How you can make profits when prices are falling

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

04 August 2024

As the saga surrounding the concessioning of Jomo Kenyatta International Airport (JKIA) unfolds, an investigation report on the would-be concessionaire, Adani Group Ltd of India, has been unveiled. It was written by an American investment company, Hindenburg Research, in January last year (2003) and it alleges that the controlling family of this company were involved in share price manipulation in order to fictitiously increase its value.

In essence, the prices of listed shares in a stock market are driven by the normal forces of demand and supply. If demand is greater than supply, the share price goes up and vice-versa. The allegation was that the Adani family created investment companies outside India and used them to mop up the Adani shares from the stock market thus creating an artificial shortage.

As a result, the company’s market value rose more than ten times over within a period of two years. However, it is important to note that these allegations have never been proven in a court of law.

The authors of the report, Hindenburg Research, are a “short-selling” investment company based in the USA. A short-seller is the kind of investor that makes a profit when the price of a share falls and loses when they rise! To understand how this works, let’s first review normal selling.

Suppose you are confident that the price of certain shares will go up from, say, Sh100 to Sh120 in the next few months. But you don’t have money to buy. So, you go and borrow Sh100,000 (at a fee, of course) and buy 1,000 shares at Sh100 each.

If your prediction is right, the price increases to Sh120, you sell the 1,000 shares for Sh120,000. You repay the Sh100,000 loan and keep the profit of Sh20,000.

What if you are expecting that the price will fall from Sh100 to Sh80? Can you make a profit? Yes! You can borrow 1,000 shares from some one (at a fee, of course) and sell them at the current price of Sh100and collect Sh100,000. Then you wait and, when the price falls, you go and buy them back at Sh80,000 and return the shares back to the lender. Sh100,000 minus Sh80,000 is a Sh20,000 profit for you!

This is the kind of investing that Hindenburg Research does and, therefore, there is an obvious conflict of interest when they publish a damning report about any company. But, to be fair, there is equal conflict of interest when a normal investment firm makes a glowing report about a company.