IN the heat of general debate over the country’s limited revenue generation, stock markets seldom attract policy focus as a major potential area for resource mobilisation.

In robust and documented economies, capital markets generally function as parallel capital resource centres. They fill the gap where normal financial markets and public finances fail to meet capital requirements. That is not the case in Pakistan.

The belief that the stock market is a barometer to gauge the pace of economic growth holds no ground here. The struggling economy and galloping stock market testify that the two are poorly corelated, the one is driven by fundamentals and the other mainly by speculative fever.

The best stock markets serve the investors, corporates and economy by channelling public savings into productive investments. They help savers to share risks and returns of large corporate businesses without having the necessary expertise for business decisions. And corporations get an opportunity to raise enormous amounts of capital to finance their business operations.

Corporations have three sources to fund their business operations: retained earnings, debt and equity capital. On which source companies put their major reliance depends on the corporate mindset. Normally, corporates should focus on business expansion and widely shared ownership.

On the contrary, a possessive mindset focuses on exclusive family ownership at the cost of business expansion. That explains why very few companies expand to become multinational corporations. Instead of using stock market to raise investment capital, our corporate sector relies mainly on bank financing. The sector is not capital market driven that helps dilute ownership. As a result, very few of the thousands of private firms are listed on stock exchanges, fewer than about a decade ago. More firms having opted for de-listing than for listing.

Developed stock markets also serve the corporate sector by rewarding corporations whose business decisions maximise shareholders’ wealth and by penalising the companies for unwise business decisions. To succeed in stock investments, it is necessary to be alert to take value adding corporate decisions earlier than others.

It is the future expected earnings – not merely the current incomes – that drive the share prices, when stock investors base their stock picking strategies on the worth of corporate business decisions and recognition of their value for expected futures earnings.

Stock markets channel the investment capital into its most productive uses. The corporations which make sub optimal business decisions either downsize or disappear.

On the other hand, companies which maximise the shareholder value attract more funds, expand and globalise.

Under the local investors’ stock picking strategies, this discipline mechanism normally fails. Local investors mainly pick stocks in one of the following four ways: first, they remember a high price from which a stock has fallen and purchase it with the expectation that it will touch its high limit again. They fail to understand that the changing mix of investment, financing and operating decisions of a company keep the risk and return profiles dynamic and a low priced stock may not necessarily touch its historical upper price limit again.

Second, investors usually pick up stocks which have declared better cash or stock dividends. When a company misses cash dividends because it has not earned enough, it is a reason for a share price fall. But when a company does not give cash dividends or its dividends are below expectations because it has better investments opportunities to utilise its earnings, it is a reason for a share price rise.

Investors normally do not differentiate between the two because they are unable to recognise the value of corporate decisions for the expected future earnings.

Same is the case with stock dividends. These do not increase investors’ wealth but investors value them under the expectation that they will have more shares to benefit from any future capital gains. The investors ignore the forces which will in fact determine the future share price.

Third, investors tend to pick stocks which they see consistently rising for a few days. They do not appreciate whether the stock is rising because of wise decisions being contemplated by the company or just because some insiders are offloading their shareholdings at inflated prices that they had themselves manipulated for the purpose.

Fourth, and most important of all, investors’ stock picking is influenced by precise share price targets which some brokerage houses and their analysts announce and the future share price directions which these market participants so precisely predict. In their forecasts and predictions, such brokers and analysts attempt to belie the random walk theory of share price movements in which most of the economists believe. According to this theory, all the known and ascertainable future information is reflected in current share prices. Only the random unknown future information which is impossible to predict has the potential to move the share price.

Investors do not understand these intricacies. The brokers and analysts also do not disclose their own shareholdings in the scrip for which they make fascinating predictions.

The investors’ four share-picking strategies commonly employed in stock investments are divorced from recognition of the value of corporate decisions for expected future earnings. The local bourses, therefore, fail to discipline corporate executives and channel the investment funds into the most productive uses.

The local bourses are disconnected from the real economy and to a great extent, from the global financial system. They work like casinos where majority of investors constantly purchase and sell shares, predict short- term share price movements and hunt quick gains from the market. When the price bubble bursts, such expectations melt away and a crash occurs.