Turnaround story vs. Boring business: Which is better?
In this issue:
» Cheaper in China: Steel or cabbage?
» Banks lose out to cheaper fund sources
» ...and more!
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Let us consider two companies that are trading at low valuations. For instance, Company A has had a few years of poor operational performance. This could be due to a variety reasons such as inability to adapt to the changing market dynamics, not much innovative capabilities, ineffective management, surging costs and the like. The market has already punished the stock for this and now the valuations are so attractive that it looks like a value buy at that moment. What more, since things have reached rock bottom, one assumes that they can only improve from thereon. Plus, should the company begin focusing more on innovation and keep costs under control, the upside from this point onwards is only huge. In other words, Company A could be a classic turnaround story.
Let us consider Company B. It is one of those companies that have been growing revenues and profits at a steady pace. It has quite a boring business; certainly not a fancy tech start-up that has been hogging the limelight these days. There is no real story in this case that can catch the fancy of investors, other than the fact that it is a solid, healthy business. The only thing is that the company is trading at low valuations only because investors have probably forgotten it exists. The business is boring after all and the management just goes about running the business rather than focusing on where its stock price is headed.
From a purely numbers point of view, both the companies are attractive because both of them are trading at depressed prices. But if you had to still make a choice between the two, which one would you go with.
Most people investing in equities are attracted towards the next big stories, themes and interesting ideas. So the prospect of a turnaround story is always mouth watering. But it is not as simple as it seems. The assumption is that the company can capture the glory of its past and so the benefits are immense. But there is never any guarantee of this. The turnaround hinges a lot on dramatic changes in the way the business is being run, which may or may not happen. If it works, investors benefit tremendously, but if does not, the losses are crippling as well.
A boring business on the other hand may not have all the fanciness of a turnaround story. But it has something that the prudent value investor will certainly not ignore: a business that has been growing surely but steadily, a management that knows what it is doing and does a very good job of allocating capital.
No prizes for guessing that our preference lies with Company B!
Of course, there will be the odd super turnaround story of a stock that will go on to give fabulous long term returns. But if one would like to invest over and over in one of the above kinds of stocks, we certainly like to think that the long term odds would favour an investor always going for boring but rock solid businesses.
Does the prospect of a turnaround story excite you or do you prefer stable, steady businesses? Let us know your comments or share your views in the Equitymaster Club.
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02:25 |
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As reported in the Guardian, iron ore prices have fallen by more than 10% to US$ 44.5 per tonne and this is the lowest level since May 2009, during the depths of the global financial crisis. Little wonder then that stocks of international metals and mining companies have taken a beating.
The scenario is not different back home where many of the Indian metal companies are also grappling with lower commodity prices. Many of them are forced to lower their prices as well to align with international prices and this has taken a toll on the overall performance of these companies. When the tide is expected to turn is anybody's guess.
03:01 |
Chart of the day | |
As per a study, banks saw their share in incremental fund flows in the economy erode from 65% in FY14 to 45% in FY15. And the gap has been filled in by non-banking fund sources such as corporate debt and equity financing. According to the study, the net portfolio inflows in to corporate debt stood at $17 bn in FY15 as compared to net portfolio outflows of $4 bn in FY14. On the other hand, equity financing from foreign direct investment (FDI) and primary market issues increased from $34 bn in FY14 to $46 bn in FY15. The falling corporate bond spreads in turn fuelled the rally in equity markets translating into cheaper capital for companies. Thus higher inflows of foreign funds provided companies with low cost alternatives to bank credit in FY15.
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04:46 |
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04:55 |
Today's investing mantra |
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2 Responses to "Turnaround story vs. Boring business: Which is better?"
Savio
Jul 22, 2015Lovely analysis of Flipkart by Rahul.
I sometimes wonder how well-heeled investors can also be as foolish as the man on the street. :)
~S
SONI
Jul 23, 2015I WILL PREFER A and B