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Robots Wouldn't Recommend These Turnaround Stocks

Apr 4, 2017

In this issue:
» This Statistic Could Derail India's Growth Story
» One of the most reliable and easiest ways to earn great long term returns from investing
» ...and more!
00:00
Richa Agarwal, Research analyst

I have written to you about how robots and machines are eating into Indian jobs and creating a demographic and job crisis.

It's not just manufacturing. Even the service sector hasn't been spared.

Employee layoffs are common news these days. But I was struck by a news piece suggesting that robots are also taking over the profession of stock picking. Here is a snippet:

  • In this satellite city of capital New Delhi, a computer scientist and a finance whiz with roots in computer science are on the Renaissance track. They have primed and started up XYZ (name changed), a fund management firm that runs on a mathematical model straddling big data analytics and artificial intelligence.

For the uninitiated, Renaissance's flagship fund, Medallion, is run by complex mathematical models. Mathematicians and computer wizards wrote the model. Apparently, this 30-year-old fund has returned 25%-plus profits most years.

Now before you get too excited, here is what you should know...

Mathematical models for investing primarily look at business data and stock prices over the last five to seven years. Based on the data, companies are ranked and selected. More than 15,000 hours have gone into writing the code (model). The founders don't want to share how it works...or patent it, as this would mean disclosing the details to the public.

The fund has been lucky so far. But then so was LTCM for a period...until its geniuses failed

The flaws in formula-based investing techniques are all-too apparent. The model prides itself on no human intervention and keeping things confidential...

We would never be comfortable with this while picking small caps for our Hidden Treasure subscribers.

Let me explain.

Markets are very competitive these days. Too much money is chasing too few good businesses. With access to information like never before, every positive, especially past performance, is already factored into valuations. The scope to make money relying just on past performance (and modelling what is already in the public domain), as such, is limited. To beat the markets, one needs to know more. Not just about the companies and businesses, but about the people running them.

This is why we meet the management of every potential Hidden Treasure recommendation. For a many of the stocks we have recommended, it was not the past performance but our conviction on the management quality (an unquantifiable factor) and their future strategy that were key to our investment rationale.

Using a machine-based model with no human intervention, we don't think we would ever be able to recommend turnaround investing cases to you, and that's where the real scope for high returns lies. In fact, two of our last three Hidden Treasure recommendations are turnaround stories (and one of them is still within the 'Buy' zone).

Secondly, we will never be comfortable not sharing our reasons for selecting a stock, and the risks associated. We want you to know for sure if a stock aligns well with your risk-return profile.

And with the track record we have achieved using this strategy, I think we need not worry about the threat from machines yet.

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------------------------------

03:15 Chart of the Day

We knew that there exists significant wealth disparity in India. However, even we were taken aback after knowing the true extent of it. As today's chart of the day highlights, the richest 10% households in India, both rural as well as urban, have significantly higher wealth than the remaining 90% combined. While the data is dated and is of the year 2012, we don't think things would be any different today.

Just to put figures in perspective a bit, while the average urban household in the richest 10% group has wealth a whopping 50,000 times greater than the poorest 10%, the same ratio for the rural households stands at a lot less but still significant 227 times.

Now, how do we bring this gaping ratio down? Extract a higher income tax from the rich? Could be. However, our colleague Vivek Kaul doesn't quite agree. Here's him.

  • A higher income tax rate is clearly not a solution to reduce income inequality in India. The solution is to bring more and more Indians who should be paying income tax, but do not, under the tax bracket. This means simplifying the income tax system. It also means making the income tax department more efficient through the use of information technology. And finally, it means reducing corruption in the department.

Bang on in our view. By the way, Vivek's latest book is creating quite a buzz. Guess what, Alan Greenspan, the world's most renowned central banker already has a copy. Bill Bonner, the founder of Agora and a bestselling author, also has one. And so do other noted finance luminaries.

Here's how you can get your copy absolutely free.

The Big Rich Poor Divide in India

04:10

How about Warren Buffett as a brand ambassador for Cherry Coke? It looks entirely plausible for two reasons. One, Buffett himself is a huge guzzler of the sugary soda, claiming to gulp as many as five cans per day. So bringing Buffett on board will have an air of genuineness about it.

Secondly, Buffett is the single largest shareholder in Coca-Cola. Therefore, if his face adorns a can of Coke and if it helps makes the brand popular, there's no reason why he wouldn't be game for it.

Well, this idea has become a reality in China. As per reports, a cartoon rendering of the billionaire investor on special edition Cherry Coke cans have surfaced all over the world's most populous nation. And if the initial reception is anything to go by, the idea is working well.

Another idea that can work well is shamelessly cloning Buffett's investments. Yes, that's right. As per a lot of studies, if investors would have closely tracked Buffett's investments and bought the same stocks that he had bought, their returns would have been nearly as phenomenal as Buffett's.

Come to think of it, isn't this one of the most reliable and easiest ways to earn great long term returns from investing? If you also think it is, we have some good news to share with you.

Keep watching this space for more details.

04:53

The Indian stock market was closed today on account of Ram Navami.


04:55 Today's Investing Mantra

"If history was all there was to the game, the richest people would be librarians " - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Rahul Shah (Research Analyst).

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What's at the very root of the Infosys pay hike fiasco?
Read On...Get Access

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2 Responses to "Robots Wouldn't Recommend These Turnaround Stocks"

Ram

Apr 4, 2017

You post on Robots and how they cannot identify turnaround stocks reveals a lot of things.

This particular program does historical analysis and recommends stocks. There is nothing to prevent another program to take inputs about future management direction, their conviction, etc and predict future turnaround situations.

In fact, the very idea of Machine Learning (and Deep Learning) is to not only use standard formula prediction like you humans do, but to also learn from past such predictions what works and what doesn't and identify patterns to provide weights to which parameter wrt future oriented information works and which doesn't. This means that these predictive algorithms will quite quickly overtake you specifically in the area of turnaround detection.

Besides, they could also use qualitative data and company specific information feeds as well as price movement information to be much more precise in their constant updation of these predictions of turnaround.

I can understand not being able to appreciate the power of ML/DL, but to bad mouth them and show and Ostrich-like propensity to avoid understanding where predictive science is going shows some amount of trepidation about it.

Lastly, to use this patently false representation of prediction wrt turnaround to make a sales pitch for your services ... Do you really think your readers are that dumb?! :)

Stock picking, whether based on past performance or on future promises can easily be performed by AI and in a few short years they will be better than most of us. Better to get used to that idea and perhaps take the bull by its horns and be the first to use these techniques to keep the edge over competition rather than run away from it.

I hope this post will make it past moderation!

Like (1)

Vipul Jasani

Apr 4, 2017

Hello,

I would like to add my views and suggestions in addition to Vivek's points on reducing inequality. Income tax is not the only tool and definitely higher tax on rich is not the solution.

The solution lies in how efficiently the wealth is getting distributed to all sections of society and Govt job is to control the greed of management or rich people by taking more money. The latest example is of Infosys COO pay hike!!
There should be a ratio to be fixed of highest salary / lowest salary in the organization. If say it is 20 then highest salary including all perks can not be more than 20 times the lowest salary in the organization.
Secondly the objective of share market is to distribute the wealth to people who otherwise cannot have their business or cannot do business but get the benefits of business by investing money in good company by way of holding shares and create wealth. therefore it is important to have financial reforms in following ways.
1. All profit making companies has to compulsorily distribute certain % of net profit as dividend to share holders.
2. If any company does not give dividend to its shareholders, the salary ratio of highest to lowest should be drastically reduced and also there should be cap on salary based on profitability i.e. lower the profit lower should be salary. If company does not make profit then dividend is not paid, the same way promoters also compulsorily should take hit by way of taking very low salary.

all these rules needs to framed by Govt / Sebi so as to maximize the awareness of real benefits of capital market and maximize the benefits to share holders and by that way distributing wealth to common people who can hold as low as 1 share of any good company and create respective size of wealth.
3. Higher taxes on land to curb speculation and improve on ease of doing business which is still far far away. Higher land prices makes many competitive projects unviable if some one starts from scratch. This is very sad part.

There can be many more such suggestions that may prove effective in reducing inequality.

Thanks,
Vipul.

Like (1)
  
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