Some of the most fascinating topics covered this week are: Stock Market (Learnings from analysing 2,800 Indian listed companies; Bubble hunting has become an art), Business (Ironies of luck; Risk is never as simple as it seems), Parenting (3 scariest chemicals to watch out for in your home) and Economy (Nutrition is India's next big headache)
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At Ambit, we spend a lot of time reading articles that cover a wide gamut of topics, ranging from zeitgeist to futuristic, and encapsulate them in our weekly ‘Ten Interesting Things’ product. Some of the most fascinating topics covered this week are: Stock Market (Learnings from analysing 2,800 Indian listed companies; Bubble hunting has become an art), Business (Ironies of luck; Risk is never as simple as it seems), Parenting (3 scariest chemicals to watch out for in your home) and Economy (Nutrition is India’s next big headache).
Here are the ten most interesting pieces that we read this week, ended August 28, 2020-
1) Learnings from analysing 2,800 Indian listed companies [Source: drvijaymalik.com]
In this elaborative article, Dr. Vijay Malik explains how he analysed 2,800 listed companies using two simple filters. 1) know about what a company does, and 2) see the financial performance of every company over the last 10 years. Then he jots down his learnings. He notes that there is severe shortage of companies with a large market capitalization. And most of the large-capitalization companies have astronomical valuations due to too much money chasing too few companies.
On financial performance of large companies, he analysed that when an investor analyses many large-capitalization companies, then he/she notices that the proportion of companies that impress him/her with their good financial performance is far higher than the companies in lower market capitalization segment. Talking about smaller companies, most of the small companies suffer from delayed receivables collection, and also some of the companies’ business model is interesting with no competing listed peers.
Talking about trends, he writes, when a trend picks up, then share price of almost every company even remotely linked to the theme, goes up. However, more often than not, when the trend is over, then the share price returns to the levels previous to the thematic stock market rally. Also, doing this exercise was nostalgic to Dr. Malik as he discovered some old well-known brands, now lying in the small-cap segment. Most of these companies are barely surviving.
2) Bubble-hunting has become more art than science [Source: The Economist]
Spotting stock market bubbles in real time is trickier—especially when the usual measures of frothiness are out of action. Wall Street types typically pore over price-to-earnings ratios, which compare a firm’s value with its profits, or free cash flow measures, which look at the cash firms crank out after investment. Warren Buffett targets firms with a high return on capital, which compares their profits with the size of their balance sheets. But the COVID-induced economic slump caused earnings to sink even as the Fed and other policymakers have helped buoy share prices. The obvious gauges of frothiness are not much use. S&P 500, a share-price index of America’s biggest public companies, reached an all-time high on August 18th in the middle of perhaps the sharpest ever economic downturn. Without hard numbers to count on, they must interpret the market’s unusual behavioural signals in order to spot the froth.
One such sign is the mystifying moves in some stocks. On August 19th, Apple became the first American company to touch a valuation of $2trn. Tesla, a carmaker that is undertaking a stock split at the end of August, has quadrupled in value so far this year. It is now worth $354bn, more than Ford, Toyota and Volkswagen combined. Nikola, an electric-truck firm (that has yet to make any lorries), has tripled in value since May. Even more perplexing was investors’ fondness for Hertz, a car-rental firm. Its share price rose tenfold after it declared bankruptcy (though this bubble has since popped).
What to do, in the face of all this enthusiasm? Other assets may start to seem more alluring. On August 14th, Berkshire Hathaway, Mr. Buffett’s investment firm, said that it had sold chunks of its stakes in banks and bought up shares in Barrick Gold, a mining company. But gold and other assets have also shot up in value this summer. As markets rise further, it may become even harder to resist joining the fray. Some investors may pile in, and exit with a profit. But even the most brilliant minds can be bamboozled.
3) Ironies of luck [Source:collaborativefund.com]
What’s risk and luck in a market? Many a times, people talk about the risks in the stock market but no one talks about luck. “In a moment of frightening enlightenment in 1993, I knew that I really did not know exactly how and why I had made all the money that I had over the prior 17 years,” Paul Tudor Jones once wrote. “That threw my confidence for a jolt.” If risk is what happens when you make good decisions but end up with a bad outcome, luck is what happens when you make bad or mediocre decisions but end up with a great outcome.
In investing, a huge amount of effort goes into identifying and managing risk. But so little effort goes into doing the same for luck. Investors hire risk managers; no one wants a luck consultant. Companies are required to disclose risks in their annual reports; they’re not required to disclose lucky breaks that may have led to previous success. There are risk-adjusted returns, never luck-adjusted returns.
So what can we learn about luck from risk? 1) Good investors attempt to quantify risk. They should do the same for luck. 2) People are good at discounting risks that threaten the continuation of their past success. They are equally good at discounting the role of luck in their past success. 3) Risk is hard to define, and means different things to different people. Luck is, too. 4) Experiencing risk reduces confidence when it should merely highlight reality, which can make people more conservative than they should be. Luck increases confidence without increasing ability, which also magnifies how people respond to it.
4) Risk is never as simple as it seems [Source: awealthofcommonsense.com]
In this blog, Ben Carlson shows how risk management can help protect you from the worst-case outcomes. But that reduction in risk often comes with a cost by enhancing other risks. For some investors, risk reduction in one area can actually lead to more risk-taking elsewhere. He starts with his personal experience of how egg shells chocked up his house drainage pipeline. After flushing the pipe with many blasts of water to clear things up the plumber gave them some advice: Never put any food down your garbage disposal. Garbage disposals are what keeps me employed. He said the garbage disposal gives people a false sense of security that they can just put anything down their sink and it will magically disappear.
There are plenty of examples like this where safety measures can offer a false sense of security, thus introducing additional risks to the equation. A study in Norway found new cars, despite having better safety measures and more advanced technology, get into more crashes than old cars. And this takes into account the fact that there are more new cars on the road. Safety measures in the world of finance are sure to have unintended consequences as well. The measures enacted during the current crisis, as necessary as they may have been, are sure to change the way investors view risk in the years ahead.
This year has been an event-driven crisis. We all know why these bonds sold off. And if you’ve been following along, you know why they have come back so strongly — the Fed. The Fed back-stopped the credit markets both financially and psychologically to keep the system functioning. The markets are doing much better than the economy through this crisis and the Fed is a huge reason why. Ben says that these market-saving measures are sure to have unintended consequences going forward. And he has a few questions like will investors take more risk going forward because of a perceived Fed backstop? Will investors be coerced into taking more risk than they are comfortable with? And so on.