What's frustrating our subscribers?

Jun 19, 2014

In this issue:
» Anthony Bolton: Important lessons from his investing career.
» Global fund managers overweight on EMs, again!
» Marc Faber remains bullish on gold.
» RBI not convinced about Andhra CM's loan waiver promise!
» ...and more!

We have often written about why investing in equities is a must given their inflation beating tendencies over the long term. And to make meaningful gains over time, investing only during optimistic periods would not have the biggest impact on one's portfolio. For this, investing during dull, uncertain periods is a must. With the way the stock markets were behaving for most of 2013, there was a lot of pessimism around. And as such investors stayed away from markets given the high amount of uncertainty.

However, that was a time when a large proportion of stocks ideas were 'buy' and 'hold' calls. And, as our subscribers would have noticed, many of our recommendations hit target prices in recent times. And mind you, this has also led us to give 'sell' calls on certain recommendations which we feel had run up way higher than their intrinsic values. Whether these calls turn out to be right or wrong over the long run remains to be seen. But from the way we look at it, if stocks seem to be priced way above our comfort zones, we are happy to let go of the upside and move on to other opportunities where the risk-reward ratio is more in favour of the latter.

Now for those who were sitting on the sidelines - investors who would have not remained invested - we can understand the frustration given how there has been a surge in prices across the board. And that too in such a short span of three months!

On a broad level, we feel that the way the market has been performing of late, it seems to be ignoring all the possible negatives. Including those that can come from outside of the country - the recent Iraq incident is a case in point. Not to mention that foreign investors have played quite a major role in the market run up in the past few months. For them, India is one of the many investing options. This should not be forgotten. Then, there is the action being taken by the central banks across the world that needs to be gauged as well.

Don't get us wrong! We are pro-India and believe in the long term prospects of the nation and that over the long term investors will make good money. But the run up in the past three months should not be an aspect that should make people take hasty decisions is what we believe. Especially considering that the current run up seems to be built on 'hope' and unreal expectations; those from the new government which would trickle down to companies in the form of strong earnings growth.

Sure, while things are likely to improve, the growth in earnings will take time to kick in is what we believe.

As highlighted by Ajit Dayal in one of his latest newsletter, there has been a significant amount of change in forward estimates made by the analyst community - in a matter of months - thereby making the Sensex seem quite attractive from a one to two year perspective.

As you would be aware, the higher rate of growth in earnings would lead to an expansion in P/E ratios. However, the problem with changing a company's long term growth estimate every now and then is that even a small error can lead to valuation blunders!

The formula used to calculate a justified P/E ratio is as follows:

P/E = (1-b) / (r-g)

Here, 'b' is the plowback ratio, while 'r' is the cost of capital. 'g' is the estimated long term growth for the company.

The cost of capital needs to be close to 10-year G-Sec rate which is about 8% plus a risk premium of 4%-5%. Or as we say, 15% is a value one could take as well as it is the rate at which the Sensex has risen on an annual basis over the long term.

So essentially, what would determine the P/E is the change in 'g'. Now, depending upon whether the 'g' is assumed at 11%, 10% or 9%, one can get normalized P/E ranging from 100 to 33!

Of course, the justified P/E is not the value we use to value all stocks - the multiple varies depending upon the company's long term trend in return ratios, dividend payout and management quality. But the key takeaway here is that steep valuations multiples can be justified with a small change in growth estimate. But, even a small error in doing this can lead to very bad investment decisions!

Now that is a risk we certainly do not want to subject our subscribers to!

We would like to end this write up with a very famous investing quote by Benjamin Graham - "In the short run, the market is a voting machine but in the long run, it is a weighing machine."

Are you feeling trapped by the 'buy high' syndrome? Let us know in the Equitymaster Club or share your comments below.

--- Advertisement ---
The most powerful investing secret...

Most investors always eye big companies.

But that's probably because they are unaware of a handful of unknown companies which have already given returns like 105% in about a year, 139% in just seven months, and many more.

And the fact of the matter is that these unknown companies have the potential to give even higher returns over a period of time.

Of course, you need someone to pick the right unknown companies from the lot.

And that's what we are writing to you about now. Just click here for full details...

 Chart of the day
There is no doubt about the fact that majority of stocks in Indian markets are looking over valued. However, as the liquidity scenario in the West shows no sign of drying up, the risk appetite remains high. Moreover corporate growth rates in the US and Europe have slowed down dramatically. Little wonder then that fund managers are willing to pay a premium for growth. A Bank of America Merrill Lynch survey of global fund managers published by Mint shows that fund managers are currently overweight on emerging market equities. In fact it was for the first time since November 2013 that global asset allocation to equities went up quite sharply in June this year. And as fund managers reduced cash holdings, they stocked up on emerging market equities. The possibility of BRIC economies regaining strength is the key premise for valuation re-rating of stocks across these regions. Promises of reforms, change of government and prospect of higher growth in the emerging markets have keep fund managers hooked. However, it goes without saying that inability to deliver on high growth promises could lead to massive correction in these markets.

Fund managers 'overweight' on EMs again!

Anthony Bolton. The name may sound unfamiliar to many stock market wizards. However, this fund manager's track record over the last 28 years is nothing short of what Oracle of Omaha has managed to achieve. A magnificent 20% compounded growth to be precise. Hence, when a man of such stature gives his two cents on investing, the advice should be taken wholeheartedly.

Mr Anthony, who retired recently, has summarized three important lessons from his investing career which can be of immense help to retail investors. Here are the 3 lessons. Know why you own the stock, know what's discounted in the price and lastly know yourself. The first two aspects have been discussed by us tirelessly many times. Hence, let us focus on third aspect today. You may wonder how knowing yourself is related to investing, isn't it?

Well, knowing your emotional psyche enables you to understand your strengths and weakness. For instance, an emotional individual will get carried away more by the current market sentiment which reflects positivity. However, what may be required now is - patience, sanity and courage to stand apart from the crowd. Only an investor who is able to segregate his emotional self can take rational decisions. We cannot agree more. In order to be successful in investing one needs to focus on intrinsic value and not price. But most investors pay attention to the latter and suffer as a result. The bottom line is let the price come to you and do not chase it.

Do you know what the biggest risk to the market these days? No, it's not the Iraq crisis. It's not the bubbling up of the Chinese real estate either. Well, it's the risk of the US central bank raising interest rates sooner than expected. Simply because it is this benchmark around which assets all across the world are priced we believe. Therefore, when the Fed Chairperson speaks, the rest of the financial community listens. So, what's on the mind of Janet Yellen, the current occupant of the seat these days? Well, it looks like the low interest rate party is certainly going to last for some more time. While she did not say so in as clear terms, she did hint towards the rates remaining low for a considerable time. This of course does not mean that long term fundamental investors should keep holding on to their stocks as long as the party is on. The fact is no one can predict in advance when exactly these events start impacting asset prices. Therefore, it helps if one invests in stocks taking into account the underlying valuations. Investing in stocks that are overvalued is easily the biggest mistake one can make in these times. Please note that ultra low interest rates cannot go on forever and ultimately, these will have to mean revert. As a result, you may not want to keep holding onto stocks which could be most vulnerable to this trend.

After a strong rally in gold prices till 2012, the precious metal lost steam in 2013 when the Fed announced its decision to trim its bond purchase program. The perception is that the economies of the rich world are recovering and so most of the so called experts are of the view that gold prices will fall. Marc Faber though believes otherwise. As long as central banks around the world keep up with their loose money policies, paper currencies will lose value. Indeed, the ECB recently made its negative interest rate policy official. The US Fed has been trimming its bond purchases but there remains great uncertainty with respect to interest rates. Japan has also been adopting a massive money printing exercise. None of these countries though have displayed any meaningful signs of recovery. Especially the US, even though the Fed has been talking about trimming its bond purchases, there is every possibility that it will resort to it once again should the economy fail to kick start in the manner envisaged. Thus, keeping all of this in mind, gold is the best asset class to be in given that it is tangible and has value. That is why, investors should certainly ensure that this yellow metal finds a place in their overall investment portfolio.

The hopes of farmers and self-help groups in Andhra Pradesh may get dashed soon. That's because the loan-waiver promise made by Andhra CM during the election time may not come through at all. Primarily because the Reserve Bank of India (RBI) remains unconvinced about it! The story goes this way. The new government was keen to issue bonds to banks against the loan dues. The government was also confident enough to make a case to RBI. But the Governor is quite reluctant to grant permission to the Andhra government to issue any fresh bonds. Even the bankers do not believe that the loan-waiver scheme can be implemented in its original shape. That's because the state finances are already over-leveraged. Not just that! Since the CM's announcement of loan-waiver schemes, there have been massive intakes of loans in last three years. Be it crop loans or gold loans! The farmers have been unscrupulously taking multiple loans. Even the eligibility criterion is being given a miss in many cases. Now with the banks already lurking with chronic asset quality issues, such lending practices will further exacerbate their woes. While the final discussion is still away, we believe, without being gullible, the government should certainly respect the central bank's stance and accordingly craft the scheme in the benefit of all.

After trading firm in the opening session, the Indian stock markets slipped into the red. At the time of writing, the benchmark BSE-Sensex was down by 94 points (down 0.4%). Sectoral indices were trading mixed with oil & gas and metal stocks being the biggest losers whereas IT and auto stocks were leading the gains. Asian stock markets were trading mixed with Japan and Taiwan being major gainers whereas China was trading in the red. European markets opened the day on a strong note.

 Today's investing mantra
"Investing isn't just about probabilities. It's about consequences, and you've got to be prepared for them." - John Bogle

Today's Premium Edition.

Does Ceat Ltd deserve higher valuations?

Ceat Ltd has identified a three pronged strategy which is aimed towards increasing margins and overall performance going forward. Does this mean that the company deserves higher valuations?
Read On...Get Access

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 "What's frustrating our subscribers?". Click here!

1 Responses to "What's frustrating our subscribers?"

viral patel

Jun 19, 2014

I have suprjit engineer 200 share @28
Sundram fastener 200 share @54
Tcpl package 350share @35
Give me idea how much I hold and how is this all company

Equitymaster requests your view! Post a comment on "What's frustrating our subscribers?". Click here!