Investing in India - 5 Minute WrapUp by Equitymaster
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Are cheapest stocks also the best performing stocks? 

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In this issue:
» Are lower oil prices a symptom or a balm?
» China misses its official growth target
» What Nouriel Roubini has to say about the US...
» Extra taxes by MNCs have risen over the years
» ...and more!


00:00
 
We live in a world where the access to information has grown by leaps and bounds. Just as opinions abound on the best possible stocks out there, so too the number of stock picking strategies followed by various value investing practitioners. The question is which of these should one follow while picking stocks? Those that take into account a variety of parameters? Or those that follow a much simpler approach?

A value investing blog called Alpha Architect decided to put various stock picking strategies to the test. The idea was to find out which of these strategies delivered the best returns over 50 years. In other words, if one were to invest Rs 100 in each of these strategies over 50 years, which strategy would come out on top? To determine this, a total of around 13 techniques were considered. These included both simple strategies and some complex models.

You could know about each of these strategies in detail by clicking here.

The results were quite interesting. The strategy that generated the highest compounded returns was the Piotroski Score. Essentially this approach involves choosing stock based on 9 signals. Of these, 4 are based on profitability, 3 are based on changes in financial leverage and liquidity and 2 are based on operational efficiency.

Interestingly, the parameter that scored second was a 'simple model based on the lowest enterprise value (EV) to EBITDA multiple. But the important thing to note here is that the returns generated from both these stock picking strategies were neck and neck with not much to choose between the two.

Most of the other complex models failed to even match up to the compounded returns of the S&P 500 during the period. The table below gives a perspective on this.

  Final corpus CAGR
Piotroski High F-Score (FSCORE) 229,607 16.7%
Simple model based on lowest EV multiple 208,941 16.5%
Magic Formula (MF). 109,312 15.0%
Price to Free Cash Flow (PFCF) 102,854 14.9%
Graham Defensive Non-Utility (GR_D_NU) 95,098 14.7%
Earnings yield + Div yield + retained earnings to book value 40,528 12.8%
Graham Enterprising Investor Revised (GR_E_I) 36,432 12.5%
Dogs of the Dow 10 (DOW 10). 24,825 11.7%
Dogs of the Dow 5 (DOW 5). 17,564 10.9%
Graham Defensive Utility (GR_D_U) 16,789 10.8%
Blue Chip Dividend Yield (WEISS). 16,714 10.8%
Graham Enterprising Screen (GR_ES) 12,397 10.1%
Cash Rich Firms (CRF) 8,038 9.2%

Worth adding that a portfolio comprising of the S&P 500 stocks would have returned a CAGR of 12.8% during the same period.

So what does this tell us? Complex methodologies that requires a lot of input does not necessarily add significant value while picking stocks. A simple approach of buying stocks trading at very cheap multiples also works equally well. This combined with some basic fundamental analysis (such as healthy business model and management quality is bound to ensure that your money is invested in quality stocks that will generate shareholder wealth in the longer term.

What stock picking strategy works best for you? Do you prefer complex models or do you follow a simple approach? Let us know your comments or share your views in the Equitymaster Club.

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02:01
 
'Both symptom and balm', screams the headline of an article in The Economist. The indication is indeed towards the tumbling prices of crude oil. People are confused as to what to make of it. Is the lower crude price a sign that global economy is slowing down? Or is it just the kicker that was needed to take economic growth to a higher level? Well, in order to get a satisfactory answer to this question, it will have to be analyzed whether the problem is demand side or supply side? As the article highlights, both a feeble demand as well as a supply shock is responsible for the current state of affairs.

In fact, it is more because of the latter than former. First up, the increase in shale oil output in the US is really sending shivers down the spine of OPEC oil producers. Secondly, production has not taken a back seat even within the OPEC what with countries like Libya pumping up the volumes to pre-war levels. Besides, with Saudi Arabia unwilling to shoulder the burden of oil cuts alone, it doesn't look like supply is going to go down much in the near future. This is indeed music to the ears of oil importing countries like India. The excess money saved can now be diverted towards more productive use like building infrastructure or can even be used to increase consumption in other areas.

02:46
 
It was not too long ago when India posted the slowest GDP growth in a decade. It seems that the economy that everyone relied on to pull up global growth rate is also faltering. China has missed its official growth target for the first time in 15 years! At 7.3% the GDP growth rate is not something to be ashamed about. Especially when the Western economies are yet to achieve half of that. However, for the Chinese policy makers, this is clearly under performance. Having said that, they are willing to 'tolerate' growth slightly below target as long as the economy is reshaped. The desire is to ensure the economy is driven more by domestic consumption and less by exports and investment. Further the worries about asset bubbles in China have got the authorities worried. Now, whether China will unleash more stimulus measures to stoke growth is not known. However, what is a given is that it will be sometime before China gets back to being the growth juggernaut it once was.

03:13
 
China is not the only one. The situation does not look that great for the US either. At least according to Nouriel Roubini. He is the economist who shot to instant fame for successfully predicting the onset of sub-prime mortgage crisis in the US. And now he has another prediction up his sleeve. While this time his prediction is not as frightening or unbelievable, it nonetheless indicates a grim situation for the US. Many have predicted a strong revival in US' economic growth. However, Roubini believes global slowdown could play the biggest spoiler. For instance, Eurozone faces deflationary scenario while both the Asian dragons namely China and Japan have their tail between their legs. Downturn in these economies can have a spillover effect and hurt the US. Strengthening of the US dollar is not helping either. It shall make exports expensive and hurt trade deficit.

In short, Roubini reckons the recovery in the US could be illusionary and take longer than expected. We cannot agree more. The US economy is in deep trouble. And while green shots are visible now confirming recovery is on track we reckon it is a bit too early to believe that Fed would react to it by raising rates. If the global situation worsens, the US could suffer more and Fed's rate hike plans may get postponed.

03:44  Chart of the day
 
With a slew of high profile cases in the past relating to income tax authorities targeting MNCs with tax bills, it seems that the global companies are now making efforts to curb the unexpectedness of such bills; all this to avoid future surprises. As per the WSJ, global companies are now believed to be negotiating with authorities to clarify ahead of time what they will owe in the future.

As can be seen from today's chart of the day, MNCs tax demand from the income tax authorities have risen in recent years. This has been largely due to additional taxes being a result of how multinational companies have been recording transfer pricing - the price at which companies within a group transact, but outside the country.

As we have stated in the past, there is nothing wrong in the concept of transfer pricing. After all, what is earned in India should certainly be subject to Indian taxes. However, when matters are taken too far, it would only hinder the foreign investment climate in the country, something which is definitely against the 'Make in India' efforts.

Extra taxes that MNCs had to dole out...


04:45
 
In the meanwhile, the Indian stock markets firmed up in the post noon trading session. At the time of writing, BSE-Sensex was trading higher by 128 points (0.5%). Barring oil and gas and pharma stocks, all the sectoral indices were trading in the green. Stocks from consumer durables and power were among the leading gainers. Majority of the Asian stock markets were trading in the red with Japan and China being the major losers. However, European markets have opened the day on a mixed note.

04:56  Today's investing mantra
"The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs" - Warren Buffett
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