Have the facts of value investing changed?

Nov 15, 2011

In this issue:
» Equity investments at three decade low
» Should power be ceded to the state governments?
» The mystery in farm credit
» Is it easy for India to bail out Europe?
» ...and more!
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Think Buffett, think simple businesses at attractive valuations. Buying tech stocks, that too when they are near historic highs, is something that is as disconnected with Buffett as chalk and cheese. However, buying 5.4% stake in IBM at a time when the valuations were seemingly expensive does not seem to have bothered the veteran investor. Hence many of us would be left wondering whether Buffett has given up the principles he himself preached all his life. In fact in an interview to CNBC, he defended his decision saying "Sometimes business facts change and it's your job to attempt to understand them." So have the facts of value investing changed? We do not think so. And we believe that Buffett has good reasons to do what he is doing.

Let us explain. Buffett's distaste for tech stocks was because of his perception of the business being complex. Over the years that seems to have been sorted out especially with his reputation of being a lifelong learning machine. Hence his buying a tech stock is something that should not worry you at all. As far as the valuations are concerned, Mr Buffett seems to have got the math right there too. Investors must understand that unlike in India, Buffett and his peers in the US contend with risk free rates that are near zero. Hence that brings the cost of capital drastically low and improves the investor's appetite for risk. IBM's fundamentals and long term prospects seem to have fitted well in Buffett's risk reward calculations.

But does that leave you with enough reasons to buy stocks that look cheap only in the very long term? Well, the fact that the return on investment must offer a huge premium over the cost of capital does not change. Hence even if the business has tremendous prospects in the very long term, the margin of safety in current valuations must be adequate. For Buffett the lure of investing in safe stocks be it in the US or emerging markets, is far more than hoarding cash at near zero yields. In fact we will not be surprised if he were to show some interest in Indian IT heavyweights too given their strict adherence to Buffett's investing criterions.

Do you agree with Buffett decision to buy the stake in IBM? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
Uncertainty in domestic and global financial markets has taken an unprecedented toll on investment in stocks by Indian households. So much so that the equity investments (at cost) comprise barely 4% of household assets in 2011. The number was this low only twice in the past 40 years - 1971 and 1985. Save the period between 1971 to 1985 which was impacted by the after effects of wars, oil shocks and stagnation in the agricultural and industrial sectors, appetite for stocks has always been higher.

Data source: Morgan Stanley Report

Which side of the Chinese wall are you? Do you think China has become overheated and a severe recession is only a matter of time or you believe that the Chinese juggernaut will chug along at a robust pace for a few more years to come? Chances are that you may still be sitting on the wall, not wanting to jump on either side. But a gentleman named Arthur Kroeber has well and truly made up his mind. He has rubbished the claim made by people such as Chanos and Faber and has argued that with sensible policies China can reasonably expect at least another decade of high-speed growth. Thus, as per him neither is there an investment bubble in China nor is its housing market full of ghost cities. And he has gone on to provide a huge mountain of data to prove his point.

Well, we don't quite exactly have the same amount of data at our disposal to try and prove him wrong. But we do contend that it is almost impossible to believe that a nation can grow at such a good pace for such a long time without having any major problems. Sooner or later, the principle of reversion to the mean is bound to catch up with the dragon nation. Besides, there may not be an investment bubble in China currently and it would be earning good return on its investments. But as Michael Porter observed, if you are dependent on a few major customers, then your bargaining power and also your revenues, the GDP in this case, may not have the strength they should have. In other words, a machine that is overly reliant on only one motor to power itself up, may come to a screeching halt if that lone motor breaks down. China surely needs more motors and pretty fast at that.

Rewind back to 2006. You will see Lakshmi Mittal becoming the proud King of Steel after successfully tying the wedlock with hitherto steel giant Arcelor S. A. for a staggering US$ 41 bn. Unfortunately, just two years the financial crisis hit and turned the global economy upside down. Since then, steel demand has declined, creating trouble for the debt-laden company. In the past, Mittal had thrived by scooping up steel and coal assets to build a giant steel company. But the gloomy global scenario has severely impacted ArcelorMittal's income and profits. For instance, the company has had to cut down its production by 20% from 116 metric tonnes in 2007. Its share of the global steel market has also correspondingly dwindled from 9.5% in 2006 to 6.4% in 2010. It doesn't come as a surprise that the company's stock is down 50% from its 52-week high. Investors have an important lesson to take away from this story. How much ever lucrative the future prospects may appear, be extremely skeptical of expensive acquisitions through heavy debt. Even a maverick dealmaker like Mr Mittal could be caught on the wrong foot.

That India's infrastructure sector is suffering thanks to policy inaction by the government is not new. The sector has suffered severely due to the lack of decision making in large projects with regards to land and environmental clearances. But the big question is how can this be resolved? Will the sector continue to face headwinds forever? The question was raised at the World Economic Forum's India Economic Summit. A possible solution for this is to empower the state governments to take a decision particularly when the projects are halted due to lack of environmental clearances. Currently, the Central government is in charge of all environment clearances for large projects. If the power is ceded to the state governments, it could speed up the entire process. But would the state governments be able to use the power efficiently and not abuse it? There are too many examples of state governments abusing the powers given to them. The Karnataka mining scandal is still fresh in everyone's mind. Therefore the Centre ceding the power to grant environment clearance to the States without putting the requisite checks in place may not really help anyone. Except to increase the level of corruption.

Though the credit of India's economic growth in the recent years goes to services and industrial segment, the importance of agriculture as mainstay for a majority of the population can hardly be understated. Ironically, despite an increase in credit extension to the farm sector at lower interest rates, the agrarian economy remains in tatters. What could be the missing link? A research by a bunch of individuals has brought some interesting facts on the table. While there has been some pick up in the growth in agriculture, much of it is on account of cotton production. The definition of farm credit has not just limited to loans to farmers. It is now dominated by the credit that goes to institutions to support agriculture growth, like buying land for godowns, keeping marginal farmers at bay as far as benefits of farm credit growth are concerned. The only logical conclusion that flows is that while farm credit has grown, it has not reached the marginal farmers, who logically should have been the biggest beneficiaries as per the ruling party agenda of an all inclusive economic growth. This is further supported by the fact that most of the loan off take has been from urban areas and in the high credit category, implying the benefits have instead been extended to other lucrative avenues, loosely defined as associated to farming.

While concrete evidence is still some years away till we get results of decennial All-India Debt and Investment Survey, there is something definitely fishy in farm credit disbursals. The question is- will we just wait till the fears are confirmed or do some damage control in the mean time?

Leading Asian economies may have emerged relatively unscathed from the global financial crisis as compared to their developed peers, but it would be wrong to assume that the former are completely immune from the ills afflicting the global economy. Indeed, because countries such as India and China do rely on exports to augment their GDP growth, the view is that they should chip in to help the Eurozone. In this regard, the Asian Development Bank (ADB) has called for both these countries to do all that they can to speed up the recovery of Europe and avoid a long term downturn that will thwart the growth of Asian economies as well. Of the two especially, China has more to lose as a significant chunk of its growth in the past was driven by exports, whereas India's growth has largely been driven by domestic consumption. But how easy will it be for India to come to the aid of Europe? Not very easy, we believe. Although it cannot be denied that a weak global economy will have its impact on the Indian economy as well, India has its own issues in the form of poor infrastructure, poverty and high inflation among others. Hence, diverting resources to bail out Europe rather than channel them towards improving the living standards of its people is certain to draw a lot of flak.

In what has been an extremely volatile session, the indices in Indian stock market today oscillated to either side of yesterday's close. At the time of writing, the BSE Sensex was trading lower by 119 points. While realty, steel and banking stocks are out of favour, pharma and auto stocks found some buying interest. Other key Asian markets are trading a mixed bag while Europe has opened on a positive note.

 Today's investing mantra
"It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent" - Charlie Munger

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3 Responses to "Have the facts of value investing changed?"


Nov 15, 2011

enviromental clearance power should not be given to state governments; they are nothing but corrupt.For instance people like Karunanidhi will bring legislation to grant environment clearance on caste basis meaning if the project is promoted by a backward perso ,it will be cleared irrespective of what impact it makes on environment.

there are many MITTALS in india also who suffer because of costly acquisition funded by debt..may be tatasteel..vijay mallaya..



Nov 15, 2011

Pls stop writing about Uncle Warren ... check this out

Guess who sold his soul !

"......Now we know why Warren Buffett exploded onto the political scene late this summer. At first, we thought his calls for higher taxes on the rich were a ploy to help him "earn" a seat on Obama 2.0's cabinet.

It's something much more sinister -- much more greedy.

It was nothing but a ruse to keep regulators out of his hair. You scratch my back, he told the feds, and I'll scratch yours.

WARNING: What you are about to read is a graphic display of what is wrong in America...

As of Oct. 28, Warren's Berkshire Hathaway had $29.7 billion worth of credit-default swaps linked to its debt. It's a figure that is hair-raisingly close to a number pulled out of thin air on Oct. 11 by the Financial Stability Oversight Committee -- the Wall Street sheriff's department created by Frank-Dodd.

The proposed rule says if a firm creates $30 billion worth of CDS exposure, it gets extra scrutiny from Bernanke and his troops at the Fed.

Imagine that... Uncle Warren slips under the radar by a whisker. And all he had to do was make a few pro-tax headlines.

Now that the rules are on paper, where's Warren? We haven't heard anything from him on his tax plans since, oh, say, 30 days ago. Go figure.

It begs a question... why would Uncle Warren sell his soul to throw the feds off his scent?

We'll answer with a question... Would you want Tim Geithner and Ben Bernanke running your business?..." (Andrew Snyder )


kirit shah

Nov 15, 2011

Sir, everything you wrote and observed cannot be neglected , but investing is an art and there is no common formula that can be blindly followed, yes one has to have the judgement and satisfation on achieving goal. Market will definitely confuse short term and long term investors.Your artical and study of indian situation is informative and useful.

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