The Fermat’s Last Theorem
A few months ago, you might have come across this news – MRF crosses Rs. 1 Lakh per share and it’s the first company in India to achieve this feat. It appeared in bold headlines in almost all business papers. I also read this with interest because Rs.1 Lakh (approximately $1250) is a large attention-grabbing number. Subsequent to this news coming out, a WhatsApp post started circulating (which also you may have seen) talking about how great an achievement it is. It talked about the humble beginning of the man who founded MRF, how the company became the foremost Indian tyre company and so on.
When I looked at it, it seemed like the best example that I had seen of how misinformation can be spread without making a single factually incorrect statement! Everything that this WhatsApp post mentioned seemed to be 100% true. But… let me just give you two examples:
- It said how a share with Rs. 10 face value is now priced at Rs. 1 Lakh. They way this piece of fact was conveyed created the impression that therefore this is the MOST VALUABLE company in India.
There are of course different meanings of the term “Valuable Company”. So, let’s look at a couple of them. By Market Value (or Market Capitalization), MRF is not even in the Top 100 companies in India. Even the 100th company in that list is about 20% more “Valuable” than MRF!
If you look at the Brand Value – MRF does not figure in the Top 50 most valuable Brands in India – MRF is ranked 55!
The same factoid (Rs. 10 face value to Rs. 1 Lakh market value) was also projected to convey that the value of the company has increased by a factor of 10000 – ignoring two market phenomena – Stock split and float available to trade, both of which have a significant impact on the share price without the share price necessarily representing the true value of the company.
Many companies split their stock (i.e., one share of face value 10 at the time of listing the company on exchanges may be replaced by two shares of face value 5 so that individual share price becomes smaller because a high share price tends to keep new investors away. Usually this is seen as a sign of a move to attract new investors and more importantly a sign of future growth of the company! For example, Infosys has split its stock 6 times. If it had not done so, I do not know what its stock price today would have been, but my rough guess is not less than 80000 or 90000 rupees (i.e., not too different from MRF’s 1 Lakh)!
Secondly, if the promoters hold on to most of the shares and make only a small portion of the total stock available to be traded in the market, that alone tends to jack the share price up due to scarcity. Usually that is done to keep the control of the company firmly in the hands of the promoters by preventing outsiders gaining a large share of the ownership!
So, stock price alone has nothing to do with the true value of the company – except for a loose connection. If the stock price is generally stable or growing over a long period of time, then most likely one could conclude that the company is doing well!
- The second interesting statement is – “It is doubling the investors’ money EVERY three years”. And this conclusion has been derived based on the fact that since it listed on BSE in 1961, its stock price has gone up with a CAGR of 25%. I have not verified the CAGR calculation but let’s assume it is correct. Therefore, what is true is that if someone bought its shares in its IPO in 1961 and held on to them for 62 years, then that person’s investment would indeed have grown by now by 25% year-on-year and therefore nearly doubled every 3 years.
BUT does that mean that in ANY and EVERY 3 year period out of these 62 years, your money would have doubled? That is what the statement in the post “It is doubling investors’ money EVERY 3 years” should mean.
For example, if I had invested in MRF on 27th July 2018 then after 3 years my investment would have grown by ONLY 0.01% i.e., not at all!
So, what is the moral of the story? Just to clarify, I have nothing against MRF at all. From all accounts it’s a very good company, that makes great products and has achieved a dominant position (nearly 24% market share) in the Indian tyre market. It has consistently done very well and has consistently grown.
But the point of the story is this.
Have you heard of Fermat’s last theorem? It was one of the most celebrated theorems in Number theory. Fermat was a famous 17th century mathematician who claimed to have found a simple proof of the statement “You cannot find 3 natural numbers (i.e., numbers like 1, 2, 3, 4 etc) X, Y, Z such that Xn + Yn = Zn where n is a natural number greater than 2”. But he never wrote the proof down. And after his death for 350 years no mathematician could find the proof until in 1993 Andrew Wiles found it. The story of the search for this proof is described in one of the most entertaining books I have ever read called “Fermat’s Last Theorem” by Simon Singh.
BUT – while Fermat’s last theorem is extremely interesting and the book describing its story is very very entertaining – the theorem and its story belong to a domain which has NO connection with either my job or my day-to-day life. I was happy to spend a few hours reading that book BUT beyond that it has nothing whatsoever to offer me which will enable me to live my life better!
Very often financial news – like the headlines proclaiming what a great achievement it is for MRF that its share price crossed Rs. 1 lakh – too is exactly like that.
Entertaining, but nothing whatsoever to do with my financial life or decisions related to my financial wellbeing. It’s just noise – interesting, sometimes even amusing (as the WhatsApp message was, with its cleverness to misinform without making any false statements) but nevertheless just noise and completely irrelevant!