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First IKEA Store in India and Investment Lessons from Herd Mentality

Last week (on 9th Aug) IKEA opened the first store in India in the southern city of Hyderabad and it was an instant rage.

IKEA mania led to stampede and more than 40,000 people visited the store on first day! They did a sales of Rs 2.4 Crore ($350K) including Rs 11,00,000 from food sold in cafeteria (i.e. Rs 40 Cr or $5 million on annualized basis – just from cafeteria)

There were many messages and photos circulating on social media about this mad rush. Here are few:

I wondered why do people go crazy about such things – be it Ikea or new Apple iPhone launch and so on.

I had attended a course on Behaviroal Finance and have read many books on such topics/themes. So I am fascinated by “herd mentality”, be it in shopping, or politics or investing.

Interestingly, I received a forward on WhatsApp on our investing group which is about Ikea phenomenon and the herd mentality in investing. I tried searching online for this article written by some fellow named Shankar but couldn’t find it. Hence not able to share the link to original post. If you happen to find it do let me know so that I can update the source.

Do read this thought provoking article…


Ikea and Herding

By Shankar on Aug 10, 2018 02:07 pm

“We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.”

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one – Charles Mackay

Ikea Store Crowd

Charles Mackay knew a thing or two about herd behaviour (In investing it is everyone jumping from one investment to another ) having researched and written the book, “Extraordinary Popular Delusions and the Madness of Crowds” in 1841 ( Yes, in 1841!) . The book shows the manic schemes of those days such as Tulipmania, South sea bubble etc. But why am i discussing that along with the opening of the Ikea store in Hyderabad?

We are wired for herding as humans are social by nature living in large societies.

We are wired to what our neighbour’s are doing, if it was bell bottom pants for previous generation it is buying torn jeans today. it is biological not logical.

We herd into investments too, it was real estate 4-5 years back, bitcoin last year and midcap funds this year

For a bubble to break there is no need for anything, like the proverbial last straw on a camels back, bubbles collapse on its own weight

So as an investor how to prepare our minds for long term ?

Investments are a vehicle to reach your goals and are not a game to maximise returns quickly. Would you hop in and hop off twenty different vehicles to reach your destination or take a direct flight ?

Investments are for your children’s education, your retirement, your wish for the good things of life like travel. It is for important goals so that we don’t have to depend on charity of others im old age and to educate our children in a better way. If we think about money this way, neither would we stand in queues infront of a store to buy something that we were perfectly fine without till the day before.

We are wired for short term flight or fight response which makes long term thinking difficult. Which is why so little people meet success in investing. We herd into investments at the wrong time and exit at the wrong time too.

Media plays a large part in it as bad news sells more than good news. You will never see a headline that says this investor made a fortune by being in it for the long term and not herding.

Successful investing is simple but not easy as it requires us to not move in and out of investments on short term performance.

Successful investing is more like farming if it takes 1o years for a mango tree to grow it will take 10 years, you can’t plant a tree today and expect fruits in 3 months. But once it is grown then it will give fruits for decades.

One easy way to beat short term outlook is not to look at our investments regularly,

Another way to avoid herding is to invest regularly so that you build wealth and you are not too bothered about short term fluctuations. This takes the trouble out of investing but remember this is for goals at least a decade away and not a money making machine where SIP’s go into one end and high returns comes out 2-3 or even 5 years later.

Hope you are part of the small set of people who invest for the long haul and avoid herds.

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Apple: The First Trillion Dollar Company

Apple recently touched market capitalization of $1 trillion!

Here are some interesting facts:

Apple IPO valuation

(Dec 12, 1980): $1.2 billion

Apple valuation on 2nd Aug 2018: $1 trillion

Stock return since IPO: 50,000%


Apple va Nokia rivalry:

Valuations today:

  • Apple: $1 trillion
  • Nokia: $30 billion

Valuations when iPhone was released in 2007:

  • Nokia: $110 billion
  • Apple: $104 billion

At one point in 1996 Apple was written off…

And now it has become the most valuable company after 22 years!

The stock movement has really tested the patience of Long Term investors.

Apple has really been a late bloomer:

A lot can be said about Apple’s financial and operating achievements. But the real insight might come from the culture and how Apple perceives and treats the employees.

Relentless, collective effort of a bunch of insanely smart and focused people for years on end towards making great products = One Trillion Dollars.

This is Apple’s welcome letter to new employees:

Source: Twitter

This might be the key to Apple’s success!

And if you want another proof here is a quote from Steve Jobs from his 2007 interview:

You know how many committees we have at Apple?

Zero. We are organized like a startup.

—Steve Jobs

Useful Pyramid For Investment Decisions

Useful Pyramid for investment decisions/ personal finance

Investment Pyramid

Warren Buffett & Charlie Munger’s Funniest & Wittiest Moments

This is far from the complete compilation of the funniest and wittiest moments of Warren Buffett and Charlie Munger – not even 1% of what the duo have given over their combined life of 182 years!

But it is a good place to begin exploring…

 

Berkshire Hathaway Annual General Meeting Videos – 1994-2018

Few weeks ago I posted a blog on CNBC’s Warren Buffett Archive. I recently saw that Berkshire Hathaway Annual General Meeting videos of years 1994-2018 have been uploaded on Youtube.

It is such a wonderful experience to see more of Warren Buffett and Charlie Munger, especially in their prime (though they were 60+/70+ then). Hope to see more such videos uploaded on Youtube. Meanwhile do watch these AGMs:

 

 

Anatomy of A Blowup

I read the following news about Jet Airways:

  • JET AIRWAYS posts loss after 11 straight quarters of profits
  • Loss higher than past 6 quarters of profit combined
  • Fuel costs and higher other expenses dent numbers

It reminded me of the following side explaining Nassim Nicolas Taleb’s assertion of “Anatomy of A Blowup”

Few days ago, Prof. Sanjay Bakshi had tweeted the same image with another example.

Great insight! The pattern is not as rare as it appears to be. Maybe, we should factor the Black Swan event as a certainty…given a long enough period.

CNBC’s Warren Buffett Archive

Yesterday I posted a short blog post with link to 2018 Annual General Meeting of Berkshire Hathaway.

I watched the Live telecast of the AGM till very late night (as per India Time). Some days back I posted a blog on Charlie Munger and shared some of his videos. Few days later I wrote another blog on my idol and his mental models.

Warren Buffett is (almost) 88 years old and Charlie Munger completed 94 years on 1st  January 2018. Since the time I have discovered the duo I have been trying to read everything written or spoken by them. But video adds one more dimension – it also shows the body language and composure. I have not wasted any opportunity to find and watch any video where either on them has featured. There are plenty of videos of Warren Buffet. But there are very few of Charlie Munger. I think I have watched all…

Since last 2 years Berkshire Hathaway started live streaming of their AGM – first in 2016 and then in 2017.  And I watched it again yesterday. It has been a wonderful experience watching the two holding marathon meetings.

One sad feeling I get is that both these great people are slowly approaching the inevitable – the end of life. They themselves talk about it often and that too in light, humorous tone. When you know that someone who you are close to is about to vanish forever you tend to spend every possible minute with that person, collect as many memories as possible. (This is also true of the person who is about to leave your life and become stranger after spending precious few years with you)

So with that feeling I try to read/listen to / watch everything featuring Warren Buffett and Charlie Munger – even though at times it becomes repetitive and predictable. I always wondered that Berkshire started Live streaming of their AGM very late, only 3 years. I have read all previous Letters To Shareholders since 1965 (you can download them here). I have also read some interesting quotes and discussion from some of the AGMs. But I always wished I could watch those AGMs or listen to the audio recording.

And my wish came true today!

I found out that CNBC has released definite collection of Warren Buffet – 24 years of Berkshire Hathaway videos, over 120 hours of videos and 2600 pages of transcripts!

This is amazing! To borrow Warren Buffett’s analogy, I felt like a kid in a candy store…

Here is the link to the Warren Buffett Archive: The Warren Buffet Archive (since 1994)

Check out the 1994 AGM clip where WB quoted “You don’t fin who’s swimming naked until the tide goes out”. Or, when asked “What is your next goal in life now that you are the richest man in the country?” Buffett’s instant reply was: “That’s easy. To be the oldest man in the country” 🙂

Well, I hope he and Charlie go on to become the oldest men alive…by a huge margin!

 

Good Read: Making the Jump from Millionaire to Billionaire, and How Long That Takes

Here is an intereting Infographic: Making the Jump from Millionaire to Billionaire, and How Long That Takes

Source: http://www.visualcapitalist.com/jump-millionaire-to-billionaire/

Some very good insights based on this…will write some other day.

Good Read: Why Financial Statements Don’t Work for Digital Companies

Here is a very good article written by Vijay Govindarajan, Shivaram Rajgopal and Anup Srivastava published on Harvard Business Review Blog.

Why Financial Statements Don’t Work for Digital Companies

Some of you may not be able to access the link, so I am reproducing the article here with due credits:


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On February 13, 2018, the New York Times reported that Uber is planning an IPO. Uber’s value is estimated between $48 and $70 billion, despite reporting losses over the last two years. Twitter reported a loss of $79 million before its IPO, yet it commanded a valuation of $24 billion on its IPO date in 2013. For the next four years, it continued to report losses. Similarly, Microsoft paid $26 billion for loss-making LinkedIn in 2016, and Facebook paid $19 billion for WhatsApp in 2014 when it had no revenues or profits. In contrast, industrial giant GE’s stock price has declined by 44% over the last year, as news emerged about its first losses in last 50 years.

Why do investors react negatively to financial statement losses for an industrial firm but disregard such losses for a digital firm?

In the 2016 book The End of Accounting, NYU Stern Professor Baruch Lev claimed that over the last 100 years or so, financial reports have become less useful in capital market decisions. Recent research lets us make an even bolder claim: accounting earnings are practically irrelevant for digital companies. Our current financial accounting model cannot capture the principle value creator for digital companies: increasing return to scale on intangible investments.

This becomes clear when you look at a company’s two most important financial statements: the balance sheet and the income statement. For an industrial company dealing with physical assets and goods, the balance sheet presents a reasonable picture of productive assets and the income statement provides a reasonable approximation of expenses required to create shareholder value. But these statements have little salience for a digital company.

Let’s first look at the balance sheet. Assets reported on a balance sheet have to be physical in nature, have to be owned by the company, and be within the company’s confines. However, digital companies often have assets that are intangible in nature, and many have ecosystems that extend beyond the company’s boundaries. Consider Amazon’s Buttons and Alexa powered Echo, Uber’s cars, and Airbnb’s residential properties, for example. Many digital companies have no physical products and have no inventory to report. Therefore, the balance sheets of physical and digital companies present entirely different pictures. Contrast Walmart’s $160 billion of hard assets for its $300 billion valuation against Facebook’s $9 billion dollars of hard assetsfor its $500 billion valuation.

The building blocks for a digital company are research and development, brands, organizational strategy, peer and supplier networks, customer and social relationships, computerized data and software, and human capital. The economic purpose of these intangible investments is no different from that of an industrial company’s factories and buildings. Yet, for the digital company, investments in its building blocks are not capitalized as assets; they are treated as expenses in calculation of profits. So the more a digital company invests in building its future, the higher its reported losses. Investors thus have no choice but to disregard earnings in their investment decisions.

Our research has found that intangible investments have surpassed property, plant, and equipment as the main avenue of capital creation for U.S. companies – which further suggests that the balance sheets has become an artifact of regulatory compliance, with little or no utility to investors. The balance sheet has also become less useful for banks’ lending decisions because banks rely on asset coverage to calculate their security. Curiously, companies are allowed to report purchased brands and intangibles as assets on balance sheet, creating distortions between earnings and assets of digital companies that rely on organic growth versus acquisitions.

As digital companies become more prominent in the economy, and physical companies become more digital in their operations, income statements too become less meaningful in investors’ decisions. In another study, we show that earnings explains only 2.4% of variation in stock returns for a 21st century company — which means that almost 98% of the variation in companies’ annual stock returns are not explained by their annual earnings. Earnings also seem to matter less for CEO pay: companies are reducing profits-based cash bonuses and shifting toward stock-basedCEO compensation, partly to keep opportunistic managers from cutting back on valuable investments as a way to report higher profits.

The current financial accounting model fails today’s companies in yet another respect. In a previous HBR article, we argued that, in contrast to physical assets that depreciate with use, intangible assets might enhance with use. Consider Facebook: its value increases as more people use its product because the benefits accrue to an existing user with the arrival of each new user. Its value growth is powered by the network in place, not by increments of operating costs. Therefore the most important aim for digital companies is to achieve market leadership, create network effects, and command a “winner-take-all” profit structure. Facebook’s gross margin of 76% on its 2017 revenues of $46.5 billion illustrates this reaping of rewards — every additional dollar of revenue creates almost equivalent value for shareholders. (You can contrast this to Twitter’s and Yelp’s 2017 revenues of $2.4 billion and $0.8 billion, respectively, as both companies have yet to reach the winner-take-all profit stage.)

Yet there is no place in financial accounting for the concept of network effects, or the increase in the value of a resource with its use. This actually implies negative depreciation expense in accounting parlance. So the fundamental idea behind the success of digital companies (the increasing returns to scale) goes against a basic tenet of financial accounting (assets depreciate with use).

It’s important to note that companies like professional services firms are also built on intangible assets like human capital. But accounting challenges for modern, digital companies are more severe, as they have increasing returns to scale on their idea-based platforms. For example, Google can service billions more clients with the same office just by adding to its server capacity. But for an audit firm to drastically increase clients, it would likely need more manpower and office space. Furthermore, costs of services for professional services firms, mainly wages, are matched to current revenues. So their income statements accurately reflect surplus created in that period, similar to industrial companies. But for digital companies, the bulk of the cost of building an idea-based platform is reported as an expense in its initial years, when they have little revenue. In later years, when they actually earn revenues on an established platform, they have fewer expenses to report. In both phases, the calculation of earnings does not reflect the true costs of revenues.

This brings us to another question: If earnings are so meaningless, then why do investors react positively to rumors concerning a digital company turning profitable? For example, when Twitter reported its first profits, its share prices jumped 20%. The same thing happened to Yelp. One plausible reason could be that this news has an important signaling effect – that the company might have crossed its initial investment phase, that it might now break even, or that it might catapult into a trajectory where it can reap winner-takes-all rewards. This conjecture challenges our overall argument that earnings have no information; another challenge could be that initial losses of digital firms convey risks involved in purchasing their stocks.

As balance sheets increasingly fail to reflect the value of the company’s resources and the income statements increasingly fail to capture the value created by the company, CEOs are now wondering what to do. They often ask us: What does preparing and auditing accrual-based financial statements achieve? Wouldn’t digital companies be better off by simply reporting a summary of their cash transactions? What can digital companies do to enhance the informativeness of their financial statements?

The answers are not yet clear. It is unlikely that accounting standards will change in the near future to allow digital companies to capitalize their intangible investments. (And even if digital firms capitalized their intangibles, the recalculated profits or assets would come nowhere close to justifying their current market values.) But there are things companies can do to convey their real worth to investors. Our work has found that investors look for certain cues about the success of a company’s business model, such as acquisition of major customers, introduction of new products and services, technology, marketing, and distribution alliances, new subscriber counts, revenue per subscriber numbers, customer dropouts, and geographical distribution of customers. Companies can disclose these items in the Management discussion and analysis section of their annual report. (For example, see Item 7 of Facebook’s annual report.)

Any significant, value-relevant development must be immediately disclosed rather than waiting for the annual report. We have demonstrated in other research that disclosures on network advantages, such as web traffic and strategic alliances, are considered highly value-relevant by investors. When combined with these nonfinancial indicators, financial performance measures become more value relevant. In addition, companies can provide detailed information on intangible investments made by the company – even if that information is not vetted by the auditors – by reporting these investments in three categories: customer relationship and marketing, information technology and databases, and talent acquisition and training.

To summarize all this, as firms become more digital and spend more on intangible investments, and as digital companies come to represent the new face of corporate America, they will also have to dramatically alter the manner and ways by which they convey their value to outside investors.

Source: https://hbr.org/2018/02/why-financial-statements-dont-work-for-digital-companies

 

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