Is your stock a value investment or a value trap?

May 17, 2010

In this issue:
» Are you buying into a value stock or a value trap?
» Akshaya Tritiya fails to ignite gold demand
» European bailout package not inflationary, ECB President
» FMCG players counting on rain gods for double reprieve
» ...and more!

--------------------- It's time you got greedy about this stock... ---------------------
We've hit upon an investment opportunity in India that can earn you a safe 100% return in the next 3 - 4 years. And we really don't want you to miss out on it.
But you must hurry... this opportunity is available for a few days only. Click here!

About a year back, very few people would have bet against the fact that emerging markets were indeed cheap relative to their growth prospects. But not anymore. Thanks to the huge rally that they have witnessed since the March of 2009 and even after considering the most recent correction, the valuations at most emerging markets have really shot up. Infact, as per some estimates, they seem to be ruling at the same levels as just before the sub prime crisis. This then begs the question of whether a fresh exposure can be taken in these markets.

While we cannot talk about other markets, we certainly feel that investing in Indian stocks even at the current levels can prove to be profitable provided one takes a long term view of 3-5 years. However, we would like to caution about the fact that most of the low hanging fruits have already been picked up and hence, investors should seriously guard against the fact that the stock that they buy into does not turn out to be some sort of a value trap. In other words, there are strong chances that an investor buys into a cheap stock that remains forever cheap! While this is true across market cycles, the tendency to commit such a mistake is at its highest during the peak of a bull run. And we believe that the present scenario is one such scenario. Thus, we advice investors to be that much more cautious during stock picking.

 Chart of the day
Today's chart of the day highlights the rebalancing act that the banks of the developed world are trying to undertake. It should be noted that in the year 2009, banks in the developed world gave out in loans, a whopping US$ 2 trillion more than what they received in the form of deposits. Needless to say, they filled this gap up with capital market borrowings. The developing world on the other hand, has deposits in excess of the loans that they have made. While this is certainly pointing towards the soundness of the banking system of the emerging markets, it could also be due to the under penetration of credit, a reality at least in India. It would certainly be interesting to see how this ratio shapes up a few years from now when credit penetration in the country would have gone up to pretty significant levels.

Source: The Economist

Akshaya Tritiya dawned this Sunday but this auspicious day did not find too many takers for gold. What seems to have deterred buyers from making a beeline for this precious metal are considerably high prices. The current price of 22-carat gold is Rs 17,500 per 10 grams. Stockmarket fluctuations of late also appear to have dampened the demand for gold on that day. Ever since the global credit crisis erupted, gold has been steadily moving northwards. The reason? With governments resorting to printing paper currency at the drop of a hat, gold has emerged as a natural hedge against inflation and a safe haven in the backdrop of uncertainty in the global markets. At the same time, prices have reached such a high that buyers do not seem too enthused in buying this metal. They are waiting for a correction. But whether that happens anytime soon is anybody's guess.

A 'sound fiscal situation' is something that central banks globally are eyeing. But we wonder if pumping in trillions to resolve a fiscal crisis is the ideal means to do this. Economists globally are condemning ECB's decision to pump in a trillion dollars to salvage Greece's sovereign rating. However, the chief of the central bank thinks otherwise. Jean-Claude Trichet, the chief of ECB has dismissed fears that the funds may stoke inflation in the European economies. He also believes that fiscal tightening will in no way hurt the economies' growth prospects. The central banker on the contrary seems pretty optimistic about European governments disciplining their fiscal status. He also called for mutual supervision amongst governments. We wonder why such learned minds come up with such noble thoughts only when they face crises.

You may be keenly awaiting the rains to beat the heat. But India's FMCG companies are looking skywards for an entirely different reason. And perhaps with much more vigour than you. This is because it is the rain gods that have the power to make or break the fortunes of these companies during any given year. If the monsoons are not normal again this time, FMCG companies will suffer a double whammy. For one, it will put less money in the hands of the India's vast and agriculture reliant rural populace. That means demand will take a hit.

Further, it will also mean a spike in agri-based raw materials for these companies. And with their ability to pass on these higher costs to customers having come under question, it will surely be a tricky state of affairs to handle. As per a recent report, these companies are currently reluctant to guard margins by fresh grammage reductions. This is despite the fact that raw material prices have been rising and margins are under pressure. The only assurance to them now will be a normal monsoon, which they are counting on to drive raw material prices lower.

If the goings on in the past few weeks is any indication, Mr. Pranab Mukherjee, the country's finance minister, should be one happy man. In all likelihood, the country's tax payers are likely to earn a potential windfall from the ongoing 3G auctions in the Indian telecom industry. Infact, by the time the whole affair wraps up, the taxpayers would be richer by some Rs 700 bn. And this may not be all. What with the divestment program once again receiving a shot in the arm, the likelihood of the Government earning another Rs 400 bn from the same has become stronger than ever. Thus, with Rs 1.1 trillion almost certain to be in the bag, the country's dilapidated finances do have a very good chance of getting back on their feet.

However, this is easier said than done. The government's track record in spending such one off non-tax revenues does not inspire a lot of confidence. The big money will bring in demands from various ministries to go slow on certain reforms like the fuel price deregulation and fertilizer subsidies. And don't be surprised if the Government is all too willing to oblige. Let us just hope that better sense prevails this time around. After all, they don't have to look beyond their European counterparts to gauge the consequences of keeping on kicking the can down the road.

How the mighty fall, and along with it their reputation. Once regarded as the home of the best and the brightest, everyone now blames Wall Street for their miseries. Even if that 'someone' is debt-laden Greece. That's right, Greece's Prime Minister George Papandreou does not rule out suing US investment banks. That is, if their investigation into the cause of their debt crisis leads the trail to Wall Street. If they find evidence of fraud or the lack of transparency, Greece will consider legal action. In our view, it won't be a surprise if we find the names of some famous investment banks, alive or extinct, cropping up in investigations. The influence of the US investment banks reached far and wide during their heydays. This is not to say that Greece is without fault. Not at all. But it does make us wonder how deep rooted the malaise of 'complex finance' emerging for Wall Street had become.

Meanwhile, the Indian stock market continued to witness selling pressure in today's trade with the BSE Sensex trading lower by around 280 points at the time of writing. Heavyweights like Reliance and Infosys were contributing the most to the weakness. Infact, almost all of Asia closed in the red today and Europe too has opened on a negative note.

 Today's investing mantra
"Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere." - Warren Buffett

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Is your stock a value investment or a value trap?". Click here!

1 Responses to "Is your stock a value investment or a value trap?"


May 17, 2010

Very good advice vis-a-vis buying blue chip shares.

Equitymaster requests your view! Post a comment on "Is your stock a value investment or a value trap?". Click here!