»5 Minute Wrap Up by Equitymaster

On This Day - 5 OCTOBER 2012
Peter Lynch would never buy this stock

In this issue:
» While FIIs were buying, mutual funds were selling
» Rupee hits 6-month high. Will the recovery sustain?
» Govt announces FDI in pension and insurance
» China in dilemma over US dollar
» ...and more!

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Peter Lynch. The man is credited with being one of the most successful fund managers and a strong proponent of value investing. With some of his best-selling books on investing, he shared some great insights about how small investors could go stock picking. One of his most important lessons for retail investors has been-'Invest in what you know.' He insisted investors to look at businesses around them, especially products and services that they came across in their routine life. That's indeed a very useful starting point. If an investor doubles up as a customer, he can get very good idea about the company's business strength and its position relative to competitors.

But there is a caveat. A great service or a popular brand need not always translate into a great investment for shareholders. Take the example of Facebook. Recently, the social networking website announced that it had crossed a remarkable milestone of 1,000,000,000 active monthly users. That's one billion! In other words, one in every 7 people is an active Facebook user. In fact, 5.5 crore users are from India alone.

But the shocking fact is that the stock has been a disaster for investors. Ever since Facebook IPOed in May 2012, the stock price is down a whopping 42%. Despite the growing user base, it is still unclear how the company will leverage the same to make money.

This is a great lesson for all investors. A company like Facebook enjoys great brand equity and a huge user base. Yet it has no clear plan that will drive revenues and profits. And it's important to understand that the most vital factor that drives share prices is earnings. So, though it is a great idea to look at businesses around you, this should only be the starting point. It is crucial to take into account factors that would drive earnings over the long term. And finally, the most important aspect is valuations. Investors must always buy stocks at a sufficient margin of safety.

Do you know of Indian businesses that despite their leadership position have failed to create wealth for shareholders? Let us know yourcomments or post them on our Facebook page / Google+ page

 Chart of the day
Since the beginning of 2012, FIIs have favoured the Indian share markets. In tandem, the BSE-Sensex has gained nearly 23% during this period. However, it comes as a surprise that that the Indian mutual fund industry has missed out the stock market rally. As per a leading business daily, two-thirds of multi cap funds have underperformed indices such as BSE 100, BSE 200 & BSE 500. While there have been heavy redemptions by unit holders, in our view, this should not be a reason for the funds' underperformance. Though one can argue that the performance should not be judged over the short term, the long term performance of several equity schemes has also been dismal. Even market regulator Securities and Exchange Board of India (SEBI) has expressed its concern regarding the consistent poor performance of mutual fund schemes against the respective benchmarks through many years.

Data source: Business Standard

Whether Indian stock markets will touch new highs this year is anybody's guess. But the trend that is equally engrossing for bankers, economists and policy makers this year is the rupee's gain against the US dollar. The rupee recently rose to a near six-month high against the US dollar. This was primarily in response to recently announced reforms. The measures to attract foreign investment in the areas of retail, insurance and pension has revived interest in the Indian currency. Moreover, the government's keenness to improve India's fiscal status has given some confidence in the state of the economy. However, it is unlikely to be a smooth ride for the rupee. Political uncertainty and relatively weak economic fundamentals is likely to make the currency gains vulnerable from here on. Moreover, the proposed reforms will face a tough fight in Parliament before they stand a chance to get passed as bills. Hence, investors and importers may make hay while the rupee outshines the dollar. However, the resolution of fiscal and current account deficit problems will decide its final fate.

A few weeks back the government announced its reforms related to FDI in retail and aviation. Yesterday it gave another set of positive announcement on the reforms front. This time it has opened up FDI in pensions, increased FDI in insurance and approved the new Companies Bill. That has given quite a bit to cheer about as far as announcements on reforms go. However, would they have a positive impact on the markets and India Inc? Well, eventually they will. But the problem is that for most of these reforms to actually have any effect, there is a need to get these Bills passed in the Parliament. And that's where the problem lies. The thing is that the government has lost support of a key ally. Amongst the ones that remain, not everyone is gung ho about these reforms. At the same time there is the Opposition as well which is not keen on these either. So passing the Bills may face difficulties. However, if political hurdles can be removed then these reforms bode well to boost the investment climate in India.

There is this old saying which says that if you owe your bank US$ 100 then it is your problem but if you owe the bank to the tune of US$ 100 million then it well and truly becomes the bank's problem. Now, replace the individual with the US Government and the bank with the Chinese Government and it becomes clear who's more worried about the serious debt situation in the US.

But is China doing anything about this problem? It certainly wants to. But its hands are tied we believe. The US$ 3.2 trillion in forex reserves that it has accumulated over the years is no small amount. And hence any aggressive gesture on its part like a hasty exit or doing most of its forex transactions in its own currency could end up hurting China itself. It will thus have to proceed with caution on this front.

As an article in Business Insider points out, China will have to take calibrated steps to push up its real exchange rate by around 3%-5% a year. This increasing purchasing power in the hands of Chinese people could eventually help the economy to lift domestic consumption to a sizable portion of around 50% of GDP. What more, it could also help the US boost its exports and thus reduce its debt burden. Thus, this looks like the only sensible way out we believe.

The capricious oil prices never fail to surprise. There was no fundamental reason to support the rise till mid-September 2012 despite an oversupplied market and slowing world economy. Except for one that speculations outweigh logic for this commodity. It was perhaps the fear of a possible conflict between Iran and Iraq that kept oil prices high. And when one would have expected the trend to continue with QE3 coming into scene, just the opposite happened. The oil prices tumbled. While this can be partly explained due to Israel's easing stance towards Iran, the timing just suggests that the event was already priced in.

With supply story tilting towards surplus, demand slowing down in the key developed economies and China showing signs of a slowdown, the easing of oil prices show that markets are finally giving fundamentals their due importance. So shall we expect oil prices to fall back to the level of US$ 80 per barrel? While fundamentals suggest so, it would be naive to assume that they will govern the oil prices. After all, the political risks are not over and liquidity is yet to come. And predictions seldom come true for a commodity as slippery as oil.

In the meanwhile, Indian share markets have recovered partially and are off the day's low. At the time of writing this, the benchmark BSE-Sensex was down by 131 points (-0.69%). Banking and IT stocks were trading weak while Capital Goods stocks were trading strong. Asian stocks were trading strong. Indonesia and Singapore equity markets were the biggest gainers. The European markets also opened on a firm note.

 Today's Investing Mantra
"So it's a terrible mistake to look at what's going on in the economy today and then decide whether to buy or sell stocks based on it. You should decide whether to buy or sell stocks based on how much you're getting for your money, long-term value you're getting for your money at any given time. And next week doesn't make any difference because next week, next week is going to be a week further away. And the important thing is to have the right long-term outlook, evaluate the businesses you are buying. And then a terrible market or a terrible economy is your friend." - Warren Buffett

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