Learn to love uncertainty

Jun 7, 2010

In this issue:
» An oversupply of equities on the horizon?
» FIIs may pull out in large numbers
» Indian IT hit by attrition woes
» India's consumption story lurking
» ...and more!

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"Uncertainty is the friend of the buyer of long-term values." These words of Warren Buffett have been the guiding light of so many renowned value investors across the world. Uncertainty could be about varied factors. The global economy, domestic economy, competition, input costs, taxes are just to name a few. But most of these are temporary. And a business with strong fundamentals is invariably able to tide over the uncertainties.

But thankfully Mr. Market does not think so. Negative sentiment tends to wreck havoc on the valuations of perfectly good businesses. And there could be nothing better for a long term value investor.

The current crisis in global markets has left investors skeptical about investing in stocks, yet again! This is despite the fact that Indian businesses are expected to be hardly affected by the crisis over the long run. Given this, it is important that you use the current uncertainty to your advantage and build a portfolio of solid stocks. Of course, the correction will still run its full course before stock prices recover. But then again, the idea is to invest systematically, bit by bit, and not at one go.

 Chart of the day
The global economic slowdown has taken a heavy toll on capacity utilization levels of several industries. Economies in the West, in particular, have seen their utilization levels dip to historical lows. But as seen in today' chart, Asian economies seem to be faring far better on the manufacturing front. Be it China's and Japan's export driven economies or India's consumption driven economy. However, to what extent the new capacities coming on stream will be put to work - is an important question to be answered.

Data source: NCAER, US Fed, Bank of Japan, Wall Street Journal

Last week, the government came out with guidelines for a minimum public float of 25% in listed companies. If any company has a market cap of over Rs 40 bn, it will be allowed to go public with 10% public shareholding. But it will have to raise it by an additional 5% till the 25% level is reached. The guidelines will have two effects. Firstly, it will create a huge supply of fresh papers over the next 2-3 years. It will also impact the pricing of the large public issues such as Coal India and BSNL. In our view, a larger public shareholding will create a level playing field and will make price manipulation more difficult. On the flipside, there could be an oversupply of equity and some companies might opt for delisting instead of diluting their stakes.

Now this may sound like a warning bell for investors. As per a survey by India's leading industry agency FICCI, the country might see FIIs pulling out in large numbers over the next six months. The reasoning being that these investors will hesitate to pour money outside the US because of the European debt crisis. And not the equity markets, even the debt markets here are likely to be impacted.

We won't comment on the whether this prediction will come true or not. However, we also believe that the broader macro scenario can remain tough for some more time. This is given that more cockroaches are tumbling out of the European cupboard - Hungary being the latest! Till the time we have more clarity regarding how governments are going to handle the crisis, times will indeed be tough for global investors. And emerging markets like India, which depend so much on this class of investors, can see some weakness.

More and more foreign banks are queuing up to set up operations in India. As per reports, five to eight foreign banks are currently waiting in the wings to enter what is being seen as a very attractive market. More so in these days of crisis, where emerging markets are quickly becoming the only source of growth in the world. Further, it is also being expected that the tough restrictions on the entry of foreign banks may be eased by the RBI. It is not surprising then that banks from different parts of the world like Standard Chartered, ANZ, Credit Suisse and Goldman Sachs are all showing keen interest in getting banking licenses. For one, the entry of these will mean tougher competition for banks already present in the country. But it could also mean more complex financial products finding their way into Indian markets. We hope the RBI adopts a strict approach when it comes to regulating the new comers.

Jobs are back for certain. But, so is attrition for the Indian IT sector. Tech biggies including Infosys and TCS have announced huge hiring plans of recruiting over 30,000 employees this year. Since the industry has been showing signs of recovery, trained professionals are needed for quick deployment on projects. The pipeline of unutilized employees waiting on the bench has also shrunk post recession.

Tech companies prefer to hire laterally as they do not have to incur any costs on training. Plus these hires can be directly used on projects. Attrition has steadily increased across all firms. At Infosys, the attrition rate rose to 13.4% in FY10 from 11.1% in the previous year. Wage hikes and retention bonuses are now back in vogue now after months of cost-cutting. We expect further attrition across IT companies till recruitment targets are met and margin pressure due to the financial incentives being doled out to curb it.

India has grown at a strong pace over the last few years. The general impression has been that consumption is the dominant factor that has fuelled this growth. After all, the automobile sector has witnessed a robust growth in sales last year. But that may have not been the case. According to an article in the Mint, in FY10, private consumption grew 4.3% and underperformed GDP growth of 7.4%. More importantly, although rural consumption has been growing, it has not been able to keep up pace with urban demand. That could probably be attributed to more caution on account of drought last year.

Overall, private consumption accounts for 57.6% of India's GDP. This means that growth in consumption is critical in driving the growth of the overall Indian economy. The Finance Minister has pointed out that for India to grow at 8.5%, private consumption has to grow at 6.5%. We only hope India does not lose out on her domestic consumption edge!

The much awaited decision on de-regulation of fuel prices is expected to come out soon. The same will have a cascading effect on a host of economic variables including inflation and fiscal deficit. It will also bring a lot of respite to India's oil marketing companies. Rest assured that we will keep you posted on the developments in this direction.

As the European debt crisis continues to throw in more surprises, investors seem to prefer to stay on the sidelines. Taking cues from global markets, the Indian indices shed considerable gains since the start of the day's trade today. Indian markets along with Japan, China and Hong Kong are in fact the biggest losers in Asia today. The BSE-Sensex was trading nearly 310 points (1.9%) lower at the time of writing. European markets have also opened on a very weak note.

 Today's investing mantra
"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch

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3 Responses to "Learn to love uncertainty"

hari mohan

Jun 9, 2010

I am regular reader of your analysis , its give me very helpful knowlede thanks


Sujit Mukherjee

Jun 8, 2010

I liked Warren Buffet's line of thought: "when others are greedy, be scared. When they are scared be greedy!"
Thats the best guideline I've found in buying equity!

Very informative this '5min wrapup'. Do keep it up.
Thanks & rgds.


Eswar Santhosh

Jun 7, 2010

"The current crisis in global markets has left investors skeptical about investing in stocks, yet again! This is despite the fact that Indian businesses are expected to be hardly affected by the crisis over the long run."

May be the right time to invest is when they "find out" how the Euro crisis affects Indian businesses and exaggerate it by N times? ;)

Equitymaster requests your view! Post a comment on "Learn to love uncertainty". Click here!