Institutional activity often tips direction of stock market prices

When I'm considering a stock for possible purchase, there is one thing I'd most like to know. Not its outlook for profitable growth, the quality of its management, or its competitive position but, rather, are institutions going to buy it? If they do, the price is sure to rise.

The domination of trading by institutions is well known - blocks of 50,000 or 100,000 shares are daily occurrences. While individuals are said to own the bulk of all common stocks, institutions account for most of the trading.

When I first entered the investment world in 1947 the institutions were a minor factor. People still had vivid memories of the crash of 1929, the depression years, the market break of 1937, and the years of World War II. Mutual funds were just getting off the ground, there were few funded pension plans and trust companies, and endowment managers concentrated primarily on bonds.

While IBM was being mentioned, it was not yet considered ''seasoned'' and Boston institutional money was still moving into such favorites as United Fruit, General Motors, International Paper, and American Telephone. The Dow Jones industrial average ranged between 165 and 212 for several years.

As the stock market gathered steam in the Korean war years, and particularly in 1954, the institutions began to flourish.

A massive marketing campaign brought mutual funds to the attention of the public, who responded enthusiastically. Trust companies, insurance companies, and endowment managers began to invest more heavily in stocks. All were rewarded as the stock market continued to advance.

The largest single factor among financial institutions has become the pension funds. Thirty years ago, with relatively few pensioners on the books and vastly more workers whose benefit days were years ahead, the pension funds had a much longer investment horizon. While current income was useful, capital gains were more desirable because that would reduce annual contributions by the parent company.

Pension-fund assets today total about $500 billion and are growing about 15 percent annually. Their impact on stock prices is obvious. Like banks, they tend to observe certain standards of prudence. To cite Harvard College vs. Amory, the 1830 Massachusetts case in which the prudent-man rule was born, trustees are ''to observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of the capital invested.'' In other words, you're less likely to be sued if the stocks you own are held by plenty of other institutions.

If a good story is just making the rounds, a stock is apt to be bought by many institutions, which drives up the price. Conversely, when bad news - Texas Instruments, for example - hits the street, many institutions rush to sell.

Institutional managers range from the passive, low-turnover kind to the very active with high turnover. Increasingly, they are scrutinized for their performance - not how well the fund performed over the last 10 years, but how things went in the last quarter or month. Since many pension funds are handled by multiple managers, there is an understandable desire to be an above-average performer. To be an underachiever for long is to risk losing the account.

This competitive pressure stimulates trading the portfolio. The ''frictional cost'' (Warren Buffet's phase) is low, since there are no taxes to pay, and since brokerage commissions are heavily discounted.

Pension funds, by their sheer size, together with banks, trust and insurance companies, and other institutions, tend to concentrate their stock holdings in Fortune 500-type companies. If your fund is $1 billion and your rule is 1 or 2 percent of the total in each stock, that's $10 million to $20 million. Since marketability (the ease of buying or selling) is important, you may wish to limit yourself to no more than 3 or 4 percent of the outstanding shares of each company. The result is that the institutions are obliged to focus their attention on the biggest companies.

This is a bonanza in a rising market (1967-72 for an example), but when things go the other way, as in 1973-74, it can be devastating.

Finding a stock before the institutions become aware of it can be very rewarding. Veeco Instruments, a manufacturer of power supplies, is an example. In 1979 it traded in low volume on the American Stock Exchange. While it had a fine operative record, the public float was small since most of the stock was in the hands of management. Only a handful of institutions owned Veeco and the company was not covered by Wall Street research.

This all changed with a stock split, a listing on the Big Board, and the sale of a large block held in the estate of a founder. The company continued to prosper, but those who bought Veeco before these events saw their investment quadruple in the period 1979-81. They have the institutions and the research coverage to thank.

Oh, to find another Veeco! Equally important, of course, is not to be a late buyer of an institutional favorite when something goes sour. Ask anyone who bought Warner Communications last December.

Sherwood E. Bain is vice-chairman of Burgess & Leith Inc., which is a member of the New York Stock Exchange.

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