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Excerpts

Why Investing is like Rioting

Investing is an inherently social exercise. As a result, prices can go from being a source of information to a source of influence.

This has happened many times in the history of markets. Take the dot-com
boom as an example. As internet stocks rose, investors who owned the shares got rich on paper. This exerted influence on those who did not own the shares and many of them ended up suspending belief and buying as well. This fed the process. The rapid rise of  the dot-com sector was less about grounded expectations about how the Internet would change business and more about getting on board. Negative feedback ceded to positive feedback, which pushes a system away from its prior state.

One of the best models for thinking about this type of behavior is the threshold model from Mark Granovetter, a professor of sociology at Stanford University.

Imagine 100 potential rioters milling around in a public square. Each individual has a “riot threshold,” the number of rioters that person would have to see in order to join the riot. Say one person has a threshold of 0 (the instigator), one has a threshold of 1, one has a threshold of 2, and so on up to 99. This uniform distribution of thresholds creates a domino effect and ensures that a riot will happen. The instigator breaks a window with a rock, person one joins in, and then each individual piles on once the size of the riot reaches his or her threshold. Substitute “buy dot- com stocks” for “join the riot” and you get the idea.

The point is that very few of the individuals, save the instigator, think that rioting is a good idea. Most would probably shun rioting. But once the number of others rioting reaches a threshold, they will jump in. This is how the informational value of stocks is set aside and the influential component takes over.

Great investors don’t get sucked into the vortex of influence. This requires the trait of not caring what others think of you, which is not natural for humans. Indeed, many successful investors have a skill that is very valuable in investing but not so valuable in life: a blatant disregard for the views of others.

Success entails considering various points of view but ultimately shaping a thesis that is thoughtful and away from the consensus. The crowd is often right, but when it is wrong you need the psychological fortitude to go against the grain. This is much easier said than done, especially if it entails career risk (which is often the case).

By Michael Mauboussin

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Links

Linkfest: August 25,2016

Some stuff I am reading today morning:

Rakesh Jhunjhunwala grills Aurobindo MD (Moneycontrol)

Mukesh Ambani’s hunt for 100 Million Subscibers (ET)

The chequered past of the Welspun Group (Moneylife)

India’s startup boom turns to bust (Mint)

Surge in IPO loans for the wealthy (BS)

Indian e-Commerce companies will die without discounts (Quartz)

When to sell a share (Subramoney)

5 Reasons why you are bad at investing (US News)

Research:Endowment effects from India’s IPO Lotteries (SSRN)

Understanding VCs (A VC)

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Chart

Fear Not – July 2016 is not Dec 2007

Source: ICICI Pru AMC

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Image

A Bull Market….in Salaries

Source: Mahesh Murthy

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Plug

Pre IPO : Hero FinCorp

Hero Fincorp,belonging to the Hero Group, is one of India’s fastest growing NBFCs

It’s latest Financial Results can be downloaded from here.

Chrys Capital is planning to invest 600 Crores in this company valuing the company at approximately 500 Rs/share

A very limited quantity of its shares are on offer for sale.

For those interested,please email me at Alpha Ideas