May 29, 2014 03:13 pm | email@example.com
Chapter 8 of the epic book Intelligent Investor written by legendary Mr Benjamin Graham (for the uninitiated, he is the guru of Warren Buffett) talks about a hypothetical character named Mr Market.
Graham writes and I quote
Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. ”
If you are a prudent investor or a sensible businessman, will you let Mr Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.”
“The true investor is in that very position when he owns a listed common stock. He can take advantage of the daily market price or leave it alone, as dictated by his own judgment and inclination. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on. Conceivably they may give him a warning signal which he will do well to heed—this in plain English means that he is to sell his shares because the price has gone down, foreboding worse things to come. In our view such signals are misleading at least as often as they are helpful. Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
Mr Graham was a funny man, he also mentioned the same thing in form of a joke, he said. Market is like your wife, if you are a sane person, you cannot listen to her all the time but you cannot completely ignore her either.
The professors and academic fraternity thinks about this in the exact opposite way. They work on the concept of efficient market hypothesis, This is what is taught in all major MBA schools. What they are essentially saying is that market is always right, at any given point of time the price of the stock exactly includes each and every aspect of its threats, opportunities, strengths and weaknesses and there is no point thinking as you cannot outsmart it.
This hypothesis cannot be farther from the truth. This conclusion like almost all academic conclusions suffer from “ a man with a hammer syndrome”. They devise a tool and then use it to prove everything that comes their way, every confirming evidence is lapped up (commitment and consistency bias) and every dis confirming evidence is discarded in the name of outliers.
Sure market is efficient most of the time, but how does that equate to market is efficient ALL the time.
Mr Graham’s hypothetical character is actually a mental model, a way of thinking for us at MysticWealth. We have seen this play out in the markets time and again. Mr Market in his exuberance and exaggeration almost always overshoots in either direction. When he is happy, he gets delirious and acts as if he is on coke and when he is sad, he gets into serious depression and post traumatic stress disorders.
No argument is complete without a case study, let me give one from the past and 01 from the current market in which we are participating.
Not that long ago, Hindustan Uniliver came up with a plan to launch their own brand of toothpastes. Mr Market after digesting this news concluded that a new entrant will seriously damage colpal’s (colgate) monopoly and subsequently hammered the stock a good 10-15% in 2 weeks.
We got interested and loaded up on colpal only to square the position off in a months time at a profit of 20%. (the fact that stock was in f&0(read leverage)) we got bang for our buck and effective absolute return turned out to be 60%.
Mr Sanjay Bakshi also participated in this inefficiency and blogged about this.
Another example that comes to my mind is Maruti Suzuki lock out; Buildings were burnt, managers were beaten up in manesar plant, all the hell broke lose and the stock tanked as if there is no tomorrow for blue chip like Maruti. We started accumulating the stock at 1100 levels and finally sold everything at 1550.
I was surfing the net and came across a company named JB Chemicals. They recently declared their results. Mr Market did not like the results very much and concluded that the growth story is over for this company and subsequently hammered the stock. From 160 odd a few days ago to CMP of 137.
We pulled out the balance sheet and found that Mr Market is pissed at the margin contraction but what it hasn’t realized is that it is due to a ONE-OFF provision of 90 million INR. Some bad debts in Vietnam. While we successfully concluded that Mr market is reacting to this bad news. The question in front of us was that is this temporary. In other words is the growth story still intact.
Further research revealed that Daljit Kohli (India Nivesh) is Long this stock and has recently issued a report suggesting that this 90 million bad debt is a one off and growth story is in tact.
Now surely, reading this report exposes us to authority bias. And trust me it can overshadow any rational thinking if the authority has a good track record.
So we decided to have a third vantage point of CAPE. (cyclically adjusted Price to earnings). Please google Shiller ratio and Meb faber to research more on that subject.
historical 10 year PE of this company is 7.57 which is in line with Daljit Kohli’s 8x FY15 earnings giving it a target of 186.00.
Yet another vantage point to consider was the overall valuation to draw a conclusion.
3 year ROE: 35%
3 year ROCE: 17%
Dividend yeild: 2% with payout of 46%
Debt free company.
Now it is impossible to avoid all the human biases out of the decision. I am no Charlie Munger but at least with the inclusion of 3-4 vantage points, I give myself a more than reasonable chance of making a rational decision. and my conclusion is that Mr Market has over reacted again and will/should realize the mistake in a quarter or two giving us the required benchmark % return to justify this special situation arbitrage.
And so MysticWealth has bought a chunk at Rs 141 a piece.
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P.S. I am off to Leh for my summer vacations so probably/hopefully be off markets and blogs for next fortnight. Till then