The fundamental rule taught in Economics 101 is the inverse relation between the price of a good and its quantity demanded (referred to as demand henceforth). In other words, the more expensive something becomes, lesser the demand for it is and vice versa. We see this in everyday life – discounting festivals on e-commerce sees record numbers of mobile phones being bought; price increases in automobiles (owing to higher insurance costs and new emission norms) resulted in a lower number of sales, etc.
Yet, there are certain goods that see an increase in demand with an increase in price. These are called Veblen goods. This is due to a perceived ‘snob value’ or ‘brand value’ attributed to this product. Think a Patek Phillipe watch, or a Ferrari or any other luxury item – the more expensive they are, the more “valuable” they become and a larger number of people want to acquire them.
The same phenomenon can be witnessed in the stock market. As a sector begins to re-rate and see price increases, more and more people seem to be buying it. Fancied stocks trading at ‘high’ multiples (I know value is subjective, but bear with me) continue seeing higher demand- like a Veblen good. A certain 6+ times levered NBFC trading at 10x its book (until very recently) saw demand going up with an increase in price, as the perceived quality of the underlying business kept getting higher. This Veblen nature of stocks has three distinct implications.
#1: Stories Overpower All Else
The perceived quality of the stock is hinged on a narrative built around the stock. It could be earnings that are drawn out easily on excel sheets for quarters together (HDFC Bank), being a market leader in the most common home decoration category for a 6 decades (Asian Paints), or having an irreplaceable space in the carpenters’ minds for sticking together two pieces of wood (Pidilite). This narrative around the stock forms the genesis of the ‘snob value’, making the stock behave like a Veblen good.
Until the story changes, until the genesis is challenged, the Veblen status is upheld.
#2: If you have a Winner, Volumes dictate when you can call it Quits
The story lends a powerful snob value to the stock, taking it to ‘irrational levels’ for longer than you can ‘remain solvent’. Theoretically, it is a great idea to play the wave as long as the story persists. However, if you are a sovereign wealth fund (or have a very large investment relative to the free float) you will not be able to exit when the story changes, without severe damages.
Additionally in thinly traded small and mid-caps, there is not enough ‘oxygen’ available at ‘high altitudes’ for you to make it back with certainty when a storm hits. In both these scenarios, quantity you own relative to the average volume traded determine if you should call it quits in expectation of a change in the narrative.
#3: Manufacturer/ Seller of Veblen Goods makes the most Profit
The key to making supernormal profits is to have enough to sell when the prices of these goods lead to an increase of demand into ‘irrational’ levels. Ferrari, Virat Kohli and the promoter doing a QIP at 10x P/B of a 6x+ levered company earn the most from the nature of Veblen goods.
It might be relatively easy to figure out the narrative leading to a company’s high quality perception. Enough vocal justifications will be made alluding to the same. To determine what can change this narrative, however, is difficult. Risk reward will always remain skewed against those betting on the narrative to continue. This is because narrative continuation assumes status quo. No simulation that our mind runs or a model (they don’t work) shows will do the trick in predicting this. There are far too many permutations. For example, this global pandemic did not feature in any model prior to 2020.
To make the most of the Veblen nature of stocks, it is best to buy before the marginal buyer is convinced of the positive narrative, that leads to its higher price and demand. This will ensure you have the Veblen good to sell as the price and consequently demand go up. It is also logical to partake in the trend as higher prices tomorrow can lead to an even higher demand. In such a case, however, the caveats of volumes and higher risk of assuming status quo must not be forgotten.
May 21, 2020 at 4:00 pm
August 2013http://doctorcassandra.blogspot.com/2013/04/stock-story-v-veblen-goods.html?m=1Dr Parag Shah
May 21, 2020 at 4:13 pm
Brilliantly written. Insightful indeed!
May 22, 2020 at 1:57 am
Excellent article. Keep it up.
Sent from my iPad
May 25, 2020 at 3:07 pm
Wow, great insight