Anatomy of the Market Movement

In the last three-odd years, the stock market has registered phenomenal growth in India. Analysts (that today includes anybody and everybody) generally extend two arguments for this growth:
a) There are fundmanetal factors responsible for this growth. The GNP is expected to grow at 7 to 8 percent and Indian economy is booming, etc. The list goes on.
b) There are liquidity factors responsible for this. FIIs are pumping money into India and hence the prices are rising.

Which one of these factors is responsible for the market growth? Both? Neither?

I think neither. Let's see.

I studied the stock market behavior in the last 30 months (of 2783 stocks) to find out:

a) Whether the fundamentals are really that strong to warrant this growth in price
b) Whether we can link FII stake in the company with the stock returns?
c) Whether we can link institutional investors' stake in general with stock returns?

I am presenting the key results here:

1. The growth in stock prices is a market-wide phenomenon and is not restricted to any particular size. The large cap stocks have registered an annualized growth rate of 50% in the last 30 months. The mid cap stocks and the small cap stocks have registered 134% and 175% growth in the same time period. To put things in perspective, Nifty registered an annaluzied growth of 62% in the same time period. If anything, the large cap stocks have registered much lower growth as compared to the relatively smaller stocks. (Size effect :))Many analysts would be happy to see these results because they are arguing that what we see is not a scam, and that price increase is not restricted to handful of stocks and that the entire market is bullish. Even I thought so, when I saw the results.
2. The median FII stake in the large cap stocks is 4% (as against 19.33% in Nifty). It is zero for the mid-cap and small-cap stocks. What does that mean? The FII investment is restricted largely to the large cap stocks. So FII investment cannot explain the huge growth we have seen for the mid-cap and the small-cap stocks.
3. May be it is the mutual funds, banks, insurance companies and other financial institutions that have invested in the mid-cap and the small-cap stocks. Let's call them OFIs (Other Financial Institutions). The OFI investment in the large-cap stocks is about 5% (against 11.6% in Nifty). The median OFI investment in mid-cap stocks is 0.01% and 0% for the small-cap stocks. The financial institutions have invested mostly in the large-cap stocks. This means the market rise is not liquidity-driven. May be liquidity increases the price to some extent. That is without FII and OFI investment, may be the returns to the large cap stocks would have been little lower. But it would have been very high nonetheless.
4. What about the fundamental story? I love the DCF story. Let's look at dividend per share. The median yield for the mid-cap and small-cap stocks is 0 percent again!!!! That is, the market has increased the prices of a group of stocks by more than 150% who have not paid any dividends. The dividend yield is a mere 0.9% for the large-cap stocks. Even here, one needs to be really mad to justify this price. To see this, the median market cap of the large-cap companies in my sample is Rs.4381 crores. With a 1% dividend yield, the expected dividend on this is Rs.43.81 crores. This reminds one of the famous Saint Petersburg Paradox.

So who do you think moves this market?

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