Risks That Do Not Yield Higher Returns - The 5 Minute WrapUp by Equitymaster
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Risks That Do Not Yield Higher Returns

Feb 6, 2016

In this issue:
» Market showing signs of fear...Should you be greedy?
» Can GDP data be trusted?
» Round up of global markets
» ...and more!
Richa Agarwal, Research analyst

We all look forward to the annual Equitymaster Conference. We get our subscribers and the stalwarts of the world of finance all under the same roof. Apart from the tea breaks where we can mingle with our subscribers, what I enjoy the most about the Conference are the open-ended question and answer sessions on stage.

The questions give us valuable feedback from our subscribers and help us know them better. And our answers offer a more personal forum to communicate our unique, long-term investment philosophy and processes.

This year, one attendee asked why we don't cover Reliance.

Pat came the reply from Rahul Shah, Co-Head of the Equitymaster Research Team: 'We don't understand the business...so we do not recommend it.'

Really - how many analysts understand the businesses they recommend? And how many are upfront when they don't?

Well...I don't blame them. I have many friends in this community. I know it could be career harakiri to admit one's limitations...that one has no clue where oil prices are heading.

One is expected to 'know' and then 'express' that knowledge with conviction. Bravado is rewarded. If one happens to be right, he 'said so'. If the bet goes wrong, well, it doesn't matter as one is with the majority (that's how the most of the brokerages function). Nothing is worse than appearing and admitting to be clueless in the first place.

Wrong premises lead to wrong calls and estimate revisions. No wonder earnings growth estimates change every quarter by so much. At times, even in direction.

Call us conservative. But we never risk subscribers' money at the expense of our ego... And we don't succumb to the pressure to give buy recommendations.

And while some subscribers complain when the markets are in an uptrend...times like these vindicate our approach and philosophy. We do not swing estimates and calls every quarter, but take a more fundamental and longer term approach. We wait for the right pitch.

We do not put your money at stake taking calls on businesses with too many moving parts. The latter makes investing analysis highly complex and risky...but hardly ever rewarding. Because we understand what we recommend, we do not panic when our stocks decline... Rather, we take advantage of it.

Peter Lynch once said:

  • If you're prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won't get bored.

Successful investing is simple. It's not about IQ, but temperament.

Our philosophy is to keep it simple. Have a checklist and follow it. Don't leave any cracks for biases to creep in.

That's the approach my team and I follow in our small cap recommendation service, Hidden Treasure. We look for uncomplicated businesses without too many variables...with prudent managements who understand risk themselves...and who are approachable and are able to clearly explain why they do what they do.

I can vouch for this approach. Some of our most rewarding calls have been on the businesses with the simplest business models.

Investing in equities is inherently risky. But that is acceptable because of the potential for high returns.

The real danger is risk that does not yield high returns...the risk of not knowing what one is doing.

Do you really understand the businesses - and the associated risks - that you bet on? Let us know your comments or share your views in the Equitymaster Club.

Editor's Note: We want to bring you ideas for thinking about investing in different ways. In fact tomorrow our friend Mark Ford will write to you of the five investing mistakes you should definitely avoid. Mark is naturally risk-averse. He has built his millions in wealth by completely avoiding risk, and he can show you how to do the same...

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3.00 Chart of the day

We are one month into 2016 and already it has turned out to be quite a volatile start for the stock markets. The crisis in China continues to deepen. Oil prices have plunged. And earnings of India Inc have yet to take off in a big way. At a time when fear and uncertainty rules the roost, investors are choosing to exit the markets. At least the inflow data for mutual funds indicates this. As reported in Livemint, net inflows into equity mutual funds stood at Rs 29 bn in January. These were less than half the average monthly inflow of Rs 75 bn in 2015.

Indeed, when the Modi led government came into power in May 2014, stock markets surged and with it the investments in mutual funds. As the hard reality has set in, the inflows have only reduced. The one solace for mutual funds is that even if the inflows have reduced, it still is better than having to deal with big outflows.

We are not surprised by this development. History has given us enough examples of how investors get very optimistic when the markets are bullish and pessimistic when the reverse happens. We think differently. We are more than happy when the markets are falling. Because it throws up that many more opportunities to recommend good quality stocks at attractive prices.

Markets Showing Signs of Fear?


The European markets were the biggest losers this week. Stock markets in Germany and France fell as much as 5.2% and 4.9% respectively. The fall was triggered when the European Commission downgraded its economic growth projections.

US stocks declined broadly on Friday, led by a rout in technology shares. The slide followed a mixed report on the US labor market. Jobs growth slowed in January, and the unemployment rate fell slightly. This weak job data dragged down the US as well as the European markets. Benchmark indices in the US ended the week down 1.6%.

Asian markets ended the week on a mixed note. Stock markets in China were up 1% ahead of the Lunar New Year. The stock markets in China will be closed for a week starting from 8 February. Japan ended the week on a dismal note with its benchmark indices falling around 4%.

Back home, the BSE -Sensex ended the week down 1%. The earnings season did not cheer the investors on Dalal Street, dragging down the benchmark indices. The upcoming budget session will be the key in terms of getting an idea of how the government intends to go about bolstering growth in the economy.

Performance During the Week Ended 5th February, 2016

4.55 Weekend investment mantra

"There seems to be some perverse human characteristic that likes to make easy things difficult." - Warren Buffett

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

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