Have you seen a peacock dance? How beautiful it looks when it spreads its huge tail!
Regardless of its beauty, the peacock’s tail is hard to explain by natural selection as it seems to be more of a handicap than an aid to survival. After all, it plays no role in helping the bird survive and actually makes its life more difficult. Having a heavy, long, broad tail makes the peacock hard to slip through dense vegetation, take flight, keep flying, and thereby escape predators.
The tail’s size and vivid color also attracts attention of predators. And growing a big tail is costly terms of energy expenditure.
In 1975, Israeli zoologist Amotz Zahavi proposed a theory to explain the evolution of the peacock’s tail. The basic idea behind that theory called “the handicap principle” was explained in 1976 by evolutionary biologist Richard Dawkins in his masterpiece “The Selfish Gene.”
Tails of birds of paradise and peacocks, the huge antlers of deer, and the other sexually-selected features which have always seemed paradoxical because they appear to be handicaps to their possessors, evolve precisely because they are handicaps. A male bird with a long and cumbersome tail is showing off to females that he is such a strong he-man that he can survive in spite of his tail. Think of a woman watching two men run a race. If both arrive at the finishing post at the same time, but one has deliberately encumbered himself with a sack of coal on his back, the women will naturally draw the conclusion that the man with the burden is really the faster runner.
In 1997 ecologist Jared Diamond explained the idea in his book “Why Is Sex Fun?: The Evolution of Human Sexuality.”
Many structures functioning as body sexual signals are so big or conspicuous that they must indeed be detrimental to their owner’s survival… Any male that manages to survive despite such a costly handicap is in effect advertising to females that he must have terrific genes in other respects. When a female sees a male with that handicap, she is guaranteed that he is not cheating by carrying the gene for a big tail and being otherwise inferior. He would not have been able to afford to make the structure, and would not still be alive, unless he were truly superior.
In other words, according to the handicap theory, peahens are programmed by evolution to go to bed with peacocks with the biggest tails precisely because those huge tails are signals of high quality (good genes).
Now, here’s question that’s been fascinating me for years: Are high absolute stock prices, especially over the long term, the functional equivalent of peacock’s tails?
That is, is the persistence of high absolute stock price in the long term — say 5 years — a signal of a high quality?
In my view, maybe.
Many people don’t get this. For a number of psychological reasons, they perceive high absolute stock prices as “expensive” as if they were a boulder being pushed up on a hill.
Pushing up such a large boulder will cost too much energy. Just as carrying a large tail will take too much energy for a peacock.
And while peahens are naturally attracted towards large tails, many investors are naturally repelled by large stock prices. And so they stay away. Which often costs them a bundle in terms of lost opportunities.
Take the case of MRF — India’s largest tyre manufacturer and retailer. Today, the company’s stock price hit Rs 80,570 per share. That’s a huge boulder.
But here’s the thing. MRF’s stock was a huge boulder 5 years ago (Rs 33,787). It was a huge boulder ten years ago (Rs 4,593) and it was a pretty big boulder even fifteen years ago (Rs 1,106). But none of that prevented that boulder from being pushed up a very steep hill.
Why did this happen? Two reasons. One, excellent fundamental performance. See table below.
And two, no issuance of new shares — for cash, in mergers, as bonus, or for stock splits. Indeed, MRF has had 4,241,143 shares outstanding like forever. And when outstanding shares do not change, and the business grows over time, its market value also grows over time and stock price keeps going up.
The reluctance of a large number of investors to invest in fabulous businesses which have large absolute stock prices might be an anomaly worth exploiting. Perhaps there is scope for a “Peacock’s Tail Fund.” :-)
But is the reverse true? Are investors who are reluctant towards buying “high-priced” stocks naturally attracted towards buying “low-priced” stocks (selling at say less than Rs 10 per share)?
In my view, yes.
Benjamin Graham felt the same and wrote about it extensively in his books. Indeed, he even had a value investing theme titled “low-priced common stocks” in which he distinguished between low-priced stocks of the genuine type and those that were just “pseudo low-priced common stocks.”
According to Graham, the vast majority of low-priced common stocks are basically stocks of businesses in deep financial trouble or the low price has been artificially created as a bait by manipulators for the gullible public who tend to equate low absolute price with a bargain price. In other words, a trap.
My own research over the years bears this out. Most of the low-priced stocks quoting for less than Rs 10 per share are definitely not bargains but belong to Graham’s “pseudo low-priced” category and investors should stay away from them. While some low-priced common stocks will turn out to be bargains, most will turn out to be foolish speculations in businesses destined to go to zero.
However, the reverse is not true. Many, though not all, high-priced common stocks will signify high quality just as large tails do in the case of peacocks. And so long as a large number of investors shun these stocks because of their “high” prices, they may also end up as bargains.
High absolute prices should not deter investors. A persistently high stock price should be used, with caution, as one of the indicators of a high-quality business. Of course, whether the business is attractively priced or not will depend on its aggregate market value in relation to its likely future earning power many years down the road.
(The author is an Adjunct Professor at Management Development Institute, Gurgaon. No position in MRF and this article should not be construed as a recommendation to buy MRF’s shares. The company was merely used as an example to make an important point.)
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