Half a century back, someone proved it in a laboratory and gave it a name: cognitive dissonance. We, amateurs, have always known it exists in our wives, although we have trouble accepting its existence in our own selves.
Disclaimer: This article was written originally in November 2007, so some data points may be outdated.
The Meaning of Cognitive Dissonance
Cognitive dissonance is what makes us CONTINUE making a fool of ourselves, even after we should have found out that we are (making a fool of ourselves). As teenagers, we remember trying to make our first crush (the girl next door?) laugh, mindless of the fact that she was laughing at us, not WITH us. Our friends could see it very clearly, but our loved–sodden selves just could not. Looking back on it, how COULD we? All
…but we did, and we continue to behave in similar variants of such stupid, unexplainable-in-hindsight behavior. Since lesser mortals don’t have the ability to stand back and look at themselves, it is left to writers, academics, and sundry world watchers (like me) to scratch their heads and come up with explanations for what is going on. And since the audience is usually made up of (lesser) unevolved beings, the loudest voice carries the day.
‘India is happening’, no doubt about that. Repeated ad infinitum, this ‘truth’ glosses over any ifs and buts. Those will be simply realized in hindsight and rationalized away with some fresh justification. Did you buy IT stocks in Jan- March 2000? If you did, have you ever sought an explanation from yourself? More important, what answer did you give yourself? Give yourself this little test to see whether you are prone to catch this disease, especially when caught in crowds/ groups.
You will ALWAYS get punished for this flaw in your thinking. And there will be no requiem.
How cognitive dissonance works
Ok, let me start at the beginning. Cognitive dissonance is the process by which the brain justifies (to itself) its actions and perceptions. It is part of your id, your sense of being, your sense of identity. It is what makes you call yourself a genius when bystanders think you are a fool. It is part of your “psychological immune system” which retrieves your sense of well-being, your self-worth, after a decision, or choice that you have made. It is what makes you spruce up your auto-rickshaw with garish pictures of film stars in the name of style, the 1990s habit of the Punjabi puppy re-decorating his Mruti with ‘accessories’, the current habit of the Punjabi Mummyji of rejuvenating her ‘personality’ with the latest plastic ‘lifts’. The Professor who holds forth (I have often shuddered at the prospect of being told by some of my students that I am a victim of the same syndrome) and the politician/ media-man who gets onto a soapbox and launches into the infinitum……….surely you have seen one or the other specimen?
There is a positive side to all this. Cognitive dissonance is what makes you think your wife is prettier than the neighbors, or nicer, or whatever it is that you think your wife is better at……! It is the ‘Nasha’ under which you prod your 5-year-old ‘be sure’ son to render the latest film number in front of a thoroughly bored, plasticine-faced crowd of guests at the Society’s Diwali Mela. That may do nothing for your reputation as a bore, but will do plenty for your son’s ‘public–speaking’ track record, so valuable an asset, any MBA will tell you…..! It helps you go up to the pretty foreigner on the train…..” hello!! Myself ……..Hari Prasad from Bulandshahr”, which the foreigners mistake for “Indian hospitality”! Helps tourism, y’ know!
This is not to be confused with post-purchase dissonance, a.k.a. ‘buyer’s misery’. That is Dr. Hyde to the above-mentioned Jekyll, the part of you that is always unhappy or paranoid with whatever he has, or wherever he is.
So let me quickly establish the relevance of this article to the current market situation. If you have bought a power co at Rs.22 cr per existing MW, a real estate co at 5% of GDP, or an infrastructure co at >50 times earnings, you need some serious Cognitive Dissonance to keep your sense of self –worth (or should that be Net Worth?!) intact.
Every serious bubble has some new ‘technical concept’ to justify the then-current reality. It is the fools’ way of saying “This time, it’s different”. In 1992, there was the Replacement Cost Theory that confused dollar prices with Rupee valuations, I remember the great Dr. Yasaswy giving a lecture at none-other-than the Instt of Chartered Accountants to ‘explain’ the Harshad Mehta theory. Too young for that, were you?
In the IT and Dotcom bubbles, these cos were ‘changing society’, killing the business cycle and increasing economic productivity to infinity. Too long a point for such a small column, the less said about that, the better. Anyway, those cos are still around, so you can ask them what they have to say for themselves. Not their fault really, you can’t save the fool from himself……!
The Valuation in India
Today’s justification is “India Shining” and “sum-of-parts” valuation. The first is obvious, YOU tell me more about it, never mind that we have a trade deficit and oil-price sensitivity that puts us abreast of America as far as the twin deficits go. A serious threat of an inflationary shock, with an irresponsible Govt distorting energy prices to create a short-term shield against inflation. When the dam breaks, the Rupee could surprise the whole of corporate India. Today’s stars with their huge capex plans, could bite the dust in a manner that our good ole’ fools cannot comprehend.
Did you know that every major corporate in Delhi has bought some sort of Yen carry trade, which knocks in a serious digital at 105+? That means, at 105 or higher, their protection expires and they have to pay at market, loans that they took at 115-122. In simpler words, a 10-20% increase in the principal value of the loan could reverse whatever ‘carry’ they may have made, i.e. the savings in interest cost of 2-4% that they have been making for the last few years. Watch the Yen: Dollar rates very closely, that is like a one-time interest rate spike that most people can’t see coming.
And when you run out of arguments, there is this “sum-of-parts”. This consists of valuing translucent subsidiaries either on operating margins or on some fuzzy ‘slice-of-potential-market’, which may or may not happen. Like those big “J-curve” valuations on which the dotcoms were sold…….you know, those presentations where the 20-something ‘entrepreneur’ would look up dreamily at the fan, roll back in his chair, and start, “the population of India, no, the world is………”.
It didn’t stop there. You now have this ‘theory’ going something like this: all holding cos should 2 be based on the value of their shareholdings in other operating cos. So you get Rs.1 lakh crores in the operating co, another 1 lakh crores in the holding co, another 1 lakh crores in the holding co to the holding co and it goes on and on…….till the bull market is over, or you run out of fools. And these valuations are now at a few percent of GDP EACH!
In one spectacular case, a Research Report by one of the top foreign banks points out a negative cash flow for the next 3 years and then uses the Replacement Cost Value method to value the co. So I suppose it is ‘normal’ to lose cash for 3 years before you generate a profit, mind you, in a RUNNING co!!!!
In another, a price target is revised by 400% just because the stock went up, using the afore-mentioned ‘sum-of-parts’ value, the major part of which is just a contract! Just like during the IT boom, when valuations would increase when an ‘order’ was received.
I won’t comment on the individual merits of these specific stocks. Just find the fellows who are buying this kind of stock, and hear their justifications. Just back from Jaipur, where a relative told me that the above-mentioned would ‘double in a month’. For once, I did not hesitate to touch his feet