The Tortoise Approach to Multibagger Returns
- In this issue:
- » Banks Credit Growth - A Case of Once Bitten Twice Shy?
- » PSU Banks to Examine Takeover of Stressed Assets
- » ...and more!
On 2 August, I wrote to you about dividends. I explained why dividends are as important as capital gains for long-term investors. To make my case, I used a comparison between a fast-growing IBM and a slow-growing Standard Oil. A classic hare and tortoise comparison.
Over a 53-year period, the stock of IBM multiplied 300 times while Standard Oil multiplied 120 times. Despite this, Standard Oil shareholders made 31.1% more money than IBM shareholders. In case you missed it, you can read it here.
Such is the power of dividends. But very few people seem to understand this awesome power.
Because the true power of dividends can be harnessed only if they are reinvested.
How many people actually do this?
In almost every annual general meeting, you will find at least one disgruntled shareholder who wants a higher dividend than what the board has declared.
But what will they do with it? Most people spend it. Nothing wrong with that of course. Many retirees depend on regular dividends.
But imagine for a second that you didn't spend your dividends. Instead, you reinvested them. As I've shown above, you could make massive returns even from 'slow tortoise' stocks. You could even beat the returns of the 'fast hare' stocks.
Now, we have nothing against fast hare stocks. We like them as much as anyone else. But the slow tortoise strategy does come with quite a few benefits:
- You don't have to worry about a catastrophe in the business: Slow tortoise companies have a very stable core business. They may not grow fast, but they usually dominate their niche. Such businesses have strong balance sheets and are not likely to go bankrupt anytime soon. This provides confidence when you reinvest your dividends.
- These companies generate tons of cash that they pay out: Slow tortoises tend to generate large free cash flow from their strong core business. If the management is good, they will pay out this excess cash. If profits rise, the dividend rises along with it. If profits fall in any given year, the dividend is usually not cut immediately.
- The high payout enforces discipline: CEOs are constantly tempted to make a foolish acquisition. If there is a lot of cash on the company's books, the temptation is that much stronger. But a high payout forces the management to focus on growing the core business. As a shareholder, this is exactly what you want.
- The risk is lower: The higher the dividend, the higher the dividend yield. If a slow tortoise stock falls sharply, its dividend yield will also rise sharply. It won't be long before the higher yield attracts value-oriented investors. Thus, the high payout tends to provide a cushion to the stock price.
- You can sleep peacefully: This may be the best benefit. In an earlier edition of The 5 Minute WrapUp, Tanushree explained why chasing fast hares could result in negative returns per unit of stress. You can read it here.
Does all this mean you should forget about hares and bet only on tortoises?
No, of course not.
Having a few hares in your portfolio is great. They offer the potential of multibagger returns. They also put the fun into the otherwise boring work of selecting good stocks.
But I strongly believe every serious long-term investor should consider the slow tortoise strategy. As boring as it may sound, it is more than enough to get rich with stocks. Here is the strategy for your review:
- Select businesses with solid fundamentals
- Buy the stock only at a reasonable price
- Collect the dividends
- Reinvest those dividends
- Hold on for the long term
Perhaps no other strategy offers a combination of simplicity, peace of mind, high return potential, and relatively low risk.
You need not struggle with this. We have done the heavy lifting already. We have prepared a special report on slow tortoise stocks with good growth potential. It's called Steady Income Small Caps. You can gain access to it here.
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03:45 Chart of the Day
Banks are in no mood to lend. According to a report by Livemint yesterday, overall bank deposits for the country crossed the Rs 100 trillion levels for the first time ever. However, both the credit and deposit growth rates for the banks have tapered over the past few years.
Bank's Credit Growth - A Case of Once Bitten Twice Shy?
Despite the central bank reducing rates over the past year, banks have not been able to completely pass on these rate cuts to its borrowers. What is stopping the banks from doing so? The Reserve Bank of India (RBI) performed its asset quality review on the banks books last year. Since then asset quality for the banks have witnessed a steep deterioration. With slippages rates increasing at over twice rate that banks are lending, banks now seem shy to lend.
Higher lending rates are necessary for the bank to earn a higher spread from the loans it disburses. Also, since the banks own a lot of government securities, a reduction in the repo rate by the central banks has provided massive gains for the banks in its treasury income due to increased bond prices. These higher profits are being used to mask losses arising due to higher provisioning. The fear of provisioning and bad loans is so high that banks are now curtailing their loan books too as witnessed by the slowdown in its credit growth rate. The banks are also struggling to raise low cost deposits from the retail customers due to a high savings rate offered by government savings instruments like PPF, KVP which have favourable tax implications than a bank fixed deposit etc. At present, it looks like the bad loans problem might just continue longer for another 4-6 quarters at least.
The government being cognizant of the stressed assets accumulated in the banking system, recently met with head of the banks to find a solution to this problem. The finance minister announced that there will be a certain case wherein a management team of public sector banks team will take over the operations of the stressed plants and facilities for the interim. In addition, some of the stressed debt will be converted to equity by the banks.
This measure is to tackle the issue of stressed assets in power, steel and shipyards. Since banks generally find no takers when they try to auction the assets in the public, a better solution being thought out is to give operational control to the banks. This step though encouraging will come with its own set of challenges. The bank's core expertise is banking and not operations, further the management bandwidth of the bank will be stretched due to this move. While there are doubts raised at how effective this move will benefit the banks, proactive nature of the government is a big positive take away from this meet.
The Media industry be it print, social or web has been abuzz about the recent ouster of Cyrus Mistry as the Tata group chairman with Ratan Tata being appointed as the chairman for the interim. On the whole, the industry seemed surprised at this sudden decision. With both the teams seeking legal counsel, there will be enough fodder in the Tata-Mistry saga to write about. What really happened there? What is the truth? Vivek Kaul has an interesting take on these recent turn of events in his latest update on the Diary titled "Why Tata Fired Mistry".
After opening the day flat, the Indian stock markets fell below the dotted line. At the time of writing the BSE-Sensex was trading lower by about 130 points (down 0.4%), while the NSE Nifty was trading lower by 33 points (down 0.4%). Sectoral indices were trading in the red with metals facing maximum selling pressure.
04:55 Today's Investing Mantra
"In the business world, the rearview mirror is always clearer than the windshield."- Warren BuffettThis edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst).
Today's Premium Edition.
- The 'Must Have' Small Cap Stocks October 24, 2016
- Why we are bullish on some small cap stocks despite the high index PE.
- Your Insurance Could Be at Grave Risk October 22, 2016
- The government seems to be transferring public money from a cash cow to a dead horse.
- The Promoters Hell Bent on Multiplying Your Wealth October 21, 2016
- How is Your Company's Promoter Growing His Wealth?
- This Proven Formula Is Predicting Big Returns for Stocks October 20, 2016
- We use John Bogle's proven formula to predict the Indian market's returns over the next five years.
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