Understand a business before you invest - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Understand a business before you invest 

A  A  A
In this issue:
» Are emerging markets a strong contrarian bet?
» China lends helping hand for India's infrastructure dream
» Did FM's anti-gold measures do more harm than good?
» Will budget allocation be enough for subsidies?
» ...and more!

Urgent Message: Hi, I know over the last few days we have sent you several communications regarding the "Extreme Value Portfolio". But given the opportunity, I just had to send you this gentle reminder. You see at 5:30 PM today, we release our very first report. And in it are full details on our first 3 stock picks. Given the opportunity, don't miss out on it! Click here to be among the first to get this report... - Rahul Goel

It's indeed a fast moving world. The trends in the social media can vouch for that. Hardly any of us would be unaware of Facebook, Twitter, Google plus etc and now out of favor orkut and BBM. In the last decade, the users have been flooded with options to socialize virtually. A few have survived, and many of them have already earned an obituary.

More and more money is being poured in coming up with new age applications with better features. While this bodes well for common users, we are more interested in analyzing what it means for Internet companies with the social media bent. And for the people investing in the stocks of such companies.

To understand this, let us first highlight some points that make a business robust and hence a good investment bet. To start with, we believe that the business should have a strong moat, less competition, high switching costs, and entry barriers, and a non flexible and persistent demand (customer loyalty) for its products and services. Barring few, most of the social media firms do not qualify on any of these basic parameters. In the light of the above, the quantum of money splashed on recent acquisitions and IPOs in the social media space may seem high . Few years back, Facebook acquired Instagram- a less than 2 year old completely free service without a business model in place for US$ 1 bn. Once again, Facebook is in news for a US$ 19 bn acquisition of Whatsapp. The latter is a relatively new cross platform communication application which does not sell advertising and earns little revenue. While the deal will let Facebook gain users of one of its fastest growing competitors, whether it is worth the money is something time will tell.

The fact is there is no finite market for the revenues earned in social media by virtue of its business model. Tomorrow, there could be another such application that may suddenly come in vogue and grow fast. It is difficult to ensure a secure market position over long time, irrespective of the amount of money spent on acquisitions in social media space at present.

Social media is just one example of a business that can be hard to understand and value. It's a common phenomenon for investors to invest in businesses where business models are difficult to value and understand. Investing in such businesses comes along with huge uncertainty . We believe that investors should avoid taking risks and stick only to their circle of competence when it comes to investing.

How important do you think it is to understand a business before investing in it ? Let us know your comments or share your views in the Equitymaster Club.

02:00  Chart of the day
Emerging Market (EM) equities were once a favorite amongst global investors. However, political instability, volatile currency and slowing growth resulted in mass exit of investors. As can be seen in today's chart, over the last three months most global fund managers have turned increasingly bearish on EM basket. In fact, in the month of February 2014, almost 29% of the global fund managers were underweight on EMs.

Since June 2013, most global fund managers are bearish on EMs. However, the perception towards EM equities turned worse after the news of Fed taper. Global investors exited high risk EM equities and turned towards developed market equities. That's because taper indicated that the developed world was recovering and it no longer needed doses of external liquidity. The sell off was further accentuated by political risks in countries like India. In general, the street consensus is underweight EM. Hence, emerging markets appear to be a good bet for contrarian investors. Nonetheless, we believe that unless structural and political risks subside global investors will continue to remain averse towards EMs.

Time To Invest In Emerging Mkts?

India's infrastructure story has become a laughing stock for global investors. Despite featuring prominently in successive 5-year plans, the sector never really took off despite billions being ear marked. Riddled in policy bottlenecks, poor execution, cost overruns, inadequate funding and corruption, the sector has become a dark spot in India's economic history. Even the large banks in the country that were so long riding on India's infra growth have given up on the sector's future. So much so that projects have halted midway for want of funds. But it seems all is not lost! And a ray of hope seems to be coming from the most unexpected quarters.

China, which has become the benchmark for infrastructure development globally, seems to be keen on replicating its success in India. In the past too the neighbouring country has shown interest in infrastructure financing. However, the attempts have been rebuffed by a government due to security issues in sectors such as telecom and power. But that has not discouraged the Chinese from making a concerted bid. It is has once again offered to fund 30% of India infra outlay for the 12th 5 year plan. One that envisages involvement in upgrading India's decrepit rail, road and power infrastructure besides telecom. So far Japan has been the only major economy offering funds for ambitious infra projects in India. However, China's interest in India infra funding pie is not difficult to understand. The dragon economy has US$ 3.8 trillion in its kitty. And with US Treasuries no long looking appealing, the economy is on the lookout for attractive investment opportunities.

Since India is in desperate need for long term external funds to realize the infra dreams, a helping hand from China could be a boon in disguise. That apart, China could also offer some technological and operational inputs. Whether the two neighbors can make it a win-win situation remains to be seen.

Last year we saw India facing serious challenges on the current account front. To bring the current deficit to a more sustainable level and arrest the rupee fall, India's Finance Minister took a series of measures to cut gold imports.

But was the FM's offensive against gold imports successful? The current account deficit has fallen from a peak level of 4.5% to 1.2%. The reason for the lower deficit has been attributed to the import restrictions and hikes in import duty of gold in 2013 which resulted in lower gold imports. While it may seems that the FM has been able to rein over India's unbridled appetite for gold, nothing could be far from the truth. As per an article in Business Standard, the FM's measures were only able to lower gold imports via the official channels.

In its quarterly report, the World Gold Council has stated that import restrictions have done little to curb demand for gold imports. While gold imports have fallen, gold demand has increased by 13% during the current fiscal year to 975 tonnes. After doing the math, it comes out that about 200 tonnes of gold was smuggled into the country. At the current gold prices, this would translate into imports of about Rs 600 bn. If the same gold had been imported through the official channels, the current account deficit would have been higher by approximately this amount.

What does this mean? It means that Rs 600 bn were converted to black money and used for these illicit gold imports. In other words, a huge loss of tax revenues for the government! So while the FM may take credit for bring CAD under control, he has created a much bigger problem for the economy.

We believe that the Indian Government seems to be a firm believer in the age old adage, out of sight is out of mind. For it has resorted to exactly such tactics while presenting the latest union budget. As per reports, the Government has allocated just Rs 350 bn towards rollover of subsidies in food, fuel and fertiliser space. But does this mean that these sectors would need only this much extra money in the fourth quarter of current fiscal. Well, not quite. The allocation seems to have been small in order for the overall picture to look good. In reality though, these three sectors I.e. food, fuel and fertilisers had actually asked for Rs 1,100 bn to be rolled over into the next fiscal. As a result, the sum over and above Rs 350 bn will have to be raised from other avenues. Thus, while this makes the Government look like they have things under control, things are hardly going to change from a tax payer perspective. It's the same old tale of subsidies not allowing the policymakers to make meaningful investments in areas like infrastructure and lay the platform for a higher growth in the future.

In the meanwhile Indian equity markets have extended their losses and are trading at day's low. At the time of writing, the benchmark BSE Sensex was down by 102 points (-0.5%). Banking and Oil and Gas stocks were the biggest losers. All the Asian stock markets were trading weak led by China and Japan. The European markets opened on a positive note.

04:55  Today's investing mantra
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets"- Peter Lynch
Today's Premium Edition
Here's how you can earn much more than the Sensex
Low cost index investing does a good job of earning attractive returns from equities over the long term. But there's an Read On...Get Access
Recent Articles:
You've Heard of Timeless Books... Ever Heard of Timeless Stocks?
August 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
Why NOW Is the WORST Time for Index Investing
August 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)
August 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.
This Company Beat the Business World's 'Three Killer Cs'
August 16, 2017
And what it has in common with beating the stock market too.

Equitymaster requests your view! Post a comment on "Understand a business before you invest". Click here!

3 Responses to "Understand a business before you invest"

sunilkumar tejwani

Feb 20, 2014

instead of pondering over ills plaguing our country, (all borne out of empty treasury) is the result of one thing: that's CORRUPTION and LOOTING of country's finances by well connected (read politicians/ bureaucrats & industrialists) who will bring back all the black money ?(read blood and sweat money of common men of our country) looted by politicians and stashed in Swiss Bank accounts. the present finance minister is himself a part of it and to top it all he is a stock market speculator,(evidence: raising import duty on Gold and asking people to speculate in stock markets) if all the black money stashed in Swiss bank accounts is restored to the treasury, we won't need any other country's dole outs.



Feb 20, 2014

I strongly believe in this. Because any amount invested by us hard earned and we think numerous times whether to invest or now, if we invest will it benefit us or we will at loss.



Feb 20, 2014

Well said about understanding a business before you invest……Not sure what Facebook will get over the long term.

Equitymaster requests your view! Post a comment on "Understand a business before you invest". Click here!


Copyright © Equitymaster Agora Research Private Limited. All rights reserved.

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407