The idea that can get you your next multi-bagger

May 7, 2014

In this issue:
» Will Indian Financial Code ever see light of the day?
» Rs 1 trillion locked in realty sector. Is there a way out?
» PSU banks write off Rs 2 trillion in decade!
» Jim Rogers senses the next big opportunity in agriculture
» ...and more!

Berkshire Hathaway AGM, an event that is touted as a value investing refresher course for many money managers saw its another instalment draw to a close recently. This year, more than 30,000 investors descended upon Omaha, Buffett's hometown and benefited from the investing insights of the legendary duo Warren Buffett and Charlie Munger.

While there were host of issues discussed, ranging from Coke's compensation plan to succession planning, it was Charlie Munger who opened the proverbial Pandora's Box according to us. He revealed the secret of Berkshire's success in a way that only he can.

While the secret may sound oft-repeated, it contains a very valuable lesson we believe. The story of how it struck to them that they should pay up for quality businesses is really interesting. Let's go through it.

Berkshire bought See's Candy, a boxed chocolate manufacturer, in 1972. See's Candy was a big brand with a great pricing power then. But the question was whether the current valuations incorporated the untapped pricing power. In other words, do valuations account for the future price increases which See's Candy could do with ease. At 10x P/E, the multiple they paid for buying See's Candy, the call was judgmental.

While the duo ultimately went ahead and bought the stock, Munger later admitted that they weren't smart enough to buy it. In fact, Warren Buffett even went ahead and candidly admitted that he would have definitely let it go at 10x.

However, as luck would have it, they bought it and made a bounty. But as intelligent investors, they took home a very important lesson from this purchase. It pertains to the value of strong brand names and valuations they can command. See's Candy's brand value compensated many times over for what may have been an expensive purchase in this case.

Taking this learning forward, the duo bought Coke in 1980's. Without See's purchase they would have never bought Coke, a similar marginally expensive strong brand play. And without Coke, Berkshire Hathaway wouldn't have been what it is today.

This brings to the fore a very important lesson for investors. And the lesson is that a well known brand can command tremendous value. It is because brand gives birth to a positive image in the minds of the users. And once embedded, it becomes very difficult to erase that image. Hence, paying a marginal premium for brands is fair.

However, Buffett and Munger didn't come equipped with this knowledge. They learned this lesson through the help of a sheer stroke of luck. But once they became aware of the tremendous value creating qualities of a powerful brand, they capitalized on it like no investors we know of. This goes to show that it doesn't matter where insights come from. One should always keep looking for them and it is that one powerful insight that can bring about a dramatic change in fortunes. As Munger said of their See's purchase, if there was any secret they learned, it was how their ignorance about brands was removed. And this is the approach that all of us should take, isn't it? It's not just about how much money we make from a stock but also about any ignorance that the investment helped remove or a great insight that it gave us.

Do you read Buffett's annual letters or have you ever attended Berkshire's AGM? If yes, what is your biggest learning till date? Let us know in the Equitymaster Club or share your comments below.

Editors Note: There's more to getting wealthy than investing in stocks... to learn American wealth coach & Daily Reckoning contributor Mark Ford's wealth building strategies check out his 11 Secrets to Building Wealth (free access).

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 Chart of the day
The glory days of the Indian IT sector seem to be over. There was a time when 30% growth rates for IT companies were considered 'normal'. These days however, an annual revenue growth of 15% (in US dollar terms) is considered excellent. This is because the software industry in India has reached a stage of maturity. High growth rates from large IT firms cannot be expected anymore. A few of the smaller firms will surely grow faster than the average but for the sector as a whole the growth is clearly slowing down. From nearly 20% YoY growth in FY11, the sector is expected to grow its revenues by just about 10% in FY14.

The sector faces challenges other than growth too. Apart from a volatile currency, staff costs have already had a negative effect on margins. Add to this, new digital technologies have made the job of retaining clients more difficult. We believe that investors, before investing in any IT stock, should be aware of these risks that affect all IT firms, in addition to the company specific ones.

Can IT industry revenues continue to expand?

Everyone's of course waiting with bated breath to know who the country chooses to be the next Prime Minister of India. However, a hard hitting article on has set its sights elsewhere. On the chair of Finance Minister to be precise. It is hoping that the person in charge of India's finances sets the ball rolling on one of the most important financial reforms of all time. We are indeed referring to the Indian Financial Code (IFC). Well, the IFC is nothing but a blueprint that attempts to make India possibly the first country in the world to turn consumer protection in finance into law. Its implementation is much easier said than done though. Simply because the IFC proposes a near total overhaul of India's financial system. And puts the consumers right at the heart of it.

This is in stark contrast to the current regulations where the consumer is offered hardly any protection at all and is routinely fleeced under one pretext or another. Interested in knowing the magnitude of this loot? Well, the article puts the amount at a staggering Rs 20 trillion. Yes, this is the amount of money where the unsuspecting small investor earns a below par return. A return so low that it does not even afford him protection from inflation. And implementing IFC would put a substantial sum of this money out of reach of entities guilty of this crime. Little wonder then that powerful corporations and the Government itself will lobby hard to not make the IFC see the light of the day.

Problems relating to bad loans continue to haunt the banking sector in India. As per a list drawn up by the All India Bank Employees Association, the top 400 loan defaulters collectively owe over Rs 700 bn to banks as of March 31, 2013. Not just that, as per an article in Firstbiz, fresh bad loans amounted to Rs 4.95 lakh crore in the last 7 years. But the most telling aspect is that public sector banks have borne the worst of the brunt of bad loans. This is because these banks wrote off bad loans worth Rs 2.04 lakh crore in the past 13 years. Banks, in the meanwhile, have become a bit cautious and are wary of lending to companies whose financials do not look too enticing. The real estate sector is one such case in point. They are also looking to implement a more effective recovery law and the release of the list of the country's top defaulters is one such step towards that. As far as PSU banks in particular are concerned, the deterioration in the quality of their assets has been a constant cause of worry for the RBI. A systemic NPA crisis in PSU banks threatens to risk the entire financial sector in India. That is why it is imperative that not only should their asset slippage be curtailed but also the PSU banks overall need to be better managed.

Jim Rogers, the legendary investor, has always been a strong advocate of agriculture. In fact, he has gone to the extent of advising students to pursue a degree in agriculture rather than wasting time doing an MBA! In an article in; he has given his latest view on commodities market. He expects correction in gold and feels that stock markets may be over priced currently. As expected, he has reiterated his faith in agriculture industry. He believes that growth in agriculture will come at the cost of a possible war between Russia and Ukraine. Both Russia and Ukraine are huge commodity producers and therefore a likely disruption in production will lead to increase in price of agriculture produce. Also, the fact that inventories of agriculture products are near historic lows will encourage fresh investments in the sector. Thus, agriculture can prove to be one of the best investments over the next few decades.

We conform to Jim Rogers' view but at the same time believe that prices of agriculture produce will have to go much higher to attract enough labor and capital. Having said that, agriculture is a necessary evil and spurt in demand due to supply constraints is likely to open new doors for the industry. So how does an investor benefit from growth in agriculture? The financial markets in agriculture producing countries such as India are often aligned with performance of agriculture sector. Therefore, investors can increase exposure to equities particularly farm producing, farm equipment or fertilizer companies.

India's real estate market has been faltering for quite some time as the country's economy has remained under stress. But, now hopes are pinned on the new government. Various real estate stakeholders viz., stakeholders builders, investors, financial institutions, and private equity players are now hoping for improvement in this sector. An article in Mint states that, US$ 16 bn of the PE funds have got locked in hundreds of real estate projects. Not only that, the sector needs an infusion of another US$ 1 bn for completion of these projects. As this sector lacks regulations, even banks have shown less interest in investing in realty projects. Thus, large parts of the projects are now financed through PE players who charge phenomenal interest rates which increase the project costs. These instances have impacted the investors' wealth and thus they are now struggling to take an exit.

This sorry state of affairs in the Indian real estate calls for solid regulations in place. For the real estate sector to revive, the government should seek to streamline the processes. Only a structural change can attract serious, long-term capital. Having said that, one should also note that this is not going to be an overnight task. It will take some time for the government to improve the policy and guidelines which are in the best interest of all the real estate stakeholders.

In the meanwhile, the Indian stock markets continued to slip in the red. At the time of writing, the benchmark BSE-Sensex was down by 116 points (-0.5%). Majority of the sectoral indices were trading up led by consumer durable and power stocks. Only IT and metal stocks were trading weak. Majority of the Asian stock markets are trading negative with Japan and Hong Kong being the biggest losers. European markets also opened the day on a weak note.

 Today's investing mantra
" In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497 " - Warren Buffett

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1 Responses to "The idea that can get you your next multi-bagger"

Archie Sequeira

May 8, 2014

Your 5-min wrap-ups are very informative, generally incisive and timely. Well done. Keep up the good work.

You seem to have a bias towards gold though.

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