What is the secret to earning your pot of gold?

Jul 29, 2015

In this issue:
» Rural economy not dependant on monsoon so much
» The road to recovery has eased a bit
» IT sector remains on firm footing
» ...and more!

We all have listened to bedtime stories in our childhood. These simple stories impressed our minds so much at that time. But as we grow up, the disconnect with simplicity widens so much that we dismiss these stories as fantasy. But nothing can be far from truth as each of these stories has a profound message. And the golden egg laying hen story is so very relevant in our investing world.

The prized hen in investing parlance is a company which has all the safety moats in place and shows promise of delivering sustainable returns in future. Of course finding such a coveted company is quite a task. But once you have zeroed on such a company do not let greed overwhelm you. Instead of getting content with only one golden egg by reaping returns from capital appreciation and dividend bounty in a single year and selling the stock early on, caution should be exercised. This is because, the power of compounding is realized only if you remain invested in a strong business over a longer period of time. Moreover, such a strategy also eliminates the risk associated with timing the markets. A stock may witness correction immediately after you have bought it, for temporary reasons. But by staying invested over a longer time period, the short term price volatility gets ironed out and the investor is able to earn superlative returns.

A look at the following multibaggers clearly shows that patient investors have been rewarded amply as compared to investors that were in a haste to earn quick returns.

Solid business earn superior returns in long term
 10 -yr CAGR5 -yr CAGR
Hawkins Cookers Ltd.42%18%
Shriram Transport Finance Company Ltd.27%5%
Titan Company Ltd.30%19%
HDFC Bank23%22%
Source: Ace Equity *CAGR -Compounded annual growth rate in share price

Even value investor, Warren Buffett has said that "When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever."In other words if you have discovered the golden egg laying company, do not be in a haste do realize all the returns in one go. Instead, be invested for the long term with an entrepreneurial mindset. It is only then you would be able to benefit from its true potential and earn superior returns. It goes without saying that like an entrepreneur you should be constantly monitoring the business fundamentals to be able to derive the maximum returns from your investment.

Do you believe that companies with strong moats have the ability to deliver maximum returns in the long term? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
With agriculture still accounting for a sizeable 14% of the gross domestic product, the monsoons have a significant role to play in the economy, particularly as a large proportion of the population still resides in rural India. However as per a report by India Ratings, the rain gods may not exactly be the harbinger of good or bad times. This is because rural India or Bharat has undergone a huge transformation over the past decade.

Falling role of agriculture in rural economy
Data Source:CSO & India Ratings

On account of government sponsored employment programs such as MNREGA, the proportion of agricultural income has come down significantly in the past decade. In fact as per data from Central Statistical Organization(CSO), the share of agriculture in rural net domestic product fell to 39% in 2004-05 from 71% in financial year 1971. On the other hand, non-farm activities contributed 61% to rural net domestic product in 2004-05. India Ratings has estimated the share of agriculture to fall further to 30% in FY13. Therefore with other sources of income, the fortunes of rural India may not be totally dependent on monsoons.

The Modi government has found it hard to keep up with sky-high expectations thus far. Short term concerns about the Monsoons complicated things further. However, things are beginning to look up for the government at least. The turnaround in India's economic growth has happened although the improvement will be slow we believe. The sharp fall in crude and gold prices (India's two biggest imports) has helped to keep the current account deficit (CAD) in check. This in turn has helped to keep the rupee stable.

The monsoon is also expected to be normal this year (it's only 5% below normal thus far) and fears of a drought have eased. This gives the RBI further room to cut interest rates. With the government focusing on an infrastructure push, we believe it will be only a matter of time before growth and employment picks up. However, we expect no miracles. India's economic recovery will be slow and a long drawn out one.

The earnings season is on in full swing and as is always the case, most of the large IT firms have reported their numbers. While there were no serious issues on the growth front, the operating performance was dull. Investors in this sector should note that there is always a seasonal impact on margins due to wage hikes as well as visa costs in the April-June quarter. However, many are concerned about pricing pressures faced by these firms. This is an understandable concern as traditional IT services have become a commoditised business.

However, fears about a complete loss of pricing power are overblown according to us. Indian IT firms continue to gain market share over global giants like IBM and HP. They continue to win large deals (although at a slower pace) and most importantly they haven't lost any major client due to unsatisfactory service. Whatever the short term impact may be on pricing due to newer digital technologies, the long term pricing power in this sector is determined by the quality of client relationships and domain knowledge. On that front, we have no worries about the Indian IT sector.

The Indian stock markets opened the day on a positive note and continued to trade above the dotted line. At the time of writing, the BSE-Sensex was trading higher by 87 points (up 0.3%). IT stocks are leading the gainers today.

 Today's investing mantra
"Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst).

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1 Responses to "What is the secret to earning your pot of gold?"


Jul 29, 2015

Your analysis shows that 10-Yr CAGRs are much better than 5-Yr CAGRs for some good corporates. Are these the CAGRs for the last 10 years and 5 years respectively? If so, won't the CAGRs for previous 5-years be far better than the 10 year CAGRs?
No corporate can keep at the top for ever. This is for variety of reasons including upheavals in the market, competition. There is always a time when going forward returns from 'good corporates which started off with moats' would lose their moats.
I understand that even Warren Buffett admitted that sticking to his investment in Coca Cola through all the decades may not have been optimal.
This is not to say that investors should turn over their portfolio every year or so, but 5 years is a fairly long period of holding. Dreaming of holding it forever while the whole world around you changes completely is living in dreams, not reality.

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