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Our Favourite Companies for the Current Environment

Jan 28, 2016

In this issue:
» Will 2016 be the year of the gold?
» Chinks in the FMCG story
» ...and more!
0.00
Rahul Shah, Co-Head of Research

Humans take decisions in one of two ways - intuitively or through strategic reasoning. Strategic reasoning is preferable, especially for critical decisions.

Unfortunately, the way we have evolved, it is the intuitive tail that wags the rational dog more often than not. The result? We often take decisions that are not in our best long-term interest.

Nowhere is this more evident than in the stock markets. Last Saturday, we fielded questions from the attendees at the annual Equitymaster Conference. Want to know the most common question? It went something like this...

Rahul, I am worried about what's happening around the globe these days. Do you think I should wait this period out and invest when the fog of uncertainty clears?

Such questions make it clear that the intuitive mind has overpowered its more rational and logical counterpart.

I'll be honest. The current environment is worthy of the chill it's sending down investors' spines. It triggers the same intuitive response of our ancestors when they spotted a Sabre-toothed Tiger in the Savannah. And while that response would have saved our ancestors' lives, it won't save us from losing our shirts in the stock markets.

Therefore, in stocks at least, it pays to get off the high horse of intuition and mount the elephant of strategic reasoning instead.

The single biggest reason successful long-term investors make money in stocks is because they don't run from uncertainty. Rather, they embrace it.

Every stock has what is known as an intrinsic value - that is, the price a rational investor would pay for the company if he were to buy it outright. Uncertain times might bring down stock prices...but not necessarily a company's intrinsic value. Therefore, the lower the stock price goes compared to the company's intrinsic value, the higher the long-term returns.

This makes uncertain times the best time to go bargain hunting. They let you buy a slice of India's future at a discounted price.

Investors are perfectly justified to fear businesses with high leverage and weak competitive positions. But should they spot a sound company they believe will increase profits ten to fifteen years from now...and is available at an attractive price...there's no reason to not grab the opportunity with both hands.

In fact, we named a few such companies in our presentation at the Equitymaster Conference. And while not all of them are actionable at current prices, we would love to recommend them if their prices fall significantly below their intrinsic values. If you'd like to know more about these stocks, you can get online access to the video recordings of the Equitymaster Conference 2016.

By the way, what are the kind of companies you are keeping an eye on in the current environment? Let us know your comments or share your views in the Equitymaster Club.


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2.30 Chart of the day

In last couple of weeks, FMCG giants Hindustan Unilever (HUL) and ITC both announced their December quarter results. Both the companies reported sluggish growth and missed analyst expectations.

As per G Chokkalingam, founder, Equinomics Research and Advisory, FMCG companies are seeing a deflationary scenario, triggered by lower commodity prices. This is unlike during 2008 crisis when FMCG delivered double-digit growth. If the commodity prices remain on the lower side for a sustained period, it will impact consumption.

As per chart below, HUL and ITC revenue growth has fallen from double digit to single digit in recent quarters.

In such an environment, both firms are actively looking for triggers outside the traditional organic model and looking for mergers and acquisitions (M&A) strategy to generate growth. For instance, HUL recently acquired Ayurvedic brand Indulekha and ITC acquired B Naturals Juice in May 2014, followed by acquisition of Salvon and Shower to Shower brands from Johnson & Johnson.

While FMCG volume growth has shown some signs of revival, pricing is becoming a challenge given the benign costs and the competitive intensity. FMCG companies are therefore focusing on acquisition strategy to improve turnover and investor sentiment. Companies are also focusing on increasing share of premium products that will improve margins.

Second consecutive quarter of low FMCG growth

3.40

Is 2016 the comeback year for gold? On the evidence so far, it does certainly looks to be the case. As per newsmax.com, gold spot prices are up 6% since the start of the year. And the way things are unravelling across the globe, the yellow metal looks set to go higher in the coming months. However, this doesn't mean investors should dive headlong into gold. As per us, gold is an excellent hedge against a financial crisis of any kind and therefore, should not occupy more than 5%-10% of one's total investment portfolio.

Do note that gold had fallen out of favor with investors these past couple of years as there was this perception that quantitative easing is working and developed economies were on a recovery path. However, it is getting clear with each passing day that the recovery was artificial and all we have ended up doing is pushing the global financial system more towards the edge of the cliff. And therefore should the freefall come, gold could perhaps be one of the few safe havens left.

4.30

Meanwhile, Indian stock markets closed lackluster today with the Sensex ending lower by more than 20 points. BSE Mid and Small Cap indices also closed marginally lower. Amongst the sectors, FMCG and energy stocks closed higher.

4.50Today's investment mantra

"Value investing is at its core the marriage of a contrarian streak and a calculator." - Seth Klarman

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

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DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
INTRODUCTION:
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

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DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
  4. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
DISCLOSURE WITH REGARDS TO RECEIPT OF COMPENSATION:
  1. Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
  2. Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
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  4. Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  5. Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
GENERAL DISCLOSURES:
  1. The Research Analyst has not served as an officer, director or employee of the subject company.
  2. Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
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