What Mega Trends can do to corporate profits...

Aug 23, 2014

In this issue:
» 5 Indian companies feature amongst world's most innovative
» How Dr Rajan is 'bullet-proofing' India
» The upside and risks from oil sector reforms
» Where are the billionaires investing...
» ...and more!

For serious long term investors, a detailed study of just two factors can determine investment success. Whether the business in question can keep growing profits. Whether there is catalyst for improvement in valuations. Now, there are several businesses that can keep growing at the average GDP growth rate without taking much risk. However, most such business fade over time and lose value to competitors. Hence for investors it is pertinent to know which business can grow at a multiple of economic growth to create maximum shareholder wealth over time. Needless to say, it is also important to know what will trigger the high growth and also act as a catalyst for premium valuations.

A look at the business growth patterns of select companies over the past two decades offers some answers. Take the case of Bharti Airtel for instance. Telecom equipment manufacturing was delicensed in 1991 and value added services were declared open to the private sector in 1992. While these triggered domestic manufacturing of telecom equipment, the breakthrough legislation came in 1994. The National Telecom Policy resolution of May 1994 liberalized and laid the stepping stone for runaway growth trend of the telecom sector in the true sense. Being the earliest incumbent and largest player in the sector, Bharti Airtel saw its profits rise multiple folds over the subsequent 6 years.

The interest of global auto majors into making India an export hub for original equipment manufacturers (OEM) was yet another trend that unraveled during the past decade. The demand for cars by India's growing middle class population and availability of cheap labour induced global majors to increase localization, adapt products to meet local needs and look at establishing India as an export hub. They even set up technical centers to strengthen R&D capabilities and overcome skill constraints. They pushed for expansion of dealership and service network. Eventually this led to huge opportunities for key domestic OEMs as well, as they capitalized on their knowhow and presence. Bharat Forge was one company that capitalized on this trend for most of the past decade.

We call these Mega Trends as they act as huge tailwinds for companies that are fundamentally solid and best placed to capitalize on the opportunity. Now these , nor do they benefit each and every company in the sector. So naturally investors need to be selective about the stocks and closely follow the management quality and decision making as well. Having done that, there is no reason why at least a few of such Mega Trends can't help investors pick out the super stocks that turn out to be the outliers in the portfolio.

How the Mega Trends were an inflection point for profit growth...
Data source: Ace Equity

Can you share such Mega Trends witnessed over past two decades and companies that benefitted from the same? Let us know in the Equitymaster Club or share your comments below.

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We just spoke about what mega trends can do to corporate profits and share prices. Investors who have the eyes to identify such mega trends beforehand are in for a bounty. The ability to innovate is another factor which investors much watch out for. Such companies through their innovative ideas have the ability to multiply profits at a rapid pace. Now you would be surprised to know that five Indian companies have featured in the Forbes list of 100 most innovative companies in the world. This is surprising because India is traditionally deemed to be a low cost outsourcing hub. Cheap labor and cost efficiency are its key strengths. And not innovation. However, having 5 companies in the top 100 list is certainly a good sign.

Out of the 5 companies that made it to the list, HUL had the highest innovation premium of 55%. As per Forbes, which ranked all the companies, innovation premium is a measure of how much the current stock price is above the value of its existing business. The higher the current stock price, higher the innovation premium since higher stock price is a reflection about the future expectations of the company.

Rest assured, we are on a look out for such innovative growth oriented companies. You will probably hear something from us in these regards very soon. Stay tuned until then.

 Chart of the day
It will be an understatement to say the RBI has been blessed with governors who are men with foresight. Governors ranging from Dr Y.V Reddy to Dr Subbarao have shown poise in the manner in which they maneuvered Indian financial markets through the toughest of global financial crisis. It seems Dr Rajan is no different. He has been the most vocal central banker to criticize the selfish monetary policies of the West in recent times. Having predicted the 2008 crisis in the US, this time around he had predicted global crisis of bigger proportion. However, instead of leaving the fotune of the Indian economy and its currency at the mercy of the US policy makers, Dr Rajan is taking tangible safety measures. As oil prices relented over the past few months, Dr Rajan has been building India's forex reserves. A measure that will ensure even if the US Fed rocks global economy with its policies, India will remain resilient to a great extent

Arvind Chari, Head Fixed Income & Alternatives at Quantum Advisors Pvt Ltd sent us this interesting chart that shows how the RBI is literally bullet proofing the currency by building forex reserves.

RBI buys up Dollars to re-build Forex Reserves

Oil and gas sector that was stifled with regulations is now witnessing some hope. The much awaited diesel deregulation was introduced in a phased manner some time back. And the way crude prices are behaving now, it might not be too long when diesel prices become fully market determined. That might seem a compelling argument in favour of investing in state run oil companies. Infact, some of the well known brokerage reports believe that the upside in such stocks is as high as 100%.

However, there are some caveats that investors must keep in mind before getting carried away. The first is that a full deregulation will depend on whether crude prices can stay at low levels, something no one can bet on. And even if that happens, it will be no guarantee that diesel will be sold at market prices. It would be worth mentioning here that even after full deregulation; oil companies continued to sell petrol below the market prices and did not have complete freedom in pricing. And that was not even compensated later, being officially deregulated. Lastly, there is a threat of huge competition from private players. A lack of level playing field has kept them at bay so far. But once they become active in already overcrowded refining space, even price wars cannot be ruled out. In short, while upside due to the expected reforms are already getting reflected in valuations of oil companies, investors must be aware of potential pitfalls while making investing decisions in the oil and gas space.

An article analysing the investment patterns of the world's billionaires would make for a good reading isn't it? So, what are these super wealthy people spread across the continents of US, Europe and Asia investing in these days? Well, as per Barron's, the pattern differs somewhat from continent to continent. Take the US billionaires for example. They have more than one third of their wealth parked in developed market equities as well as fixed income. Hedge funds and private equity investments make up another 22%.

Asian billionaires on the other hand prefer real estate and direct investments over hedge funds. And as far as Europe is concerned, they too prefer real estate. But they have also shown good amount of interest in hedge funds and private equity. Important to add that billionaires in all the three continents have equities as the single biggest avenue for parking their wealth. Another important observation is the high allocation to cash, perhaps a sign of risk averseness after the 2008 crash and also the impending rise in interest rates.

The global markets maintained the robust momentum streak and closed the week on a firm note amid easing concerns over the situation in Ukraine and a fresh bout of merger and acquisition activity in the US discount retail sector. A flurry of positive economic data and the likelihood of no interest-rate hikes have sent positive signals across U.S. and global markets. However, the U.S. Federal Reserve remains concerned over the geo-political tensions and the not so strong employment data. Hence the investors have remained skeptical of the sustainability of the market gains. The U.S. markets were up by 2.1% for the week gone by.

Asian markets have stood mixed for the week gone by, however, most of them have closed on a positive note. Soft economic data from the U.S. and the delay of the Federal Reserve's stimulus package lifted the Asian stock markets. While China closed higher by 1.6%, Japan was 1.5% up. Back home Indian markets too closed the week 1.2% higher.

Performance during the week ended August 22, 2014
Data Source: Yahoo Finance

 Weekend investing mantra
"A business or stock is not an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy. What's required is thinking rather than polling. Unfortunately, Bertrand Russell's observation about life in general applies with unusual force in the financial world: "Most men would rather die than think. Many do." - Warren Buffett

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