»5 Minute Wrap Up by Equitymaster

On This Day - 1 JUNE 2010
Will this help India overtake China's growth?

In this issue:
» The effect dividends can have on stock returns
» Why the strong GDP growth failed to cheer markets
» Do financial forecasts have any value?
» SEBI's clampdown extends to derivatives
» ...and more!!

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Perhaps the question that we ask most often to company managements here in India is how they are dealing with competition from companies in China. For Indian companies that sell within India, there is the fear of cheaper imports from China. For companies that export their wares, there is again competition from China that constantly hounds their share in the international markets. Indeed, China has flooded the world with its goods, becoming the big daddy of the global manufacturing sector. Thus giving sleepless nights to many an Indian promoter.

All this has been made possible by this one big competitive advantage that the dragon nation possesses - ultra-cheap labour. No wonder then that Chinese goods are some of the cheapest in the world. And this is one of the biggest reasons for their extensive popularity. But this may all be about to change soon.

Foxconn is the world's largest contract manufacturer of electronics that supplies to companies like Apple, Sony, Dell, Nokia and HP. It has recently been finding itself struggling to manage the rising expectations of younger workers at its 300,000 worker factory in China. Worker protests demanding wage hike have marred the operations of many units including that of Honda's in the past week.

China has traditionally looked down on worker protests. But instance like these have been getting more frequent of late. Reports suggest that manufacturers are struggling to attract and keep young workers. Brought up in an era of relative affluence, they are proving less willing to put up with poor wages.

India's manufacturing sector too has seen challenges in recent times. Particularly in the form of land acquisition delay and infrastructural bottlenecks. Also the least expected - terrorist attacks. However, China's 'low cost' advantage may not remain that challenging going forward. Thus, a more level playing field for Indian companies may be on their way. Could this be case for India taking over China's GDP growth rate? Time will tell.

 Chart of the day
Investors seldom take into consideration dividends. For most, they are simply cheques of measly amounts that they receive in the mail that do not really matter much. It is rise in share prices that matter to them. But as today's chart of the day shows, dividends are definitely not something to be ignored. It pegs the Sensex 'Total Returns Index' against the BSE-Sensex. The Total Returns Index, not known to many, also takes into consideration dividends announced by companies, and assumes them to be reinvested. While the BSE Sensex may be far from that magic 21,000 number, the Total Returns Index is well above that. Infact, it stood at a good 22,474 as per yesterday's closing.

Data source: CMIE Prowess

India's GDP growth has come in at a strong 8.6% during the quarter ended March 2010. This has however failed to cheer the markets. The concern probably lies in the consumption growth number. As per reports, India's private consumption growth stood at just around 2.6% during the quarter. This was almost half the growth achieved in the previous quarter (ended December 2009). The number was also not very encouraging for FY10 - at 4.3% as against 6.8% during the crisis year of FY09.

So, are the markets right in not giving much heed to these numbers? We believe yes. This is given the Indian economy is domestic consumption driven. It remains to be seen how the consumption numbers come in the current year. But if the growth remains lacklustre, it will be a matter of serious concern. This is especially with respect to sustaining a high GDP growth rate in the future.

It is a very important debate for investors. Do financial forecasts have any value? After all, the entire industry of traditional equity research is built on forecasts. An interesting article we read today says the problem is not with forecasting itself, but how it is done. You see, future is inherently uncertain or probabilistic. Hence, forecast cannot be single point estimates. They must be in terms of a probability distribution - with measures of central tendency (such as an average or median) and measures of dispersion or variation. The problem with most forecasts, no matter how detailed, is that they are only point estimates of central tendencies. So the underlying assumption is that the future is certain. It is not!

Much of the blame for the financial meltdown lies at the door of complicated models that did not sufficiently recognise the dangers of unexpected events. It is high time financial modeling embraced uncertainty and considered a wide range of events. In our view, the inherent strength of a discipline like value investing is that it specifically tries to counter uncertainty through a margin of safety. A practice the broader industry could benefit from.

Mis-selling of financial products has been the cause of global financial meltdown. But the pain is felt more acutely when ignorant retail investors lose their shirt gambling on complex products. With this in mind, mutual fund regulator SEBI has clamped out on this practice. SEBI has proposed a set of guidelines for vending financial products. Currently banks sell nearly a third of all financial products including mutual funds and insurance. Broking firms and portfolio managers also enjoy a considerable clout. However, their sales are guided by the sales executives' 'targets'. And not by the risk profile of the potential investor. This most often leads to mis-selling. SEBI's guidelines seek to penalize such act and ensure that investors buy only what suits them. It also seeks to limit the use of derivatives to portfolio hedging rather than as a speculative instrument. We believe that these guidelines could go a long way in regulating the maturity of Indian financial markets.

If you do not know the kind of impact good governance can have on business, just ask cement companies present in the eastern state of Bihar. On second thoughts, forget it. They may not even have the time to pay any heed to your question, thanks to the tremendous surge they are witnessing in the off take of cement. A leading business daily has put the growth number at 35%. Yes, that's right. Cement demand in Bihar has grown by 35% in the financial year FY10, coming as it does, on the back of a 13% rise in FY09. For close followers of the economic activity in the state, the numbers may not have come as a surprise.

It should be noted that in FY09, Bihar had the fastest pace of GDP growth among all states at 11.4% and this in turn seems to have boosted demand for all commodities, including cement. Also important to add that the cement demand is not coming from big infrastructure projects but is actually being driven by rural demand and demand from home builders and small businesses. As to how long this buoyancy will last? Well, if governance continues to be good, given the low per capita consumption of cement in state, demand should remain robust for quite some time to come. And this could well be music to the ears of cement companies present in the state.

Developed economies worldwide are facing sluggish growth while emerging economies are quickly breaking past records. While this growth may look good on paper, BRIC economies may be overheating and developing asset bubbles, according to renowned economist Nouriel Roubini.

High inflation, foreign capital inflows, and unfavorable currency appreciation are standard accompaniments for a quick-paced recovery, and the BRIC nations are not immune to these evils. Roubini, however feels that Brazil and India are still in 'better shape' than China due to the strength of their domestic demand.

All in all, positive GDP numbers may not look good for too long; unless inflation shows some respite, spending in developed economies improve, and structural reforms in the emerging nations are implemented.

Meanwhile, the Indian markets witnessed a negative trading session today after a weak start. At the time of writing, the BSE Sensex was down by about 290 points. The metal and energy indices led the pack of losers. However, pharma stocks have managed to hold their own. Asian markets across the board had a weak outing today. Europe has also opened lower.

 Today's investing mantra
"Volatility is a symptom that people have no idea of the underlying value - that they have stopped playing the asset game. They're not buying because it's a company with certain attributes. They're buying because the price is rising." - Jeremy Grantham

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