The Ellsberg Paradox offers empirical proof that we favor known probabilities over unknown ones. We stay away from uncertainty and try to give higher weight to known things. Risk means that the probabilities are known.
Uncertainty means that the probabilities are unknown to us. We can make calculations and decide either making bet or not while risk involved. But when uncertainty comes, we cannot make any calculations so decision-making becomes harder.
Only in very few areas where we can count on clear probabilities: casinos, coin tosses, and probability textbooks. Often, we are left with troublesome ambiguity.
Investment – We generally mixed up when we think about risk and uncertainty while investing. We tend to keep saying that we get higher returns where the risk is higher. But actually, we get higher returns where uncertainty is higher. When things started getting certain, valuation starts reflecting certainty, and chances of making good returns reduce.
COVID-19 pandemic is an uncertainty rather than a risk, and we can see that return comes after the pandemic event.
The 13th part of the Series is “Current temptation, future frustration”. This series is based on the companies which are currently darling of the market and many trying to catch such opportunities but it has a probability to become a reason for future frustration. It can wipe out the majority of gains in wealth. I am trying to put some of the number-crunching facts by which we can identify ongoing issues in the companies and can save our wealth.
I am starting this article with one of the company which is engaged in the business of real estate construction and engineering-focused solutions have a 52 weeks low price of Rs.16 and LTP is Rs.24.5, which is a 52-week high price This company has rewarded ~53% of return in a year.
Let’s start looking at the numbers.
We can see that the company has a strong promoter holding which gives confidence to many people to get attracted to the company.
We can see that all-time high sale of the company with Operating profit.
When we look at the balance sheet then we can see a few +ve as well as a few -ve points also. The company is debt-free with very lower fixed assets that need to be utilized to produce revenue. But when we see at the -ve points, then we can see that another liability has increased rapidly in FY20 & FY21, whereas revenue has not grown at that pace.
Also, when we look at the receivables, they that has grown at a rapid pace. Cash on the book was Rs.16.97 cr in FY18 which has gone in FY19 with high growth in receivables. None of the line items has reported change in such a way.
We can see at working capital then found that the cash conversion cycle has worsened rapidly, due to higher debtor days. 291 days of Cash Conversion Cycle in FY18 to 5.38 years in FY20 and 3.68 years in FY21. This shows highly worsening of working capital.
Now, we look at the related party statement then the real face behind beautiful makeup gets revealed.
Here, I found that the company has huge related parties transactions which help to boost sales growth. When we look at the related party sales to the total sales then
Entire sales of FY19 & FY20 come from a related party and in FY21 also has 63% of sales come from related parties.
The company has taken borrowings from related parties but which are categorized as the non-current liabilities.
This entire series is based on past available data and ignored the future development of companies and the stock market always looks at the future.
The contagion bias describes how we are incapable of ignoring the connection we feel to certain items – be they from long ago or only indirectly related (as with the photos).
When we have faced some events in life and if anything related to those events comes Infront of us then we cannot ignore it and cannot stop reacting. Connection in our minds comes alive and we start getting disturbed.
One person has cheated on me a long back but when I met a family member the person, I cannot ignore the connection between both the person and I became rude in conversation.
If we have made an investment in any stock and have incurred a loss, then that sector, management, valuation, or anything will stay in our mind. When we meet up in a similar situation then our mind again lives that connection that impacts our thinking and decision making.
We heard that companies that originated from particular cities have a higher probability of wealth destruction. When any investment opportunity comes in front of us from similar cities then we used to ignore that opportunity without doing proper research on it.
So that we need to prepare a checklist for every stock, every time. If a stock is passing that checklist, then we must invest in it rather than getting biased from any past events.
At some point in your life, you’ve won a game you’ve never played before or witnessed a young child say or create something with worldly depth. These are both examples of events we attribute to something called beginner’s luck as if chance caused them to happen. – Lifehacker
Investment – When someone starts investing and he has reaped good returns on the initial investment. Then he starts thinking that he pursues an above-average skill and knowledge which has rewarded him well. This is known as beginner’s luck and that makes novice investors blind to making wise decisions and efforts.
The stock market always checks novice investors with beginner’s luck and those who can come out of the trap, can have a better chance to survive further. We should focus on long-term success rather than one year or a month of success. Sometimes, novice investors earned an above 50% return on their investment and they start thinking of themself as talented as Mr. Warren Buffett. Nowadays, one-two correct bets promote them from analysts to fund managers. They started to manage the funds of family and friends.
We should understand that the stock market is a sea and, we need to have remained lifelong students to walk in the depth of the sea. Not a master, because the master is always a market.
We should not get excited by one or two of success but have to remain grounded by focusing on long-term success. If we keep meeting success during a longer horizon then we can consider ourselves mature investors.
