Adani & Alphabet & the concept of Fragility - Two Groups which lost $100 billion in market value in the same month

Adani - Hindenburg Saga

Since January 24, 2023 the market-cap of seven listed Adani Group companies has fallen by nearly $100 billion. The group shares have been in a free fall since the Hindenburg Research report came to light. The report has made some serious allegations on Adani Group regarding overvaluation, over leverage, artificially inflating share price, etc which caused the free fall. The shares of some of the companies continue to fall even after 1 month since the report was released. 

Google - Bard Launch

Open AI’s Chatgpt is a AI generative chatbot that has gone viral and achieved 100 million users within 2 months of being made public in Nov 2022. Microsoft was quick to capitalise on this popularity and immediately invested USD 10 billion. It also integrated the chatgpt into Bing search engine. Bing is the second most popular search engine with 15% market share. Google which is the most popular search engine with 85% market share to counter Chatgpt/ Bing, introduced its own AI chatbot Bard. Bard gave a wrong answer on its launch event which led to loss of $100 billion in market value of Alphabet which is parent of Google.

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Spot the Difference: 

While prima-facie both the events look similar wherein both the Business groups lost $100 billion market value due to adverse news, yet they are actually very different from an investors point of view.

To understand the difference, we need to first understand the concept of Fragility. Fragility is a term that describes how vulnerable a system or an asset is to external shocks or stressors. A fragile portfolio is one that suffers large losses when market conditions change unexpectedly or unfavorably. A fragile portfolio can also be prone to volatility and drawdowns, which can erode investor confidence and wealth.

To explain the concept, let me take the example of a flower vase (courtesy N N Taleb). We know a flower vase is fragile. If it falls, it’ll break and can never be used again. But what we don’t know and can never guess is when it will fall or under which exact circumstances it will fall. Flower Vase may never fall as well. On the other hand, a rubber ball is not fragile and will not break by a mere fall. A Rubber ball is less fragile than a flower vase.

From an investors point of view, we can only measure fragility in our portfolio. We can never guess when an adverse event will occur. We can only ensure that fragility in our portfolio is low such that even if an adverse event occurs, it will have minimal impact in the portfolio.

The valuations of Adani Group companies from P/E point of view is overvalued as some of the companies are in the range of P/E of 300 to 800. To justify this P/E, Adani needs to grow fast. Fast growth can only be achieved with external capital. That is also the reason why Adani is leveraged too. Leverage and Overvaluation are two factors which increase fragility.

Alphabet on the other hand has zero debt and hold cash in hand of $120 billion as on 2022. The valuation from P/E perspective is also 18. 

Hence, Alphabet is less fragile as compared to Adani Group. 

Any adverse news will likely have larger impact on Adani as compared to Alphabet. In fact Adani had to withdraw FPO. It also had to prepay Debt to instill confidence. This further will likely slow down growth as access to external capital is impacted. 

Alphabet on the other hand is working towards improving Bard without worrying about market value or external capital. 

I never got worried about recession or COVID or any other adverse news events as my only focus was having a low fragile portfolio. My focus on reducing fragility in my portfolio gave me courage to remain invested in equity markets in the past ~10 years without cutting down my portfolio at any point of time. Low Fragility apart from giving me courage also gave me peaceful nights without worrying about adverse news.

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The Solution:

Here are some steps to follow for reducing fragility in equity portfolio:

1. Investing only long term capital i.e. money which we dont need in next 10 years. While there might drawdowns due to adverse news events, most of the drawdowns will be only short term in nature and may last maximum upto 3 to 5 years. Hence, time is a weapon which we can use against short term volatility. Time heals most of the wounds and hence will also reduce fragility. 

2. Investing in companies which do not have Debt. Leverage increases fragility. Lack of leverage/Debt reduces fragility.

3. Getting associated with companies whose Management does not like taking Debt. There are Two types of Management. Type 1 - If given Rs 100 Crs capital, they invest in 5 different projects of Rs 20 Crs each without taking any Debt. Type 2 - If given Rs 100 Crs capital, they take Debt of Rs 900 Crs and invest in as single project of Rs 1000 Crs. Style of Type 2 Management increases fragility of the company. IF they succeed, they will have multiplier growth effect. But the chances of failure is high due to high fragility. On the other hand, in Type 1 style, while the growth prospects may be at a slower pace, the chances of failure is low. 

4. No to BAAP (Buy at any Price). We should not enter in a company when it is overvalued. Overvaluation increases fragility as any adverse news will correct the valuations.

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