A precious investing advice from Mrs. Einstein

Jun 7, 2012

In this issue:
» Gold could rally really, really quickly
» Robert Shiller's advice to students of finance
» Peak oil has not arrived just yet
» Auto makers do not want higher excise on diesel cars
» ...and more!

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There's an interesting incident that happened when the great scientist Albert Einstein's wife was being shown around a giant observatory. Built with the purpose of observing the motion of celestial bodies and doing intricate calculations, the observatory was indeed a sight to behold. But none of this seemed to impress Mrs. Einstein. Not even the giant telescope that was then the world's largest and the one instrumental in recent discoveries about the nature of the universe. Mrs Einstein, hardly looking impressed, retorted that her husband does all of that merely on the back of an old envelope!

Well, the above story is as much about Einstein's great intellectual ability as it is about the wonders of trying to keep things simple. The latter especially, has profound implications for the field of investing as well. Take the case of financial modelling. There is a big myth that has permeated the world of finance. It is the myth that in order to value a stock successfully, one has to keep building complex financial models. In fact, the more complex the model the better the valuation.

However, as Einstein has proven, nothing could be further from the truth. What matters is not models that have macros upon macros built into them but an understanding of a handful of key drivers of the valuation of the asset. And if you have a firm grip on these key drivers, then an extremely basic model, comprising of only a few rows and columns is more than enough according to us.

Perhaps no greater evidence of this can be found than by studying techniques adopted by Warren Buffett. Although he hasn't shared his valuation technique in great detail, he has given enough hints over the years that he does not believe in building detailed financial models.

Please bear in mind that we are not asking you to do all your calculations on the back of an envelope. There has been only one Einstein and there is only one Buffett. But for finding attractive investment opportunities, a simple financial model should more than suffice according to us. And details should only be added if they add value. Greater effort should instead be spent towards researching more companies. Thus, even though unwillingly, Mrs Einstein may have shared one of the best investing advice one would ever receive.

Do you think complex financial models are the key to successful investing? Share your views with us or you can also comment on our Facebook page / Google+ page.

 Chart of the day
India may be in throes of one of its worst slowdowns in recent years. But that hasn't stopped its real estate prices from growing at a generous pace. Infact, as the consultant Knigt Frank has observed, the country has emerged as the third fastest growing real estate market in the world in the last one year. At 12% though, the number looks little on the lower side as there are quite a few pockets where the rise has been really steep. Certainly not good news for the already struggling average citizen of the country.

Source: Knight Frank global house price index

Many of us pride ourselves for the prestigious degrees we have earned. Ones who land into plum jobs straight after college have all the more reason. After all, a solid degree and a fat pay cheque are strong reasons for keeping collars up. However, there are teachings that the best of schools, colleges and universities cannot impart. Ones that are not just instrumental in shaping our lives. But they also help us bring about a change to the society. Take the case of an economist or an investment banker for instance. It is possible that both just concentrate on maximising profits for the firm they are employed with. This could certainly earn them big bonuses for few years. But their degrees will not live up to the reputation when asset bubbles and financial crises evolve. Their lessons in financial theory, economics, mathematics, and statistics will be of no worth. Unless they have some lessons in history, philosophy, and literature as well.

A speech by Yale university professor Robert Shiller to young finance graduates emphasises on this. It highlights why finance graduates should never lose sight of the purposes and overriding social goals of finance. More importantly, why finance, at its best, does not merely manage risk. Being the steward of society's assets, it is the responsibility of finance professionals to help achieve society's financial goals. There could not be a better way to express the need of the hour in global finance. If only the bankers, economists, accountants and traders would follow this.

Policy paralysis. Government inefficiencies. Scams. These are words that are getting synonymous with the Indian government. As a result, yesterday, the Prime Minister sought to change the perception by his meeting with the key economic ministries. The solution offered by him was to declare some infrastructure projects critical. He also stressed on the need to boost private investments in the country. Well Mr Prime Minister, this is something we all knew. There is nothing new in this. Unfortunately talking about it does not really help.

A better solution to take India back on the path of growth was the one offered by the Chief Minister of Gujarat, Mr Modi. He said the government needs to 'govern' in order to facilitate the economy's growth. This means that the government should focus on facilitating investments by companies. And this can only be done through clarity in policies, transparency in decision making and implementing the policies. Though this sounds like common sense but unfortunately the current UPA government seems to have forgotten the basics. The government is meant to govern. Not preach. Hope they listen to Mr Modi.

The pace at which oil prices have risen in the last decade has led everyone to wonder if peak oil is here. However, as per Mr. Ed Morse, Commodities Research Chief at Citi, even after 8 years from now, the oil will trade at around US$ 80-US$90 per barrel. His logic is simple. The high oil prices in recent years have led to a surge in spending in the upstream segment. This has led to highest ever capital expenditures in this decade. The bottomline is this capex will be translating into higher supplies in the coming times. His theory of prices coming down further gains weight as forward contracts for oil are trading in the stable range of US$ 85 - US$ 90 per barrel.

Until recently, the oil crisis was cited as the next Euro zone crisis as prices kept defying gravity. In such times, his theory comes as a breath of fresh air. We believe that 2020 is too far to come up with an estimate for prices for a commodity as volatile as crude oil. That said, the high prices at which crude oil has been trading in the recent past do defy demand supply logic and a correction looks likely.

With petrol prices shooting and diesel remaining the same, the gap between these two fuels has considerably widened. So much so that there are voices from all quarters demanding either freeing up diesel prices or levying higher taxes on diesel fuelled vehicles. Raising diesel prices is a political hot potato. So the focus has now shifted to taxing diesel fuelled vehicles instead. Not surprisingly, auto companies have lobbied against such a move. Auto companies over the past few quarters have seen sales and profits moderate. This has been on account of firm interest rates, a slowing economy and rise in petrol prices.

The only saving grace for them has been a surge in demand for diesel vehicles. Sales of diesel vehicles increased 35% to account for 47% of the overall volume in the passenger vehicle industry in FY12. Petrol car sales declined 15% during the period. This is despite the fact that diesel vehicles attract an initial premium of around Rs 80,000. So an additional tax on such vehicles will only make matters worse for the industry. Further, we believe that such a move will only make the grounds fertile for more uncertainty, administrative issues and consequently corruption.

Cycles of excess greed and fear are very characteristic of collective human nature. That is why manias and crashes have been a regular feature of the global financial history. There is no reason why such phenomena will seize to recur in the coming times. As per Jeff Clark of Casey Research, there is a strong case for a gold mania very soon. History tells us that a mania in gold is directly related to government debt, deficit spending and money printing. There is little doubt that policy makers and central bankers have been doing exactly that. Such reckless policy measures have massive adverse impact on respective currencies.

It goes without saying that currency devaluation does nothing but fuels inflation. And that's when investors rush to safe havens such as gold to safeguard the value of their savings. Why do you think Indians are so fond of gold? We have known the value of this precious metal, especially in times of crisis, for thousands of years. We believe that at a time when governments are destroying the value of their currencies, this traditional wisdom is likely to hold in good stead.

Meanwhile, indices in the equity market in India continued with their rich vein of form with the Sensex trading nearly 200 points higher at the time of writing. Banking heavyweights like HDFC Bank and ICICI Bank were seen driving most of the gains. Asian stocks also closed on a strong note with Europe too trading in the positive currently.

 Today's investing mantra
"The boom and the bust were normal-just two more swings in stock returns over the past century. Reversion to the mean is the iron rule of the financial markets". - John Bogle

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1 Responses to "A precious investing advice from Mrs. Einstein"


Jun 13, 2012

If such models are created by our great management graduates to create a aura around them and show the world that they are totally a different material. If we really look at the current sorry state of economic affairs, they are all inventions of our great management graduates giving out fantastic derivative products they themselves do not understand and also all those creative accounting and so on. Nothing against managment grads.

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