Cumulative advantage

Today, I read a couple of interesting papers on "cumulative advantage". Simply put, cumulative advantage means that if an object is slightly more popular than another at just the right point of time, then it will tend to become more popular still.

Let me illustrate this with a simple example. In an urn, you have two balls of different colors, say green and red. You pick out one ball at random and then introduce a second ball of the same color. For example, if you picked a red ball from the urn, then put the red ball back in the urn and add another red ball into the urn such that you have 1 green, 2 red balls now. (iteration 1)

What has happened here? You have improved the chances of picking a red ball now by 16% (from 50% to 66%) and reduced the chances of picking up a green ball by the same %age, by performing a random act (iteration 1).

In the social sphere this is more profound, as human beings tend to interact with each other and follow directions. Cumulative advantage can drive an average music or book to a blockbuster. It's a bit like while watching videos Youtube, we tend to click first on videos which have the maximum views and if time permits, we move to the lower 'viewed' movies. We are hence trusting the crowds judgement that a higher viewed video will be better than a lower viewed one. With millions of people thinking the same way, huge distortions are created. Professor Duncan Watts, through his experiments published in his paper, shows how popularity develops in a controlled ecosystem.

The principle has some learnings in the investment world aswell, particularly venture capitalists.
1. It is difficult to predict winners. While it is true that better quality products have a better probability of success, there is no assured link between commercial success and quality.
2. Flexibility decreases over time. In other words, once the results are established, they become sticky.

To conclude - the next blockbuster might not necessarily be a better product. It may just be a set of lucky circumstances :-) (and a little help from you)

If you like this content, then do check out my new blog on investing and stock markets for lots more information on the Indian equity markets

What a target !

I've seen some really good price targets in the last few weeks ... but this one beats them all. Citi (on March 12, 2008) placed a price target of Rs. 2,400 on Motilal Oswal Financial Services. This is a 247.50% appreciation over the Mar-12 price of Rs. 690.55

The report compliments MOFS's diversified businesses, it's move up the value chain and low-risk approach to business. This has allowed Citi to place a 25% multiple over the other market players in valuations.

HEG Limited

The graphite electrode business in India is an oligopoly with Graphite India and HEG ruling roost. I already hold a position in Graphite India (which is down by almost 22% from my buy levels 3 months back). Now, it's time to recommend it's cousin, HEG Limited for a buy.

Fundamentally, this business seems to have a good future. The firm is one of the largest in India, well established and progressive. They were carrying some unprofitable loads such as their steel business, which is now gone. On the price-earning front, the stock trades at a 1 yr fwd P/E of 6.70 (similar to Graphite India) and a rising EBITDA margin (over 25% now). The FCF of the business is a healthy 8% of sales.

A report by Emkay also highlights that HEG holds a 40% stake in Bhilwara Energy Limited. Based on the previous two private placements with US funds, Emkay estimates HEG's share in Bhilwara at Rs. 98 per share. Therefore, at the current price of Rs. 259 per share, HEG's standalone business is valued at about Rs. 150 rupees per share which amounts to a m-cap/sales ratio of 0.78.

Using mathematical models to find love

I first thought this would be some flashy book title by an obscure author, merely trying to sensationalize a rather naive, boring statistical approach. I was surprised to find that it was the internet behemoth, Google that had churned this research paper into a product. The application is currently in beta.

Interestingly, Google managed to find a way to commercialising this application with contextual advertising. The online dating market is estimated at over USD 2.3 billion. And as no new innovation has happened in this segment in the last 2 years, Google might be instrumental in reshaping the industry.

Access link : http://www.google.com/romance/