Archives for June 2018

The Paradox of Knowledge

Tourist: This is a dangerously steep road with a sharp bend. Why isn’t there a hazard sign for motorists to slow down?

Guide: We had a warning sign untill yesterday. But since accidents were rare, officials concluded that the spot isn’t that dangerous after all. So they removed the sign.

Tourist: Don’t you think the rarity of the accidents was precisely because of the warning sign?

Guide: Ugh..

Amused at the stupidity of the officials? That’s because it’s easy to spot the cause and effect relationship between ‘presence of warning sign’ and ‘frequency of accidents.’ You can test the hypothesis. Remove the warning sign and if too many cars start plunging down the valley, there we have it – a clear correlation between an action and its consequences.

StockTalk (June 2018)

High Quality Vs Low Price

If you pay peanuts, you get monkeys. ~ Old adage

If you remember the stock market crash of 2008, you also remember that it spared almost no stock. Companies, even the well-managed ones, lost half or more of their market capitalization in few months.

As an example, Pidilite (makers of Fevicol), which was one of those extremely well-managed businesses then, lost 55% between December 2007 (just before the crash started) and March 2009 (the bottom). Titan and HDFC Bank, two other stalwarts, lost 50% each. In short, the crash was like a bad dream for people even in these marquee stocks.

But for those who held on to their nerves, and to these stocks, the next decade was about to turn into a beautiful dream.

As an example, assume you were owning Pidilite near its peak in December 2007 and went into a deep sleep that continued till today (June 2018). Your return from the stock would have been around 1,000% (CAGR of 26%) over this decade!

InvestorInsights: Revisiting Lessons from 2008

This isn’t your typical VIA interview, but a collection of wisdom from a few investors we have interviewed in the past. The topic is – lessons from the 2008 crisis. A decade has passed since this crisis (time flew, again!), and most lessons would have been forgotten (we have short memories).

As we see around, investors – especially new than old – are practicing speculative behavior. Not many investors who felt the pain in 2008 would possibly think this is a good idea even if no major crisis may be lurking around the corner. And this is exactly what came out from the questions we asked a few seasoned value investors, who were close witness to the crisis in 2008.

How Much is Enough?

As I was talking with my daughter Kavya about the importance of making a living doing work she loves, and saving and investing well, she asked a question that trumped me. I was not prepared for it.

“How much is enough, Papa, to live a happy life?” she asked.

Kavya’s question reminded me of a recent post I did about my talk to a group of friends. The focus of my talk was on a few important questions I have tried to seek answers to at various stages of my life, and that have helped me tremendously in choosing a path that, when I look back at, I am glad I chose.

One of the questions that I talked about was – How much is enough?

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BookWorm: Risk Savvy

From health risks to financial decisions, it’s often hard to make decisions because the statistics are usually presented to us by experts who misinterpret the data themselves. This remarkably intelligent book simplifies the world of probability, risk, and uncertainty. Plus, the book contains many simple (but powerful) rules to avoid the grave consequences of risk illiteracy.

Stories lie but numbers don’t, goes the adage. However, evolution has wired the human brain in such a way that our neural machinery isn’t optimized to have an intuitive feeling for numbers. As a result, numbers mislead us. Sometimes in shocking ways.
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The Turkey Illusion

Note: This post was originally published in the May 2018 issue of Value Investing Almanack (VIA). To read more such such insights on behavioural finance and other deep thoughts on value investing and business analysis, click here to subscribe to VIA.

When anyone asks me how I can best describe my experience in nearly forty years at sea, I merely say, uneventful. Of course there have been winter gales, and storms and fog and the like. But in all my experience, I have never been in any accident…of any sort worth speaking about. I have seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in disaster of any sort.

Those were the words of E.J. Smith, captain of RMS Titanic, the ship that sank in the North Atlantic Ocean on 15 April 1912, after colliding with an iceberg during its maiden voyage, drowning 1500. Out of 2200 people onboard only 700 could be saved.

Since it has never happened in the past it’s unlikely to happen in the future. That’s perhaps the most dangerous assumption to make when the stakes are high. Smith’s mistake wasn’t in failing to predict the disaster. No one could have. His blunder was in not preparing for it.

On Titanic, there weren’t enough lifeboats for 2200 people. To add insult to an injury, the lifeboats actually had the capacity for more than 700 people but in confusion to get the ladies and the children first, many lifeboats were lowered partially filled. They hadn’t practiced the emergency evacuation protocols properly.

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Behaviouronomics: Probability Blindness

Most people learn about probability concepts through examples of coins and dice. But that rarely helps in developing an intuitive mind for probabilities. The cure for it is to leverage the idea of natural frequencies.

The day remains deeply etched in my memory. I was in the fifth standard and the maths teacher had introduced the concept of percentages that day. It sounded freakishly alien and I just couldn’t fathom it. I literally had tears in my eyes because it seemed that everybody in the class understood it except me.

The teacher had repeated the definition – percentage is when you normalize any ratio to base of hundred – at least a dozen times in the class that day. It didn’t help.

Then my father explained, “Look. When you divide something in two equal parts, each part is called half, right? Instead of calling it half, let’s call it 50 percent. Now, when you divide something in four equal parts each portion is one fourth, correct? Let’s call that 25 percent.”

Feynman’s Hack and the Map of the Cat

Richard Feynman, a celebrated scientist and the winner of Nobel prize in Theoretical Physics, was infamous for barging into any classroom (unrelated to Physics) in his university. He would then ask questions and make his fellow professors uncomfortable.

One day Feynman decided to attend a Biology class. Being aware of Feynman’s history of mischief, the Biology professor posed a condition to discourage him. Feynman could attend the class provided he would do all the assignments and write research papers like everyone else attending that class. To the professor’s surprise, Feynman agreed.

Feynman’s first assignment required him to study the nervous system of cats. So he went to the librarian in the biology section and asked her if she could give him a map of the cat.

“A map of the cat, sir?” she asked, horrified. “You mean a zoological chart!”

Spotlight: Envy, A Powerful Motivator but a Lousy Satisficer

The emotions of envy hinge on the habit of maximizing the returns in every area of life. Habitual maximisers always have a creeping anxiety about missing something. If you don’t stop at a near-satisfactory solution, it may take you an eternity to reach the smallest conclusion or perform the smallest act.

Lalchand, a new investor decides to pay a visit to the Mecca of Indian stock market – The Dalal Street. As he approaches the BSE building, a big bright glow sign board catches his attention.

“Guaranteed Multibagger Stock Ideas. Free!” The dancing lights around the letters were hypnotic.

His eyes immediately started searching for all too familiar star mark which usually punctuates such claims and leads you to conditions-apply disclaimer. Unable to find it, he gives in to the temptation and enters the building. An attractive receptionist greets Lalchand. She walks him into a spacious office.
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