What is the Lollapalooza Effect?

April 19, 2021

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Strategic Alpha

There are many extreme events in the world. These events can be explained with the help of the Lollapalooza outcome. Everyone defines the Lollapalooza effect differently. Charlie Munger, a renowned American investor, defines the Lollapalooza effect as ‘The most important thing to keep in mind is the idea that especially big forces often come out of these one hundred models. When several models combine, you get lollapalooza effects; this is when two, three, or four forces are all operating in the same direction.’ Charlie Munger’s definition of the Lollapalooza effect is different from the textbook definition of the Lollapalooza effect.

Definition of Lollapalooza, as per the book charlie Munger’s Almanak

Lollapalooza is, as personified by Charles Munger, the critical mass obtained via a combination of concentration, curiosity, perseverance, and self-criticism, applied through a prism of multidisciplinary mental models.

In simple words, Lollapalooza Effect is a bigger outcome achieved even though the inputs are not proportional but simultaneous. This happens when many things come together to create a critical mass to create 1+1=11 instead of 1+1=2.

Without going too much into the definitions, let us understand the Lollapalooza effect with certain examples.

There are both positive and negative effects to Lollapalooza’s outcome. Also, there are a number of biases at play. One aspect of the Lollapalooza effect is that people tend to imitate those people who are around them. Let’s take the case of a team. If someone joins a high-performance team as a part of a workplace, he may imitate other team members who are high performing and his performance will also improve. The same effect works in a low-performing team though in a negative way. New people who have joined the team tend to replicate the negative performance of other team members too leading to lower performance. 

The 2008 financial crisis is another example of the Lollapalooza effect. What happened during the 2008 crisis? Under the mortgage crisis, everyone had the incentive to give newer loans without understanding the risks. This is because the risk of these loans was not borne by them as these loans were then sold off to other people. This led to a huge bubble in the housing loan market.  When the bubble burst, the S & P Index crashed by around 50% of its value. 

Whenever there is an auction situation, the behavior of those who participate in it also creates a Lollapalooza effect. A person places a certain bid. There are many other people participating in the auction who tend to imitate the bids of others. Hence, they place higher bids. The tendency to pay higher bids continues. Ultimately, the person who places the highest bid wins the auction. More often than not, the entity that wins the auction ends up overpaying for the asset. There have been many examples of companies acquiring other companies by overpaying. In many cases, since companies don’t have adequate funds, these acquisitions are funded by debt. The twin problems of overpaying for an asset and leverage create a Lollapalooza outcome. Such leveraged entities may take years to recover from this mistake. In some cases, these firms even end up in bankruptcy.

There are a lot of factors that come together to create a good macroeconomic environment leading to a bull market for a number of years. The Sensex rose from around 3000 in 2003 to more than 20000 in December 2007. This translates into absolute returns of more than 550% during this period. What were the factors that led to such a humongous rise in Sensex? Good economic growth, real estate boom, rising corporate earnings were some of the positive factors that led to such a humongous rise in Sensex. But, the boom also had seeds of the bust. For instance, the highly leveraged Balance Sheets of real estate companies played a role in causing the bubble to burst.

Now, let us look at the lollapalooza Effect With Respect to Blog Stocks- SAIL
If you read my SAIL Blog, I have been writing about it for a long time. Many things were acting good for the company but markets were not able to see that from the past 2 years. The stock was Beaten down for long long years, even after positives like, increase in employee efficiency of the company and many other factors discussed in the blog. It was waiting for some triggers for years to go up. But just after May 2020, Many factors began to play out with SAIL. Lockdowns, leading to supply shortage, Prices of Commodities started going up. The company has already reduced the employee cost from 25% of the sales a few years back to around 12% of sales in 2020, which was resulting in savings. This company had a capacity utilization of 60% so it had room for producing more than other players who are working at the cutthroat. This company had that opportunity to sell more. China started importing Steel suddenly after a decade, it became a net importer of steel. So the Pricing scenario improved and all these factors coming to play simultaneously helped SAIL turn the corner and it posted the highest Qtrly profits in Dec Qtr compared to the past many many years. These triggers led to value unlocking for SAIL, the stock which was deeply undervalued. This lollapalooza effect led the stock price to create a big momentum and the price moved from 35 to 90 in just the past 6 months.

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The author of the blog Mr.Suyog Dhavan is a Full-time Investor / Value Trader and Value investing/Trading Mentor. His style of Investing is inspired by Mohnish Pabrai, Peter Lynch, and Porinju Veliath. He is the founder of Strategic Alpha Wealth, A Premier stock market mentorship firm with a mission to touch the lives of 1Lakh people through its mentorship program.

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