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Do you agree with Buffett's version of Aesop's fable?

May 18, 2012

In this issue:
» Is capitalism on the wane in the US?
» Japanese pension fund buys gold for the first time ever
» No relief from power cuts even in scorching summer
» Should JP Morgan be split into a smaller size?
» ...and more!

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For centuries and centuries, fables by the famous Greek writer Aesop have been the bedtime favourites of many a children. Aesop's fables, you would probably know, are known for their wit and wisdom. For instance, one of the very famous stories is about a hawk and a nightingale wherein the moral of the story goes thus: 'A bird in hand is worth two in the bush.' In simple terms, it means that it is better to have a sure thing instead of gambling for something bigger.

If legendary investor Warren Buffett would have followed Aesop's advice, we would have probably not even known him. For all the enormous wealth that he has created over the last 6 decades as an investor, has been by doing exactly the opposite of what Aesop said. The business of investing is all about letting go of the bird in hand in search of two in the bush. Meaning, one defers consumption in the present and invests money into assets that will give back more money at a later date.

But there are certain caveats that cannot overlooked. If your investment goes for a toss, you not only lose the two in the bush but also the bird that you had in your hand. So what do you do? As Buffett puts it, make sure there are two in the bush, that is, make sure that the pay-off is certain.

That's easier said than done, especially because stocks can be so volatile and unpredictable. So how does one find certainty in pay-offs? Listen carefully to what Buffett has to say about this. The most important thing that an investor must do is find companies with a competitive advantage that have had a history of great earnings and returns. He elaborates his premise with the example of Coca Cola. The company has completed over 125 years. This shows that the company has endured numerous business cycles, two major world wars and all kinds of crises that have conspired during this long period. Will a company that has been successful for so long disappear in the next 10 years? That's highly unlikely. The company operates in about 200 countries and its business has been growing. This means that there is certainty in the business. Moreover, the company has pricing power because of its strong brand value. So, by investing in such solid businesses with a strong past track record you can be almost certain about having two birds from the one that you let go of.

How do you ascertain you have two birds in the bush in place of the one that you set free? Share your views with us or you can also comment on Facebook page / Google+ page.

 Chart of the day
Since August 2011, one of the biggest concerns for the Indian economy has been the rapid decline in the value of the rupee. Moreover, there seems to be no end to this fall. With the rupee now touching an exchange rate of about Rs 54.8 per US dollar, the Indian currency continues to set newer records, albeit, on the lower side. In fact, this is not an anomaly but a long term trend. If you look at the rupee-dollar exchange rates over the past two decades, the rupee has continuously lost value against the dollar. In 1992, you could buy a dollar for just Rs 28.95. The same dollar would now cost you close to Rs 54.8. That means the rupee's value against the dollar has dropped by a strong 47% in the last 20 years.

Source: Rediff.com

One would either love or hate capitalism depending on the kind of experience one has had. As far as we are concerned though, the correct form of capitalism is a boon to mankind. No other system perhaps has done as much to unleash human potential as has capitalism. Now, what if we tell you that capitalism seems to be in a downward spiral? And that too in arguably the most capitalistic land in the world, the USA.

The Economist points out how the number of listed companies in US has fallen by a huge 38% since 1997. What more, the number of IPOs also do not make for a good reading. They have declined from an average of more than 300 per year during 1980-00 to barely 100 in 2001-11! What possibly could be the reason behind this sorry state of affairs? It is a combination of a lot of things. Excess regulation, extremely short term oriented shareholders and the flourishing of other forms of funding like private equity are the major ones we believe.

Make no mistake, the competition to capitalism in the form of other funding avenues is indeed welcome. But capitalism too has to thrive and not decline like it is happening in the US. Without capitalism, most of the inventions of the 19th and 20thcentury wouldn't have seen the light of the day perhaps. It also gives ordinary people a chance to participate in the wealth creation journey of profitable enterprises. Thus, it is time authorities and fund managers stopped strangulating capitalism for their own vested interests. And let it flourish like in the past.

In the simmering heat of summer, all you can ask for is some decent cooling. But even those who can afford it cannot enjoy the privilege! This is thanks to the pitiable state of India's power sector. That apart, even industries need to bear losses due to load shedding. The malaise, it seems, ranges from power producers to distributors to state electricity boards (SEBs).

Data from the Central Electricity Authority reveals that 18% of the country's total generation capacity has been shut down in April. That is almost 35,000 MW of power capacity. Of this, about 25,000 MW has been closed under 'forced outage'. Most of this relates to lack of fuel (coal). Moreover, there is reluctance on the part of state utilities to buy expensive power despite availability. Add to that the lower demand from financially strained SEBs. Coal shortage, funding constraints and distribution losses have therefore plunged several states into darkness. The snail paced reforms that the sector is witnessing is unlikely to bring any remedy soon.

China is now on its way to becoming the biggest source of gold demand. It has surpassed even India's insatiable appetite for the yellow metal. And just recently, Okayama Metal & Machinery became the first Japanese pension fund to make public purchases of gold. So is this a sign of diminishing faith in paper currencies and other asset classes? Well maybe so.

Historically, the US$ 3.4 trillion Japanese pension market has stuck to traditional assets. According to a consultant, Towers Watson, bonds accounted for 59% of industry assets in 2011. This is the highest share in the world. And just 6% was invested in alternatives such as property, private equity and hedge funds, one of the lowest. Now, pension funds warming up to gold can help stoke demand for the metal.

Unlike stocks or bonds, gold may not yield any returns in terms of dividend or interest payments. But, it can act as a buffer against shocks. For Japan the earthquake, global slowdown and prolonged Eurozone crisis shows that it's better to be safe than sorry. Pensioners may soon find their pockets lined with gold.

The Indian government is facing tough situation. It is finding it difficult to bring the fiscal deficit under control. And now the planning commission of India has asked for a huge 132% rise in the gross budgetary support (GBS) for the 12th Five-Year Plan. The GBS is the amount of funds the centre is required to allocate to meet the plan expenditure. The responsibility of distributing GBS among ministries, departments and state governments rests with the Planning Commission. The plan panel has also sought a significantly higher allocation for the food ministry. This would enable it to prepare for implementing the food security law in the next fiscal. It could further inflate the subsidy bill. It has also sought higher allocation for education, tribal affairs and water sectors. However, the Finance Ministry is not willing to agree on such a hefty hike. This is due to their strained financial positions. The government and the planning commission need to find a balance between expenditures and revenues in order to ease the fiscal pressure.

'Scale and diversification' versus 'gigantic and complex'. This is a never ending debate for companies. It is good for them to scale up operations and diversify their businesses as it is taken as a sign of stability. But when does it put a brake on increasing its size? Is there an ideal size that does not let the company go into the category of being too complex? Unfortunately there are no answers to this except for experience. And the bitter experience of sub-prime crisis tells us that gigantic financial institutions can become too complex to regulate. The latest reminder of this is the huge trading loss borne by JP Morgan.

As per Federal policymaker, Mr Bullard, JP Morgan should be split into a smaller size. He states that rather than trying to change regulations as per the complexity of the business, it is best to make the business smaller. Hence making it easier to regulate. We could not agree more with Mr Bullard's view. Higher the complexity in a business, greater the possibility of something going wrong. It is easier to simplify the business structures and run them efficiently. That is the need of the hour. Not more regulations which can be bypassed through complicated structures.

Meanwhile, the Indian stock markets have been trading deep into the red on weakening of rupee and global cues. At the time of writing, BSE Sensex was down by 188 points (1.2%). All sectoral indices were trading in the negative. However, FMCG major Hindustan Unilever Limited was an exception. Asian stock markets too displayed negative sentiments.

 Today's Investing mantra
"At age 19, I read a book [The Intelligent Investor] and what I'm doing today, at age 76, is running things through the same thought process I learned from the book I read at 19." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Do you agree with Buffett's version of Aesop's fable?". Click here!

    3 Responses to "Do you agree with Buffett's version of Aesop's fable?"


    May 21, 2012

    If a company is around for 125 years does not mean it will not fail . Further , shares of such a well known and old company would be fully priced. Where is the margin of safety in this case which Buffet himself advocates



    May 19, 2012

    Buffett is right when he says that 2 birds is better than 1 in the hand but not always right. Take the case of Lehman Bros. It was around for almost the same period like Coca-Cola but then, it fell like a pack of cards in the aftermath of the 2008 financial crisis. So Buffett's belief is not completely foolproof.

    Like (2)

    Anwar Ali Tyeb

    May 18, 2012

    Fully agree, and this 5 minute wrapup is simply put, ''Investment Jargon Made Easy to Understand''and deals with current problems and suggests solution in shuch a simple language that even an i... can understand

    Like (2)
    Equitymaster requests your view! Post a comment on "Do you agree with Buffett's version of Aesop's fable?". Click here!