is nestle india in a lollapalooza trap? - · pdf file03/09/2016 is nestle india in a...

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03/09/2016 Is Nestle India in a Lollapalooza trap? https://mallikgaddam.wordpress.com/2016/03/25/isnestleindiainalollapaloozatrap/ 1/4 Is Nestle India in a Lollapalooza trap? Imagine you are in a dilemma to buy a shirt and not yet convinced to purchase it due to its price. While you were struggling with your indecisive behavior, an other customer picked the shirt and then you realize, that’s the last piece available. In such a scenario several psychological scenarios come together, which impacts your decision. 1. Envy : You might turn envious that an other person may own a shirt which you like. 2. Scarcity : It is the last shirt in the store and you may not own it ever in your life 3. Social Proof: The other person is buying it , so the shirt is good Result of this could be that you might want to buy the same commodity for a higher price than what’s actually quoted. When two or more psychological biases come together, the effect gets compounded on a tremendous scale. Charlie Munger calls this combination as Lollapalooza Effect, and he coined it during a 1995 Harvard speech here Munger points to the open auction system as an example of the Lollapalooza effect. He believes that in this environment, several psychological biases converge, causing people to act foolishly. Namely, the psychological phenomenon known as “social proof” leads people to imitate the actions of others in an effort to reflect

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Page 1: Is Nestle India in a Lollapalooza trap? - · PDF file03/09/2016 Is Nestle India in a Lollapalooza trap? ... Lollapalooza effect on Nestle India Fear : Fear that Maggi would never again

03/09/2016 Is Nestle India in a Lollapalooza trap?

https://mallikgaddam.wordpress.com/2016/03/25/is­nestle­india­in­a­lollapalooza­trap/ 1/4

Is Nestle India in a Lollapalooza trap?

Imagine you are in a dilemma to buy a shirt and not yet convinced to purchase it due to its price. While youwere struggling with your indecisive behavior, an other customer picked the shirt and then you realize, that’s thelast piece available. In such a scenario several psychological scenarios come together, which impacts yourdecision.

1. Envy : You might turn envious that an other person may own a shirt which you like.2. Scarcity : It is the last shirt in the store and you may not own it ever in your life3. Social Proof: The other person is buying it , so the shirt is good

Result of this could be that you might want to buy the same commodity for a higher price than what’s actuallyquoted.

When two or more psychological biases come together, the effect gets compounded on a tremendous scale.Charlie Munger calls this combination as Lollapalooza Effect, and he coined it during a 1995 Harvard speechhere

Munger points to the open auction system as an example of the Lollapalooza effect. He believes that in thisenvironment, several psychological biases converge, causing people to act foolishly. Namely, the psychologicalphenomenon known as “social proof” leads people to imitate the actions of others in an effort to reflect

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03/09/2016 Is Nestle India in a Lollapalooza trap?

https://mallikgaddam.wordpress.com/2016/03/25/is­nestle­india­in­a­lollapalooza­trap/ 2/4

seemingly appropriate behavior. As a result, during an auction, participants will often engage in bidding warsbecause that’s what the people around them are doing — not because they’re passionate about acquiring theitem up for auction, or because they’ve drawn the logical conclusion that they’re offering a good price for theitem.  Though the Lollapalooza effect is often shown in a bad light, it can have both positive and negativeoutcomes.

Let’s get back to investing..

Nestle India  (NI) stock price plunged from its highs of Rs 7499 to Rs. 4990 almost trading at a PE multiple of 28to its 2014 PBT (Profit before Tax). In other words, you are assuming NI to grow at 6.5 percent terminally. Inhindsight, NI earnings grew 16 percent CAGR in the last ten years. (Note this is even before I capitalized NI’sintangible assets like Cerelac, Lactogen, Nescafe, KitKat, Milkybar and others contributed by its SG&A).Concept of capitalizing intangible assets is beautifully explained in the book “Its Earnings That Count”

Why this carnage?1. NI’s flagship product Maggi was banned from production till November 2015 due to claims on high leadcontent. Maggi contributes around 30 percent of Nestle’s revenues. The only product in their portfolio whichis growing both in terms of value and volume.

2. In the same time Patanjali came up with Patanjali noodles. Patanjali is perceived as an healthy brand and itspotential growth is presumed to be robust

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03/09/2016 Is Nestle India in a Lollapalooza trap?

https://mallikgaddam.wordpress.com/2016/03/25/is­nestle­india­in­a­lollapalooza­trap/ 3/4

3. During the same time Indian markets got knocked by a 30 percent, with majority of market voices terming itto be a bear market.

Lollapalooza effect on Nestle IndiaFear : Fear that Maggi would never again regain its numero uno position in the market. I am not saying the fearis unwarranted for, but on the first month of its relaunch it did regain its market leadership position. Source : Business Standard

Availability Heuristic: The availability heuristic is a mental shortcut that relies on immediate examples that cometo a given person’s mind when evaluating a specific topic, concept, method or decision. Patanjali noodles is somuch talked, written and tweeted about, that now it is presumed it will replace Maggi. I am not doubting thepotential of Patanjal Noodles, all I am saying is: it is too young to bite the bullet. Maintaining quality is achallenge. Source : DC

Herd Mentality: People are influenced by their peers to adopt certain behaviors, follow trends, and/or purchaseitems. In stock markets traders sell when others sell and vice versa. This is how our markets are behaving withthe pace at which markets plunged. Massive sell off in Nestle led to it trading closer to its 2009 lows in terms ofvaluation

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03/09/2016 Is Nestle India in a Lollapalooza trap?

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Therefore, it’s important to recognize when a Lollapalooza effect might come into play while investing. Whenvarious complex scenarios and competing motivations converge, it can result in a volatile situation. As a rationalinvestor , one should be aware of this effect in order to make an effective investment decision

Acknowledgements: I profusely thank  Jana, for providing his thoughts on Nestle . you can follow him here.

Disclaimer: As of this writing, I own shares of Nestlé India. This is not a recommendation to buy, sell, or hold. Iam not a SEBI registered analyst. I am sharing it so that you can learn something from this.Author: MallikarjunGaddamTwitter: @arjun848