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Long vs short

The pervasive short-termism amongst equity investors is preventing them from making decisions that will benefit them

Long vs short

The news of HDFC and HDFC Bank's merger is now more than a fortnight old. By itself, this wasn't really news, in the sense that this was a merger waiting to happen at some point or the other. It could have been now, in some months or years, or even some months in the past. The writing has been on the wall for a while. However, this fortnight has been a great refresher course in how short-term thinking pervades the equity markets and stock prices are driven by such thinking.

When the news of the merger first came, the immediate reaction in terms of the stock price of both companies reflected an enormously positive response. The stocks jumped up sharply that one day. Then came the reaction, or perhaps I should say retreat. Both stocks had been declining for nine straight trading days, covering 16 calendar days. Even though this record was not extended further, I find the justifications being trotted out for this price decline to be emblematic of pretty much what is wrong with the general attitude of many equity traders or analysts.

Looking back at where HDFC and HDFC Bank are coming from and the details of their businesses, there is little doubt that what we have here are corporate institutions of exceptional quality which are perfectly positioned to continue this success for years to come. Essentially, arguments covering days and weeks won out over those covering years.

There's one interesting thing I have noticed over the years, which is that analysts who expect a stock to do badly because of XYZ short-term reasons are essentially saying that those who run the business will not be able to get past these problems because they (the analysts) cannot, at the moment, think of how the problem can be solved.

I first noticed this during the run-up to the Y2K era in the late 90s. At that time, there was no shortage of analysts who would say that once the Y2K remedial work was over, the Indian IT services industry would collapse. My counterargument used to be that analysts should step back and look at the entire journey of the leading IT services companies and make a judgement based on the business model and the competence with which the management had implemented.

Essentially, if an Infosys, Wipro or a TCS had come from practically nothing to where they were during the seven-eight years up to 1999, then they would find a way to go further, much further, regardless of this or that problem in the immediate short-term future. In contrast, the conventional analyst argument amounted to saying that because I, being a great analyst, cannot figure out a way beyond this immediate problem then surely the company's management also will not be able to. Compounding this arrogant view is the fact that practically the whole population of investors, individual as well as professional, live from quarter to quarter and are simply not interested in evaluating anything that shows up over longer periods of time. Long-term evaluation of a business's prospects is much less dependent on facts that are visible today and far more on understanding broad trends and evaluating management quality.

Interestingly, this unwillingness to do so leads to the opposite error too. Instead of being unjustifiably pessimistic about a business, there are companies about whom there is unjustified optimism. This is clearly visible in the embarrassment that some of the formerly hot new-age digital businesses have become. If the people running a given business haven't found a way to make a profit after almost a decade of trying, then the conclusion should be obvious.

The thing to understand is that evaluating the long-term prospects of a company is a fundamentally different activity than doing it over the short-term. You can make four rows in an Excel sheet and make projections for four quarters. However, if you want to figure out 10 years, then it won't help to just extend the same spreadsheet to 40 rows.

Also read:

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