|»5 Minute Wrap Up by Equitymaster|
On This Day - 10 JANUARY 2012
Should one only invest in large cap stocks?
In this issue:
Investors would do well to recall that valuations in 2007 had reached astronomical levels. The important thing to note during that time was that companies across market capitalizations were trading at much higher prices and thus even businesses with good fundamentals were looking quite expensive in the overall bull run in that year.
Therefore, we believe that generalizations such as companies with higher market capitalizations do better than those with lower market caps may not be the right thing to do. There are certain parameters that have to be given their due consideration. This means that if a company has a strong balance sheet (good return ratios, not too dependent on debt with strong cash generation), good competitive advantage (in terms of products, brands, market share, pricing power) and more importantly reasonable valuations, there is no reason why such companies should not reward investors in the long run. In these scenarios, it does not really matter if the stock is large cap or midcap provided it more than adequately meets the above mentioned criteria.
Thus, a highly volatile market such as one that we are witnessing now provides a fertile ground to investors to do some research and invest in good quality stocks at bargain prices with a long term investment horizon.
Let's first understand what led China into becoming the global manufacturing hub. There were three main reasons: cheap labour, cheap currency and robust government initiatives to attract foreign capital. However, the Chinese yuan has appreciated by about 20% against the US dollar over the last five years. During the same period, China's annual inflation has on an average been 1% higher than that of the US. What is also worth noting is the fact that between 2005 and 2010, pay and benefits surged by 19% annually for average Chinese factory workers.
Compare that with a modest rise of only 4% for US workers. By 2015, BCG estimates US manufacturing to be just as economical as Chinese for many goods made for North American consumers. In fact, after hitting a low of 8% in 2008, the US share of global exports has been on the rise. This means good news for the US dollar but bad news for emerging economies including India. Many believe that the Indian rupee has been beaten down mainly due to the Eurozone crisis and will regain lost ground once the crisis eases. However, if the US economy does make a comeback, and the Indian economy continues to suffer from a high current account deficit and high inflation, the rupee may remain depressed for much longer than we think it should.
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