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The Timeless Formula to Successful Investing

Jan 18, 2016

In this issue:
» India imports 25% more gold in 2015
» India stock markets on trade on a muted note; small caps worst performers
» ...and more!
00.00
Richa Agarwal, Research analyst

What once seemed impossible has happened: Oil is below US$28 per barrel. The economic data suggests that the US economy is out of gear. China's massive investment-led economy is shrinking under its own weight.

The future of the global economy and oil prices is a hot topic these days. Almost every financial daily and economist has a view on what's going on with oil and where it will go in future. What is most amusing is that no one saw this coming. No one was suggesting oil could give such a jolt a few years back...

The era of high oil prices lasted so long that it was considered to be the new normal. And then the crash happened, which is now being seen as a precursor to another global slowdown and crisis. The Asian stock markets have been sent into a tailspin and are at their lowest levels since 2003. The risk of a global recession is palpable.

What does this say about economists and markets?

Well, neither learn from history. While reams have been penned analyzing any topic under the sun, a basic fact is overlooked. One can never predict certain events and their timings with absolute certainty. This lack of humility and failure to acknowledge forecasting limitations has been the downfall of many self-proclaimed geniuses and their blind followers.

But then, acknowledging these limitations, what is one to do? Surely, you do not expect us to imagine the worst and do nothing...

Well, at the risk of sounding conservative, we believe the best course of action is to anticipate and prepare for shockers. This means not getting carried away by macro and theme-based investing that gets thrown out the window as volatility rears its head... Instead, we choose value investing.

But as easy as it sounds, practicing value investing requires great fortitude. Many find it boring and lacking in action. The financial industry, with incentives based on short-term performance, certainly does not reward this attitude. No wonder the short term is all the so-called experts and traders/brokers are bothered about. What else can explain the rush for freshly listed companies, some of which are yet to taste profits?

My team and I make sure that we do not lose sight of the big picture when we recommend smallcap stocks. We know we can't forsee certain part of this picture... That's why, to make up for it, we give due weightage to fundamentals and margin of safety.

During more optimistic times, we have received criticism from subscribers for being too conservative and ignoring markets and momentum, particularly when they see other traders and brokers offering recommendations with conviction - a conviction that stems from the short-term run in the stocks they recommended.

Yes, many smallcap stocks delivered good returns in 2015 but did not figure in our list of recommendations. And we have no regrets.

As my colleague Ankit Shah suggested a few days back:

  • We just took a cursory glance at the financials of some of the small cap stocks that have delivered multi-fold returns in 2015. We noticed that some of these companies are loss-making...or have just turned profitable after some years of losses...or have very poor profitability.

    While small cap stocks have been the biggest winners in 2015, they also lead the list of biggest losers. For instance, among the stocks that crashed 50% or more this year, nearly 97% belong to the small cap category.

The recent gains in most smallcap stocks are most likely driven by speculation in illiquid stocks, since they have little fundamental or valuation support - the key pillars of value investing. It could be a case of irrational markets getting more irrational.

If a strong process and investing philosophy does not back these short-term runners, most of these returns will likely reverse in the next cycle. Such stocks could be ticking time bomb. And as they blow up, the loss will be much more painful and longer lasting than the thrill they offered. As Nassim Nicholas Taleb, author of Fooled by Randomness, says, 'It does not matter how frequently something succeeds if failure is too costly to bear.'

In times of volatility, our advice to investors is that themes are unlikely to take you far. But a long-term focus and fundamentals and valuations will. The latter will keep you prepared for any unseen events that will interfere with market cycles. That way you can afford to be greedy when others are fearful and make volatility your friend. The markets might get worse before they get better. But if you are here for the long term, the best time to buy is when the news is at its worst (subscription required).

Do you think that value investing could be the most rewarding investing approach in the long term? Let us know your comments or share your views in the Equitymaster Club.


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3:00 Chart of the day

Today's chart of the day shows India's gold import bill over the last five years. From the high levels of US$ 53,921 million in 2011, India's gold import bill in 2015 stood 35% lower at US$ 34,982 million. Does this mean India's gold demand has dropped over the years? The answer is no. The decline in India's gold import bill is broadly in tandem with the declining trend in gold prices over the last five years. International gold prices are down over 40% from their all-time high level of US$ 1921.5 on 6 September 2011.

India's Gold Import Bill - 5 Year Trend

As per Business Standard, with an estimated 105 tonnes of gold import in December 2015, the total gross import in the year 2015 crossed 900 tonnes. That's 25% higher than 2014. However, the rise in the 2015 gold import bill over 2014 has been just about 12%. This is because of low gold prices in the international market. Average international gold price dropped by 8% in 2015. However, from the annual high, international gold prices declined nearly 20%. Moreover, more imports took place at lower prices, resulting in the relatively lower increase in the import bill.

As you know, India is a very big consumer of the yellow metal. Over the years, we have managed to accumulate 20,000 tonnes of gold! The government has been trying to find ways to put so much gold to some productive use. The launching of the sovereign gold bonds was a step in that direction. Will this scheme be successful? Here is an interesting perspective on the sovereign gold bonds scheme by Vivek Kaul, author of Vivek Kaul's Diary.

4:00

The Indian stock markets are trading on a muted note since the start of the trading session. At the time of writing, the BSE-Sensex was trading lower by about 23 points (-0.09%), while the NSE-Nifty is trading lower by about 24 points (-0.32). Most sectoral indices are trading on a negative note with oil & gas and telecom leading the losses. However, metal, banking and IT indices were trading in the green. The S&P BSE Midcap and S&P BSE Smallcap indices are trading significantly lower by about 1.21% and 2.58% respectively.

4:30 Today's Investing mantra

"In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Ankit Shah (Research Analyst).

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2 Responses to "The Timeless Formula to Successful Investing"

Alphones

Jan 18, 2016

Until the middle of year 2015, every economic gurus were worried because of high price of crude oil.
Now, it is other war round. Because of low price in crude oil, economy is struggling. What a wonderful story?
Please note one thing. Low oil price is a blessing for all of Europe and Asia except the middle east.
please note one thing. Mr. China is producing goods more than the world population needs. And you can also see new companies mushrooming in china each day.
Until few years before, the Chinese economy was unaccounted by these great economic gurus.
Because, they have dumped their money into China, now they are worried.

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G S Apte

Jan 18, 2016

Hi,

Recent market correction has proved that, instead of getting carried away along with other investors and analysts, it is better to stick to some sound process of value investing. Since earnings can not be predicted with accuracy, "margin of safety" is the only proven strategy to safe guard investor.

There will be good amount of buy opportunities now going forward, and those who have remained grounded to value investing will find excellent buy opportunities now. Instead of buying at higher PE and PB multiples, if one can wait for right valuations, s/he can generate optimum returns, else one may end up generating sub optimum returns.

Investing based on momentum and buying growth stocks at high valuations has some advantages, but current market corrections can prove that strategy wrong. As of now, it looks like that, valuations in Indian market could go further down, and investors can take benefit of those low valuations.

We have to hope that, current situation would improve in later part of 2016 and beyond to help investors reap some benefits.


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