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Opto Circuits, and Power of Story in Investing

If you clicked on the headline expecting to read my view on Opto Circuits, I’m sorry to disappoint you because this post isn’t about that.

The reason I mention Opto Circuits here is because I have received several emails over the past few days requesting for my view on the stock.

Given the number of requests for this specific company, I would definitely work on the same and try to release a report soon via StockTalk. But what intrigues me is – Why are so many people suddenly talking about a small-size company called Opto Circuits?

What’s the story?

Well, that’s what I’m going to discuss today – investing and power of “the story”.

————“Safal Niveshak’s Facebook Jam”: Revised Timing———–

Based on the poll I recently conducted, the revised timing for “Safal Niveshak’s Facebook Jam” is now…every Saturday, 9-11 AM…starting tomorrow.

The Facebook Jam is a real-time mechanism for you to get answers to your stock market investing and personal finance related questions.

So I would love to see you there!

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This post is inspired from a recent interview I read of Aswath Damodaran, and then his book (on investment fables). For those who don’t know about Damodaran, he is Professor of Finance at the Stern School of Business at New York University, and one of the leading global authorities in the fields of corporate finance and equity valuation.

Here is what Damodaran wrote in his book Investment Fables

Investing is full of stories that sound good when they are told but don’t hold up under close scrutiny. Consider a few: Buy stock in good companies and the returns will surely follow. Buy after bad news. Buy after good news. Stocks always win in the long term. Follow the insiders. Buy stocks with big dividends. Buy stocks that have gone down the most. Go with stocks that have gone up the most.

What Damodaran wrote also seems true of Opto Circuits. There certainly is a story (or a set of stories) that people are hearing (or want to hear) about Opto Circuits.

Here are 11 stories on the company I’ve just read on the Internet and in the company’s annual report…

  1. Opto Circuits’ management expects 20% revenue growth in FY13.
  2. Opto Circuits has commenced work on its new single-product special economic zone near Bangalore.
  3. Opto Circuits has the best operating margins in the industry (average of 28% over the past 10 years), and even these are expected to improve by a couple of percentage points in the next year.
  4. Opto Circuits is expected to benefit from economies of scale, which will help it improve its margins.
  5. Opto Circuits earns amazing return on equity, which has averaged 40% over the past 10 years.
  6. Opto Circuits is seeing an improved working capital cycle, which will help it improve its balance sheet.
  7. Opto Circuits will be tying up with companies outside India for promoting its products in FY13.
  8. Opto Circuits reported a huge 88% growth in its net profit in the recently completed quarter.
  9. Opto Circuits’ stock has fallen 33% from its 52-week high price.
  10. Opto Circuits has been advised as a ‘Buy’ by a brokerage, which expects it to rise 65% over the next one year.
  11. Opto Circuits has been categorized among India’s fastest growing companies by a leading business magazine.

Interestingly, all these stories on Opto Circuits point towards the positive side, which leads me to ask this question – “What really is the big story behind Opto Circuits?”

You see, the reason such stories around stocks like Opto Circuits sound alluring and make us take notice is that there is a grain of truth to each one of these stories.

Of course, none of them is foolproof…but there is always some truth in such stories…and we are much more likely to be swayed by them than we would be any number of graphs and numbers.

What makes an investment story compelling?
Damodaran says that investment stories are convincing not only because they are told well but also because they draw on several common factors.

As he writes in his book, most good investment stories appeal to a fundamental component of human nature, whether it is greed, hope, fear, or envy. They are also backed up by the evidence (as you can see in the Opto Circuits example above), at least as presented by the storyteller.

Investment stories also come in several forms. Here are just a few of them…

  • Buy stocks of companies with safe balance sheets – like those having zero debt – and great returns will follow.
  • Growth stocks always do well in the long term.
  • Investing in high dividend yield stocks will always pay in the long run.
  • You can never make a loss buying a stock with low price-to-earnings ratio.
  • Stocks that trade at less than book value per share are great long-term investments.
  • Companies with stable earnings are safe bets.
  • Look for stocks at the 52-week lows, and you will find a potential multibagger.
  • Buy ‘momentum’ stocks – that are going up – and go along for the ride.
  • Follow the right investment experts, and invest in the stocks they pick.
  • Stocks always win in the long term.

But should you believe?
Should you believe all good investment stories that you hear…like the ones on Opto Circuits?

Not at all! Exactly like you must not believe when I say that Clariant Chemicals and NHPC make for good investment stories at current prices!

Instead, here are three things I suggest you must do whenever you hear a nice investment story that you are willing to believe to be true…

  1. Be curious about what makes the story work. For instance, before you start to believe that all stocks with low price-to-earnings (P/E) become great investments, know whether this has been true in the past or not. Of course, this sound logical because you are buying stocks at low valuations, but then there have been numerous cases where stocks selling at 5x P/E have fallen to 1x P/E.
  2. Appreciate the fact that no investment story will work all the time. Take the case of FMCG stocks, which are rising even in the current bad markets. These are known as defensive stocks, simply because the companies here conduct simple businesses (like selling soaps, noodles, or toothpastes) and have safe balance sheets. But if you were to ask me if these really are defensives now, at average P/E of 35x, my answer will be ‘No!’ In short, what was defensive earlier might be dangerous now.
  3. Know that every story also has its villain – the weak spot. For instance, when you look at low P/E stocks, there might be two primary concerns that you may encounter – one, these stocks might not have much growth in earnings to offer, and two, they may be very risky (and that’s why the P/E could be so low).

Overall, most stock market stories that we read and hear in the media across bull and bear markets are for the optimists who believe that one will always win in the long term.

In good times, they tell you the story, “This time it’s different! This market will continue to scale new peaks because the Indian economy is going great guns, China is booming, US and Europe are consuming big time, etc. etc. You should expect to see your stocks double in six months.”

You believe them…and double your investment in stocks.

In bad times, they say, “Don’t worry! Given the law of averages, we will be back to great times very soon! So hold on to your stocks. Be a long term investor.”

You again believe them….and average your dud stocks.

So, when it comes to investing in stock market, the power of “the story” is very strong.

But your job must not be to just be a silent listener. Your job must be to bring the story into scrutiny and see if that really holds true.

In other words, you need to get past the story-telling because it’s easy to fall into it saying, “Hey, this company is worth a lot!”…or “If this is on StockTalk, there must be a great story behind it!”

In the meanwhile, let me find out “the story” behind Opto Circuits. 😉

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Yes curiously waiting for your view on opto circuits

  2. Sanjeev Bhatia says:

    Apt post. After so many years in equity markets, I believe all such “stories” are meant to be taken with a pinch of salt. Many a times, these are planted by operators in order to jack up the prices of their holdings. In any case, it is alwyas better to wait to see if the “story” turns out to be true and then enter. I am reminded of “One up on Wall Street”, an excellent book byPeter Lynch, who says he is very skeptical when he hears stories about “next Microsoft” or “next Apple”. Here in India also, we have heard numerous stories about “next Infosys”, next BHEL, etc etc but they all fizzle out. Another thing I have learnt is that TV channels and so called experts are experts in only one thing, that of creating lot of Noise. Perhaps finance is the sector which has largest number of myths floating around as you have pointed out. Even if a company is great, it doesnot mean it is great to buy at any level. As WB says, it is better to buy a fair company at good price rather than buy a Great company at very high prices.

    Wish it was so simple to invest and create wealth from stock market…LOL.

    Great Article.Waiting anxiously to hear Your STORY on Opto.

    • Thanks for your comment and inputs, Sanjeev! Indeed, the idea must be to go behind the story and understand the real truth…as here, unlike our movies, the hero (the positive side of the story) doesn’t always win in the end. 🙂

  3. Interesting post Vishal.
    And after hearing a lot of “This time it is different” and “History repeats itself”, I have come to my own conclusion regarding market patterns –
    “History neither repeats nor it is different this time around. Its just that history RHYMES.”

  4. Vishal,
    In my stock picking and investing( doing the due diligence i knew)…OPTO Circuits has given value for money.
    So waiting with bated breadth for your clear analysis……
    planning a workshop in the Mumbai area shortly?????????

  5. Sujit Zine says:

    What ever is the story behind ever stock… i think what matters the most is even if you see the story matching the ground reality and quartery results of the company but the stockk price does not match the results then do you have the conviction to hold the stock.. or rather buy more…
    for example…Opto circuits is making yearly profits of around 5 billion.. market cap is today 15 billion..so why do we have to think about balance sheet management .. and working capital(seriously)..i think for me simply a company with half a billion turnover should be vauled at least 2 billion… and how many companies in INDIA are making 500 crore profits.. of opto circuit size..

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