An alternative method to investing in quality businesses - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

An alternative method to investing in quality businesses 

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In this issue:
» Gold to reclaim its safe haven status in 2014?
» Bitcoins: Soon to be extinct.
» Another bubble brewing in the US realty market.
» China's uncertain future.
» ...and more!

00:00  Chart of the day
Strong brands. A healthy balance sheet. Good management. Steady long term growth rates. Above average return on capital. These are just some of the many traits of good quality businesses.

There are quite a few companies that have consistently performed well on the back of their strong moats being in place. And with that, their earnings have been on the rise even during gloomy times and uncertain economic conditions. And in the process, their stocks have outperformed the broader markets as well.

However, on the back of the love of the market participants for such companies, it seems that the valuations that these good quality stocks have been commanding in recent times is making it difficult for long term investors, especially the value seeking ones, to find a good and comfortable entry point. While one may argue that growth rates are expected to remain firm over the next few years and because of their infallible qualities, they should command good premiums over their peers.

We do not contest the same. Good, solid businesses having strong moats ingrained in their business models should command a premium. But, overpaying for them at valuations that are close to their all time highs is not something we are comfortable with. At the end of the day, these valuations are based on growth assumptions. And the way the stocks are trading at current valuations, the justifiable growth rates expected are seemingly quite high, which in our view would be difficult to sustain over a long period.

Nevertheless, since a lot of assumptions go into figuring whether valuations are justified or not, we thought a good alternative way for investors to look at the attractiveness of a stock is by gauging its dividend yield chart. Since high quality companies have the tendency to payout a good portion of their profits, and that investors would be buying into such businesses for earning good dividend yields over the long periods, a good way to gauge the attractiveness of such companies' stocks would be by looking at its dividend yield chart. The same has been made displayed in today's chart of the day.

An alternative way to gauge a stock's attractiveness
It may be noted that we have excluded the special
dividends that were paid out so that there are no spikes in the yields.

For making the chart, we have taken the dividend paid out of the previous year and divided it by the stock price over the next year. For example, the dividend paid out in CY02 for a company is divided by the stock price from 1 January till 31 December, 2003. This is done with the assumption that investors would at least be expecting the same dividend per share as was paid out in the previous year.

Looking at long term trend of the same, investors could gauge the attractiveness of such quality stocks. Average dividend yields for the longer periods would be a good starting point we believe. When stocks are trading at dividend yields above the long term average, one could term the stock to be an attractive one and vice versa. It may however be noted that this method would be applicable for consistent performers that have been paying out dividends for many years.

Do you take dividend yield into consideration while buying stocks? Let us know your comments or share your views in the Equitymaster Club.

Investors flocked to them in 2013 in the hope of keeping their portfolio safe and sound. But seeing riskier asset classes like stocks outperform gold and bonds by a wide margin left them thoroughly disappointed. In the case of gold especially, investors could be once bitten twice shy in 2014. The yellow metal plunged in 2013 and recorded a year on year fall after a decade. The US's claims of economic recovery and no signs of inflation made the case against stocks weaker. As a result excess liquidity fled gold and went into stock markets. Similarly bond yields too displayed trends contrary to expectations. The Fed's intent of reducing bond purchases gave a push to bond yields. As a result bond prices went lower. In the US, the yield on the 10-year Treasury note climbed from 1.8% to as high as 3% in 2013 as investors sold bonds in anticipation of the Fed's pullback. However, as per Moneynews, gold may reclaim its 'safe haven' status sometime in 2014 itself. Economic and political instability world over shows no signs of receding. And hence investors should not make the mistake of doing away with safe assets like gold and bonds from their portfolio.

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Here's another one on Bitcoins. An article over at Bloomberg highlights how the virtual currency is a high-tech dinosaur soon to be extinct. And the rationale? Well, all one has to do is separate the technology from the currency and we are left with a system that has existed before too. The author goes back in history to illustrate examples of how alternate currency systems were prevalent in many countries at one point in time or another. But were they able to replace the fiat currencies? Certainly not. In fact, it was the Government controlled money that spelled the doom for alternate currencies. And hence he argues that it is not going to be any different for Bitcoins. While the author is correct on all other form of alternate currencies, how is he going to explain the value that has been so wonderfully retained by the yellow metal gold? And this has always been the core of our argument. While we are not sure whether Bitcoin will survive another few years, gold's history shows that it is more likely to be around many more centuries in the future. And thus, if at all one wants to protect oneself from the devaluation of fiat currencies, gold and not Bitcoins is the place to be in our view.

Predicting market bubbles is a race against time. You have to be ahead of the curve to see the unforeseen. Also, since you would be against the herd, there would be a need to have a strong conviction to stand your ground. So, when someone who has had two forecasts rights on the money, makes the third one, it is natural for us to lend our ears to it. We are talking about Noble Laureate, Robert Shiller, who in the past accurately predicted the stock bubble of 1990's and housing bubble of mid 2000's. As per him, there is another bubble brewing in the US housing industry now. The S&P/Shiller index which tracks home prices of 20 cities has risen by 13.6% in 12 months until October. This is the biggest gain in the last 7 years. A rise in the index obviously indicates that the property prices are rising. And this is not because the fundamentals of real estate industry have changed. It is because of cheap liquidity which is finding its way into asset prices including real estate. The sub-prime crisis was a result of reckless lending. And if this price rise turns out to be consistent and culminates into a bubble, it would be a result of Fed's monetary experiment with cheap liquidity.

China has seen stupendous growth in its GDP over the last decade. So much so that when the global financial crisis struck in 2008, much hope was pinned on the dragon nation to rebalance global growth. That has not really happened. No doubt the country has become a force to reckon with in the international arena. But steadily, many of the ills afflicting the country are also coming to the fore. For starters, the engine of China's growth was exports and investments, both of which have slowed down. Indeed, prolonged recession in the developed world has weakened exports from the country. Domestic consumption is not enough to support growth. As a result, there has been a dependence on debt financing. This has been through loose monetary policies. Indeed, according to George Soros, the challenge for China going forward will be achieving a balance between maintaining growth and amassing debt. For the time being atleast, China's future does look a tad uncertain.

In the year 2013, the Indian share markets saw a lot of ups and downs. Nonetheless, the benchmark BSE-Sensex ended the year with a modest annual gain of about 9%. But it is worth noting that this upside was largely attributable to strong FII inflows. On the other hand, domestic mutual funds remained net sellers are there were high redemption pressures. While FIIs bought stocks worth Rs 140 bn during the year, mutual funds sold stocks worth Rs 220 bn.

Now the question is - will the new year see a reversal in the mutual fund trend? If the head of India's largest mutual fund is to be believed, revival could be on the cards. In an interview with ET, Milind Barve who heads HDFC Asset Management shares his views on the markets and the challenges for the mutual fund industry. Mr Barve has a positive outlook on the stock markets over the medium to long term. But the mutual funds are struggling to get new equity inflows. The reason being that retail investors are wary of investing in stocks. The only silver lining is that the redemption pressures have reduced in recent times.

In the meanwhile, Indian stock markets slipped below the dotted line after opening the day on a firm note. At the time of writing, the benchmark BSE-Sensex was down by 144 points (0.7%). Barring software stocks, all sectoral indices were trading in the red with the stocks from the capital goods and FMCG spaces leading the losses. Asian and European stock markets were also trading mixed.

04:55   Today's investing mantra
"Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and stock mutual funds altogether." - Peter Lynch
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4 Responses to "An alternative method to investing in quality businesses"

Cvr jogarao

Jan 10, 2014

The presentation is quite lucid. In general PSU companies give a much higher dividend 3 to 5 percent of price per share compared to private sector companies some of which do not give even 1 percent.



Jan 4, 2014

Yeah. Dividend is an important criterion when buying stocks as investment.Traders need not bother about dividend.

Like (2)

K.S.Yousuf Ali

Jan 2, 2014

Can Equity master help us by providing a short list of good dividend yielding stocks.

Like (3)

K.S.Yousuf Ali

Jan 2, 2014

Yes. I also believe in taking into consideration the dividend yield in long term investing

Like (5)
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