»5 Minute Wrap Up by Equitymaster

On This Day - 1 MARCH 2012
The most certain way to make money in stocks

In this issue:
» Government finances under a lot of stress
» Micro finance in India is alive and kicking
» Nifty is not overvalued with respect to peers
» Bill Gross' words of wisdom for investors
» ...and more!

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A small question to start with. What is it that determines the price of a product? Well, it is virtually ingrained in our minds that it is the cost of production that determine prices. But is this the right answer to the question? May be not. Because if this were true, tickets to an India-Pakistan cricket match would have cost the same as tickets to say an India-Bangladesh match. Or passes to a Rolling Stones concert would have come with the same money as say passes to a concert by some local band. But we know that this really isn't true. Thus, it is not really the cost of production that seems to be driving prices. But rather the value that people put on the product and the available quantity of it. In fact, cases can be found where selling prices actually determine the cost of production. For e.g. if people were to quit smoking, price of tobacco and other things like cigarettes could well fall to zero.

Surprising as this concept may sound, let us tell you that if used properly, it could become your sure shot ticket to the rich house. And do you know who the foremost proponent of this concept is? Well, none other than the Oracle of Omaha, Warren Buffett. The super investor has mentioned a countless number of times that he looks to invest in businesses with very strong moats. It turns out this moat is nothing but the unique ability of a firm to price its products in such a way that people are willing to pay far in excess of the cost price that has gone into its making. In other words, like the cricket match example, the value and cost associated with the product should be poles apart.

That's it. Even if you spend the rest of your lives looking for such businesses and end up finding only a handful of them, you are surely going to end up quite rich. This is because these businesses not only earn a high return on capital but are also a great hedge against inflation. People who value something won't mind paying a slightly higher price for it year after year, isn't it? Think of most of Buffett's most successful investments like Coke, Gillette, See's Candy, Wrigley etc and you will realise that buyers consider these brands to be premium. In other words, they don't mind paying for these products a price that is much higher than the cost and investment incurred to manufacture them.

Do you think investing in companies whose products are highly valued than its competitors the best way to make money in stocks? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
Today's chart of the day shows why infra stocks have found very few takers on the bourses in recent months. As is evident, it is the sector that has witnessed the biggest jump in debt restructuring cases in India. The total debt that has been approved to be restructured jumped more than 3 fold in Dec 2011 over March 2011. While the sum involved for the steel sector is the highest, the growth over March 2011 is only a paltry 4%. Telecom too has seen restructuring go up quite a bit in recent times.

Source: LiveMint

Regulations can at times make or break business fortunes. But management credibility and foresight also play a pivotal role. In fact the latter is instrumental in long term value creation. Look no further than the micro finance institutions (MFI) in India to get some solid examples in this regard. Both the Indian micro finance sector and its once blue eyed boy SKS have lost investor confidence. But statistics show that few rotten apples have not really spoiled the entire basket. In fact many smaller players outside MFI stronghold Andhra Pradesh have seen phenomenal growth over the past 2 years.

Regulatory changes have crushed the unsustainable margins of the larger entities since 2010. However, smaller MFIs like Bandhan and Ujjwan were proactive in slashing their lending rates. That too even before the regulatory overhaul occurred. The crackdown on Andhra Pradesh MFIs benefited them even further. Several reputed private equity investors took exposure in the smaller MFIs. The reason was better management, use of technology and good asset quality control. With the funds, these entities have managed to scale up their balance sheets. In fact Bandhan has taken over SKS in terms of share of MF loans in 2011. That the fortune of this economically benign business model is not sealed is a very enthusing sign.

The revenue deficit for FY12 so far has touched 109% of the budget estimate. This is even when the year is not yet over. The actual fiscal deficit for the year so far is 5% higher than the budgetary estimate. Further, although revenues and spending tend to spurt during the closing stages of the year, it is not likely to make a significant difference to the overall grim picture. So what has contributed to such bad numbers? The first is lack of buoyancy on the tax front on account for the economic slowdown. Second and more importantly, unrealistic revenue projections in the Budget itself. The government has been too conservative in estimating its expenditure, especially subsidies for fuel and fertilizers. Further, tax revenues till January were only 69% of the budget estimate.

Here it may be noted that in absolute terms, tax collections were higher than last year. But because the budget estimate was unrealistically high, the overall tax picture looks weak. The non-plan expenditure zoomed to 87% of the year's total in the first 10 months itself. The only silver lining in the cloud was that despite such constraints, the government did not cut back on capital expenditure which is an important contributor to GDP growth. Indeed, there is no doubt that the government will have to come out with some concrete solutions to address this issue. After all, there is so much that the central bank can do.

Investment firm PIMCO's Bill Gross has some wise words for investors in the developed world. He urges investors to embrace a defensive strategy. He cites two main reasons for this stance. One is the limit of zero-bound interest rates. And two, the systemic debt risk engulfing the global financial markets.

Let's try to understand this from a larger perspective. In the past few decades, asset prices in the US accelerated at a rapid pace. Who was responsible for this? None other than the US Federal Reserve. The central bank kept printing money recklessly. This gave a false impression of wealth creation. With the busting of the asset bubble in 2008, the grim reality of the developed world became evident. So what's going to be the 'new normal' in an environment of credit and zero-bound interest rate risk? In the opinion of Bill Gross, it's going to be muted growth, high unemployment and orderly deleveraging. For instance, falling interest rates lead to a decline in the interest component of personal income. Correspondingly, the spending power of consumers is adversely affected. This is a perfect example of how central banks can wreck havoc in an economy. Thankfully, our central banker back home is much saner than many of its counterparts.

Indian stock markets have had a steep rise in 2012. A sudden rise in stock prices has led to expansion in the price to earnings (P/E) multiple of the stock market. Thus, valuations have suddenly turned expensive when compared to other emerging markets. But before jumping to any conclusion we need to standardize the earnings to reflect consolidation if that is not the case. This is because consolidated earnings are a true representation of company's earnings.

Thus, a market that might appear expensive on a standalone basis might be cheap when consolidation comes into picture. This is precisely the case with Indian markets. The standalone Nifty P/E is 19.5x. And the consolidated figure is in the region of 15.2x. Thus, Indian markets still appear to be reasonably priced on a consolidated basis. However, they command a premium when compared to other BRIC nations. But that premium is attributable to high RoEs and strong growth prospects. And with foreign capital chasing growth, we expect the premium to sustain in future as well.

Meanwhile, indices in the Indian stock markets continued to trade weak right from the start today. BSE Sensex was trading lower by 170 points at the time of writing. Heavyweights like RIL and ICICI Bank were seen driving most of the declines. Most of the Asian indices also closed lower today. .

 Today's Investing Mantra
"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability - the reasoned probability - of that investment causing its owner a loss of purchasing-power over his contemplated holding period." - Warren Buffett

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