The one question that every investor must ask... - The 5 Minute WrapUp by Equitymaster
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The one question that every investor must ask...

May 27, 2011

In this issue:
» India's food subsidy gap is spiralling
» Indian rupee still dances to FII tunes
» Climate change will intensify food crisis
» US headed towards another financial meltdown?
» ...and more!
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00:00
 
A little known billionaire investor named Mr Mark Howards has a very simple advice. Ask this one question before you invest in a stock: Is it cheap? This may sound funny to you. But that is the problem with all great advice. Simple things are very difficult to follow.

To elaborate a bit, the problem is that most investors are obsessed with the upside. Moreover, with blue chip stocks, the valuations are often overlooked. In our greed, we blind ourselves with illusions of optimism. But while doing so, we recklessly undermine the several risks that may put our investments in jeopardy.

The next question is: Do you fully reckon what risks you are undertaking when you invest? In Mr Howards' own words, "Nothing is more risky than a widespread belief that there's no risk." This is very true, especially, if seen in the context of the problems brewing in the Indian economy right now. Had we thought well enough about the consequences of rising commodity and food prices, high interest rates, governance failures, etc?

The best place to look for probable risks is the past. Look at the past economic crises. You will definitely learn a lot about economics and business. More than that, you will learn about the follies of the mass mind. If history is to be believed, most of us are bad students. The way bubbles form and eventually bust clearly shows that the collective mind of the masses has a short term memory. It forgets quickly the consequences of excess greed and fear.

Stay away from all the noise and the hoopla! Visit the stocks markets like you visit a shopping store and not a carnival. Look at the products and their price tags. And think about what could probably go wrong with them. Exactly the way you buy a washing machine.

Do you evaluate the risks well before investing in stocks? Share your comments with us or post your views on our facebook page.

01:07
 Chart of the day
 
We already know well enough about the poor state of our public-distribution system (PDS). The World Bank had recently even warned that 60% of our massive food subsidies do not reach the poor at all. Here is another shocker about some serious financial mismanagement by the Indian government. Today's chart of the day shows the difference in cost incurred by the Food Corporation of India (FCI) and the subsidy received from the government. To put it in simple words, the amounts mentioned in the chart indicate the difference between the real and official food subsidy bill of the government. In the last 6 years, the government's food subsidy defaults have risen by a staggering 800%. It is important to note that the government is planning to introduce the Food Security Act in the monsoon parliament session. This law, which promises cheap food to the poor, will further cause our food subsidy bills to skyrocket.

Data source: Ministry for Food and Public Distribution
(*Provisional; **Estimate)

01:43
 
That Indian stock markets swing to the tunes of FIIs is indeed common knowledge. What is relatively less known but equally important is the fact that even the Indian currency is heavily influenced by what the FIIs do. Take the case of what happened in 2008. An outflow of US$ 13 bn led to the rupee falling by as much as 30%! And there is really no way of suggesting that a similar outflow this time around would not lead to the same fate. The only way out of this quagmire perhaps is to attract more of the 'long term' money as opposed to the overreliance on 'hot money' like say the FII inflows.

But the story is hardly inspiring on this front. FDI into India -the long term money that we referred to - actually decreased in 2010, giving us the ignominy of being the only nation amongst the BRIC to have met such a fate. And with scams and corruption scandals galore, India's reputation as an investment friendly destination is only taking a turn for the worse. Clearly, maintaining confidence in the rupee is yet another in a long list of serious hurdles the Government will have to overcome to keep the India growth story going.

02:17
 
The RBI's aversion to allowing foreign banks too much leeway in India is well understood. The last time the central bank drew up a roadmap for welcoming foreign entities, the global subprime crisis struck. After that there was very little reason for the RBI to encourage foreign banking entities with high risk appetite to make foray into India. The foreign entities have been getting licenses to open 12 branches a year. With this, their growth in the retail space has been so slow that ones like Standard Chartered have only 94 branches in the country. That too with operations of over half a century in the country! Hence the request for faster growth of franchise is also understandable. However, the RBI seems willing to welcome the foreign banking entities this time only if they commit larger doses of capital. They need to turn their local operations into wholly owned subsidiaries of the parent company. It also means the Indian subsidiaries would be required to have their own capital, and cannot tap their parents' balance sheets. With such self-reliance, the foreign banking entities would certainly become safer bets we believe. Once again we commend the RBI for its foresightedness.

02:58
 
The food shortage in India and the consequent rise in prices have so far been blamed on poor monsoons and inadequate storage facilities. But food shortage could now be a more serious problem globally and could have serious repercussions on India as well.

The World Meteorological Organisation is of the view that global food output may be hurt going forward as climate change brings more extreme weather over the next decade. In fact, extreme events are expected to intensify in the future and this combined with less rainfall in some regions will hamper crop production and agriculture. Not just that, population and incomes have been rising. This will put that much more pressure on land and water posing a big threat to food security.

Already, food prices reached a record high in February and pushed millions into poverty. One solution is to focus on agricultural research which would involve adapting farming to climate change. Whatever be the case, some strong measures will have to be taken to remedy the situation. Otherwise, consistently high food prices would generate breeding grounds for revolutions like the ones seen in the Middle East.

03:47
 
While U.S is yet to recover from the aftermaths of the 2008 subprime crisis, the tell-tale data for the US housing sector suggests another housing crisis brewing. The US house price index has seen the biggest annual decline since the low set in April 2009. The housing starts are down 11% month-on-month in April 2011. The picture looks even gloomier if you look at the huge pile of non-performing mortgage loans and the lower recovery rates. Killing any hopes of recovery, the index of subprime mortgage securities is down 20 % in the past few months and selling foreclosed property is taking long time.

Is there any way of fixing this mess? We doubt so. It looks like the Obama government will have to carry this albatross round its neck for a lot longer. The numbers are proof of failure of QE2 to stimulate housing. The poor housing data along with a dry job market leaves little hope for the troubled Americans. They also suggest that there is another financial crisis in the making. It won't take long before troubles in the housing market spill over into the economy creating serious ripple effects across the globe.

04:30
 
In the meanwhile, the Indian stock markets built on their opening gains and continued to trade strong. At the time of writing, the benchmark BSE Sensex was up by 180 points (1.0%). Barring consumer durables and auto stocks, all sectoral indices were trading positively. Most of the Asian stock markets too were trading in the green with China and Japan being the only exceptions.

04:50
 Today's investing mantra
"Yes, risk-taking is inherently failure-prone. Otherwise, it would be called sure-thing taking." - Tim Mcmahon

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9 Responses to "The one question that every investor must ask..."

Jayant S.Patel

May 30, 2011

This simple advise is valuable.
One should follow it
Jayant

Like 

NV SUBRAMANIAN

May 29, 2011

Buy cheap and sell high is fundamental mantra. That apart patience is a necessary virtue. quick bucks are possible once a while but not always. Herd mentality,one day or other, will lead to stampede where the weak will be trampled.

Like 

Vinayak M Prabhu

May 28, 2011

Dear Sir,

How we can identify particular stocks are cheap?

Thanking you,

Vinayak.

Like 

sharad agrawal

May 28, 2011

90 % investors are build to loose money , & in this ratio is not going to change in nxt 10 years.

Like 

subrata

May 27, 2011

A very valuable piece of advice. Thank you for sharing.

I feel sometimes really lost in so called tips from experts....I also wonder why these experts does not follow their own advice and get rich!!!

Like 

Ganesh K

May 27, 2011

I not only agree with Mark Howards but followed it for deceded too. My suggestion to all those who want to make decent money- Check if the stock has gone to a level when the BSE sensex was about 14000, if yes, then only buy it. Or wait till the market goes to that level and start buying in small quantities of good A group shares.

Like 

jagdish sanghvi

May 27, 2011

In response to your above question whether it is cheap or not is really the question for you to answer for a lot of us who do not have the expertise to evaluate the stock or not have resources at their disposal. These people, the retail investors, who have blind faith in your guidance go out and act as advised by you.

So basically the question is for you to answer. Will you please answer it for the benefit of all the readers of 5 minute wrap?????

Thanks in advance.

Like 

Mr. D. D. Vora

May 27, 2011

sir, i read yr article - not regularly but i understand the value of these article under the head. Upto say 1995IPO were offered at reasonable price , if at premium investments were paid its value, recently in present book building system, there is no reward of investment, if investor does not sell his investment in time, you have knowldge of such prestigious IPO and investors now weep. Even four star or five star ratings were given to those issues. Why SEBI, or BSE or NSE does not pay attention to these robbaries Ofcours promotors of the issues have minted money, but what about the small investors. I think we should not blame RAJA or Kalmadi only.

Like 

Yugandhar

May 27, 2011

"One solution is to focus on agricultural research which would involve adapting farming to climate change. "

Our bookish knowledge and science will tell us only that. But it is the most foolish thing to adapt farming to climate change because that is simply impossible. Everyone must read the book "The one straw revolution" by Masanobu Fukuoka, a japanese plant scientist turned natural farmer and philosopher. His book will open anyone's eyes to the folly of human beings. The only solution is to move along with nature through "natural farming" and simple and natural living, and not fight against it with foolish and narrow science. When nature fights back it will be too painful to bear.

Like 
  
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