Wednesday, October 18, 2006

Stock markets and 'denigration of history'

I am currently reading a book "Fooled by Randomness" by Nassim Nicholas Taleb. The book is all about the hidden role of chance in stock markets and life. The book was chosen by Fortune as a part of the "ultimate reading list". In the second chapter of this book there is an interesting note on "denigration of history". Denigration, by the way, means to treat as lacking in value or importance. Here's an excerpt:

Reality is far more viscious than Russian Roulette. First, it delivers the fatal bullet rather infrequently, like a revolver that would have hundreds, even thousands of chambers instead of six. After a few dozen tries, one forgets about the existence of a bullet, under a numbing false sense of security. This is related to a problem called denigration of history as gamblers, investors, and decision makers feel that the sort of things that happen to others would not necessarily happen to them.

Second, unlike a well-defined precise game like Russian Roulette, where the risks are visible to anyone capable of multiplying and dividing by six, one does not observe the barrel of reality. Very rarely is the generator visible to the naked eye. One is thus capable of unwittingly playing Russian Roulette - and calling it by some alternative "low risk" name. We see the wealth being generated, never the processor, a matter that makes people lose sight of their risks, and never the losers. The game seems terribly easy and we play along blithely.

The note reflects how investors tend to behave during bullruns. Valuations are pushed up to unrealistic levels like they were once in case of IT stocks during 1999-2000. IT companies such Infosys, Wipro, Satyam, HCL Tech, etc. were all trading at P/Es of over 70-75 times. Investments in these companies at that point would have probably evened out now, ie. after six years. Atleast, these evened out. What about investments in scrips like Global Telesystems, Himachal Futuristic Communications, Silverline, Zee Telefilms, Pentamedia, etc.? I am sure these will never recover, atleast not in this lifetime. Though some like Silverline Technologies are trying hard to get investor interest as can be seen by these announcements: 1, 2 and 3. I think they are best avoided.

Do we see such instances of "denigration of history" in todays markets? Maybe. I think real estate companies could belong to such a category. Companies such as Unitech, Mahindra Gesco Developers, Phoenix Mills, Ansal Properties & Infrastruture. These companies are trading P/Es of between 50-240 times. With the bigger companies trading at even higher P/E ratios. Unitech is quoting at a mcap of over Rs.25,000 crore. This for a company that earned a mere Rs.135 crore over the preceding four quarters. Something sounds really inexplicable there. There were news reports that DLF, a Delhi-based real estate developer which is coming out with an IPO was expected to be valued at a phenomenal mcap of over Rs.100,000 crore. All this sounds crazy to me. Maybe I am wrong, but I would like to proven wrong, convincingly. Will monitor these companies closely over the next few quarters.

Btwn the book "Fooled by Randomness" is simply awesome. A must read for any investor.

No comments: