This is a wonder story/blog I read from a mailed of groww.in.
In the 1800s, the French were in a peculiar situation – with rats.
The French had colonized parts of southeast Asia. They controlled the Indochina region (modern-day Vietnam).
The French found Hanoi city to be small and dirty – unlike French cities.
So they started demolishing and rebuilding. They built massive structures – palaces, churches, and so on.
The French also wanted to keep the city clean. They built a vast sewage drainage system underground.
Rats vs the Authorities
Around the same time, a pandemic was spreading throughout the world – bubonic plague. One of the worst-known pandemics in history.
This disease would spread from rats to humans.
It spread to many parts of the world carried by traders moving across borders. Traveling soldiers were another reason.
Awareness about the threat from rats spread. Some infected rats reached Hanoi on trading ships.
The rats discovered the vast sewage drainage system underneath Hanoi and made it their home.
The French authorities noticed this and decided to fight.
In April 1902, they hired Vietnamese rat catchers. The rat catchers would go down into the dirty sewage drains and kill rats.
The rat catchers were incentivized to kill more and more rats. Towards the end of April, they killed almost 8,000 rats.
The effect of this move was visible.
The number of people dying from illnesses: more rats killed, fewer people died.
While this showed some success, it was no match for the rats’ capabilities. They reproduce incredibly fast.
So the French authorities came up with another idea: they incentivized everybody for killing rats.
Any person could kill rats and collect the prize money (1 cent per rat).
Because the number of people involved in this operation was so high, the authorities feared the municipal offices would be overflowing with dead rats.
To make it easier, they asked people to instead get just the rats’ tails and not the entire dead rat.
The authorities monitored this number closely: the number of rat tails collected.
This was their window into how the spread of diseases was managed in Hanoi city.
If the number of rat tails collected was low, it indicated a potential increase in illnesses. If the number of rat tails collected was high, all things were going according to plan.
Long Term Effect
This worked well.
A large number of people started killing rats. The authorities were pleased with the number of tails being brought to them.
Some time passed.
French authorities started noticing rats in the city – rats without tails.
Many local people realized that if they killed the rats, they’d run out of an income source.
So, they would catch rats, cut their tails and release them. The rats continued to reproduce – making more rats. The people submitted the tails and got the incentive.
Later, it was discovered there were farms outside the city which would breed rats for their tails.
Counting the number of rat tails was no longer a good way to measure how public hygiene was faring.
Numbers Obsession in Investing
The importance of various metrics changes from time to time.
A common mistake we do is to treat certain numbers as the most important measure of something.
There was a time when investors used to treat the dividend paid by a stock as the golden metric. If the dividend paid was high – good stock to invest in.
Newer companies emerged. Trends shifted.
A few newer companies didn’t pay a dividend – because they reinvested the profits back into the business.
Some investors caught on to this. They stopped looking at the dividend and instead focused on the profits earned.
Gradually, more investors paid attention to profits.
Again, with time, the way some companies operate changed.
Some companies were willing to delay earning profits to gain market share. In that case, revenue and revenue growth became important.
Again, some investors caught this soon. Some investors were late to understand. Some investors continued to not give it importance.
Likewise, for very new companies, even revenue was low. But the size of the potential customer base became a crucial metric to judge future success.
There’s a deeper lesson in all of this.
The lesson isn’t that you should understand which number is the most trendy one.
Numbers alone never tell the entire story of a company.
As an investor, which kind of a company do you want to invest in? A successful one.
How do you measure this?
That’s the tricky part.
There is no single number or metric or ratio you can look at to judge an investment.
Individual numbers don’t tell you enough.
One common example: the PE ratio.
Many investors are obsessed with the PE ratio of stocks.
What is the PE ratio? In simple words, it is the ratio of the price of a stock to the earnings of the company.
If the PE ratio is above a certain limit, they feel it is a bad investment. If it is below a certain limit, it is a good investment.
This ‘limit’ is different for different people.
But this singular obsession with the PE ratio of a stock harms investors more than it benefits.
There are many companies with low PE ratios.
And they are low simply because those companies are performing poorly – nobody wants to invest in them.
No matter how low and attractive their PE ratio looks, they’re bad investments.
Likewise, there are many companies with high PE ratios. That doesn’t mean they are bad investments.
Some very good stocks have had high PE ratios for years.
Another common behavior: some investors buy stocks based solely on their price!
If the price of the stock is below Rs 50 or Rs 10 or Rs x, they invest in it.
Again – wrong assumptions are being made here.
Yet another one: watching the 52-week trend of a stock. If a stock has been climbing for 52 weeks, they’ll buy it.
Flawed logic. It’s the same mistake being repeated.
Mutual fund investors obsess about the beta ratio, AUM, expense ratio – all of these mean nothing on their own.
There are many examples like this.
The point remains.
Investors should focus on the larger story – on what the number actually represents – not only on the numbers in isolation.
