When you Begin , hope for a vague Ending !

As one stepped out of the theater after watching "Lipstick under my Burkha", there was a discussion about what life holds for those women. One wondered what they did the next day or for the rest of their lives. The scenarios were many & the director very kindly left that to the viewer's imagination.

He left absolutely no clue about how this unfolds & no there wont be a sequel like Bahubali so this was not done to create suspense rather an admission that he does not know where its headed either - to each viewer his own. I like such vague endings both in movies & in stocks.  

With the Nifty above 10,000 one often hears these question - How far will this go ? Is there more steam  left to this rally ? This happened when the Sensex crossed 30k, now its closing in on 33k. Plenty had a reason to stay out at 30k & now have a reason to step in at 33k. While one might be judgmental but no one knows for sure whether they are right or wrong. Like some movies, the end is vague & unlike all movies one never knows how long before this ends, more so for individual stocks than benchmarks. The 'unknown end' is probably the best part about investing.   

For a deeper understanding of the importance of unknown, lets do what Charlie Munger says "Invert, always Invert". One such category, where the end is clearly known are DVR's. There might be a debate about the discount that it should trade at but as of that particular day, it will not trade at a price higher than the main stock.

Any buyer of the DVR is interested only in the discount, so he will buy Tata Motors DVR as a proxy at a discount which theorists peg at 10%. If it is at a discount of 20%, one should be a buyer but if one does then who will he sell it to at a 10% discount as the next buyer will not have a trade. The main stock is more liquid & active than the DVR thus this is not a proxy of scarcity, why would someone buy the DVR at the same price or higher. So now the game changes instead of a 20% discount, the buyer will look for 30% & hope to sell it at 20% and 1st game will be repeated leading to a further step down on the discounting ladder. Eventually the stock has settled in the range of 40-50% discount, depending on how bullish/ bearish the participants are. The only way this could narrow is if we had a buyer who had no intention to sell - probably the promoter/ issuer else Game theory indicates that the discount is meaningless.

Lets take another category where the End is 'nearly known' - Holding Companies. Unlike Berkshire, in India holding companies are not capital allocation vehicles, they are vehicles for settlement/ succession in large business families. For a pure holding company, the worth today is arrived by calculating the attributable value of all the holdings which if listed is easily available. Amongst the easiest to analyze is Kama Holdings, the holding company of SRF Ltd with almost no other holding/ asset of significant value.

FY 13 -17

=> SRF has appreciated at 76% CAGR 

=> Kama has appreciated at 72% CAGR 

They seem like mirror images & the discount after widening has narrowed, albeit slightly higher than the starting point. 

FY 13 - 16

If we were to leave one glorious bull year out then 

=> SRF has appreciated at 170% CAGR  

=> Kama has appreciated at 62% CAGR 

An investor in Kama has to wait for SRF to perform & sustain then can he hope for Kama to catch up. This not an ideal trade off but that's how these instruments work. Also, despite such a mammoth rally, the discount has only widened & Game theory payoffs indicate that discounts don't work on instruments without an expiry. 

=> If this were a 5 year bond, with an inbuilt buyer then the price would steadily move up.(Another proof to this is the 15-20% discount that perpetual bonds with 5 year call options trade at vs 5 year bonds of the same entity) 

=> If this were a futures contract with a monthly expiry, then again the price would have been discovered. In holding companies the end price is clear but when & by whom is not thus market discounts them aggressively.  

    

Next time if you feel unsure about making an Exit, if you have diverse views in your mind or from your coveted circle of influencers - Rejoice, as that diversity is providing you a chance of a fair price. 

'A vague end, is an investor's friend'