July 20, 2012

If facts change, do you change your mind?

I have often ‘preached’ on this blog – when facts change, one should consider them rationally and change one’s mind if required. Well, as always, it is easier to preach than practice.
Let me tell you a recent story.
I spoke very briefly about a company in this post. The company was Ricoh (I) ltd. You can download my detailed analysis of the company here.
So after doing this detailed analysis in late 2010, I built a decent position at an average price of around 35-37 Rs/ share.  The company continued to perform poorly (as I expected) as it had done an acquisition and was also investing heavily into sales and marketing.
The topline grew by 40%, but the net profit dropped from around 15 Crs to a loss of 5 Crs in 2012. The price continued to stagnate in the range of 37-40 rs during this period.

I have been consolidating my portfolio and weeding out the weaker ideas for the last 2 years. As a result, I exited Ricoh in the feb-march time frame. I think it was a rational thing to do based on the information I had as of March 2012.
The change
The company declared the Q4 2011 results in April and reported the following
Q4 sales growth, YOY – 60%
Net profit growth, YOY – 73% (12 Crs profit in Q4 versus 11 crs loss in Q3)

The price action can be seen below

As you can see, the market did not react immediately to the turnaround in the performance and there was a 1-2 month window for an intelligent investor to digest this information and purchase the stock.
So that proves my level of intelligence J
The explanation
It is easy to call the decision, stupid and move on. The true reason for my failure to capitalize on the change in performance (which I was expecting) is due to a behavioral bias.

The bias is called the commitment and consistency bias. In simple words, once one makes a decision, the tendency is to ‘commit’ to the decision and be consistent with it. This results in ignoring positive information as in the above case or holding on to a losing position (inspite of consistent negative news) and hoping that the price will rise in the future.
Not a one off case
The above incident was not a one off in my case. I have made the same mistake twice earlier – in the case of VST industries and Mayur uniquoters. I sold the stocks and then saw the fundamental performance improve, after the sale. Instead to getting back into the stocks (as I already knew about the companies), I just ignored them and lost out on pretty decent gains.

I have become alert to this bias now and am paying more attention to sudden turning points in the performance of the stocks I hold or have held in the past.

It is better to look foolish (in my own eyes), than miss out on a good idea

Added note – The above example does not mean Ricoh India is a good buy and should be purchased at the current price. It is quite possible that the performance may regress and so would the stock price. The example is only for illustrative purposes.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.


Shantanu said...

A very insightful post.

It is very important to curb one's natural tendencies. It's difficult though and not many can successfully accomplish such task.

Anonymous said...

Hi Rohit,

While you used 'Ricoh' just as an example to make your point, the results were out in April, the stock started picking up only in June-July. So the price rise may not be only due to good results. It does not take the market 2 months to analyze the results and reflect in the price. Could there be some other information which is not available to public which may have triggered this.

The point mentioned in this article are still valid and very true.


Rohit Chauhan said...

Hi shantanu
thats true ...the really good investors are good at it ...the rest like me have to learn


Rohit Chauhan said...

Hi anon
quite possible ...but i have noticed this happen quite often. you can look at several companies which went on to be multi-baggers, the market initially does not react

and then also it under-reacts to the upside ..typically long term growth stories are usually undervalued by the market


madhu said...

dear rohit, at last u have time to look at this aspect of your investing style
i have a very simple rule . i hold or buy more whenever u have exited a stock after a long hold- eg niit tech, mayur,... also, allahabad bank, srf etc . they r all five baggers or more for me.
i love ur hits, and i love ur misess much more

Rohit Chauhan said...

hi madhu
thats make you smarter than me :)

anyway all the stocks i exit dont do well ...some stagnate and often there are better ideas too. for example concor is one such company


Shantanu said...

@ Rohit: Haha ... and like me as well

Ankur Jain said...

Hi Rohit,

Completely agree with you on both the points :

1. Markets normally takes a lot of time (ranging between a few days to a few quarters) to EFFICIENTLY price in the negative / positive news. We were invested in Panacea Biotech which supplies vaccines to WHO. The company came with an announcement that WHO has found irregularities in the manufacturing facilities and the production of vaccines has been suspended indefinitely. More than 80% of the sales came from WHO. We expected the stock to open on down circuit next day and remain on lower circuits for a few days. However, we found that next day there was no reaction in the stock price. The negative reaction came after 3-4 days when the stock hit lower circuit and continued hitting lower circuits for a few days.

2. Changing the mind when the facts change is the most potent tool while investing. It's a very common mistake and the sooner we learn it, the better for us. I think selective amnesia is required. Remember everything about the company but the price at which you sold and the price at which it traded when you were working on the company. We need to always focus on the margin of safety and intrinsic value.



Rohit Chauhan said...

Hi ankur
completely agree on both the points

i have myself seen that market does not discount the positive or the negative news for quite some time. in addition, the less followed a stock, the long the time before the new data is assimilated. if something happens with infosys, it is immediate, but not so with small and mid cap companies

on the point of changing the mind i agree, it is important to look at the changed facts with a fresh mind. the past does not matter if there is a material change. i have read that investors typically under wieght long term changes ..both on upside and downside. i have been guilty of the same quite often


sameer said...

Hi rohit,
Is Deccan Chronicle good contranian bet?


Rohit Chauhan said...

Hi sameer
no ..there is something fishy going on. unless you have good information it does not make sense

i know nothing beyond what is publicly know ...so i am not touching it

luckily i never got comfortable with the company and never invested. thanking my lucky stars now and good advise from some of my friends like ninad kunder and ayush mittal


Akash Parmar said...

Hi Rohit,

I just finished "Black Swan" and "Fooled by Randomness".

Taleb talked about Soros in one of these books, that he changes his mind everyday about which idea is good/bad.

This attitude of constant vigilance sounds good theoretically but is quite tricky to achieve. I tried and quit in 2-3 months. It requires you to be closely involved,which i find difficult with a day job.

Also it might not be good to change your mind with every small piece of additional information. This overreaction to small changes is what value investing essentially bets against--- in the long term the jagged edges of the graphs are smoothened out.