Is This Stock the 'Buy of the Decade'?

Sep 23, 2015

In this issue:
» The newspaper boom in internet-deficient India
» Is the US shale gas boom over?
» Market round up
» ...and more!

A historic scandal has erupted in the global auto sector. The world's No 1 car company,Volkswagen AG, has cheated over 11 million consumers with a false promise of environmentally friendly diesel cars. The scale of the deception has shocked consumers, regulators, and investors alike.

Will people trust the brand ever again? Will the company have to pay US$18 billion in fines, as is being reported? Will the CEO go to jail? Have other auto giants done the same thing? We will know the answers soon enough. But spare a thought for the poor investors.

The stock crashed from 162 euros to about 106 euros in just two days! And it's down about 60% in the last six months. It's trading at a price to earnings (P/E) ratio of 5.7. A similar example in India recently was Nestle's Maggi Fiasco.

This leads us to the million dollar question: Should you buy such stocks in these situations? As an ardent follower of Warren Buffett's investing ideas, we know how to view this scandal.

A quick history lesson is in order. In 1963, the world's largest credit card company, American Express, was involved in the 'salad oil scandal'. The eventual damage to the company was US$175 million. The stock crashed.

At that time, an unknown 35-year-old fund manager from Omaha bet big on it. He put 40% of his fund's money into this one stock. Why did he do it? And what can we learn from this? We believe the lessons will tell you if Volkswagen is the 'Buy of the decade' or not.

  • Will the core business survive intact? In case of American Express, the answer was yes. People were still going to use Traveller's cheques and credit cards.

  • Can the balance sheet withstand the hit? Having analysed the financials, Buffett knew that it could.

Positive answers to these two questions convinced Buffett that the company would pull through. The rest, as they say, is history. Within a year, the stock was up more than 40% and has been a compounding machine ever since. It's no wonder that Buffett says he likes to buy great companies when they are on the operating table!

So what about Volkswagen? The two companies are not comparable but the lessons are similar. There's no doubt that the company's core business will survive. Global diesel car demand is not going to crash due to this scandal.

What about the balance sheet? The company has already set aside US$7.3 billion for potential damages. The very fact that it had this much money lying around should be a source of comfort. However, it may have to pay out more.

The two key points are:

Thus, the stock is presenting a great opportunity for global fund managers right now. But how many will bite the bullet?

It's important to recall the wise words of Buffett's guru, Benjamin Graham: 'In the short term, the stock market is a voting machine. But in the long term it is a weighing machine.' Volkswagen has been voted down right now. But a few years down the line, the situation could be completely different.

What do you think? Is the stock of Volkswagen the 'Buy of the decade'? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The print newspaper business has been a favourite of Warren Buffett. But demand for newspapers in developed economies has been slowly dwindling in the face of tough competition from the digital avalanche. In India though, the story is different. The newspaper business is flourishing as more people from smaller towns and rural areas have added to the reader base due to growing literacy levels and higher disposable incomes. As per the recent census data, the percentage of population that can read and write has increased to 74% in 2011 from 64% a decade back. The literacy rates have gone up sharply in poor agricultural states of Bihar and Jharkhand. And this new emerging consumer class outside megacities prefers to read newspapers in its native language rather than in English. Therefore it is no surprise that English publications that dominated the newspaper market have now been overtaken by local language publications. In FY14, Hindi publications accounted for half of the total circulations in India as compared to 14% share for English publications (Source: Ministry of Information and Broadcasting).

Therefore Indian newspaper publishing companies are increasingly coming out with regional publications to reach out to the growing vernacular markets. Moreover, with advertisements still contributing more than 40% to overall revenues as compared to less than 15% in US, UK and Japan, the Indian newspapers are able to price their publications low and grow volumes (Source: World Association of Newspapers and News Publishers). Therefore, the circulation of Indian newspapers has been growing at a fast clip. Since 2010, the total daily newspaper circulation grew at compounded annual growth rate of 25% to reach 270 m in 2014.

Newsprint business continues to boom

Discovery and production of shale had helped the US achieve self-efficiency in energy thereby bringing in sweeping changes in crude oil dynamics. However, as the production process is technologically more intensive, it requires high crude prices to remain financially viable. But the rout in crude oil prices since 2014 has put US shale producers in a tight spot.

And if reports are to be believed, then weak prices are here to stay making it difficult for them to hold their heads above water. Both International Energy Agency (IEA) and US Energy Information Administration (EIA) indicate a crude production surplus of 2.6 m barrels per day in August 2015 which is the highest since the oil price collapse started in 2014. As per EIA, the excessive build-up in crude inventory is not only on account of higher production but also a steep fall in consumption. This is reflected in the crude demand growth that has halved to 1.2% in the last one year.

Further, US has been curtailing crude output since April even as the Oil Producing and Exporting Countries (OPEC) has been raising production to drive out costly shale and defend market share. As Iran is also expected to add on substantially to crude output by early 2016, the US shale producers will find it increasingly difficult to remain financially viable going ahead.

At the time of writing, the Indian markets were trading in the green. The BSE Sensex was up by about 70 points or 0.3%. Gains were seen in banking stocks while auto stocks were trading weak. The Midcap and smallcap indices were also trading flat.

 Today's investing mantra
"Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market" - Warren Buffett

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

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1 Responses to "Is This Stock the 'Buy of the Decade'?"

Ananda Rao

Sep 23, 2015

VolksWagon stands literally "People's Car" as somewhere studied. India experienced "Satyam" (the ultimate truth). In both the cases there were certain honest admission of deficiencies that rocked them down even in stock market. Satyam changed hands and name to Tech Mahendra the down-trending from 500+ to bottom of 6+ regained to 150+. Hence Volkswagon may also come again as suggested in the article.There were admission of faults by Honda like super brands recalling the sold vehicles to rectify defects but none had bad experience in popularity. Similarly, Tata Nano is looked down because it's pricing as people car scared the owners to own such a car that psychologically reflects owner's downtrodden status. Hence Honesty should also be expressed in a diplomatic way but not irrationally.

Equitymaster requests your view! Post a comment on "Is This Stock the 'Buy of the Decade'?". Click here!
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