Motilal Oswal Asset Management Company Ltd. (MOAMC) is a public limited company incorporated under the Companies Act, 1956 on November 14, 2008, having its Registered Office at 10th Floor, Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai - 400025.
Motilal Oswal Asset Management Company Ltd. has been appointed as the Investment Manager to Motilal Oswal Mutual Fund by the Trustee vide Investment Management Agreement (IMA) dated May 21, 2009, executed between Motilal Oswal Trustee Company Ltd. and Motilal Oswal Asset Management Company Ltd.
 
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Motilal Oswal Asset Management – Buy Right Sit Tight Insights- January 2017

Blogs Blog Details

Mr. Raamdeo Agrawal

Chairman, Motilal Oswal AMC

Dear investor friends,

Firstly, I wish you a very happy and prosperous 2017! One way to fulfill this wish is to invest in the equity markets, armed with investment insights and frameworks. I will keep sharing some of mine through “Buy Right Sit Tight Insights”, and hope you find the same useful in your investment journey.

In this edition, I briefly discuss the role of Narrative and Numbers in equity investing.

Beware of the Narrative Trap!

 “A compelling narrative fosters an illusion of inevitability.”
— Daniel Kahneman, in his book “Thinking, Fast and Slow”

The whole of equity investing can be reduced to the dynamics of two factors – Narrative and Numbers.

What is Narrative?
The simplest definition of Narrative is a story. In the equity investing context, it is a cogent argument for investing in a stock. A narrative typically weaves together elements of the past and present to create a fabric of the future. In this sense, it is the “fabricated future” of a stock.

What is Numbers?
If Narrative is story, Numbers is history! If Narrative is the fabricated future, Numbers is the irrefutable past and present. It is the stark reality of a stock captured by a wide variety of hard facts and figures – company market share, revenue, margins, return on capital, growth, capex, dividends, valuation multiples, etc. 

Narrative & Numbers – the dynamics
There is a dynamic inter-linkage between Narrative and Numbers. More often than not, the driver of most investment decisions is the Narrative. But whether the investment will be successful or not depends largely on the extent to which the Numbers track the Narrative.

The matrix on the next page captures the potential outcomes of the Narrative-Numbers interplay. 


The four quadrants can be explained as follows – 

Strong-narrative-Strong-numbers (MULTI-BAGGER):  If a strong Narrative is followed by strong Numbers, the stock will most likely emerge as a multi-bagger, led by earnings growth and valuation re-rating.

Weak-narrative-Strong-numbers (CREDIBILITY GAP):  At times, stocks have strong relevant Numbers, but not much of a Narrative to accompany them. We may call these cases Credibility Gaps. Markets tend to be circumspect of the reported Numbers as unsustainable or even “too-good-to-be-true”. So, valuations may remain modest, and yet such stocks tend to outperform led by sheer earnings growth. 

Weak-narrative-Weak-numbers (UNDERPERFORMER):  This is self-explanatory.

Strong-narrative-Weak-numbers (NARRATIVE TRAP):  Many times, stocks come accompanied by a strong Narrative. But the reported Numbers just fail to live up to the Narrative. We call these Narrative Traps. For some time, such stocks may outperform as the Narrative drives up valuations. However, if the Numbers fail to match up within a reasonable time, the stocks will eventually end up as deep underperformers.

Like stocks, like markets: India – Multi-bagger or Narrative Trap?

The Narrative-Numbers framework can be applied not just to stocks but to markets as a whole. Take India for example.

Ever since the new government came into office in mid-2014, the Narrative for Indian equities is strong – visionary PM, business-friendly government, far-reaching reforms led by absolute majority in Parliament, one of the fastest growing economies in the world, favorable demographics, falling interest rates, and so on.  As a result, market valuations are rich with TTM (trailing twelve-month) P/E around 20x, 10% higher than long-period average.
However, the Numbers for India remain persistently Weak – investment cycle has not picked up, the banking sector is laden with bad loans, corporate earnings growth are flat for the last two years, and further downgrade possibility looms.

Post-demonetization, the Numbers are expected to improve beginning FY18. If this happens, the Indian market will be a long-run Multi-Bagger. If not, it may well prove to be a Narrative Trap.

Conclusion – Beware of the Narrative Trap
In his classic book, “Thinking, Fast and Slow”, Nobel prize-winning behavioral economist Daniel Kahneman says, 
“A compelling narrative fosters an illusion of inevitability.” A Narrative largely involves the future which is fraught with uncertainty. Hence, the reality (i.e. Numbers) may be significantly different from expectation (i.e. Narrative).

In equities, “a compelling narrative” usually means super-rich valuations in anticipation of robust numbers ahead. Many IPO offerings also come wrapped in compelling narratives. Investors need to beware of such potential Narrative Traps. If one has invested in a stock based on Narrative, and the Numbers fail to live up to expectations within reasonable time, it is advisable to cut one’s position even at a small loss. Holding on to the stock with hope could lead to a much bigger loss and deep underperformance.


I welcome your feedback and suggestions for improvement. Please email the same to insights@motilaloswal.com.

Thanking you,

Raamdeo Agrawal
Chairman


Disclaimer
This bulletin has been issued to explain our investment philosophy. The information contained in this document is for general purposes only and should not be construed as investment advice to any party. Readers shall be fully responsible / liable for any decision taken on the basis of this bulletin. Past performance may or may not be sustained in the future. This bulletin is not for circulation in general and is meant for intended recipient only. The bulletin does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied by such statements.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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