of income, growth, and value stocks
  • Diversification’s role in bearing the intensity of risks from income, growth, and value stocks.
  • Risk return trade-off comparison for effective investment source determination

The problem of uncertainty and past performance analysis

Lastly, the existence of uncertainty in the financial market brings in the complexity of making a choice. As investors are often unsure about the performance of stocks due to the existing uncertainty in the market, thus there is always a fear of loss associated with the investment. For this, several investors believe that the only efficient time of making an investment is when the prices of stocks are going up and during the time of fall in the market, they opt for staying away from the market.

However, after the crash of 1987 when Dow Jones Industrial Average plummeted by 22.6% it has been realized that the rising stocks could also witness a drastic fall (CNN Money, 1997). Thus, in order to make a more secure and optimal investment, instead of hallucinating and having guesswork, predictions about the stock movements need to be done. This prediction of stock market movements contributes to having effective decisions about investment along with understanding the influence of financial news and understanding the sentiments of investors.

Though a rational investor values the risk-return trade-off but historical performance also is an important part of investment decisions. Based on the historical performance, the investor opts for predicting the future movement of stocks and making decisions accordingly. Among the available methods of prediction i.e. technical analysis (polynomial regression or linear regression models), traditional time series forecasting models (momentum, exponential smoothing, moving average, or ARIMA), and machine learning methods (artificial neural networks or support vector machines); this study focuses on having the traditional forecasting model i.e. ARIMA in order to provide information about the risk and make relevant predictions. As ARIMA is the method that could be used but for having the suitable model determination as per the statistical characteristics of stocks historical dataset, there is a need to have ARIMA model development for stocks.

Herein, the development of the model helps in understanding the statistical relationship between variables by studying their past movements, thus, raising the accuracy in predicting price movement based on historical prices. Though these formulated models help in making effective decisions, 100% accuracy could not be derived due to the existence of uncertainty. Still, all the investors i.e. individual or institutional could either formulate them or use stated models to have minimization of investment risks. With these formulated models, the investors could consider the past prices of the respective company and make predictions about the aspect that whether prices would rise or fall for the stock in future. This would help in avoiding guesswork and making an intellectual and optimal investment.

This behaviour of investors led to the third objective formulation wherein a model needs to be developed for predicting the behaviour of stocks. Herein, the study works on the aspects i.e.

  • Examination of stocks dataset efficiency in predicting growth, income, and value stocks behaviour
  • Build a forecasting model for stock movements.

Start Investing in the Indian stock market

The Indian stock market is the hub of opportunities and risk. But to be on the gain side of the economy, it is essential to make timely relevant decisions by considering all the required information. Having the volatility and uncertainty though complicate the investment procedure but with the assessment of different categories of stocks in order to derive eliminate the problem of identification, lack of knowledge, and limited past performance information; the study assesses the behaviour of growth, income and values stocks. Further articles provide detailed information about the different aspects related to these problems and determine the model which would help an investor to make an adequate investment.

References

  • CNN Money. (1997). Dow millennium marks.
  • SEBI. (2018). Annual Report 2018-19.
  • Sharma, R. (2019). List of Stock Exchanges In India. Groww.
  • Singh, M. (2020). An Introduction To The Indian Stock Market. Investopedia.

Priya is the co-founder and Managing Partner of Project Guru, a research and analytics firm based in Gurgaon. She is responsible for the human resource planning and operations functions. Her expertise in analytics has been used in a number of service-based industries like education and financial services.

Her foundational educational is from St. Xaviers High School (Mumbai). She also holds MBA degree in Marketing and Finance from the Indian Institute of Planning and Management, Delhi (2008).

Some of the notable projects she has worked on include:

  • Using systems thinking to improve sustainability in operations: A study carried out in Malaysia in partnership with Universiti Kuala Lumpur.
  • Assessing customer satisfaction with in-house doctors of Jiva Ayurveda (a project executed for the company)
  • Predicting the potential impact of green hydrogen microgirds (A project executed for the Government of South Africa)

She is a key contributor to the in-house research platform Knowledge Tank.

She currently holds over 300 citations from her contributions to the platform.

She has also been a guest speaker at various institutes such as JIMS (Delhi), BPIT (Delhi), and SVU (Tirupati).

 

I am a master's in Economics from Amity University. Having a keen interest in Econometrics and data analysis, I was a part of the Innovation Project of Daulat Ram College, Delhi University. My core expertise and interest are in environment-related issues. Apart from academics, I love music and exploring new places.

Discuss