An investment mistake one should never make! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

An investment mistake one should never make! 

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In this issue:
» World's best bond fund manager on US debt
» Bumper 3Q in store for IT, but are valuations cheap?
» Public and private sector IPOs to again lock horns in 2011
» Food prices at an all time high globally
» ...and more!!

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Clearly, no other cult has grown as much in recent times as Facebook. At last count, the social networking giant had membership that had swelled to a mind numbing 500 million. To put things in perspective, if thought as a separate nation, Facebook would be the third largest country on the planet.

Quite certainly then, if a firm of the calibre of Facebook is coming up for listing, one would certainly want to invest in it. But there is a small question that begs itself. To what extent would one be willing to go to become a shareholder in the company? Surely not to the extent that Goldman Sachs has gone we believe. Apparently, the world's largest investment bank has picked up a stake in Facebook that values the latter at a whopping US$ 50 bn!

Allow us to tell you why we think this one of the most ridiculous deals we have seen in recent times. You see, Facebook is expected to generate revenues to the tune of US$ 2 bn in 2010. Thus, Goldman Sachs seems to be valuing Facebook at an exorbitant price to sales multiple of 25 times! To give an indication, Google, which generates nearly 1,300% more revenues than Facebook trades a price to sales multiple of just 6.5 times. Mind you, the fact that Google's multiple also looks extraordinarily high is not even being considered here.

If you thought that brokers and investment banks like Goldman Sachs have your best interests in mind, this example would perhaps force a complete rethink. Make no mistake, by way of underwriting fees and its marketing and sales muscle, Goldman Sachs will no doubt make money from the deal. It will also try and ensure that when the IPO hits the market, the total valuation of Facebook is even more than US$ 50 bn. It is up to you to decide whether deals like these make any sense to you. As per us, such investments should be avoided at all costs. After all, isn't margin of safety the cornerstone of investment success?

01:12  Chart of the day
Today's chart of the day shows how gold and silver investments have fared over each year over the last decade. Important to add that over the entire decade, while Gold has turned out to be a 5-bagger, silver, its precious metal counterpart has performed much better and has turned out to quite close to a 7-bagger. Will they repeat their stellar performance in the forthcoming decade as well? Our guess is perhaps as good as yours but we believe that they could be good investments as long as Governments keep their printing presses running over time and keep on raking up debt by the trillions.

Source: Casey's Daily Dispatch

Keeping with precious metals, let's hear what the commodities champion, Jim Rogers, thinks. According to him, silver prices have more room to grow than gold prices. Silver is still 40% below its all-time high. So, it is far from any bubble territory yet. He has disclosed that he still owns silver. But he is not very willing to buy at the current level as silver prices have shot up quite a lot in a short period. But he is surely not selling it anytime soon. He will buy more of it when prices dip. As far as we are concerned, our founder, Ajit Dayal sums it best and also echoes our view when he says that gold should be viewed as a form of insurance rather than an investment avenue. To that extent, timing the purchase could be futile. Just keep accumulating small amounts at periodic intervals.

IPOs had a great outing in 2010. While there were a lot of public offers by private players, the notable feature during the year were public offers by PSUs. The latter were especially much more attractive, fetching better returns to investors. The reasons were simple. Most PSUs that came out with IPOs had good financials. Plus, because the government wanted to divest its stake, it wanted greater investor participation. In fact, IPO proceeds flowed to the government and not to the PSUs. And so, these issues were priced very attractively.

This was in sharp contrast to IPOs by private players which were very aggressively priced with not much headroom for strong returns. Now, the year 2011 is also expected to be another strong year for IPOs. What is more, more public offers by PSUs are lined up. This means that private players will have to seriously think hard and not price their IPOs at exorbitant levels. Real estate players especially will have a much harder time. Investors have learnt their lesson well and will be choosier while putting in their money into IPOs. And an expensively priced IPO by a private player will only mean that investors will flock to the more profitable PSU IPOs.

When it comes to investing in debt instruments, you would obviously go for the best rated one. But what if the biggest debt fund manager in the world asks you to do otherwise? Chances are that you would ignore the fund manager's opinion and do what seems obvious. In that case let's tell you that you would be making a huge mistake.

Bill Gross who looks over the world's biggest bond fund PIMCO favours emerging market debt over US Treasuries. He believes that the latter is set to lose its top credit rating anytime soon. And this belief stems from the fact that the US Fed is nowhere close to stop its currency printing press. While the US government goes on to accumulate trillions of dollars of more debt, the government papers will deteriorate in safety and value. And saner rating agencies will not shy away from de-rating US Treasuries. In such a scenario, investing in more mortal emerging market debt seems like a more lucrative option. For neither are these economies set to go in US-like economic tailspin anytime soon. Nor are the interest rates here going to get any closer to that in the developed economies.

The Indian IT industry has witnessed spectacular growth in the past couple of quarters. Revenues were boosted by increased demand. Deal pipelines were healthy and plump. In fact most experts expect that the tailwinds of these pipelines to flow into the third quarter as well and make it another good quarter for the companies. However, they expect rupee to play a spoil sport on the margin front.

We do agree with the experts that stronger deal pipelines would definitely help the IT companies dish out a better third quarter performance. It may even offset the impact of lesser number of billing days that is typical of the December quarter. Interestingly, the stock performance of the IT companies has mirrored their robust financial performance. The IT companies have seen substantial run up in their stock prices and are now commanding ridiculously high valuations. This means that people in the market expect the spectacular growth to justify the premiums being paid. We beg to differ in this view. While we do believe that their revenue performance should remain robust for times to come but this still does not justify the expensive valuations that most companies are trading at.

That the world is facing a food shortage isn't any news. But that food prices will rise so fast in response to this scarcity has come as a shock. Food prices now, in fact, stand at levels higher than what they reached in 2008. We had then seen food riots across several countries, including India. Given that the situation has worsened again, the world again remains on tenterhooks. Sugar, corn, wheat, cereals, cooking oil, vegetables, you name it and the prices are shooting through. Natural disasters that destroyed crops, first in Russia and now in Australia, also take a share of the blame. We just fear what could happen if things get even worse!

Meanwhile, Indian stock markets continued their downward journey today with the BSE-Sensex trading lower by more than 100 points at the time of writing. Heavyweights like L&T and ONGC were seen causing most of the damage. Most Asian markets closed strong today while Europe has also opened on a largely positive note.

04:55  Today's investing mantra
"I'd be a bum on the street with a tin cup if the markets were efficient." - Warren Buffett
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1 Responses to "An investment mistake one should never make!"

C S Radhakrishnan

Jan 6, 2011

I am responding to the observations on the Face Book
deal by Goldman Sachs and on the IPOs of Private
Companies versus those of the Indian PSUs.
A comparison between the market pricing of Google and
Face Book is not valid.To begin with the valuations of
Google are based on its established revenues and some
good guess on future potential.In the case of the
latter, it is just a wild guess that the huge membership
will necessarily convert itself to revenues when that
factor is leveraged. I agree that the valuation offered
by the leading Investment Banker is considerably at
variance from its established reputation as a
conservative Banker. One can only wish them and their
shareholders good luck to have the dream materialized.

It is not everyone's case that the fundamentals of all
Indian PSUs are generally sound. There are gems like the
Navaratnas and then there are those which survive on
Government blood transfusions.The sterling performance
of the recent PSU issues should be an eye opener for the
Private companies seeking public support for growth. The
below par performance of the shares priced abnormally
high should warn those waiting in the wings. The total
volume of investment cash available, including the
FDI,is broadly limited. Money going into acquiring PSU
shares is mostly recycled cash after downloading other
shares.There is a valid justification for such re-
routing of investment. But such an attraction does not
exist for most of the new private offers.

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