Behavioural aspect of financial analysis

Financial Bloggers are often accused of one thing – repeating the same thing again and again and again. I agree with it; I tend to repeat things again and again.

Let me tell you one of my good experiences. I was about to finish my masters course at the Rotterdam School of Management. So, there was an informal session going on with one of my favourite professors. Having finished the course around 2 hours before time, he asked us if we had some questions that he may answer. My fellow students asked him about his past, his job profile (he was a full time trader previously), family, etc.

I posted a different question altogether:

What is the toughest question you’ve faced while teaching your students in finance?

It seemed as if he was just waiting for this question. He started by responding:

It’s not only the toughest question, but also the most embarrassing question – and this question repeatedly keeps on bugging the finance professors across the world.

He then continued:

“The toughest question every finance professors face, and even you may face someday, is: You teach several high caliber students about investments and trading. If you are so intelligent and smart about investments, finance and trading, why aren’t you rich?.”

The moment he said this, there was a big laugh in the class. However, after a moment, there was silence. The reason was that people realized what they had learned during the entire course and then (probably) they asked the same question to themselves. After spending so much money, taking a break from a well paid job, doing a costly course at an international business school, we were not in a position to answer the simple question.

Well, then we had a nice discussion about the reality of markets and financial products. What all we’ve learnt during the entire course, in a nut-shell was that “one cannot make enormous profits consistently in the market”. One may be lucky for 1, 2 or a few years – but how long can he carry on making profits – no one knows. Come together the fundas of diversification, asset allocation, tax saving, psychological biases, behavioural finance, disciplined approach, systematic investment plans, blah, blah, blah – all these terms factor in and ultimately the individual is left with no big profit in the end of everything.

My professor was already a trader with a reputed MNC financial firm and was based in New York. He said that the most interesting thing that he spotted during his career was how stupidly people behave with their money, how ignorant they are with respect to the financial products and markets, yet all this is done to get more money. Hardly anyone knows how to calculate the profits. Hardly anyone is willing to learn the right mathematics, but the moment there is a news on business channels, quoting EBITDA, Profit after tax, EPS, etc., etc., people will be fascinated about the numbers – though they hardly understand the meaning of those numbers. Brokers, investment advisors, agents & sometimes even organizations declaring financial results use these figure very well to make a fool of people. All they end up doing in the market is making bets.

In my previous articles, like DCF analysis, I attempted to give the right picture.

In my another article: Should you invest in IPO, I attempted to disclose the profit/loss calculation with respect to IPO applications.

Interestingly, for both these articles, people either responded by saying that they have not understood the method OR they picked up their best performing investments to prove that they are in big profits.

I’m not trying to say that you are in complete loss or not doing the right thing – but I’ve always advised to look at the whole picture. For example, you may have earned enormous profits in the recent IPO like Power grid IPO. However, look at the whole picture – let’s say past one year. How many IPO’s have you applied for? Were you allotted shares for all those IPOs which you applied for? How much was the profit that you made? Is the overall profit better than what you’ve lost in risk free bank accounts or FDs?

Similar thing goes for profit/loss calculations for stock trading and investments. Just take last 1 year or 2 year horizon or your entire investment horizon since when you started trading. Do a DCF analysis and see where you stand. Have you performed better than the risk free bond returns or bank account? If yes, have you performed better than the market – like those tracked by ETF? If yes, they can you continue doing so consistently year after year? If the answer to any of the above questions is no, then you must give a second thought to your investment strategies.

Well, sorry for repeating the same things again :- )
Thanks for reading till the end.


Have questions, please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.

You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.