Investing in India - 5 Minute WrapUp by Equitymaster
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Lessons from the blunders of India's largest conglomerate 

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In this issue:
» Markets set to deliver best year since 2009
» June quarter GDP may not be a signal of a revival
» What Modi should not learn from Japan!
» When it comes to Gold don't listen to economists ...
» ....and more


00:00
 
The Indian equity markets are on a dream run. Every week seems to bring with it a new life-high for the benchmark indices. Mid and small cap stocks too are flying. Brokers are enticing investors with claims of ridiculously high Sensex levels. The stock prices of a large number of companies with poor fundamentals have more than doubled in this rally. Are you tempted to enter the markets at these levels? If yes, then which stocks should you buy?

We believe there is a common link to the answers of both these questions. It goes without saying that investors should buy stocks of only fundamentally sound companies. However, this is not the only important aspect of it. Just two days ago, in the 5 Minute WrapUp, we highlighted the need for investors to pay close attention to the valuations before entering the markets. As legendary investor Warren Buffett's guru, Benjamin Graham famously said; "Price is what you pay. Value is what you get" . To put it simply, if you overpay when investing in even the best businesses, you might have to wait a long time for the value of that business to catch up with the price. Investing in stocks which are trading at expensive valuations also brings with it another risk. These stocks usually trade at such levels, due to high expectations of future growth. If anything at all were to happen to derail the growth story, the stock could go into a free fall.

This is not a vague theory. It is a proven fundamental principle of investing. It applies to investments made by company managements as well. As a leading financial daily has pointed out, the new Tata group chairman has written down overseas investments to the tune of US$ 2.2 bn, made during the tenure of his predecessor. These were marquee investments that had captured the imagination of the country. Corus (by Tata Steel), JLR & Hispano Motors (by Tata Motors), Orient Express (by Indian Hotels), Brunner Mond (by Tata Chemicals) were all investments made by the group during the good times in the last decade. Most of these came at a high price. Years later, the group had to accept reality and write down many of these investments. For investors in these stocks, the reality was quite painful indeed.

We believe there is a good lesson to be learnt here. No matter how good the fundamentals or growth prospects might be, investing should always be done keeping in mind a sufficient 'margin of safety'. This is true for individual investors as well as company managements. The margin of safety concept can help protect against the downside risk to your investments. This is especially true in times like these, when the markets are scaling new peaks. However, your broker would probably not tell you this. Instead, he might recommend jumping on the bandwagon and enter stocks trading at high valuations. We caution investors against such an approach. Not because it might not work but because it will expose investors to unnecessary risk. At Equitymaster, we practice a far safer way of investing. Our ValuePro portfolio recommendation service, for example, incorporates the 'margin of safety' principle into the stock selection process. For investors who might not have benefited from this service and would like to invest their money with a margin of safety, we recommend that you join ValuePro now.

Do you incorporate a 'margin of safety' in your investments? Let us know in the Equitymaster Club or share your comments below.

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02:10  Chart of the day
 
What has been driving markets the past few months? Well... a bunch of factors. One of which includes a favourable outcome of the general elections; a result of which all concerns over political instability disappeared. Then, we have the liquidity factor. Cheap money across the world is finding its way to riskier markets. Thirdly, the improving sentiments are expected to kick start the economy in terms of investments as well as increase in outputs, which eventually are expected to trickle down to companies in the form of higher earnings. Not mention the fact that the favourable economic indicators such as lower oil prices and its favourable effect on the deficits of the country. Today's chart of the day show cases the yearly returns of the Sensex. And it seems that the market performance in the year till date has been very strong, the highest level since 2009.

With broader valuations hovering above the long term averages, it should make investors quite jittery about entering the markets at current times. However, from what it seems that is not particularly the case. This we say because the net investments by domestic institutional investors have turned positive - first time since February this year - in the month of August. This is a sign that retail investors are re-entering the markets. Whether they have got their timing wrong is difficult to comment on at the moment. But going by history, returns from investing in times of above average valuations have been much less than compared to investing in periods of uncertainty.

How much will 2014 benefit investors?

02:40
 
That both the RBI and the government's statistical data have started showing signs of 'green shoots' in the economy were a relief. In fact the Indian stock markets have almost factored in a GDP growth higher than the projected 5.7% for this fiscal. However, the government's economical statistics are notorious for inaccuracy. And if an article in Livemint is to be believed, there is enough reason to be skeptical this time too! The expenditure side numbers of GDP remain dodgy as ever. In addition, the macro numbers do not seem to match up with numbers at the micro level. Take, for instance, the gross fixed capital formation (GFCF) figures, which is the indication of investment in infrastructure. In June 2014, GFCF grew 11.2%, well over the 2.9% growth seen in 1QFY14. However, as per Mint, the revenues of 166 listed capital goods firms didn't show such a dramatic increase. At a tepid growth rate of 3.4% in the June quarter, they were a reminder of the fact that GDP growth is sometime away. Investors would there do well to not buy too much into the green shoots theory. Instead buying stocks with sufficient margin of safety is something that is more advisable.

03:25
 
The camaraderie between Modi and Shinzo Abe is well known. Hence, when our PM was about to begin his maiden trip to Japan expectations were sky high. Japan being a technologically advanced country we had a lot to learn from it on issues pertaining to trade, investment, energy and defense.

However, as an article in Livemint highlights there are also some areas where we should be careful in not emulating the Japanese. We know that Japan emerged strongly after World War 2. However, it never went on to become a super power for a couple of reasons. For one, Japan's relations with its neighbors were bitter. Another thing which went against Japan is that it preferred to be a follower than a leader. It chose to follow rules rather than create them. Hence, Japan never achieved super power status. We believe therein lies an important lesson for India.

Willingness & execution capability can win you votes. But it shall not give you a power house status. Political vision and diplomacy are crucial for that. And we believe that the current government has that. As an example, the new government did not buck down under the pressure from WTO and signed the treaty which it deemed to be inappropriate. Also, we have seen the PM's willingness to ensure cordial relations with its neighbors. His trips to the neighboring countries are a testament to that fact. As such, it appears India has learnt its lessons well beforehand.

04:05
 
With its first quarterly loss this year, is gold once again falling out of favour? The yellow metal has fallen around 2.6% since June as per reports and further declines cannot be ruled out. The reason? Well, it seems many economists are convinced that we have moved to an era of sustainable growth. And in such an environment, gold is not very attractive. Besides, with the news of US Federal Reserve keen to hike rates fast gaining ground, gold may also lose its luster as an inflation hedge.

We are not quite convinced though. Yes, the yellow metal does act as an inflation hedge. But what about the trillions of dollar of paper money that has been pushed through the system in the name of quantitative easing? Has it not devalued money and set the global economy up for a huge catastrophe if it is not taken back? And if it is indeed allowed to stay in the system then it will certainly give rise to inflation sooner than later. Therefore, in such times, one should definitely cling on to the yellow metal and not read too much into what the mainstream economists say. They don't have any great track record in calling crises correctly and usually wake up late.

04:40
 
The Indian stock markets continued to trade firm in the post noon trading session. At the time of writing, the BSE-Sensex was trading up by 196 points (0.7%). All the sectoral indices, barring FMCG, were trading in the green. Capital goods and power stocks were the major gainers today. Most of the Asian markets were trading in the green with China and Taiwan being the major gainers. European markets have opened the day on a mixed note.

04:55  Today's investing mantra
"Only when the tide goes out do you discover who's been swimming naked." - Warren Buffett
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