Irrational Exuberance And Behavioural Finance

Irrational Exuberance And Behavioural Finance

Often we see many stocks trading at a price that diverges highly from their actual intrinsic value. With more media channels/websites giving their opinion (BUY/SELL/HOLD) on every stock price, innocent retail investors react to this information, lowering their long-term returns.

For instance, a few days back, TTML shares were trading at Rs.291, but after the GOI decided to convert their outstanding debt to equity at Rs.41.5 per share at a 9.5% stake, the investors realised how much they were overpaying for the stock price.

In my view, this irrationality exhibited by investors gets explained in #behavioralfinance, where researchers have tried to model how investors react to information and predict how prices will change. Robert Shiller‘s book “#Irrationalexuberance” – a unity of psychology, statistics, and finance, is an excellent read on this topic.

However, DCF is the antithesis of behavioural finance because it assumes that the asset’s value is the present value of its expected cash flows. Thus, my firm belief in value over price has delivered excess returns and always shielded me from buying anything over its actual value.

In essence, finance is the only discipline where temperament matters over skill, and experience count for nothing (I have seen experienced guys making fundamental errors).