In 2014, Theranos Inc, the billion dollar company she founded, was on top of the world. While still at Stanford, Holmes filed for a patent for a portable device that would deliver drugs, monitor patients’ blood, and adjust dosage as needed. Theranos has raised $ 700 million from leading investors, although he has stipulated that he will not have to reveal how his technology works. She then quickly began to enter into external partnerships (Capital Blue Cross and Cleveland Clinic) to offer Theranos testing, and Walgreens struck a deal to open Theranos testing centers. Holmes’ net worth has exceeded $ 4.5 billion.
Later, it was discovered that Theranos’ blood test machine, Edison, could not give accurate results. Theranos therefore ran his samples on the same machines as those used by traditional blood testing companies. A lengthy scrutiny began in 2016 and finally, last week, a federal jury convicted Holmes on four counts of investor fraud.
It’s a dark story. Now let’s talk about a more merry one. It was 1993 and Eden Gardens, Kolkata, hosted the semi-final of the Hero Cup between South Africa (SA) and India. India, batting first, posted a low 195 on the board. SA was initially 145 for 7. But then a 44 point partnership between Brian McMillan and Dave Richardson only needed six points for the latter.
With just one lead to go, Indian skipper Mohammed Azharuddin could have chosen Kapil Dev, Srinath or Jadeja to play (established bowlers had 11 overs left). Instead, he asked Sachin Tendulkar, 20 at the time, to pitch his first game of the match, and that too with SA needing just six out of six. Miraculously, Sachin only conceded three points and India won the match. Azharuddin was hailed as a captain with great foresight.
These stories are fun, but they raise a bigger question: why would Cramer praise Holmes without even knowing if his products worked, or why have people unanimously hailed Azharuddin as a visionary skipper?
The answer is simple but profound. For them, the decision was good if it resulted in a good result. To them, Holmes was a visionary because she raised a billion dollars, not because her product worked.
Azharuddin was a visionary because India won. If you won, it must be because you made a good decision. This is a subtle point; allow me to elaborate further.
What if the decision was wrong but gave a good result? No sober person thinks that coming home safely after driving while intoxicated is a good decision or good driving ability. But you may have reached your destination safely despite a bad decision to drive while intoxicated. Often times, we don’t judge a decision on its merits, regardless of the outcome it generated. Annie Duke, author of Thinking in Bets, says professional poker players have a word for it – result. Just because they won the hand, they must have played well!
Now, how often do we as investors fall into the trap? Just because our current returns have been good due to a sector in a positive cycle, have we ever built a narrative that the sector is a sector to invest in all the time? Take a look at the table below where we discuss two cycles. Many of you may remember the capital goods rally of the 2000s. But can you correctly identify the second sector in the exhibit below?
The BSE Capital Goods Index, between September 2000 and January 2007, increased 32 times, an increase of 62% between September 2000 and April 2003, when the Sensex fell 28% and rose 19 times between April 2003 and December 2007. couldn’t do anything wrong; ABB increased 24 times and Crompton Greaves increased 44 times. Companies borrowed billions of dollars and a whole investment philosophy was woven around how the infrastructure built by India Inc would drive these stocks to the stratosphere. And then it collapsed with the global financial crises. This index did not revise 2007 highs until 2019.
Could you correctly identify the second sector above? The one who increased by 60% between February 2016 and December 2019 and only decreased by 10% during the Covid downcycle? This is the BSE FMCG index.
Do you remember a similar story that has been built over these four years? How were the constituents of the index such wonderful companies whose profits would continue to grow and valuation multiples would continue to reassess themselves? Well, since the troughs of Covid, the Sensex has doubled; the metals, computer and real estate indices tripled, and the FMCG index returned a meager 34%.
I will end with a quote from Nassim Taleb: “Heroes are heroes because they are heroic in their behavior, not because they win or lose. Remembering that sectors operate in cycles and not falling into untested narratives will likely produce superior results for our portfolios.
(The author, Jigar Mistry is co-founder of Buoyant Capital. His views are his own.)