Recommended by Experts, Invert please!!

I was talking to a friend’s father who has been investing in the equity markets since some time. On asking about his investment methodology, he said that he listens to the news and basis the recommendations of the experts, he invests in the stock markets. Incidentally, this behaviour is followed by millions of investors who are glued to their TV screens between 9:30 am to 3:30 pm every day, trying to emulate the experts. Investors tend to weigh the opinion of an authority figure more heavily, thereby leading to Authority Bias. Humans usually have deep-seated duty to authority and tend to comply when communicated by an authority figure.

My friend’s father was particularly unhappy with his portfolio’s performance; having checked some of his stocks in the portfolio – again recommended by ‘authority figures’ made me twitch. Some of the following stocks had fallen between 40% – 80% since January of this year.  

  • Dish TV: The company has incurred losses in 7 out of the last 10 years; what was the expert thinking while recommending this? Fall in market price since January: -48.7%
  • LEEL Electronics: The company, despite being profitable, summation of Cash Flow from Operations (‘CFO’) since the last 21 years was negative, combined with an approx. debt of INR 1,000 making it vulnerable fundamentally. Fall in market price since January: -74.0%
  • Cimmco: The company has incurred losses in 18 out of the last 21 years; what was the expert thinking while recommending this? Fall in market price since January: -59.4%

All the above stocks were recommended by some stalwarts or experts. Well, we all get influenced or mis-influenced at times by some of these authority figures, however, we can perhaps avoid or reduce this bias by following the famous mathematician, Jacobi’s Inversion principle – Invert, Always, always invert. Look at any principle upside down.

Just by inverting and answering some of the following questions would have led to avoidance of loss between 40% – 80% of one’s hard-earned money, despite being recommended by ‘experts’

Would you want to invest in companies which:

  • do not have Average Return on Capital Employed greater than 12% – 15%? None of the above companies produced average returns on capital of more than 8% p.a. (less than the government yield)
  • do not have produce positive Free cash flow over the last 10 years? With no profitability produced historically, question of free cash flow does not even arise.
  • will not be able to service their debt? With mounting losses and negative CFO, chances of servicing their respective debt is going to be very difficult.

After all, if children are supposed to do their home-work, aren’t we?

Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action. 

 

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