One rule every long term investor should know - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

One rule every long term investor should know 

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In this issue:
» Which of the two Chidambarams will show up for the budget?
» Unintended consequences of Japan's monetary easing
» Is China witnessing green shoots of recovery?
» Dr Doom is bullish on gold
» ....and more!

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Ask any chemistry student the atomic weight of a certain element and his answer would be the exact replica of the one given by any other chemistry student. But try asking why a certain business is successful to a group of 100 business experts and chances are you would get 100 different answers.

Given this background, is there no way for us to pick the right business to invest in and compound our wealth? For if there is no definite answer to why a business is successful, our stock picking would be reduced to a matter of pure luck. Fortunately though this is not the case. Of course, we cannot expect pin-point accuracy in something that involves so many human decisions. But there are certainly rules out there which when followed closely could certainly help us in investing in the right companies.

The most basic of these is that in order to succeed at investing, we have to invest in a company that is a part of the fastest growing industry. Right? Nothing could be further than the truth we believe. Because if an industry is growing fast, it will also attract a lot more competition. And thus within no time, your firm would either lose market share or its margins would fall so much that it will start earning no more than its cost of capital.

Thus, the rule cannot be that one has to always invest in a fast growing industry. For if supply is easily able to catch up with demand in such industries, then the profitability of all the players can come under pressure. Which is why the basic rule or the guiding principle has to be that we should look at such companies or industries where supply cannot easily catch up with demand. And even if it can do so, the costs involved should be very high.

Only when one of the above two or both conditions have been met will the firm under question be able to keep generating profits year after year. After all, isn't this very similar to what Warren Buffett calls a moat and places so much emphasis on. Thus, what an investor should look for is not high growth. If it is there, well and good. But even without high growth, a firm with a strong moat gives an investor the best possible chance at long term wealth creation. And this one rule every long term investor would do well to not forget.

What do you prefer? A high growth industry or companies with strong moat even if the growth is low. Share your comments with us or post your views on Facebook page / Google+ page

01:19  Chart of the day
Even as its neighbour China keeps recording current account surplus after surplus, India does not have even a fraction of that advantage. On the contrary, its external debt, one of the means to finance its current account deficit has constantly been on the rise. As today's chart of the day shows, India's external debt moved up to US$ 365 bn as on Sep 2012, more than 60% high than what it was around 4.5 years back. What more, even the cover that forex reserves provide to external debt reduced to 80% from 85% in March 2012. Clearly, another indication that the country does need to bring down its current account deficit.

Data Source: Financial Express

Voltaire, the famous French historian and philosopher has a famous quote to his credit, "Paper money eventually returns to its intrinsic value---- zero." The way central bankers and governments have been devaluing their currencies, Voltaire's insight may indeed be validated sometime in the future. The US Federal Reserve Chairman Ben Bernanke has received enough brickbats for his reckless money printing exercises. In recent times, Japan has been receiving a lot of attention, albeit for all the wrong reasons.

The newly elected Prime Minister Shinzo Abe seems ready to pull the accelerator on fiscal stimulus. And he also seems keen to control monetary policy by taking away the independence of Bank of Japan. His moves are directed towards ending Japan's decade-long fight with deflation. Export-oriented economies generally prefer to devalue their currencies to boost exports. But will a depreciating yen help the Japanese economy to bounce back? An article in Business Insider puts forth some serious doubts. For one, a depreciating yen does not have the same export-boosting power that it used to have earlier. On the other hand, a weaker yen will raise the prices of everyday necessities. This, in turn, would lower the real incomes of the Japanese people. It is worth noting that Japan has a significant aging population and relies heavily on imports of food, clothing, and energy.

December 2012 seems to have been a good month for the Chinese economy. Exports rose 14.1% from a year earlier. This was the fastest in seven months and well above November's 2.9% growth. Imports rose 6% in December from a year earlier after a flattish trend in November. Both these figures were better than what most had estimated. In addition to this, China also witnessed an increase in its trade surplus to US$ 31.6 bn from US$ 19.6 bn in November.

China so far had been witnessing a slowdown in its economy. Given that it has largely been export oriented, recession in both the US and Europe had hampered growth. The December numbers have, however, increased optimism that the economy is on a rebound. And a surge in Chinese GDP growth certainly augurs well for the global economy as well. But it would make more sense to wait for a few more months before taking a call on where the economy is headed. Although the December numbers are quite good, basing predictions on the health of the economy on one month alone does not seem too prudent.

We told you earlier why Union Budget 2013-14 is being eagerly awaited. The same is set to establish the fact as to whether the incumbent Congress government can live up to its words. The FM, the PM and many others have dismissed concerns on rating downgrade front. All on the hopes of economic recovery through reforms. When and whether such reforms will become effective remains the big question.

An article in Firstpost has taken a humorous stance on this. It talks about how FM Chidambaram has split personalities 'Mr Right' and 'Mr Wrong'. While the former is in favour of reformist policies, the latter would rather compromise on reforms to save his political career. It is true that Mr Chidambaram has given out confusing signals not just on tackling fiscal deficit, but on several other issues. Especially gold imports, disinvestment and higher taxes for the rich. Probably one will have to wait till the Budget speech is read out to know which Chidambaram wins over the other.

Dr Doom is finally bullish on something. And that is gold. Despite the recent correction in the price of the yellow metal, Marc Faber still believes that having gold in his portfolio is essential. The recent fall in the price of gold followed the deal averting the fiscal cliff in the US. As the US dollar was not headed towards doom, people stepped away from the safe haven metal. But in Faber's opinion, this is not going to last. Unfortunately his optimism has nothing to do with expecting a better outlook for gold. He wants to keep gold more as an insurance policy. Insurance in the event of the US dollar's devaluation. He expects the government to continue printing money. This would eventually lead to the devaluation of the US dollar. And if this happens, gold would be the best place to remain invested in.

Mr Faber's theory actually holds water in the current global scenario. Crisis hit countries are printing money in order to find a solution for their problems.

Unfortunately, they are either oblivious to or choosing to remain oblivious to the repercussions of this unlimited printing. Such a flood of liquidity may give them a temporary boost but would lead to the devaluation of their currencies. Take a look at what happened in Zimbabwe and you'll know what this money printing will eventually lead to. In such an event, gold would shine once again.

How long will it take for unemployment in the US to hit 6.5%? Well, with more and more graduates being churned out every year and fewer jobs in the market, this situation could take years. Why is the 6.5% benchmark important? When the jobless rate reaches this magical figure, from the current level of 7.8%, the Federal Reserve will start raising interest rates. Currently interest rates in the economy are hovering at benign levels of 0-0.25%.

The only thing that can reduce the unemployment rate is growth. But, the American economy has growth only at around 2% over the last several years. If growth suddenly sees a spurt and another recession is avoided, the jobless rate could hit 6.5% over the next few years. The average Fed forecast is for unemployment to drop to 6.3% in 2015. But, is this sustainable? The fiscal cliff has been avoided for now, but with the debt ceiling deadline looming, we wonder for how long this economy can survive on pumped up steroids.

Meanwhile, after opening in the positive, indices in the Indian equity markets moved in the red with Sensex marginally lower by around 20 points at the time of writing. Auto and PSU stocks however are bucking the trend. While Asian indices have closed strong today, Europe too is witnessing a positive trend.

04:54  Today's Investing Mantra
"It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities." - Charlie Munger

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5 Responses to "One rule every long term investor should know"


Jan 11, 2013

yes Companies with Moat will create wealth in the long run;(also we can not simply neglect the fact a company has MOAT would also be growing example 3M for instance moat of research);On that Logic gail should create wealth for investors in the long run.But will it ?Let us not forget the Govt.


uma shanker trivedi

Jan 10, 2013

very nice & educative reading.



Jan 10, 2013

The one rule every long term investor should know which Buffet calls it a moat or demand exceeding supply and even if the supply meets the demand it will be at a heavy price.

In other words can this rule be applied to a company which not only has got a first mover advantage but coupled to become a Top Dog too. Am I right?



Jan 10, 2013

The WRITEUPS under these columns are well researched &very informative .Pl. keep itup.

Like (1)


Jan 10, 2013

The writer says that the US currency will be devalued due to excessive printing.
I would like to know as to what will the US currency be devalued against since the govt all over the world are resorting to money printing to fund their socialistic obligations or to fund their spending programs. The only thing that will rise is commodity prices.

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