In investing, doing less is more - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

In investing, doing less is more 

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In this issue:
» Yet another masterstroke by the Oracle of Omaha
» Mid cap stocks plunge on governance worries
» Not just India, even Vietnam has a gold problem
» These short cuts could be expensive for IT companies
» ...and more!

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From the time we were born, the adults around us encouraged us to be active. Always do something. Keep busy. Being busy is almost treated like a virtue. Even success is associated with busy people. If you're not busy and doing a thousand things, people would think you are useless and wasting your time.

Unfortunately, a lot of people bring along this same mindset when they enter the world of stock investing. Many come with the belief that if you're a serious investor, you have to be very active and watchful. Never miss an opportunity. Buy low. Sell high. Buy again when the stock corrects. Sell again at a higher price. Make the best of every market rally. If you meet these people, they will invariably ask you two questions: 1) Where is the stock market headed? 2) Which stocks to buy?

Now the truth is that this kind of approach seldom works in investing. Of course, your stock broker will be very happy with you for the frequent trading. The government of India will be happy to collect more taxes from you. But you, as an investor, will be busy but not successful.

Every stock market participant is out there to find lucrative money-doubling opportunities. But the fact is that not all can be winners. Every time you're entering a trade, you're trying to outwit millions of other investors and speculators. The probability that you will often be on the right side of the trade is low. In the game of stocks, playing more has no positive correlation with success.

Who would understand this better than the most successful investor on the planet? Warren Buffett is known to have said, "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."

In fact, there have been long intervening periods when Buffett wouldn't buy anything at all. He would patiently wait for the right stock at the right price, without caring where the overall market was headed. And then finally when the perfect opportunity would arrive, he would grab it with both hands. This method has worked for him. And there is little doubt why it will not work for you.

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01:17  Chart of the day
Domestic FMCG companies such as Godrej Consumer Products (GCPL), Marico and Dabur have grown at a robust pace of 20% average annual growth over the last five years. In a bid to expand their businesses further, these companies acquired several foreign brands and companies. Consequently, the share of the international sales to their total revenue has increased. The chart of the day shows that between FY06 and FY12, the contribution of international sales has increased substantially for most FMCG companies. However, the benefit at the topline has failed to percolate at the bottomline.

Sometimes, acquired brands take a long time to break-even. Hair-styling brand Code 10 acquired by Marico in 2010 and Dabur's Namaste acquisition in 2011 continue to remain in red. However, GCPL has seen reasonable success with several acquisitions such as Megasari in Indonesia, Darling Group in Africa and Cosmetica Nacional. This may be on account of the fact that GCPL has focused on product acquisitions in which it has a strong core presence.

Data source: DNA Money

You know what's Warren Buffett's secret sauce? Well, amongst other things he has this amazing knack of betting heavily when the odds are in his favour. And doing nothing when they are not. It is this quality of his that perhaps made him enter into an interesting bet with a money management firm about 5 years back. And what exactly was the bet? The bet was who amongst an index fund and five funds of hedge funds picked by a money management firm would perform better in the next 10 years.

Now, there's a reason Buffett would have placed his bet on the index fund. And it has to do with the fact that in only one of the last 10 years have the hedge fund index been able to beat the S&P 500 index. Secondly, hedge funds are notorious for charging high fees, which again eats into the returns that their investors make.

Thus, with these two facts in front of us, it is obvious that Buffett is more likely to win than the money management that is backing the hedge fund. And half way through the bet, the outcome is indeed along expected lines. While the index fund is up around 9%, hedge funds are languishing far behind with gain of just 0.13%. Another carefully thought out masterstroke by the ace investor we believe.

Every stock has some sort of governance premium embedded in it. For instance, companies like Infosys, which have strong management and good governance practices, command a higher premium. However, there are some companies, typically in the infrastructure and real estate space that command lower premium because of shady governance practices. And it is worthwhile to note how market reacts when that premium erodes. Take the case of IVRCL Infrastructures and Housing Development Infrastructure Limited (HDIL) for example. Both these stocks lost about 20% in yesterday's trade. HDIL lost ground after one of the promoters sold stake in the company to acquire land. It should be noted that the company had huge debt on its books and high percentage of pledged promoter shares. IVRCL tanked after news of the murder of an NHAI official who was overseeing a road project being built by the company. In both the cases management clarification did nothing to support the stock price later. Market had lost faith in their governance by then and the stocks were duly punished.

The above episodes show the importance of good governance. A failure in that regard could result in a free fall irrespective of valuations. Thus, apart from financials, management quality and corporate governance should be one the key factors investors should watch out for while investing.

The Indian IT Services sector is known for delivering quality services at affordable prices. This is turn has helped the sector to grow to a nearly US$ 100 bn industry today. However, the global crisis has dampened the demand for the sector in recent times. Companies are now fighting for market share as the size of the market is not increasing. This has led to intense competition amongst the IT vendors. As a result companies have come under pressure to protect their margins. Accordingly, companies have been forced to find out innovative ways of cutting costs.

Many companies are now employing less experienced and cheaper software engineers to execute projects. This in turn ensures that the costs are lower but has had an adverse impact on the quality of work being delivered. Interestingly the companies are getting away with this to a large extent. According to a leading IT Services Company, European clients are more conscious about high quality rather than costs as compared to their US counterparts. Therefore a reason why lower quality has not really hurt the Indian IT companies could be lower demand from Europe due to the crisis. But eventually lower quality is bound to come back and haunt the Indian IT companies. Compromising quality is actually the best way to lose a client. It would be best for IT companies to clean up their work. Otherwise the stable to improving margins may just be a short term trend.

Fuel price hike was not the only dampener for Indian households in recent days. The government's attempt to curb gold buying was an equal disappointment for many. The move to raise import duty on gold was essentially meant to ease off the pressure on current account deficit. Of late the yellow metal was seen as the single biggest culprit for India's deficit problem. But it seems Indian households are not the only ones disappointed with such a move. Our counterparts in Vietnam face a similar predicament. Thanks to gold's inflation hedging properties and importance in social functions, the metal has increasingly found favour. More importantly lack of trust in equities and low interest rates has made other investments relatively unattractive. Gold on the other hand has had an impressive run in recent times. In fact in the past 10 years investments in gold have outperformed investment in equities. The 30 year story of gold and Sensex is however skewed towards the latter. Thus try as they might, governments in India and Vietnam will not be able to wean investors off gold. That is until other asset classes like equities and debt find more favour.

In the meanwhile, the Indian equity markets were trading firm today. The BSE-Sensex was up by about 79 points at the time of writing. Auto and realty stocks witnessed maximum buying interest. While Asian stock markets closed mixed today, the European stocks have mainly opened in the green.

04:45  Today's investing mantra
"I have no idea where the market is going to go. I prefer it going down. But my preferences have nothing to do with it. The market knows nothing about my feelings. That is one of the first things you have to learn about a stock." - Warren Buffett

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    4 Responses to "In investing, doing less is more"


    Jan 29, 2013

    I am not an active trader. I fully agree for the methodology explained. But what is wrong if you know pretty well about a stock and make profit by owning it and setting in short duration.
    Is it wrong if you invest may be 25% of your total investment in such "Risky" calls?


    Ramasubramanian v

    Jan 25, 2013

    Trading frequently only shows how unsteady and unstudied you are. It is an indication of confusion prevailing in you. If you have completed the study and made up your mind, then there is no need to trade frequently. Whether you are interested in grain or bran (indicating small gain) is indicative of your 'investment maturity'. It is better to be slow and aim at acquring robust shares at low prices so that you will always gain! IT IS BETTER TO WAIT FOR CRISIS PERIOD AND GRAB THE OPPORTUNITY. Occasions such as political instability, war mongering situation, riot periods and budget periods are ideal period to acquire shares of good companies AT HISTORICAL LOW PRICES which we want to hold for life time!!



    Jan 25, 2013

    An Excellent and inspiring article !!! Thanks a lot. Keep it up ! We expect more of this type.



    Jan 25, 2013

    Follow Buffet but with slight modification. Stay invested in 10-20 shares for ever but exit and re-enter at opportune times. You will make more money.

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