Thinking about Thinking

The brain has a amazing ability to contemplate based on the sensory stimuli that it receives which it then matches with the memories that it has stored to arrive at a suitable response to the stimuli. This is common across all species and with us homo sapiens. The human mind however differentiates itself with other species in its ability to contemplate itself contemplating over something. This particular repetitive quality or as we popularly call it second order thinking, is to quote Prof Ramchandran’s talk on Ted the “Holy grail of  Neuroscience”

One of the interesting aspects of second order thinking is its ability to have a slightly more rational approach as it analyses the relatively emotional reaction of the first order thinking.  But to quote Yogi Berra “In theory there is no difference between theory and practise. In practise there is”.

So let me come to a practical experience that I went through last month. I had bought Hero Honda about a year and half back at around Rs 1400 . This was the phase post the break up with its erstwhile partner Honda and the market had turned bearish on the stock with the outlook for the company appearing bleak. I had at that point tried to sit back through the clutter, think through what were the key success variables in the two wheeler business and what value did Hero bring to the table. Though the market was focussing on the technology front, my thoughts led me to believe that the key differentiator ( beyond the brand/ positioning etc) that Hero bought on the table was the distribution strength that it had and the associated mindshare. Having looked at the past instances and examples of Bajaj  & TVS, technology was available off the shelf, maybe costing 400-500 crores which could be acquired and a product portfolio built in 2-3 year horizon. But building distribution especially rural distribution was a challenging task.

Fast forwarding and having collected about Rs 150 ( 70+35+45) of dividend along the way and missed opportunities to sell the stock at 2200 ( I got greedy :-)), I started pondering last month over how the business environment had evolved over the last one year. The company had moved forward on executing the technology gap by acquisition/ tie-ups and has progressed on taping the export markets. Couple of things have happened which made me start looking at a exit. The domestic market had slowed down and Hero was finding it difficult to grow on the large base that it had, coupled with slowdown in the export markets resulting in a relatively delayed launch in the export markets. But most importantly its erstwhile partner Honda has been making progress and gaining marketshare at a pace which to be honest I had not anticipated. 

This is where something interesting happened. As my brain started formulating this line of thought, I began to notice from my comforts of my car that more and more newer bikes and scooters that appeared on the road were largely from Honda and to a certain extent Bajaj. My scanning eyes would rarely notice a Hero bike or scooter.

My second order thinking was telling me that this was clearly availability bias coupled with reinforcement bias playing out where the brain was scanning for data to confirm a decision that was already taking shape in my mind. It knew that Hero’s strength was largely in 100 cc segment and it never had a strong foothold in the urban landscape where the competition was stronger. So logically the second order thinking should have prevented the first order thinking from garnering any fresh data points. But to the surprise of my second order brain, I was still not able to stop looking out of the car window trying to notice the increasing number of Honda vehicles on the road. Though I was rationally able to think that I was being irrational, it didn’t help take away the irrationality.

I did finally sell Hero Motocorp around the 1950 levels and exited the position. Till date my third order thinking is not able to reconcile the inability of the first and the second order thinking to merge together. If all this sounds confusing, well it reflects the confused state of my mind :-).

Addition to the Blog

I have added a new series of links in the blog which covers links to blogs / websites of professors / academicians.

My areas of interests is in the domain of economics, capital markets and behavioural finance. I would be most happy if readers of the blog have suggestions in terms of academicians in these domains, links to whom I could add to the blog .

Out of body experience

Wikipedia defines an “Out-of-body experience” (OBE or sometimes OOBE), is an experience that typically involves a sensation of floating outside of one's body and, in some cases, perceiving one's physical body from a place outside one's body.

The ability to stand away from oneself and watch ourselves and our behaviour in a particular situation.

I want to take extend this concept to a “Out of market” experience. Can we take ourselves out of the market and observe our own thoughts and behaviour at every stage of the market ?

A few months back everybody and their grandmothers were talking about a market which having jumped off the cliff was very likely to continue falling. To quote Munger “ The light at the end of the tunnel appears to be of the incoming train”.

I remember a few participants in the market talking about a bear market rally and I specifically remember Shankar Sharma doing it. His thought was that though we are in secular bear market there could be swift bear market rallies which could take the market up by nearly 50%. I was at that point wondering how do market participants behave in a bear market rally?. Wouldn’t the belief/ knowledge that it is a bear market rally curb the rally or does one tend to alter outlook when one reaches the situation?

This brings me back to my original thought of “ Out of market” experience. Can I at this stage take myself out of the exuberance that I experience right now seeing my stock go up 20% everyday and ponder?

Ponder on whether is the worst over or are we amidst a sharp bear market rally and the jump from the cliff has landed us with Alice in Wonderland.

For ppl who have had the privilege to watch Darby, Tigger & Pooh along with their children( I do with my daughter) it’s the time to move that finger to their heads and “Think Think Think”.

Bull Market Blogger

I am at a risk of being labelled as the “bull market blogger” who appears when the markets perk up and disappears as the down cycle starts :-).

I have been fairly irregular on the blog over the last few months primarily due to the fact that I had to make a choice between saving my business and saving my blog :-). Clearing business won over the blog.

Plan to write more often and provide a update on the past ideas that I had listed in the blog.

Satyam Maytas Deal - Audaciously Appalling

It rarely surprises me to see promoters pulling a fast one on minority shareholders but the Satyam proposed buying out of Maytas has really surprised me for the sheer audacity of the promoters.

I will not run into the finer mechanics of the deal as there is enough information on the web but the sheer magnitude of money ( US$ 1.3 Billion) being siphoned out to bailout Ramlinga Raju’s son is appalling.

The market has always been sceptical about Mr Raju’s ethical standards. Remember the 500 crore Indiaworld deal that was done during the dotcom boom. The market was abuzz with rumours on how a significant chunk of the money went back to Mr Raju and his family and got siphoned out of the Satyam balance sheet.

No wonder Satyam always trails Infosys and TCS in terms of valuation. This would be a test case to see how far institutional investors push the promoters and ensure that the deal is reversed.

Incidentally “MAYTAS” is the reverse of “SATYAM”.

FCCB - Buyback time

Last week RBI in its press release announced allowing Indian corporates to prematurely buyback FCCB’s that have been issued.

1) The RBI has decided to permit corporates to premature buyback of FCCBs where the source of funds for the buyback is:
i) Foreign currency resources held in India (including funds held in EEFC accounts) or abroad and/or
ii) Fresh ECB raised in conformity with the current ECB norms, provided there is a minimum discount of 15 per cent on the book value of the FCCB.

2) In addition, the Reserve Bank will consider applications for buyback of FCCBs out of rupee resources provided that:
(i) There is a minimum discount of 25 per cent on the book value;
(ii) The amount of the buyback is limited to US $ 50 million of the redemption value per company; and
(iii The resources for buyback are drawn out of internal accruals of the company as certified by the statutory auditor.

Indian corporates have used the FCCB route to raise capital in the current investment cycle. These low cost funds which were pegged to aggressive stock prices for conversion were now coming back to haunt balance sheets. Clearly with the stockmarket crash FCCB’s were either unlikely to be converted into equity or converted at a lower rate ( Ex Pyramid Saimara) resulting in greater equity dilution.

The current credit crunch has come as a boon in disguise for corporates that are sitting on cash or have a steady stream of export income. FCCB’s are quoting at a significant discount to the face value and it is a ideal opportunity for corporates to buyback these bonds and clean up their balance sheets.

I can see a lot of corporates ( Ex Ranbaxy ) using the RBI go ahead effectively. In these tough times it is better to buyback your debt at a discount than equity.

We learn from history that we don’t learn from history - Part 2

I had in my earlier post talked about two trends that history tends to repeat. One was the cyclical nature of markets, the other is the fact that

All Empires Die
Francis Kukuyama wrote a essay in 1989 “ The End of History” presumptuously arguing that the advent of Western liberal democracy reflects the end point of the mankind’s ideological evolution.

Mr Kukuyama seems to have missed out on the rationalising ability of all winners in believing “ Since I won, I was right”. It is this belief that makes all winners propagate their way of life to the rest of the world. Alexander thought of doing it so did the Romans. The Spanish decided that Christianity is the best religion and carried out their inquisitions. The British followed it up with their way of life and the British sense of fairness ( as they plundered the world) was what the world needed.

And of course now the American way of life that pervades every aspect of our lives from Coke to free markets and exotic derivatives.

The denizens of these empire tend to lose touch with reality and believe that the moral high ground arising out of victory translates into a easy life. The greed of a empire works towards propagating itself hoping to make the rest of the world pay for its upkeep. It peaks at the height of the enterprising ability of its citizens and slowly deteriorates as its citizens start enjoying the fruits of the efforts of their forefathers.

From the point that it starts living off its vassal states and their citizens to the point where it gets lazy to be enterprising and slowly giving that advantage off.

America the empire that took over from the British is in a decline and is slowly giving up its right to rule the world. You can’t be a king with tattered clothes and IOU’s to your subjects. It wont happen tomorrow but it is happening as the power shifts and I suspect will shift to the Chinese who will rule the world over the next century. Though this is apparent to an outsider as he sees the Americans sell off their family jewels to feed themselves, for Americans I don’t think the wake up call has happened.

It is the rationalising nature of the human mind which believes that the good old American way of life will continue, failing to read the writing on the wall or the path of history that will lead to the decay of the empire.

The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
The order is
Rapidly fadin.
And the first one now
Will later be last For the times they are a-changin. - Bob Dylan

Some humour to make us feel young again

While reading through the web I came across Eddie Cantor who was a comedian and here's a quip by him during the Great Depression of 1929.

Eddie Cantor, said that his broker had told him "To buy this stock for my old age. It worked wonderfully. Within a week I was an old man!" :-)

We learn from history that we don’t learn from history - Part 1

This is amongst my favourite paradoxes and I savour the deep meaning that the paradox throws at us.

It is human to experience the wide range of emotions which enrich our lives. From the exhilarating highs to the depressing lows. Markets are like mirrors that stare back at us, displaying our own emotions and blurring the picture over a period of time. Do our emotions define the markets or does the market define our emotions? Who is the dog and who is the tail gets lost in the concoction of emotions that wag around us.

History poses the same problem to the human mind. Does history define the path that we will walk or do we chart the path which will rewrite history?. Surprisingly, though science has progressed on all frontiers, the human mind still remains where it was and experiences the same set of emotions. The thrill of a hunting kill is the twin sister of the kick in executing that profitable trade. Our primal emotions have moved unaltered through history and are bounded by the framework that history defines for us. We are destined to operate within those boundaries, believing that we will rewrite history as history makes us repeat it.

There are two discernable trends that I want to touch upon where history keeps repeating itself.

Cyclical nature of all markets
Man is not a rational animal but a rationalising one. The ability of the human mind to rationalise everything from valuing eyeballs during the dotcom boom to sending millions of Jews to the ghetto is amazing. We don’t find answers for our questions but define the questions for the answers that we have already decided on.

This rationalising ability of the human mind makes it experience the exhilarating high to the depressing lows.

“Greed is good” said Ivan Boesky at Berkeley’s which Michael Douglas ( Gordon Gekko) later made it famous in the movie “Wall Street”.

Combine greed with the rationalising nature of the human mind and we get “irrational exuberance”. To covet the other man’s land, gold or his wife while keeping our‘s at home has driven human civilisations through history and it will continue. Fear of losing your life or your wealth over it is the flipside of that pursuit. Can we overcome the cycle of greed and fear? We haven’t in 8000 years of human evolution and I don’t see we managing it now. So we will go thru this fear phase to experience the next round of unbridled greed. The actors in the play might change but the play will go on.

To quote Shakespeare

“All the world's a stage,
And all the men and women merely players:
They have their exits and their entrances”

To be continued ......

Iceland getting chilled out

The wonderful small little country of Iceland which is inhabitated with about 3,20,000 denizens is heading for bankruptcy. It is on the verge of joining the elite group comprising Lehman Bros, AIG, Washington Mutual and could become the first country to go down in the current credit crisis.

What is interesting is not the fact that a country is heading for bankruptcy, a lot of them have in the past from Asian to African countries. What however is interesting is the fact that it would be amongst the first so called "developed" "rich" countries which will go down.

We live in interesting times. The times they are a changin.

End of Year Closing Sale

We have a end of the year closing sale going on. One on One free :-)

To quote Mark Twain " We are now interested on the return of our money and not the return on our money".
Well thats how the market is behaving as it stampedes itself thru the exit door.

Its Darkest before Dawn

"The Door's" wonderful song " The End" comes to my mind when we look at the current gloom hanging over the world

This is the end
Beautiful friend
This is the end
My only friend, the end

Of our elaborate plans, the end
Of everything that stands, the end
No safety or surprise, the end
I'll never look into your eyes...again

Can you picture what will be
So limitless and free
Desperately in need...of some...stranger's hand
In a...desperate land
......
.........
..........
The west is the best
The west is the best
Get here, and we'll do the rest .......... :-)

Ironically Jim Morisson wrote this a few decades back and I m sure Wall street wasnt there on this mind when he wrote this.

But on a serious note the seeds of a bull market are planted in the abyss of a bear market. There is some great value that is today available on the streets. It is darkest before dawn.

The 3C’s of Investing

When I went passed out of my B School and stepped into the corporate world, I left behind the golden rule of marketing that Mr Kotler’s blue coloured marketing management book listed down. The 4P’s of marketing. By the time I was passing out the 5th P was getting added to it called Packaging.

I moved to the 3C’s of marketing in the real world.

1) Convince
2) Confuse
3) Corrupt

It was simple and effective.

Convince - You start with a product and try convincing the customer on how great the product is and better than the competition. Like how u r shampoo will make hair more silkier and beautiful. If this doesn’t work then move to the next stage …

Confuse – If refuses to be convinced, confuse him. He needs to buy your product bcos it has ZPTO, AFGO, Booster technology, Oxidation technology, Salt crystals etc. Most customers will get adequately confused to buy the product. If this doesn’t works move to Step 3.

Corrupt – Buy 1 get 1 free, get 30% more, buy shampoo get toothpaste free, Rs 10 off etc. Economists will call it incentives. Problem is when everybody is working on corrupting the customer.

Well the 3C’s works as well in the investing domain. Companies / Management go thru the same cycle marketing their stock.

Convince - Managements will make some nice presentations and give the relevant sound bites to convince investors on the great future of the business and the company. If this doesn’t convince investors to chase the stock, move to step 2.

Confuse - Announce increase in FII limits and a few takeovers across the world. ( It doesn’t matter some of these are shell companies owned by the promoters sister in law). Float about 15 subsidiaries so it is really tough to figure out whether any of those takeovers are covering for the cost of capital.

Announce a few large scale diversification into current hot sectors or flavour of the month - Telecom licenses, real estate, infrastructure. If this doesn’t work move to Step 3

Corrupt - Announce a stock split. Thrown in a bonus issue as a bonus. And if all this doesn’t work announce a share buyback DLF, Sasken, Mastek, Reliance Infrastructure …….. This one works for sure.

Oversexed guy in a whorehouse.

Warren Buffett once quoted this when Forbes asked him how he was feeling with the market crash in 1974

Well that’s how I am feeling :-). Unfortunately unlike Buffett, I don’t have the spare money to enjoy (and a wife who is watching over my shoulders :-)).

Though everybody is shouting from the rooftops on how the environment is vitiating and how the market can go below 12,000 and then 10,000, I will stick my neck out and say that this is the time to start building on your portfolio.

I m not saying buying stocks like RNRL, Ispat etc just because they have fallen 75 % from the top. They could and most likely will shrink further, But there are a lot of great companies with visible earnings available at mouth watering valuations. I agree that valuations might become even more mouth watering ( what is cheap can become cheaper) but then its tough to catch the top and bottom of the market.

I believe that equities are the best bet to ride out inflation. They might underperform in the short run due to sentiment but companies with low debt on the books and strong cashflow’s will be better positioned to increase marketshare and hence encash as the cycles turn.

One of the advantages of inflation is the fact that replacement costs for companies which have already build capacities in terms of land, plant & machinery etc keeps going up. It provides a natural hedge to the depreciating value of your money as the value of those assets go up. Look at historical costs of putting up a cement plant or building a brand compared to putting up or building one now.

Avoid companies where a lot of the valuation is based on future growth which requires capital. These companies will or have already witnessed serious contraction in their PE ratio as growth tapers off due to lack of capital or that it comes at a high cost.

Yeh na thi Hamaari Kismat ……

Yeh Na Thi Hamari Kismat, Ke wisaal-e-yaar, hota,
(It was not in my destiny, to be united with my lover)
Agar aur jeete rehete, Yahi Intezaar Hota
(If I had lived any more , I would still be waiting for it) …… Mirza Ghalib

Well what does Ghalib have to do with investing other than feeling poignant with the current state of the capital markets :-).

I have been struggling over the years to overcome one of the behavioural biases that I suffer while placing a order. In a fairly well traded stock there is enough liquidity and the impact cost of a trade is very small. So the market at a particular moment has the right price for the stock ( I m not talking about valuations here) based on the buyers and the sellers in the market.

The bias that I am referring to originates when I am buying a stock, I tend to put a price slightly lower than what the market is trading at to get a so called better deal. The implicit assumption by doing this is that one believes the market at that moment is inefficient and the actual price of the stock should be lower than what it is traded at.

Similarly when one is selling, one tends to place the sell order at a slightly higher price than where the stock is currently trading. Same implicit assumption that the market is inefficient however, this time the view is diametrically opposite that the market is paying less than what you believe is the fair price.

This is the dissonance where the market can’t be inefficient both ways. I have missed out on a lot of buying or selling opportunities and like Ghalib waited forever for the price to come :-).

The times they are a changin

The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
The order is
Rapidly fadin.
And the first one now
Will later be last
For the times they are a-changin. – Bob Dylan

One wonders if Dylan was singing about the markets and watching the sectors churn by the sidelines.

Well the times they are surely changing as the old sweethearts like Real Estate, Power, Infrastructure etc are going through their phase of PE contraction as money has moved into beaten down sectors like IT, Pharma etc. Equities have made way to commodities and commodities will make way to what i dont know.

The cycle will repeat and the times will keep changing :-).

Innovation and Investment

I was reading the BusinessWeek dated last week of April ( better late than never :-)). The cover story is about the annual global survey that BusinessWeek does on the “Most Innovative Companies”.

It was heartening to see two Indian companies in the top 25, the Tata group and Reliance Industries. The Tata group made it to the list, fuelled by the $2500 Nano for the masses.

The brief description given on GE which stands 4th in the ranking list was about the $ 1500 Electrograph which its engineers based out of India have created focussing on servicing the bottom of the pyramid in developing countries.

One of the things that we tend to do in our minds is to equate innovation with industries like Pharma, Technology, Engineering etc. But innovation is far beyond this and covers the smallest of things in the smallest of industries. It is about the small sachets of shampoo to the rock bottom pricing that we have seen in the telecom industry.

How do you blend innovation and investment?

It is critical to look at companies which have innovation ingrained in their DNA. In this I don’t mean R & D spends which though important is not the be all and end all of the process of innovation.

Are the companies that one invests in, capable of coming up with disruptive technologies and processes which could change the rules of the game. Reliance made it to the list for the way it is rewriting the rules of the retailing industry in India.

In the current world of higher food prices Walmart has managed to bring food prices down. How did they manage it? Most cereal makers put their product in large sized boxes ( Compare a Kellogs box with the amount of cornflakes in it). They do this to enable greater shelf space and branding. All Walmart did was promise the same amount of shelf space for their products but pushed mfgs to reduce box sizes. This reduced not just the amount spent on paperboard but also reduced the transportation costs as more boxes got fitted in the same trailer.

A latter post on how innovation has kept the US economy going and reinventing itself.

“Nitwitted ninepins” – ( Captain Haddock in Tintin& the Land of Black Gold)

Billions of blue blistering barnacles, they finally did it.

In my earlier post I had written on the worry variable associated with oil. The markets have moved substantially lower since then.

The government finally developed a spine and did the right thing in my opinion. The move from the government will ease the pressure on the oil marketing companies and the associated fiscal deficit build up. More importantly passing down the costs will result in greater energy efficiency in the economy and will hopefully contract demand.

I think this move could have a interesting fallout. It could actually lead oil prices lower. With demand contracting across the world in economies that are passing on the cost of oil, India and China were the last major bastions where subsidised oil was fuelling demand. China I suspect wont move till the Olympics are through but India’s move might trigger a move down in oil which is increasingly getting bracketed as a bubble.

We of course have to wait and watch.

Come on baby, light my fire

You know that it would be untrue
You know that I would be a liar
If I was to say to you
Girl, we couldn't get much higher ( than $ 135 a barrel :-))
Come on baby, light my fire
Come on baby, light my fire - The DOORS

Well how much higher is oil going to go. At over $ 135 dollars a barrel it sure is going to burn down a few economies including us.

Are we at the beginning of the beginning or are we nearing the end of the end of the bull run that we have seen in oil. I for one have no clue on this one.

But I know that the current subsidy situation that exits in India and countries like China, Indonesia etc is unsustainable. Demand needs to start contracting as it is in the countries that are passing thru the cost to the consumers.

We are anyway burning down the oil marketing companies with the subsidy bill.

I don’t think markets in India have factored in the implication of oil other than downgrading a few auto stocks or companies which use petroleum derivatives as inputs, or the interest rate sensitive’s.

Sustained oil prices at this level will start affecting both the world and the Indian economy in a more dramatic fashion and could induce some paradigm shifts. Both politically and economically.

I m more worried with oil at $135 than I was when the markets were sub 15000.

Reliance Naturally Resourceful Limited

The stock is currently at Rs 110. It has come down from a 52 week high of Rs 248. I am not going to dwell into PE ratio’s ( just about 263 times ) to discuss whether it is currently undervalued or overvalued.

This post is about something different.

I just ran through the FY08 results that the company has posted on the BSE site.

As on Mar – 08

Equity - 816 crores
Reserves - 913 crores
Total networth - 1729 crores

Scenario 1
Let’s examine how much debt the company can take on its balance sheet.

1) Debt equity ratio
Let us assume that the company can leverage its balance sheet and take debt in a 2:1 ratio or let me be more generous maybe 3:1.

Networth - 1729 crores
Total Debt - 5187 crores

2) Interest Cover Ratio
Let’s assume a interest cover ratio of 2:1 and RNRL can borrow at 8%.
EBIDTA – 170 crores ( Mar 08 )
Total Debt - 1060 crores

Assuming we have a Corporate banker who is willing to take risks then he would potentially open to lend about Rs 5187 crores to RNRL on the balance sheet.

Scenario 2
Loan against shares
Current market Cap - 18054 crores
Haircut ( 60% ) – 7221 crores
(I have been ultra conservative there are bankers, NBFC’s who would give more)

So you can borrow about 7200 crores by placing RNRL stock as collateral.


The banker won’t be willing to lend more than 5200 crores for the companys balance sheet / operations but the same banker would be willing to lend over 7200 crores against the company’s stock.

Imagine the gap when the stock was at Rs 250.

I rest my case.