The 'Buy buy...Bye' syndrome

There are times when we decide a price that we're willing to pay to own a fundamentally good stock, say when it's trading at 20-30% discount to its intrinsic value.
And in a falling market, we find that the stock comes tantalizingly close the intrinsic value just to bounce back to the old unattractive levels.
Let me give you an example of this... In recent times, a company that I felt was trading at a discount to its fair value was SBI

SBI touched a high of 2540 on 14th Jan 2008, and since then it has breached a strong support line and resumed its uptrend... as shown below

@ CMP of Rs. 1,565...Here are a few estimates of the P/BV of SBI

                                    P/BV                       P/E

                          FY09E    FY10E     FY09E   FY10E

Citi                      2.17        2.06           14.53     10.63

Kotak                  2.05         1.84           16.65     13.08

Consensus           2.11         1.95           15.59     11.86

SBI touched it's year low of 1025 on 1st July 2008...and was trading at the following consensus multiples

                          FY09E    FY10E     FY09E   FY10E

1007                    1.36        1.25           10.02     7.62

1100                     1.48       1.37           10.95     8.33

1200                    1.62        1.49           11.95     9.08

Very attractive multiples for the India's top bank by M-Cap, Assets/loans/deposits...
ONGC's case is similar as it tested new lows and resume its upward march....
These cases make me think...whether we should invest in a very active manner and pounce on opportunities, or should we buy into good companies in a systematic manner...
I will try to answer this in the next post

The Art of selling stocks

The current state of the markets reveals a thing or two about the behaviour of investors.I saw an article on rediff  discussing about what mutual funds have been buying/selling. 

The top 5 'sells' by mutual funds are the following 

 > Jaiprakash associates 

> Cairn India

> Zee entertainment

> IDFC and

> Satyam computers.

3 of the above companies, Jaiprakash, Cairn, IDFC have delivered stupendous returns to investors who'd entered 2-3 years back. Jaiprakash associates at today's closing price of Rs. 73 has still managed to give a 2 year return of 73% while IDFC has returned 85% during the same period (taking today's closing prices for all companies), Cairn delivered 86%.

Many companies which have collapsed in this fall are companies which have given a good return over a period of 2-3 years... despite the steep correction. The sell off in market out-performers is reflective of how we as investors behave. 

During a market fall when we see our portfolios, we tend to sell off the assets which are in the green (making profits), and hope that the rest of our portfolio recovers. This is because a loss causes much more pain than the satisfaction that an equivalent gain would bring us.We can compare our practice of selling profitable investments during bearish phases, with the shorting of an investment that has outperformed the market till now.

Whether this is correct or not, is something that the fundamentals and other factors will tell us. However, if the fundamentals of these companies are sound then there is no reason why such stocks shouldn't bounce higher than the markets on a rebound. 

For those of you, who've seen your well researched profitable picks pare their profits due to purely 'technical reasons,' I have one thing to say... Hold your horses or sell off if you feel that these technical sell-offs will take your stock to the lowest of lows but remember that you will find it tough to buy them back at the lowest of lows, as it's almost impossible to pick the bottom.

Psychology and investing

While reading Fooled by Randomness and More than you know... I encountered a term called the Babe Ruth effect. This term was used to explain the simple concept of expected return of an investment, which is the sum of the products of the returns and their probabilities of occurrences. To make it simpler here's an example: An investment having two payoffs: a 100% upside with a probability of 20% and a 10% downside with a probability of 80%. This investment will have an expected return which is as follows: 100% *20% + (-10%) * 80% = 20% - 8% = 12%.

The Frequency v/s Magnitude trade-off

The noteworthy feature of the above example is that seeing the probability of return i.e. 80% chance of getting a negative return and 20% chance of getting a positive return, it would be very tempting to write a call or go short on the security. However, it is very important for us to understand the effect of the magnitude of the return for the probabilities while taking decisions. This is also known as the frequency v/s magnitude trade-off.

This is the Babe Ruth effect, as Michael Maubossin and Bartholdson call it in their paper. They named this observation after a legendary baseball player Babe Ruth, who exhibited similar characteristics with respect to his hitting.

Investment lessons

The paper on the Babe Ruth effect gives some advice on approaching investments which include thinking in terms of decision trees, focusing on things we know, making the most of the limited opportunities and understanding that we don't need to put everything in stake every time.

Apart from the lessons mentioned, we must also delve deeper into the investment decision tree which may lead us to conclude various things.

Problems with this approach

I'm afraid that most investing decisions we take are not simplistic enough to enable us work in the decision tree manner and gauge the magnitude/probabilities so explicitly.

More rumination in this area may bring us to issues like: Whether we should sell puts/calls when we spot gaps which may result in a high probability low return event and be content with a paltry return or buy a put/call which will lead to us forgoing the premiums in maximum occasions while leading to massive payoffs in the unlikely event scenario. Taleb seems to favour the second scenario.


Other thoughts on the same tune...

Hold on to your beliefs in tough times

The continuous movement of the markets and the news that flows influences us in a such a way that we tend to sway our loyalties/discard our personal beliefs in favour of some research by a bank which hasn't been able to guard itself from this crisis. This is something that we must be wary of. We shouldn't let these blips or short term concerns override the decisions that we've based on our sound judgment.
I say this because, this crisis and all the other crises in the past have shown how foolish these institutions are in guarding the interests of their own shareholders... Some have had their asset bases shaved off to quarter of the what they had in the peak of the bull run!
And in a desperate bid to save themselves from utter damnation (read: the bear stearns episode) many are seeking capital from Middle east investors... the same sovereign wealth funds which the westerns considered anathema are now rescuing them.


PS: Back after a long hiatus for CFA preparation. Please pour in with your views to help me improve my thought process.

Comment based addendum: The frequency magnitude trade-off... The sheer magnitude of the return in the event of a positive earnings surprise should prompt an investor to go long despite a very high chance of negative return or opportunity loss (0% return). Please check the below figure.

When is it a bear market?

Just found a really hilarious article on Business standard

When is it a bear market?

Mudar Patherya provides some key signs of a bear market.

You know it is a bear market when…

# Someone who has been earning Rs 75,000 a month (including DA) suddenly starts asking herself philosophic questions like “Can I eke out an existence at Rs 7,500 a month?”

# You suddenly swipe your card into work at 9.30 am, coast over the irritable desire to look at the watch at 9.54 am or excuse yourself to the toilet at 9.55 am if only to conduct hushed conversations with a mechanical voice at the other end

# You start getting ‘great work cards’ from colleagues; seniors call you into their cabin wanting to know the raaz behind your sudden increase in productivity

# You start impressing the neighbour’s daughter with the use of words like ‘planning’, ‘portfolio construct’ and ‘instrument mix’

# You move from page 1 to the back page of business newspapers’ Money and Markets by reflex action

# You go to the doctor with the ‘sinking feeling in the solar plexus complaint’ but she checks your pulse and there is nothing wrong, she asks you to say ‘aaah’, stick your tongue out and you are absolutely fine

# Your favourite fantasy is not running around trees in the rain wearing white shoes behind Mallika Sherawat but for some curious reason ‘9.56 am, 21 January’

# You boast at a party of having shorted the market at 21,000 and suddenly the listeners drift

# You start taking a perverse consolation from the fact that we are better than ‘Gayatriben’s husband, who had to sell 30 per cent of his inventory to pay the broker’

# The children start getting the drift that the world has changed in some way they are yet to fathom because the holiday destination has been switched from Phuket to Puri and the carrier from Thai International to Puri Express second class and all the parents will proffer is a stoical ‘Paisey phainkne ki kya zaroorat’

# All those people who would arrogantly demand “Will it double in two months?” now venture to tentatively explore “Will it get back to the prices we bought in two years?”

# You stop getting cold calls – ‘Good morning Mr Patherya, how is your day? Can we come and see you for five minutes? Send you the proposal on the email? No, we would like to come and see you instead’ - prospecting your brokerage business from financial securities firms

# When you get a mail on Narayan Murthy’s ‘simple living, high thinking’ stuff and you cc it to 23 people in office who in turn cc it to 250 others, who in turn forward it to 1,563 people who in turn send it to 12,304 people – and within 37 hours, it pops back into your mail with an interesting addition ‘If you circulate this to 7 people in the next hour, your portfolio will bottom out; if you don’t then the company in which you hold stock will do a buyback and your letter of offer will be waylaid in post’

# You start having tea with friends and lunch with in-laws; the word ‘social’ doesn’t remind you of an awful waste of time

# You can actually have a business meeting without sms alerts on market movements

# The restaurant steward motions you to the tables closest to the television (featuring CNBC) and you tell him ‘Somewhere where we are not distracted please’

# Experts when they find calls coming in from business channels offer their mobiles pleadingly to colleagues with ‘Please keh do ki I am in a meeting and main phone karoonga but after 3.30’

# People suddenly discover they have relatives in the US who they have not spoken to for 18 years and then they confront them with the opening line of ‘Tya badhu barobar’

# When Marc Faber predicts that the index will go down to 12,000 and in the same newspaper edition a consensus of brokers indicates an index of 19,000 by the year’s end

# When the envelope carrying the dividend cheque is treated with considerable respect

# When you ask for the ‘Black Swan’ by Nicholas Nassim Taleb at the bookstore and the manager responds with ‘Kya baat hai, every third walk-in is asking for this?’

# When merchant bankers tell IPO clients “You will need to leave value on the table for investors”

# When an effective stress test becomes dirt cheap; all you need is the financial newspaper and if after the 37th line of the stock quotations page you find your pulse accelerating and breath halting, then you need a GP

# When the broker calls and you tell him ‘Aap mat call keejiyega! Darkaar hogi to main karoonga’

# When you want to do a fund raiser and you diplomatically skirt anyone connected with the stock market

# When your chartered accountant calls and says ‘Bhaiji, problem solved. Is baar losses khareedney ki naubat nahi aayegi’

# When you invite the guy who had a big problem meeting his margin calls and he says ‘Aajkal to mein kahi baahar jaata nahi hu, sirf office and back’

# When the standard escape route for every analyst becomes ‘ghatey to liyo’ and when the stock declines, they say the same

# When the word ‘neevra’ is used in every seventh line by brokers, analysts, tipsters, jobbers and market writers

# When even a casual ‘ghabraao nahi’ lifts the clouds enough for the caller to call three others and say ‘Babubhai kahey chhey hay ghabraavnu jehvu chhej nahi’ and within half an hour of frantic calling and re-calling, some 23 people are walking in a better frame of mind to office

# Everyone is poorer, but bloody hell, no one is admitting it.


PS: Here's the source http://business-standard.com/common/storypage_c.php?leftnm=10&autono=319183

A compilation of great reads, hope you find it useful!

Reading list

I. Barbarians at the Gate, by Bryan Burrough and John Helyar

II. Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, by Hersh Shefrin

III. Confessions of a Street Addict, by Jim Cramer

IV. Den of Thieves, by James B. Stuart

V. Devil Take the Hindmost: A History of Financial Speculation, by Edward Chancellor

VI. Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, by Nassim Nicholas Taleb <128/tab>

VII. Liar’s Poker, by Michael Lewis

VIII. Monkey Business: Swinging Through the Wall Street Jungle, by John Rolfe and Peter Troob

IX. Reminiscences of a Stock Operator, by Edwin Lefevre <332.6/lef>

X. The Mind of Wall Street, by Leon Levy

XI. The Predators’ Ball, by Connie Bruck

XII. Wall Street Meat: My Narrow Escape from the Stock Market Grinder, by Andy Kessler

XIII. When Genius Failed: The Rise and Fall of Long-Term Capital Management, by Roger Lowenstein <332.6/rog>

Another List

I.Markets in general

I. Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

II. Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris

II. Equities

I. Black Swan, the Impact of the High Improbable - Taleb

II. Where Are the Customers' Yachts, Fred Schwed

III. The Essays of Warren Buffett : Lessons for Corporate America by Warren E. Buffett

III. Investment banking

I. The Accidental Investment Banker: Inside the Decade that Transformed Wall Street

II. The Last Tycoons: The Secret History of Lazard Fr?res & Co. by William D. Cohan

III. Valuation: Measuring and Managing the Value of Companies, by McKinsey & Company Inc.

IV. Fixed Income/Derivatives

I. Bonfire of the vanities

II. Fiasco: The Inside Story of a Wall Street Trader by Frank Partnoy

III. Traders, Guns & Money: Knowns and unknowns in the dazzling world of derivatives by Satyajit Das

V. Quant

I. A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

VI. Hedge Funds

I. Hedgehogging by Barton Biggs

II. More Than You Know: Finding Financial Wisdom in Unconventional Places by Michael J. Mauboussin <>

VII. Psychology

I. How We Know What Isn't So by Thomas Gilovich

II. Influence: The Psychology of Persuasion by Robert B. Cialdini

III. Why Smart People Make Big Money Mistakes And How To Correct Them by Gary Belsky and Thomas Gilovich (for managing ones own finances)

IV. Psychology of Finance by Tvedel <>

VIII.Economics

I. The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities by Bernard Baumohl 330/BAU>

Deepak Mohoni's picks!

1. Trading in the Zone – Mark Douglas

2. How to make money in stocks - William J. O'Neil

3. Market Wizards - Jack D. Schwager

4. New Market Wizards - Jack D. Schwager

5. Stock Market Wizards - Jack D. Schwager

6. Street Smarts – Larry Connors and Linda Bradford Raschke

7. Connors on Advanced Trading Strategies – Larry Connors

8. Trader Vic : Methods of a Wall Street Master - Victor Sperandeo

9. The Dow Jones - Irwin Guide to Trading systems - Bruce Babcock

10. Fooled by Randomness The Hidden Role of Chance in the Markets and in Life – Nassim Nicholas Taleb

11. Dynamic Hedging. Managing Vanilla & Exotic Options - Nassim Nicholas Taleb

12. Chaos and Order in the Capital Markets - Edgar E. Peters

13. Fractal Market Analysis - Edgar E. Peters

14. A Multifractal Walk Down Wall Street - Benoit Mandelbrot

15. Beyond Technical Analysis. How to Develop and Implement a Winning Trading System - Tushar S. Chande

16. Stock Market Logic - Norman G. Fosback

17. Winning on Wall Street - Martin Zweig

18. Reminiscences of a Stock Operator - Edwin Lefevre

19. A complete guide to the futures markets - Jack D. Schwager

20. Trader Vic II - Principles of successful speculation - Victor Sperandeo

21. Understanding Options - Robert Kolb

22. Master the Market with Confidence Discipline & A Winning Attitude - Mark Douglas

23. The Disciplined Trader - Mark Douglas

24. Trading For A Living - Alexander Elder

25. Come Into My Trading Room - Alexander Elder

26. Disciplined Trading - van K. Tharp

27. Trade Your Way to Financial Freedom - van K. Tharp

28. Smarter Trading - Perry J. Kaufman

29. Trading Systems and Methods - Perry J. Kaufman

30. The new commodity trading systems and methods - Perry J. Kaufman

31. Day Trading with Short Term Price Patterns & Opening Range Breakout – Toby Crabel

32. Campaign Trading – Tactics and Strategies to exploit the markets – John Sweeny

33. Day Traders Bible or My Secrets of Day Trading In Stocks - Richard D Wyckoff

34. Hit and Run Trading - Jeff Cooper

35. Money Management Strategies for Serious Traders - David C. Stendahl

36. One up on Wall Street - Peter Lynch

37. The Compleat Day Trader Vol 1 & 2 - Jake Bernstein

38. The Day Trader's Bible - Richard D. Wyckoff

39. Trading by the Book - Joe Ross

40. Trading to Win - Ari Kiev

My picks!

1. Intelligent investor - Benjamin Graham <332.6/gra>


PS: Sorry for the long break, I'll be back with more faltoo fundae :P
PPS: The catalog numbers are library catalogs that I had marked for convenience.