Opto Circuits, and Power of Story in Investing

If you clicked on the headline expecting to read my view on Opto Circuits, I’m sorry to disappoint you because this post isn’t about that.

The reason I mention Opto Circuits here is because I have received several emails over the past few days requesting for my view on the stock.

Given the number of requests for this specific company, I would definitely work on the same and try to release a report soon via StockTalk. But what intrigues me is – Why are so many people suddenly talking about a small-size company called Opto Circuits?

What’s the story?

Well, that’s what I’m going to discuss today – investing and power of “the story”.

————“Safal Niveshak’s Facebook Jam”: Revised Timing———–

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This post is inspired from a recent interview I read of Aswath Damodaran, and then his book (on investment fables). For those who don’t know about Damodaran, he is Professor of Finance at the Stern School of Business at New York University, and one of the leading global authorities in the fields of corporate finance and equity valuation.

Here is what Damodaran wrote in his book Investment Fables…

Investing is full of stories that sound good when they are told but don’t hold up under close scrutiny. Consider a few: Buy stock in good companies and the returns will surely follow. Buy after bad news. Buy after good news. Stocks always win in the long term. Follow the insiders. Buy stocks with big dividends. Buy stocks that have gone down the most. Go with stocks that have gone up the most.

What Damodaran wrote also seems true of Opto Circuits. There certainly is a story (or a set of stories) that people are hearing (or want to hear) about Opto Circuits.

Here are 11 stories on the company I’ve just read on the Internet and in the company’s annual report…

1. Opto Circuits’ management expects 20% revenue growth in FY13.
2. Opto Circuits has commenced work on its new single-product special economic zone near Bangalore.
3. Opto Circuits has the best operating margins in the industry (average of 28% over the past 10 years), and even these are expected to improve by a couple of percentage points in the next year.
4. Opto Circuits is expected to benefit from economies of scale, which will help it improve its margins.
5. Opto Circuits earns amazing return on equity, which has averaged 40% over the past 10 years.
6. Opto Circuits is seeing an improved working capital cycle, which will help it improve its balance sheet.
7. Opto Circuits will be tying up with companies outside India for promoting its products in FY13.
8. Opto Circuits reported a huge 88% growth in its net profit in the recently completed quarter.
9. Opto Circuits’ stock has fallen 33% from its 52-week high price.
10. Opto Circuits has been advised as a ‘Buy’ by a brokerage, which expects it to rise 65% over the next one year.
11. Opto Circuits has been categorized among India’s fastest growing companies by a leading business magazine.

Interestingly, all these stories on Opto Circuits point towards the positive side, which leads me to ask this question – “What really is the big story behind Opto Circuits?”

You see, the reason such stories around stocks like Opto Circuits sound alluring and make us take notice is that there is a grain of truth to each one of these stories.

Of course, none of them is foolproof…but there is always some truth in such stories…and we are much more likely to be swayed by them than we would be any number of graphs and numbers.

What makes an investment story compelling?
Damodaran says that investment stories are convincing not only because they are told well but also because they draw on several common factors.

As he writes in his book, most good investment stories appeal to a fundamental component of human nature, whether it is greed, hope, fear, or envy. They are also backed up by the evidence (as you can see in the Opto Circuits example above), at least as presented by the storyteller.

Investment stories also come in several forms. Here are just a few of them…

• Buy stocks of companies with safe balance sheets – like those having zero debt – and great returns will follow.
• Growth stocks always do well in the long term.
• Investing in high dividend yield stocks will always pay in the long run.
• You can never make a loss buying a stock with low price-to-earnings ratio.
• Stocks that trade at less than book value per share are great long-term investments.
• Companies with stable earnings are safe bets.
• Look for stocks at the 52-week lows, and you will find a potential multibagger.
• Buy ‘momentum’ stocks – that are going up – and go along for the ride.
• Follow the right investment experts, and invest in the stocks they pick.
• Stocks always win in the long term.

But should you believe?
Should you believe all good investment stories that you hear…like the ones on Opto Circuits?

Not at all! Exactly like you must not believe when I say that Clariant Chemicals and NHPC make for good investment stories at current prices!

Instead, here are three things I suggest you must do whenever you hear a nice investment story that you are willing to believe to be true…

1. Be curious about what makes the story work. For instance, before you start to believe that all stocks with low price-to-earnings (P/E) become great investments, know whether this has been true in the past or not. Of course, this sound logical because you are buying stocks at low valuations, but then there have been numerous cases where stocks selling at 5x P/E have fallen to 1x P/E.
2. Appreciate the fact that no investment story will work all the time. Take the case of FMCG stocks, which are rising even in the current bad markets. These are known as defensive stocks, simply because the companies here conduct simple businesses (like selling soaps, noodles, or toothpastes) and have safe balance sheets. But if you were to ask me if these really are defensives now, at average P/E of 35x, my answer will be ‘No!’ In short, what was defensive earlier might be dangerous now.
3. Know that every story also has its villain – the weak spot. For instance, when you look at low P/E stocks, there might be two primary concerns that you may encounter – one, these stocks might not have much growth in earnings to offer, and two, they may be very risky (and that’s why the P/E could be so low).

Overall, most stock market stories that we read and hear in the media across bull and bear markets are for the optimists who believe that one will always win in the long term.

In good times, they tell you the story, “This time it’s different! This market will continue to scale new peaks because the Indian economy is going great guns, China is booming, US and Europe are consuming big time, etc. etc. You should expect to see your stocks double in six months.”

You believe them…and double your investment in stocks.

In bad times, they say, “Don’t worry! Given the law of averages, we will be back to great times very soon! So hold on to your stocks. Be a long term investor.”

You again believe them….and average your dud stocks.

So, when it comes to investing in stock market, the power of “the story” is very strong.

But your job must not be to just be a silent listener. Your job must be to bring the story into scrutiny and see if that really holds true.

In other words, you need to get past the story-telling because it’s easy to fall into it saying, “Hey, this company is worth a lot!”…or “If this is on StockTalk, there must be a great story behind it!”

In the meanwhile, let me find out “the story” behind Opto Circuits. 😉