On holding stocks

I never understood one thing about investment analyst reports – the “hold” recommendation. This is “between” the “buy” and “sell” recommendations (which are self-explanatory), and it tells an investor to hold on to the stock if he already owns it, but not to buy if he doesn’t.

The problem with this is that the difference between buying and holding a stock is small, especially given the current efficiency of equity markets and consequent low transaction costs. The only difference between holding and not holding a stock is that in the latter case, you spend the transaction cost of buying the stock. That is all. Based on this, it is intriguing that the two have remained distinct analyst recommendations for ages now.

I can think of two possible explanations:

 

  1. One can assume that the investor is fully invested (not holding any cash), and so buying a stock means that he has to sell something else in order to allocate capital to this stock. So in other words, the cost of getting the stock into you portfolio is higher than the trading cost itself – it comes in at the cost of another stock. With these increased transaction costs, it’s possible that it’s not worth buying the stock .

  2. Analysts hate to admit it (look at the precision with which they dictate price targets), but there is a wide band of error around their estimates of what price the stock will trade at at some point of time in the future. So the buys are those that are much more likely to be trading up than the holds. So by saying “hold” you are saying “yeah this stock might go up, so I’m not so confident about it so don’t bother buying if you don’t have it already”.

But then there is this school of thought that says that analyst’s buy/hold/sell recommendations do not matter at all, and the value they add is in providing the investor access to the company’s management. Matt Levine has written plenty about this, and you should read his latest stuff on this.

Scott Adams’s advice and career options

Some five years back, I took a piece of advice from Dilbert creator Scott Adams. A few years earlier, he had blogged that there are two ways in which one can be successful in a career –

 But if you want something extraordinary, you have two paths:

1. Become the best at one specific thing.
2. Become very good (top 25%) at two or more things.

The post had made an immediate impression on me when I had read it back in 2007. And when I was planning to leave a full-time corporate career in 2011, it was Adams’ old advice that I turned to.

There were a number of things that I’d found myself to be good at (definitely top 25%) – mathematical modelling, data analysis, writing (based on this blog), economic reasoning, financial markets and maybe even programming (I’m a good coder but lousy software engineer). Combining these, I reasoned, I could do very well for myself.

And over the last five years I have done reasonably well for myself. I’ve built a fairly good freelance consulting practice which brings together my skills in mathematical modelling, data analysis and economic reasoning. The same skills, along with an interest in public policy, have led to me joining a think tank as a Resident Quant. Data analysis and writing together has got me a column in Mint. Yet another subset led me to become Adjunct Faculty at IIM Bangalore. And yet another led to my book, which is currently under publication.

However, now that I’ve decided I’ve achieved enough in my portfolio life, and am looking for a full time job (it was supposed to happen a while back I know, but I postponed it due to an impending location change – I’m moving to London in March), I’m not sure this strategy (of being reasonably good in multiple things rather than the best at one thing) is particularly optimal.

The problem is that the job market hasn’t evolved to sufficiently demand people who are good at several things (rather than at one thing). This is a consequence of not enough people following Adams’s second advice – they’ve chosen to strive to be the best at one thing instead.

And so, if you are like me, and consider yourself reasonably good at several things rather than the best at one thing, the job market doesn’t serve you well. Think of all the things you’re good at as dimensions, and your skillset being represented by a vector across all these dimensions. Traditional job markets tend to look at you from the point of view of one of these dimensions (the skill they’re hiring for). And so, rather than showing your potential employer your full magnitude, you end up only showing the projection of your vector along the dimension you’re optimising for.

And if you are good at several things, it means that the magnitude of the vector along any one skill is far smaller than the magnitude of your full vector. And the job market is likely to leave you frustrated!

 

In contract bridge, when you are dealt a hand that is equally strong in all suits, you bid to play a No Trump game. In this scenario, though, it seems like it’s impossible to effectively play No Trump.

Getting candid at coffee day

I have a reputation for occasionally saying outrageous things, and things that I shouldn’t be saying. I frequently make people uncomfortable by saying what I say, including what I sometimes write on my blog. I’ve been long wondering, though, if it is more rational to say shocking stuff to people you know well, or to those you don’t.

I remember this party from ages back where I had just been introduced to this couple, and within ten minutes I’d started expounding the inner beauties of the Goalkeeper Theory (which states that it is okay to hit on someone already in a relationship). I remember the female half of that couple visibly shudder and cling on to her boyfriend within minutes of my exposition.

Some people might recommend higher discretion when you are introduced to someone new, since you don’t want to create a bad first impression. The other way of looking at it is that people you are meeting for the first time, at a cafe or a party or something, are also people you are unlikely to ever encounter once again in life. Consequently, the downside of saying something outrageous is limited. On the other hand, there is a chance that they might be genuinely impressed with your fundaes and you might end up in a stronger relationship (at whatever level) than if you never said the outrageous thing.

On the other hand, while you might be comfortable with people you know well, the danger with saying outrageous or uncomfortable things is that there is a lot at stake. You have already invested significantly in the relationship, which gives you the comfort to say what you want. But if the person genuinely gets offended, you’ve lost a friendship or relationship or more!

So from a risk point of view, if you are the types that likes to make “bold” conversation, and potentially outrage or upset the counterparty, do so when you are still building the relationship. After all, it makes sense to invest in high volatility instruments when the downside is limited!

PS: Don’t try this at a job interview.

When I missed my moment in the sun

Going through an old piece I’d written for Mint, while conducting research for something I’m planning to write, I realise that I’d come rather close to staking claim as a great election forecaster. As it happened, I just didn’t have the balls to stick my neck out (yes, mixed metaphors and all that) and so I missed the chance to be a hero.

I was writing a piece on election forecasting, and the art of converting vote shares into seat shares, which is tricky business in a first past the post system such as India. I was trying to explain how the number of “corners of contests” can have an impact on what seat share a particular vote share can translate to, and I wrote about Uttar Pradesh.

Quoting from my article:

An opinion poll conducted by CNN-IBN and CSDS whose results were published last week predicted that in Uttar Pradesh, the Bharatiya Janata Party is likely to get 38% of the vote. The survey reported that this will translate to about 41-49 seats for the BJP. What does our model above say?

If you look at the graph for the four-cornered contest closely (figure 4), you will notice that 38% vote share literally falls off the chart. Only once before has a party secured over 30% of the vote in a four-cornered contest (Congress in relatively tiny Haryana in 2004, with 42%) and on that occasion went on to get 90% of the seats (nine out of 10).

Given that this number (38%) falls outside the range we have noticed historically for a four-cornered contest, it makes it unpredictable. What we can say, however, is that if a party can manage to get 38% of the votes in a four-cornered state such as Uttar Pradesh, it will go on to win a lot of seats.

As it turned out, the BJP did win nearly 90% of all seats in the state (71 out of 80 to be precise), stumping most election forecasters. As you can see, I had it all right there, except that I didn’t put it in that many words – I chickened out by saying “a lot of seats”. And so I’m still known as “the guy who writes on election data for Mint” rather than “that great election forecaster”.

Then again, you don’t want to be too visible with the predictions you make, and India’s second largest business newspaper is definitely not an “obscure place”. As I’d written a long time back regarding financial forecasts,

…take your outrageous prediction and outrageous reasons and publish a paper. It should ideally be in a mid-table journal – the top journals will never accept anything this outrageous, and you won’t want too much footage for it also.

In all probability your prediction won’t come true. Remember – it was outrageous. No harm with that. Just burn that journal in your safe (I mean take it out of the safe before you burn it). There is a small chance of your prediction coming true. In all likelihood it wont, but just in case it does, pull that journal out of that safe and call in your journalist friends. You will be the toast of the international press.

So maybe choosing to not take the risk with my forecast was a rational decision after all. Just that it doesn’t appear so in hindsight.

Service charges

So the Indian government has said that it is not mandatory for customers to pay “service charges” at restaurants. It will be interesting to see how the restaurant industry will react to this.

The basic idea of a “service charge” is a “forced tip”. Given that Indians aren’t big tippers, restaurants, about a decade ago, started levying a service charge on top of the bill, ranging from 5% to 15%. Some restaurants mention this on the menu explicitly. In others, the print is fine. Some customers have come to accept the service charge. Others fight it.

The National Restaurants Association of India hasn’t taken too kindly to the notification, and has said they’ll take the government to court on this matter. It sounds like a rather extreme reaction, but illustrates the effect of behavioural studies.

Lower end eateries typically publish menus with “all inclusive” prices. If a cup of coffee is listed at Rs. 10, you pay Rs. 10 for it. Mid-priced and higher-end restaurants, however, have defaulted to showing prices exclusive of taxes and charges. With a 5% VAT, 15% Service Tax and (typically) 5% service charge, the final bill comes out to about 25-30% higher than the labelled price.

Now, frequent restaurant goers are aware of all these charges, and that the bill will be much higher than the sticker price. If they are rational, they should be taking into account these additional charges when deciding whether to go to restaurants, and when they do, what to order.

The problem, however, is that these charges are not immediately visible at the time of ordering, and so the customers end up ordering more expensive food than they had budgeted for (after controlling for the overall price level of the restaurant itself). It is a behavioural effect, where the customers’ minds are tricked by the number in front of them rather than what they will immediately end up paying.

The order that service charge is not mandatory will now push restaurants to include them in the sticker price of the food itself (it doesn’t matter what you call it – it’s ultimately revenue to the restaurant). The immediate impact of this will be that sticker prices will have to go higher, which will put a “bigger price” in front of the customers’ eyes, and they will order less.

How much less is not clear, but the fact that the restaurants association wants to take the government to court suggests it’s not insignificant. The high end restaurant business runs on extremely low margins (think what you may of the pricing), and even a less than 5% impact on revenues can have a significant impact on the bottom line.

It will be interesting to see if the government next mandates menus to print prices inclusive of taxes. It will be another behavioural nudge, but will end up ruining the restaurant business even more.

More on focal points at reunions

On Friday, just before the IIMB reunion started, I had written about reunions being focal points that help a large number of alumni to coordinate and meet each other at a particular date and venue. What I’d not written about there was the problems that could potentially be caused with the said venue being large.

In this case, the venue was the IIMB campus itself. While all official events, meals and accommodation for outstation attendees had been arranged in a single building (called MDC), the fact that people would explore the campus through the event made the task of coordination rather difficult.

The whole point of a reunion is to meet other people who are attending the event, and so it is important that people are able to find one another easily. And when the venue is a large area without clear lines of sight, finding one another becomes a coordination game.

This is where, once again, Thomas Schelling’s concept of Focal Points comes in. The game is one of coordination – to land up at locations in the venue which maximise the chances of meeting other people. While our class WhatsApp group enabled communication, the fact that people wouldn’t be checking their phones that often during the reunion meant we could assume there was no communication. So when you arrived at the venue, you had to guess where to go to be able to meet people.

Schelling’s theory suggested that we look for the “natural, special or relevant” places, which would be guessed by a large number of people as the place where everyone else would coordinate. In other words, we had to guess what others were thinking, and what others thought other others were thinking. Even within the reunion, focal points had become important! The solution was to search at those specific points that had been special to us back in the day when we were students.

On Saturday morning, I took about ten minutes after entering campus to find batchmates – I had made poor guesses on where people were likely to be. And once I found those two batchmates at that first point, we took a further twenty minutes before we met others – after making a better guess of the focal point. Given that the reunion lasted a bit more than a day, this was a significant amount of time spent in just finding people!

 

 

A simpler solution would have been to start with a scheduled event that everyone would attend – the venue and starting time of the event would have defined a very obvious focal point for people to find each other.

And the original schedule had accommodated for this – with a talk by the Director of IIMB scheduled for Saturday morning 10 am. It seemed like a rather natural time for everyone to arrive, find each other and go about the reunion business.

As it happened, revelry on the previous night had continued well into the morning, because of which the talk got postponed. The new starting point was to “meet for lunch around noon”. With people who were staying off-campus, and those arriving only on Saturday arriving as per the original schedule, search costs went up significantly!

PS: This takes nothing away from what was finally an absolutely fantastic reunion. Had a pretty awesome time through the duration of it, and I’m grateful to classmates who came from far away despite their large transaction costs.

The purpose of reunions

So later today and tomorrow, the class of 2006 at IIMB is going to have a reunion. Reactions to this have been mostly mixed. Some people have been excited about it for months together. Some have been dismissive, loathing the idea of meeting some people they used to know. Most have gone along with the flow, quietly registering and promising to turn up.

As I’ve dealt with people showing all these reactions, I was thinking of why reunions make sense. I had even tweeted this last year:

As the reunion has come closer, though, my views have become more nuanced. Yes, I’ve kept in touch with all those batchmates I’ve wanted to keep in touch with. However, transaction costs (have I told you I’m writing a book on that topic? Just wrapped up third draft) mean that it’s not been possible to meet many of them.

It is not feasible, for example, to schedule a trip all the way to London because a handful of people you want to meet live there. Nor is it possible that even if you visit Mumbai, regularly, you are able to put “gencu” with everyone you have intended to put gencu with.

And so it remains, that you keep putting off meeting those people you want to meet until a time when transaction costs are low enough for you to be able to meet.

There are transaction costs that operate in other ways as well – a scheduled bilateral meeting is a commitment to exclusively talk to each other for at least close to an hour. And sometimes when you want to meet someone for the purpose of catching up, you aren’t sure if you can spend an hour with them without either of you getting bored. And so you put off that gencu.

The beauty of a scheduled reunion is that it takes into account both these costs. Firstly, by ensuring a large number of people congregate at one place at one time, it amortises (among all the counterparties you meet) the cost of having travelled to the meeting. Secondly, given that there are so many people around there, you don’t have an obligation to talk to anyone beyond the time when it’s pleasant for both of you (sadly, IIMB has outlawed alcohol on campus during the last decade so “i’ll go get a refill” trick of walking away won’t work).

The other great thing about a scheduled reunion (organised by the Alma Mater’s alumni office) is that it acts as what Thomas Schelling termed as “focal points“. Focal points are basically solutions to coordination games where each player plays in a natural or obvious way, expecting others to play the same way as well, so that they coordinate.

Now let’s say that the IIMB Class of 2006 decided to all meet sometime during the course of the year. Coordinating on a date would have been impossible, with any arbitrarily chosen date attracting too few people for network effects to take effect.

With the alumni office proposing a date and venue, it now becomes an “obvious solution” to everyone coming together and going through a process on that date (anchoring is also involved). People are willing to make the investment to meet on that date because they expect others to be there as well. So I’ve registered for this weekend’s event with the expectation that a large number of my batchmates would have done so as well, and each of them would have in turn registered for a similar reason.

Over the next couple of days I expect to spend a lot of time with people I’ve anyway been in touch with over the last 10 years. I might also spend a small amount of time with people I don’t really want to meet. But there is a large number of people I want to keep in touch with, but can’t due to transaction costs, and that is where I expect the reunion to add most value!