Why MRF is Indian Stock Market’s Peacock Tail

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.

 

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The tail’s size and vivid color also attracts attention of predators. And growing a big tail is costly terms of energy expenditure.

 

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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.

 

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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.

 

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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.

 

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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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COMMENTS

Nilesh KAMERKAR

5 months ago

High absolute prices shouldn't deter investors? - Benjamin Graham would cringe.

1) What if the seller is more informed? - In most cases seller would be better equipped because he is most likely booking profits whereas the new buyer is 'hoping' to make going forward.

2) Can Benjamin Graham's teachings, be selectively done for 'psuedo low priced stocks' stocks only?

3) Security Analysis has also shown the way, which type of low-priced stocks can be bought as a 'group' & when.

Aditya Govindaraj

5 months ago

Interesting. But it's nothing new, except this: pick good quality stocks and hold them "forever". Besides, high priced stocks usually have low liquidity & higher spreads, a deterrent in asset management business, unless you have clauses like 'you cant withdraw funds for 10 years'. As as individual investor, it might work to your advantage, if you have the skin and patience. Might. FWIW, Infosys used to be a peacock. See where it is now.

Anyway, hindsight is 20/20. Nothing beats due diligence and focus. And here's the kicker: nothing is guaranteed.

Samarth Raut

6 months ago

Really an apt and interesting analogy! A very good article to read.

Yasoteja

6 months ago

Superb example to convey the thought sir! A big fan of yours

Rajiv Bhatt

6 months ago

I would like to share my view regarding stellar performance of MRF. Since last 7 years rubber price is very low which is main raw material for tyre industries. Secondly automotive sector in India grew rapidly particularly in four wheel segment caused for consistent demand for the. Thirdly neighborhood countries like Pakistan, Bangladesh,Srilanka, Nepal, Bhutan and Myanmar imports majority of their tyre from India. There are still scope of bullish trend in stock prices of front runner tyre companies like MRF, APOLLO, CEAT
considering replacement tyres demand due to robust growth in automotive sector.

Atul Doshi

6 months ago

Excellent Piece of writing. Handicap Principle explained with nice analogy. Sanjay keep posting. Love to read you.

Krishna Kumar

6 months ago

I have Page industries for like 10 years. Now at 10x aquisition price. Recently bought Bosch after 20% dip from peak. Let's see. It's not that investors are averse to these. In fact the attraction is the strongest. But the fear overrides Greed.
Concentration is a real worry if your total market exposure is modest and liquidity is another concern, though entirely unwarranted. MMTC once was in this club. Yes, Special situation funds can look at this niche.

REPLY

Ace Bond

In Reply to Krishna Kumar 6 months ago

Talked like a true genius sir.

Krishna Kumar

In Reply to Ace Bond 6 months ago

Thank you

Nikhil Mishra

6 months ago

Thanks Professor for pointing out an anomaly in Investors mind. Stocks with high prices are very rationally kept to be high by the promoters to avoid trading and on any day very few shares change hands so that over the years only long term investors who want to become partners in business remain shareholders. Simultaneously it's a monumental achievement to see the growth of share price over the years which is certainly show off.

Amrish Shah

6 months ago

👍

Jayant

6 months ago

Absolutely Right.

Kuldip Singh

6 months ago

The Lindy Effect?

Market has entered a round of rally – Weekly closing report

We had mentioned in last week’s closing report that Nifty, Sensex might head higher. The major indices of the Indian stock markets rallied during the week and closed with weekly gains on Friday over last Friday’s close. The trends of the major indices in the course of the week’s trading are given in the table below:

 

 
The major indices of the Indian stock markets were range-bound on Monday and closed with small gains over Friday’s close. On the NSE, there were 793 advances, 728 declines and 58 unchanged.
 
Both the BSE and NSE opened on a flat note tracking negative Asian cues on Monday. The key Indian equity indices traded higher on the back of buying in IT (information technology), consumer durables and healthcare stocks as the day progressed. But the gains were not sustained, as there was no momentum among the bulls. At the end of the day’s trading the major indices closed with minor gains over Friday’s close.
 
In a major market development, IT bellwether Tata Consultancy Services (TCS) on Monday emerged as the first Indian listed company to cross the $100-billion mark in terms of market capitalisation (m-cap).
 
Mahindra Electric and cab service Meru on Sunday announced a joint electric vehicle (EV) pilot project in Hyderabad, to be replicated in other cities soon. Their joint statement here on Earth Day said that under the pilot project, Meru will deploy Mahindra's eVeritos’ all-electric sedans.
 
The major indices of the Indian stock markets saw an uptrend on Tuesday and closed with small gains over Monday’s close. On the NSE, there were 125 advances, 100 declines and 1,822 unchanged.
 
Buying in oil and gas, banking and auto stocks, coupled with broadly positive global cues, lifted the key Indian equity indices on Tuesday. Index heavyweights like Reliance Industries (RIL), Yes Bank, Adani Ports, Mahindra and Mahindra, and Larsen and Toubro were the top gainers on the BSE. Selling pressure in metals, IT (information technology) and consumer durables stocks trimmed some gains of the benchmark indices, market observers said.
 
The State Bank of Pakistan on Monday voiced its concerns over the surmounting value of US dollar against Pakistani rupee in the open market. Currency markets in the Indian sub-continent could see some turbulence in this context.
 
LIC Housing Finance Company Ltd said it closed last fiscal with a net profit of Rs1,989.58 crore. In a regulatory filing in BSE, the company said it had posted a net profit of Rs1,989.58 crore last fiscal up from Rs1,931.05 crore posted during the year ended March 31, 2017, while its total income for last fiscal stood at Rs15,072.90 crore up from Rs14,080.34 crore for the year ended March 31, 2017. The Board of Directors of the company have recommended a dividend of Rs6.80 per equity share of Rs2 each for fiscal 2017-18. The dividend on equity shares will be paid on or after August 20, 2018, the company said.
 
The major indices of the Indian stock markets suffered a minor correction on Wednesday and closed with small losses over Tuesday’s close. On the NSE, there were 546 advances, 1,194 declines and 309 unchanged.
 
The key Indian equity indices traded on a flat-to-negative note on Wednesday afternoon tracking weakness in the global markets coupled with selling pressure on oil and gas, banking and capital goods stocks.
 
Two-wheeler manufacturer Hero MotoCorp made an upward revision in the ex-showroom prices of its motorcycles and scooters with immediate effect. "The upward revision in the prices has been done to partially offset the consistently rising input costs, including the prices of commodities," the company said in a statement.  "The increase in the prices of the two-wheelers is up to Rs625. The exact quantum of the increase will vary, basis the model and the specific market." 
 
IDFC Bank reported a decline of 76% in its standalone net profit for the fourth quarter of 2017-18. According to a BSE filing, the bank's net profit during the quarter under review declined to Rs41.93 crore from Rs175.95 crore reported for the corresponding period of the previous fiscal. On a financial year basis, it reported that its standalone net profit decreased to Rs859.30 crore for the year ended March 31, 2018 from Rs1,019.73 crore for the previous year. 
 
The major indices of the Indian stock markets rallied on Thursday and closed with gains over Wednesday’s close. On the NSE, there were 783 advances, 927 declines and 337 unchanged.
 
Key Indian equity indices on Thursday traded with moderate gains with buying observed in IT (information technology), FMCG (fast moving consumer goods) and consumer durables stocks. Index heavyweights like Tata Consultancy Services, IndusInd Bank, Tata Motors, Reliance Industries and ITC were the top gainers on the BSE. According to market observers, mixed trend in the global markets, along with caution on the day of derivatives expiry and selling pressure in oil and gas, capital goods and telecom stocks, trimmed the gains of the indices.
 
Global software major Wipro Ltd reported Rs1,801 crore consolidated net profit for fourth quarter of fiscal 2017-18, registering 21% annual decline from Rs2,267 crore in the same period last year. In a regulatory filing on the BSE, the city-based IT firm said consolidated revenue for the quarter under review (Q4) also declined, albeit marginally by 1.6%, to Rs13,769 crore from Rs13,988 crore in the same period the year ago. Under the International Financial Reporting Standards (IFRS), net income is $277 million and gross revenue $2,115 million for the quarter. IT (information technology) services contributed $2,062 million, posting 2.4 per cent sequential and 5.5 per cent annual growth in dollar terms and Rs13,410 crore in rupee terms, up 1.3% sequentially from quarter ago.
 
On Friday, the major indices of the Indian stock markets rallied and closed with significant gains over Thursday’s close. On the NSE, there were 919 advances, 800 declines and 328 unchanged. The key Indian equity indices on Friday traded in positive territory due to firm global cues and robust buying in banking and capital goods stocks.
 
Reliance Capital reported a rise of 21% in its consolidated net profit for 2017-18 which rose to Rs1,309 crore ($201 million). According to the company, its total income during the fiscal under review grew by 13% to Rs19,898 crore ($3.1 billion) from Rs17,640 crore in the corresponding previous year. The company further reported that its net worth as on March 31, 2018 stood Rs16,605 crore ($2.6 billion). "As on March 31, 2018, the total assets of the company stood at Rs93,851 crore ($14.4 billion) - an increase of 14%," Reliance Capital said in a statement.
 
Lending major Axis Bank reported its first net loss since 1998 due to a rise in NPA (non-performing assets) provisioning. According to the lender, its net loss stood at Rs2,189 crore during the fourth quarter (Q4) of 2017-18 from a net profit of Rs1,225 crore reported for the corresponding period of last fiscal. "One area where we have been disappointed with our performance has been credit risk. We made some significant bets on the infrastructure sector, which have turned out poorly in this credit cycle," Axis Bank's Managing Director and CEO Shikha Sharma said. "Consequently, our NPA ratios have risen materially over the last two years. We have been course correcting since as early as 2013, balancing our portfolio mix, strengthening risk management frameworks, focusing on higher rated corporates, and re-orienting the corporate lending business towards working capital loans." As on March 31, 2018, the bank's gross NPA and net NPA levels rose to 6.77% and 3.40% from 5.28% and 2.56% as on December 31, 2017 respectively. On a financial year basis, the bank reported that its net profit for the year ended on March 31, 2018 declined by 93% to Rs276 crore from Rs3,679 crore for the previous year.
 
Lending major Yes Bank reported a 29% increase in net profit for the fourth quarter (Q4) of 2017-18. According to the lender, its net profit during the quarter under review rose to Rs1,179.4 crore from Rs914.1 crore reported for the corresponding period of last fiscal. The bank said that its net interest income (NII) for the said quarter grew by 31.4% to Rs2,154.2 crore from Rs1,639.7 crore earned during the corresponding quarter of the previous year. On a financial year basis, the bank reported a growth of 26.9% in its net profit for the year ended on March 31, 2018, to Rs4,224.6 crore from Rs3,330.1 crore for the previous year. The 2017-18 NII rose by 33.5% to Rs7,737.1 crore from Rs5,797.3 crore for the previous year. "FY18 has been a landmark year in Yes Bank's ‘Large Bank Growth Phase' with the bank crossing significant milestones in size, outreach and granularity while continuing to deliver on satisfactory earnings," Yes Bank's Managing Director & CEO Rana Kapoor was quoted as saying in a statement.
 
IT (Information Technology) bellwether Tata Consultancy Services (TCS) said it has added a third office in Texas as part of its agreement with US insurance company Transamerica, which will add more than 200 new employees. The IT sector is looking up for Indian exporters and American multinationals and the stock markets are bullish in this regard.

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Nifty, Sensex on an uptrend again – Thursday closing report

We had mentioned in Wednesday’s closing report that Nifty, Sensex were dipping on global cues. The major indices of the Indian stock markets rallied on Thursday and closed with gains over Wednesday’s close. On the NSE, there were 783 advances, 927 declines and 337 unchanged. The trends of the major indices in the course of Thursday’s trading are given in the table below:

 

 
Key Indian equity indices on Thursday traded with moderate gains with buying observed in IT (information technology), FMCG (fast moving consumer goods) and consumer durables stocks. Index heavyweights like Tata Consultancy Services, IndusInd Bank, Tata Motors, Reliance Industries and ITC were the top gainers on the BSE. According to market observers, mixed trend in the global markets, along with caution on the day of derivatives expiry and selling pressure in oil and gas, capital goods and telecom stocks, trimmed the gains of the indices.
 
China's trade with India saw robust growth in the first quarter, with bilateral trade hitting $22.1 billion, up 15.4% year-on-year, official data showed on Thursday. This is good news for those in the stock markets who are watching the growth in Sino-Indian relations and the Chinese leaders’ meeting with PM Modi next week. In the case of US and China, on the contrary, there is practically, a trade war.
 
Global software major Wipro Ltd reported Rs1,801 crore consolidated net profit for fourth quarter of fiscal 2017-18, registering 21% annual decline from Rs2,267 crore in the same period last year. In a regulatory filing on the BSE, the city-based IT firm said consolidated revenue for the quarter under review (Q4) also declined, albeit marginally by 1.6%, to Rs13,769 crore from Rs13,988 crore in the same period the year ago. Under the International Financial Reporting Standards (IFRS), net income is $277 million and gross revenue $2,115 million for the quarter. IT (information technology) services contributed $2,062 million, posting 2.4 per cent sequential and 5.5 per cent annual growth in dollar terms and Rs13,410 crore in rupee terms, up 1.3% sequentially from quarter ago. Wipro shares closed at Rs280.30, down 2.39% on the NSE. Nifty IT index closed at 14,026.65, up 0.97% on the NSE.
 
Aditya Birla Group company UltraTech Cement reported a decline in its consolidated net profit for the fourth quarter of 2017-18. According to the company, its Q4 net profit declined to Rs724 crore from Rs726 crore reported for the corresponding period of the previous financial year. Further, the company reported that its consolidated net sales during the quarter under review increased to Rs9,298 crore from Rs6,922 crore in the corresponding quarter of 2016-17. "During Q4 FY18, the company recorded a robust growth of 31% in volumes with a 5% increase in realisations," the cement manufacturer said in a statement. "The quarter continued to witness increase in input costs attributable to rise in pet coke and coal prices and the ban on pet coke usage in TPPs." On a financial year basis, the company reported that its consolidated net profit dipped to Rs2,534 crore for the year ended March 31, 2018 from Rs2,714 crore reported for the previous financial year. "The Board of Directors at their meeting recommended a dividend of 105%, at the rate of Rs10.50 per equity share of face value of Rs10 each aggregating Rs288.34 crore," the statement said. "The company will absorb the Dividend Distribution Tax amounting to Rs59.27 crore, resulting in a total payout of Rs347.61 crore." The company’s shares closed at Rs4,079.45, down 1.39% on the NSE.
 
The rupee recovered from its 14-month low to trade higher by 11 paise at 66.79 against the US dollar in opening session today on fresh selling of the dollar by exporters and banks amidst higher opening in domestic equity market. Forex dealers said besides selling of the American currency by exporters and banks, weakness in the dollar against other currencies overseas supported the rupee. The domestic currency had tumbled 52 paise to hit a 14-month low of 66.90 against the US dollar, the third biggest single-day fall for the domestic currency this year, amid surging crude prices coupled with headwinds on the macro-economic front in form of widening trade deficit. Foreign institutional investors are always watching the currency markets to pick and choose among emerging markets to invest in.
 
The top gainers and top losers of the major indices are given in the table below:
 
 
The closing values of the major Asian indices are given in the table below:
 
 
 

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