Back in 2014, Theranos Inc, the billion-dollar company that she founded, was on top of the world. While still at Stanford, Holmes filed a patent application for a wearable device that would administer medicine, monitor patients’ blood and adjust dosage as needed. Theranos raised $700 million from prominent investors despite stipulating that it would not have to reveal how its technology worked. It then quickly began securing outside partnerships (Capital Blue Cross and Cleveland Clinic) to offer Theranos tests, and Walgreens made a deal to open Theranos testing centres. Holmes’ net worth crossed $4.5 billion.
Later, it was discovered that Theranos’ blood-testing machine, Edison, could not give accurate results. So Theranos was running its samples through the same machines used by traditional blood-testing companies. Lengthy scrutiny started in 2016 and finally, last week, a federal jury convicted Holmes on four charges of fraud against investors.
That is a sombre story. Let us talk of a more cheerful one now. The year was 1993 and Eden Gardens, Kolkata, was hosting the semi-final of the Hero Cup between South Africa (SA) and India. India, batting first, posted a meek 195 on the board. SA initially was 145 for 7. But then, a 44-run partnership between Brian McMillan and Dave Richardson left it needing just six runs off the last over.
With just one over to go, India’s skipper Mohammed Azharuddin could have chosen Kapil Dev, Srinath or Jadeja to bowl (established bowlers had 11 overs remaining). Instead, he asked Sachin Tendulkar, 20 years old at the time, to bowl his first over of the match, and that too with SA requiring just six off six. Miraculously, Sachin managed to concede just three and India went on to win the match. Azharuddin was hailed as a captain with tremendous foresight.
These stories are fun, but they beg a larger question — why would Cramer lavish praise on Holmes without even knowing if her products worked, or why did people unanimously hail Azharuddin as a visionary skipper?
The answer is simple but profound. For them, the decision was good if it resulted in a good outcome. To them, Holmes was a visionary because she raised a billion dollars, not because her product worked.
Azharuddin was a visionary because India won. If you have won, it must be because you made a good decision. It is a subtle point; let me elaborate further.
What if the decision was bad but it yielded a good result? No sober person thinks that getting home safely after driving drunk reflects a good decision or good driving ability. But you might have reached your destination safely despite making a bad decision to drive when drunk. Often, we do not judge a decision on its merit, separate from the outcome it generated. Annie Duke, the author of Thinking in Bets, says that professional poker players have a word for it – resulting. Just because they won the hand, they must have played well!
Now, how often do we, as investors, fall for resulting? Just because our current returns have been good due to a sector being in a positive cycle, have we ever built a narrative that the sector is one to perennially invest in? Have a look at the chart below where we discuss two cycles. Many of you may remember the capital goods’ rally in the 2000s. But can you correctly identify the second sector in the exhibit below?
BSE Capital Goods index, between September 2000 and January 2007, was up a whopping 32 times — up 62 per cent between September 2000 and April 2003 when the Sensex fell 28 per cent and up 19 times between April 2003 and December 2007. The constituent stocks could do no wrong; ABB rose 24 times and Crompton Greaves, up 44 times. Companies borrowed billions of dollars and an entire investment philosophy was woven around how the infrastructure built by India Inc would drive these stocks to the stratosphere. And then, it collapsed with global financial crises. That index did not revisit the 2007 highs until 2019.
Could you correctly identify the second sector above? The one that rose 60 per cent between February 2016 and December 2019 and fell only 10 per cent during the Covid downcycle? It is the BSE FMCG index.
Do you recall a similar narrative that was built during those four years? How the constituents of the index were wonderful companies whose earnings would keep growing and valuation multiples would keep re-rating? Well, since the Covid lows, the Sensex has doubled; the metal, IT and realty indices have tripled, and the FMCG index has returned a paltry 34 per cent.
I will end this with a quote from Nassim Taleb: “Heroes are heroes because they are heroic in their behaviour, not because they win or lose.” Remembering that sectors operate in cycles, and not falling for untested narratives will likely yield superior results for our portfolios.
(The author, Jigar Mistry is co-founder of Buoyant Capital. Views are his own.)