What Peter Lynch Would Tell You About Recent IPOs...

In this issue:

» New challenge for oil producing countries

» India's corporate earnings remain under pressure

» Revival of Indian banks on the cards?

» ....and more!

When was the last time you checked the non-performing assets of the bank you park your fixed deposits with?

When was the last time you checked whether the large retail chain you shop at is profitable?

Did you ever try to figure out if the movie multiplex you visit often is a company with positive cash flows?

How much dividend did your favourite airline pay to its shareholders?

These are rhetorical questions. My point is that our familiarity with these companies makes us so comfortable that we rarely bother to dig deeper.

This is where the anchoring bias kicks in. We evaluate the company based on our limited knowledge of its operations. For the bank, it is the interest rate it offers on fixed deposits. For the retailer and multiplex owner, it is the popularity and the footfalls. For the airline, it is the affordability, frequency, and punctuality of trips.

Our familiarity with their products and services clouds our opinion on the company. Eventually, we fail to differentiate between the two.

Company managements use this to their advantage. Whether it is for launching new products or schemes, the company banks on the popularity of its flagship offering. So far, so good. But what about investing in the company? Is the product's reputation a good enough reason to buy?

Well, if you consider the most popular IPOs of 2015, investors have been gullible enough to lap up stocks of very familiar companies. Adlabs Entertainment, Coffee Day Enterprises, Dr Lal Pathlabs, Interglobe Aviation, and Narayana Hrudayalaya are household names. The local Cafe Coffee Day's coffee shop and that cheap Indigo flight are more significant to investors than the companies' P&L and balance sheets.

And investors can defend this with the advice from legendary value investors who advocate buying what you know. So companies too seem to have borrowed a leaf out of Peter Lynch's One Up On Wall Street to promote their IPOs as 'known entities'.

Unfortunately, the depth of such knowledge is not sufficient to be invested in the company for the long term. You could buy your daily cup of coffee from your favourite cafe and travel with the airline that offers affordable flights. But before you buy the stock, you may want to check whether the coffee shop or the airline is and will continue generating returns for shareholders.

Incidentally, in a recent interview with the Wall Street Journal, Peter Lynch himself complained that investors apply his advice too loosely. Buying what you know holds good only when the knowledge of the company is all-encompassing. Moreover, nothing - not even your long familiarity with the business - should overshadow the price you pay for the stock.

Did you subscribe to any recent IPOs purely based on your familiarity with the company's products or services? Let us know your comments or share your views in the Equitymaster Club.

2.20 Chart of the day

The earnings of the Indian corporates for the past couple of quarters have been tepid. While the investment cycle is yet to turn, various economic and political factors have kept the earnings growth subdued. Rate cuts by banks have been gradual. Erratic monsoons have hit rural consumption. And key reforms have faced political logjams, which has hampered big investment projects.

India Inc earning to GDP bottomed out?

It is quite evident from today's chart of the day, that the corporate earnings to GDP ratio has hardly seen any improvement. In fact the ratio has continued to decline. Years 2007 and 2008 have been best for the Indian corporates in terms of profitability. In FY15, the ratio stood at 4.0%, the lowest since FY04.

While it may take a while for the ratio to go back to FY08 levels, the government's effort to kick start the investment cycle and put reforms in place, could be the much needed boost to earnings. Once the earnings cycle picks up, opportunities for investors will also come along by way of higher EPS growth and attractive valuations.

While corporate India continues to witness poor earnings growth, the challenge looming large over banks is the recovery of bad loans. As the Indian banking system continues to grapple with stressed assets the RBI has directed banks to clear these bad assets by 2017, through SDRs (Strategic Debt Restructuring). As we explained in a recent edition of The 5 Minute Wrapup, SDR accounts put together amount to Rs 641 billion of loans, or 1% of total loans in the sector.

On the positive side, as banks are actively taking steps to clear these distressed assets, it could spur M&A activity in the economy. Under various instances, the banks might be converting their debt holdings into equity. This means banks can they turn around the beleaguered businesses by successfully divesting their ownership stake to any interested buyer. Apart from relieving the bank of the stressed asset and the equity stake, this effort could bring about a revival in the economy as well.

Just few days back OPEC's decision not to cut oil production have further plunged the oil prices. And here is one more development which could further put adverse pressures on the oil prices. As reported in Mint, in a historic decision, US has decided to lift a four decade old ban on oil exports. Its reasons are far from economic cooperation with other nations. As OPEC seems set to spoil the viability of US oil production lower, this seems to be a desperate attempt by US to minimize the damage. Whatever be the case, in this major stand off, India seems to be a key beneficiary.

This might not immediately benefit India with prices on a decline and oil oversupply. But when the oil price trend reverses, India will have the choice to source it from non Middle East countries. With export ban no longer in place, India's oil sourcing options will be less concentrated. It will certainly make energy sector better positioned against the capricious oil prices and supplies.

After opening on a flattish note, the Indian markets have witnessed selling pressures and are trading well below the dotted line. At the time of writing, BSE Sensex was trading lower by about 296 points. All the sectoral indices were trading in deep red with stocks from software and banking sectors facing maximum brunt.

4.50 Today's Investing mantra

"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)." Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).