Do you pick stocks or do stocks pick you? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Do you pick stocks or do stocks pick you? 

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In this issue:
» Rising demand, shrinking supply to support gold prices
» Can inflation-indexed bonds replace gold?
» Who will win the currency wars?
» More evidence on why big banks are big threats
» ...and more!

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Do you know which stock exchange in the world has the highest number of listed companies? It is none other than our very own Bombay Stock Exchange (BSE). As of December 2012, the exchange boasted a total number of 5,191 listed companies.

Indian investors indeed have a massive list of companies to choose from. But in essence, just a small percentage of these companies would really make the cut on vital parameters such as business fundamentals, financial track record, quality of management, and so on.

So how do you go about picking stocks? Or is it the other way round, are stocks picking you? Is your choice and discretion a mere delusion?

Let us explain what we are trying to hint at. There is a tendency among human beings to focus on things and information that are close at hand. At the same time, our imperfect neural wiring may cause us to ignore things that may not be easily accessible. Charlie Munger calls it the availability-misweighing tendency.

Try and put this in the context of stock investing. Which are the companies that immediately come to your mind when you think about stocks? If you ponder a bit, you will realise that a bulk of these companies are the ones that are given the maximum visibility. These are the companies that are often discussed on TV channels. There are frequent news pieces about them in the newspapers. Several brokerage houses actively cover these stocks. They have glossy annual reports sprinkled with flashy photographs and inspirational pep talks. Such extensive media coverage may give you the impression that a certain company is safe and trustworthy. But what if all of it was just a great public relations (PR) exercise?

Of course, we are not at all trying to say that stocks that are widely covered should be avoided. But as an investor, one must learn to differentiate between great PR and great fundamentals. Do not let your views about a company get coloured by the former.

According to you, which stocks are cases of great PR but bad fundamentals? Share your comments or post them on our Facebook page / Google+ page

01:08  Chart of the day
The Reserve Bank of India (RBI) in its monetary policy yesterday cut the cash-reserve ratio (CRR) and repo rates by 25 basis points (0.25%). But at the same time it made very clear the various risks that the Indian economy faces. While inflation is certainly one of the key risks, the other equally worrying factor is the current account deficit (CAD). Indeed, as today's chart of the day shows, CAD (as a % of GDP) has been continuously increasing over five consecutive quarters from July-September 2011 (2QFY12) to July-September 2012 (2QFY13). This is bound to have an adverse impact on the stability of the country's exchange rate at a time when domestic growth has also been slowing down. What is more, the rise in imports has largely been on account of fuel and gold imports. This is of more worrying to the RBI, than had the high CAD been on account of import of capital goods.

Data source: Business Standard

When something goes up for 12 years in a row it is difficult to get away from further optimism that is being built around it. The same thing is happening with gold now. It has dropped 8% (in US dollar terms) from its high in October 2012 because of improved financial situation in the US and relative financial stability in Europe. However, many are still bullish on gold. Generally, when the economic conditions improve equities are in favour. But gold bulls feel that the demand supply economics are still in favour for the rally to continue. For instance, as per reports central banks across the world bought 536 tonnes more of gold than what they sold in 2012, highest in last 50 odd years. However, the gold output during the same period increased by just 0.2%. This is the lowest growth figure in the last four years. Thus, with demand increasing and output shrinking gold prices can rise further. It would take a strong worldwide economic recovery to push gold prices off the cliff.

If we thought only Indians were obsessed with gold, we have been proven totally wrong. Even the inflation afflicted Vietnamese have shown a strong inclination towards the yellow metal. The government has been exploring various means to wean Indians off this gold obsession as it has been adversely impacting the current account. Soon after raising the import duty on gold, the RBI has come up with another solution.

No doubt investors flock to gold as the metal is an excellent hedge against inflation. Hence, the Reserve Bank of India's attempt is to divert attention to inflation-indexed bonds (IIBs). These bonds will offer investors an alternative to gold without hurting the economy's current account deficit. What neither the government nor the RBI realise is that a lot of the gold is bought by investors in semi-urban and rural areas as well. These are people on whom the sophistication of IIBs will be completely lost. Hence it is very unlikely that such bonds will do much to allay the government's 'gold fears'.

There's a bias in psychology called as confirmation bias. And it has this ugly habit to make us stick to our preconceived notions. This despite the notion being proven wrong. As a matter of fact, even well known gurus fall victim to this tendency we believe. Like this currency guru at one of the world's largest financial firms, Citibank. The guru is of the view that the currency wars that are currently underway between various economies will eventually be won by the rich countries. Really? And what exactly makes him take such a stand? Well, he opines that countries with deflation have a big advantage. Simply because falling prices just don't have the inflation risk that poor countries with inflation have. We would disagree. We believe that deflation is nothing but an indication that a correction process is underway and needs to be allowed to proceed. Just because an economy is deflating doesn't give one the license to print money. In fact, printing more money would only hurt the correction process and set us up for an even worse deflation later on.

The guru's other argument is that while it is okay to have domestic price inflation in some countries, the same is unwelcome in other nations. Thus, while US would love to have housing prices 20% higher, China would certainly not want it. This is yet another illogical statement we believe. We all know what happened when ex-Chairman of Fed Mr Greenspan tried to increase house prices in 2002-03. It gave us a crisis so big that we are yet to recover from it. Thus, the housing prices are in lower in US because that's what the market wants. You can't just reflate them by artificial means. And even if they go higher, the trend won't be sustainable.

Well, the currency guru has a lot more similar arguments to give. But we think we've offered enough reasons to prove why we he could be way off the mark here.

Last year leading investment bank, JP Morgan had come under fire for a US$ 6.2 bn trading loss. The loss also termed as "Whale trade" was caused by some derivative positions taken up by its Chief Investment Officer (CIO). The matter was subsequently taken up by the US Senate Permanent Committee on Investigations for investigating any wrong doing. The investigation has taken an interesting turn. It turns out that another division of the bank had taken contra positions for the same trade. Now for those of us who may not understand what this is, it simply means the same bank was betting on two different outcomes involving the same trade. This is not really illegal in itself because banks can take opposing positions in the same trade. But if the matter is not revealed by the bank then it suggests that something may be wrong. And this is what JP Morgan is accused of. In its report to the Senate Committee the bank has stated that this matter never came up in it internal investigation.

The bigger implication of this is the quantum of loss that JP Morgan caused. This brings back the 2008 discussion whether such banks are indeed getting too big to manage. Ever since the scandal of Lehman Brothers hit the market and triggered the crisis, the size of banks has been debated about. Most experts feel that banks should be scaled down to make things manageable. The incident of JP Morgan clearly indicates that perhaps it's time that the legislators and bankers took this discussion more seriously. After all, such losses hurt the overall markets. While investors with deep pockets see a dent in their investments, the smaller ones get wiped out.

In the meanwhile, the Indian equity markets were trading above the dotted line. The BSE-Sensex was up by about 20 points (0.1%) at the time of writing. Realty and oil and gas stocks were leading the gains. Barring Malaysia and Indonesia, major Asian stock markets were trading in the green.

04:55  Today's investing mantra
"So much of the world of investing is people who are trying to beat indexes, and they have a willingness and eagerness to make decisions in the next 24 hours. This condition didn't exist years ago. It has created a "hair trigger" effect. An example of this hair trigger effect was Black Monday in '87. The cause was program trading and stop loss orders." - Warren Buffett

  • Warren Buffet - The Value Investor
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    1 Responses to "Do you pick stocks or do stocks pick you?"


    Jan 30, 2013

    with great PR these company having a good past record and are generally heavyweight on an average like Reliance Group companies, DLF, TATA Group companies no matter some of these companies doesn't shows far out fundamentals presently but still It's about winning credibility of consumer which takes long time and these companies are considered for the same and about imperfect neural wiring albeit it's there investor with short term orientation should go with this as it's common in all those who influence markets yes it's advised to be corrected by very patient and long term investor like Munger.

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