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An Investment Secret Almost Guaranteed to Give Great Returns

Jan 14, 2016

In this issue:
» Indian aviation sector flying high these days
» China's bid to defend the yuan may go awry
» ...and more!
0.00
Rahul Shah, Co-Head of Research

Its results time for India Inc. And while most results have been in line with expectations, Bajaj Corp's quarterly results really got me thinking about companies that kill it over the long term...

For the fifteenth time in a row, the company has managed to keep its operating margins in a tight range. In fact, margins expanded last quarter, leading to a bottomline growth of 20%. Topline growth was tepid at just 4%, but operating margins were rock solid, which has kept operating performance in good spirits.

In investing parlance, what Bajaj Corp has achieved is called pricing power. The company's key raw material is crude oil. The commodity's crash over the past few months has significantly cut the company's cost.

But did it have to pass these savings on to its customers? Certainly not. Therefore, while the product prices remained almost the same, the fall in raw material prices helped boost the company's operating performance. But what happens when the price of crude rises? Well, the company passes it on to customers in the form of higher product prices.

This makes Bajaj Corp one of the few companies that can have its cake and eat it too. When the environment is inflationary, it can maintain margins by passing on input cost increases, and when the environment turns deflationary, Bajaj gets to keep the savings.

Little wonder Warren Buffett sees pricing power as the single most important aspect of a business. If you've got a business that allows you to raise prices to keep up with inflation, you've got a terrific business in my view.

Now, let's take this a step further. How about a business with above-inflation pricing power? This may seem absurd, but there are cases of companies unleashing their untapped pricing power by increasing prices at a frenetic pace over the course of a few years. Of course, a company cannot indefinitely increase prices above the rate of inflation. However, it can for a limited amount of time, and investors smart enough to notice are hugely rewarded.

An example that comes to mind is Page Industries. Our analysis suggests that between FY11 and FY14, the company increased the price of its key product around 11% per annum, significantly higher than the 6-7% inflation rate. Page Industries has pricing power all right. But realising that it can raise prices at a rate higher than inflation without affecting demand was a bonanza for shareholders.

And that's the key takeaway here. Inflation-adjusted pricing power is a potent weapon for long-term market returns. However, a company that has an above inflation pricing power that it can maintain for a few years takes it to an entirely new level.

How about sharing your experience in investing in such a company? Let us know your comments or share your views in the Equitymaster Club.


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2.35 Chart of the day

The Indian aviation sector in on a high, literally. Listed airline stocks are busy touching five-year highs these days. And as today's chart of the day shows, India has topped the rest of the world when it comes to air passenger growth in the month of November. And by a large margin at that.

Indian air passenger growth touched 25.1% YoY in November. The world's largest aviation market, the US, came in second at 9.1% YoY growth, a far cry from the Indian market.

As the price of crude oil suffers steep declines, airlines are making hay while the sun shines. As a report in business daily Mint points out, fuel costs account for about 45% to 55% as a proportion of the revenues of airlines in India. Thus 4% fall in fuel cost adds around 2% to the operating margins of airlines. Further, the resultant lowering of fares by airlines is spurring demand for air travel.

Do remember though that this party is unlikely to last forever. So be careful before you bet your buck on it!

Indian aviation sector flying high

3.50

We have seen how what happens in China has a direct bearing on India and its markets. Not surprisingly, smart investors keep close track of the funny business that goes on in the dragon nation.

But some of what they do back there can be quite complicated, and confusing. The government loves to try and control every aspect of the economy. Whether they are successful is a different matter, but try hard they do. And in the process, sometimes go to extreme lengths.

No wonder understanding all of this can get quite intimidating. For example, these days China has been using its foreign exchange reserves to aggressively defend the value of the yuan against the US dollar. As Vivek Kaul, Editor of Vivek Kaul's Diary points out, US$ 557 billion is the mammoth amount it used in 2015 to defend its currency. And to avoid various unpleasant situations, it will have to keep selling dollars and buying yuan.

But it may be running out of firepower. China's stock of liquid foreign exchange reserves that it uses to defend the yuan is limited. So it cannot do so indefinitely. And if it runs out, it could lead to a run on the Chinese financial system. This may have grave implications for not only the Chinese but also the world economy. We strongly encourage you to read Vivek's thoughts on this issue to get the complete low-down these implications and more!

4.48

The Indian stock markets were trading on a dull note today. At the time of writing, the BSE-Sensex was trading up by around 20 points. While telecom stocks were seen doing well, losses were seen in realty and banking stocks.

4.56 Investment mantra of the day

"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for ten years" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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2 Responses to "An Investment Secret Almost Guaranteed to Give Great Returns"

R K Sharma

Jan 15, 2016

Why did'nt you tell me in your valuepro report :-
" For the fifteenth time in a row, the company has managed to keep its operating margins in a tight range. In fact, margins expanded last quarter, leading to a bottomline growth of 20%. Topline growth was tepid at just 4%, but operating margins were rock solid, which has kept operating performance in good spirits.

In investing parlance, what Bajaj Corp has achieved is called pricing power. The company's key raw material is crude oil. The commodity's crash over the past few months has significantly cut the company's cost."
2) I would have definitely invested on this fact alone....PRICING POWER. I was undecided and not convinced by the recommendation at that time because in your report it was stated that this company was a one product company i.e. BAJAJ ALMOND DROPS ....i use it.

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N

Jan 14, 2016

AGGARWAL

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