A framework to instantly take your stock analysis to the next level.

Why does the market behave the way it does.

When i started out investing, i was looking at different strategies and philosophies to implement in the market. Like everyone else, i started with “value investing” - looking for cheap stocks and brushing off the “high PE” ones. Then i learnt why high PE is high PE “for a reason”. So i graduated to growth investing and started ignoring anything that did not promise secular growth and so on. I am sure this is how most investors’ journey in the market progresses.

But what i realised is none of these philosophies are able to explain the market’s behaviour in totality. I had questions like:

1. If the stock is valuable, why is it so cheap?

2. If the stock is so expensive why isn’t it correcting for years together?

3. Why is HDFC Bank valued at 4x SBIN even though SBIN is a larger business.

4. Why is HDFC Bank valued at 2x of ICICI Bank even though they are peers and similar.

5. Why are some stocks so volatile while others have more or less smooth linear moves.

6. Why are some stocks punished on bad news while others are unaffected on similar news?

7. Why do stocks get re-rated or de-rated by the market?

Over the years i sought to find a framework that will answer these questions - questions about why does the market behave the way it does. What really matters to the market? I knew there is more to it than the balance sheet, P&L and the cash-flow statement.

What i learnt observing the markets, reading, watching and implementing different systems is this: Stocks are People.

Every stock is a different organism at different points in time. Just like with people - the character, pedigree, age, mood and the environment matter. The trick to analysing any stock is to try to figure out what sort of the person is this stock currently. I am using the word stock but it may as well apply to sectors and asset classes too.

Just like how we value people with certain characteristics more than others, the market values the stocks very differently based on several characteristics. I am not talking so much about the fundamental attributes here - which we are all aware of, anyway. These are qualitative characteristics which often matter more than fundamentals. They are very similar to ones we look at in people. Let’s look at some of them:

1. Trustworthiness - an impeccable history of no wrong-doing to a patchy history full of issues

2. Reliability - an impeccable track record of execution to a track record with many fits and starts

3. Age - how long has the market known this stock and how well versed is the market with the behaviour of the business across cycles

4. Potential - The Future.

5. Pedigree - Tera Baap Kaun?

So we have an acronym - TRAPP. If you’re in the good books of the market with respect to the five above you will be treated like a king by the market and if any of the pillars is shaken the market will punish you like there is no tomorrow or until you reinstate the pillar back - which takes time and significant effort. Often one or more of these five pillars will dominate the market’s perception of the stock but they all matter when it comes to deciding how the market will treat the stock overall.

Now instead of running stocks through the usual value/growth filters, run them through the TRAPP filter. This will help you understand much better why the stocks behave the way they do.

1. Why is Bajaj Finance getting such a long rope inspite of the not so great numbers across last several quarters. Nothing else can explain it but TRAPP. It’s a business and a management that has earned the trust of the market, has shown relentless execution across crises, the market knows the business well across several years- the risks of the unknown are little and the future is looking promising with its fintech ambitions. Now the other NBFCs/banks that could very well do all this fintech business but there is one little problem - the market does not trust them. A mistake Bajaj finance makes will likely be ignored but if another NBFC makes even the smallest of the mistakes, it will be punished disproportionately.

2. AU Bank and Ujjivan - Now you see what happened, why it happened and if it can get worse. Market’s trust was shaken and when that happens nothing else matters and you are punished. Now unless this is repaired and just like with people it will take time, the market will not value these entities like it did before. This also explains why the market got so excited when Aditya Puri bought into PNB Housing - the stock instantly went up several notches in pedigree.

3. This also explains why DMART trades the way it does. Now i am not commenting on the valuation but the fact everything in TRAPP lines up and does impeccably - the business will always trade at super premium to most other stocks with similar growth and similar fundamentals.

4. Let’s look at Zomato. Trust - Public track record of scale up. Reliability- not so much yet but good execution so far. Age and Potential - Young and very promising. Pedigree - Backed by reputed names, hence high. So we have a 4/5 - which explains why its being treated the way it is. Now imagine Zomato (the exact same business) was promoted by Anil Ambani or Kishore Biyani - do you think it would have got the valuation it did. Certainly not.

5. Let’s look at cryptos now. Let’s look at bitcoin in particular. There are no fundamentals to speak of anyway. So the only way to analyze them is TRAPP. Over the last ten years the crypto investors have worked relentlessly to strengthen the trustworthiness of the protocol, reliability of the transactions, the market has seen a fair amount of crises and what do you think the likes of Elon Musk and Microstrategy doing? Building pedigree. Within the crypto universe this framework helps you explain why a bitcoin is more valuable than Eth which in turn is more valuable than many other coins. It also explains why crypto is so volatile - the market just doesn’t know you yet and your every move will be look at with scepticism and confusion.

You can look any almost any market event and your understanding of the market behaviour will increase manifold if you look at the event through this TRAPP framework.

One could utilize this framework to take decisions with respect to your portfolio, build investing strategies and also take advantage of this understanding of market behaviour to exploit trading opportunities in the market.

I will write about it in future posts.