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Stocks That Work Even When You Are Dead Wrong

Feb 20, 2016

In this issue:
» China's forex reserves shrink by half a trillion dollars
» Disinvestment failure may make way for PSU private placements
» Update on the markets
» ....and more!
0.00
Tanushree Banerjee, Co-Head of Research

What do you keep under your mattress?

Keeping cash under the mattress might have been a fringy - indeed laughable - idea in the past. But before you laugh this time, consider this...

Central bankers around the world are now targeting cash. They want economies to go cashless so nobody can hoard cash in vaults or under their mattresses.

But why would anybody do that in the first place? In the past, it was out fear of bank runs, government corruption, and all manner of black-swan events the hoarders dreamt up.

But now the danger isn't theoretical; it's real. Banks are beginning to charge us to keep funds with them!

If this seems ridiculous to you, don't worry: It is. And the truth is India is far from encountering negative interest rates. Not to mention we Indians are obsessed with gold; most of us store more gold than cash in our vaults and under our mattresses.

Now, you might not be considering storing cash under your mattress anytime soon. But you cannot ignore the reality of negative interest rates in the world today. The policy could even be adopted by major central banks, which could turn the concept of fixed, risk-free returns upside down. And that's why all investors need to know about alternatives to bank deposits for safe and regular income.

But why do investors gravitate towards safe fixed income products in the first place? It's because they're are risk averse and don't want to subject their investment to a wrong decision.

If that sounds like you...what if we were to tell you of a system to earn regular income outside the bank? And the system is likely to work even in when many of your assumptions are dead wrong?

The secret to earning this kind of regular income is simply to invest in companies that have excellent track records of capital allocation. This means the company creates more than a rupee of shareholder wealth for every rupee reinvested in the business each year. These are essentially companies with very high return on capital employed (RoCE).

You'll typically find that most of these companies do not need to re-invest much capital to grow - and therefore prefer to be generous with their dividend payouts. They are not just consistent in paying out dividends. But their dividends grow over the years, sometimes for decades!

That's why stocks of capital-efficient and high-dividend-paying companies can be your best bet to earn regular returns outside the bank. All you need to do is ensure is that the company is a really good allocator of capital. Such stocks will work wonders even if you go horribly wrong on assumptions like growth, margins, etc.

If you don't believe me, take the cases of Hawkins, Page Industries, VST Industries or Gruh Finance. The earliest shareholders of these stocks have accumulated more wealth from dividends than they ever could have hoped from a bank deposit.

Don't worry about the future of bank deposits. There is a way to avert negative returns. But you need to prepare to keep your funds outside of the bank if you want to earn healthy regular returns. But first you need to understand the method to do that really well.

In the future, most banks outside India may charge you for deposits. And the banks in India may offer you returns far less than the inflation rate.

But before you contemplate stashing cash under your mattress, give dividend stocks a serious thought.

Are you preparing to earn healthy regular returns outside the bank? Let us know your comments or post them on Equitymaster Club.


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2.10 Chart of the day

There was a time when China was considered a force to reckon with. So much so that it was expected to play a crucial role in boosting global growth when the 2008 crisis had pushed the developed world into recession. One indicator of China's growing might was the quantum of its foreign exchange reserves. A year and a half ago China held as much as US$4 trillion in reserves.

But things since then have changed and how. The last several quarters have given ample evidence of how China's economy is slowing. This has taken its toll on Chinese stock markets as they have been extremely volatile. In a very uncertain environment, money is flowing out of China and the central bank is struggling to support the yuan. Hence the shrinking Chinese reserves. As reported in the Economic Times, by the end of January, reserves stood at US$3.4 trillion. How low this will go to is anybody's guess.

But the remarkable thing is that despite a noticeable fall in reserves, China still continues to hold the largest amount of reserves as compared to other countries. Today's chart highlights this clearly. For instance, China's reserves are nine times that of India's. China does seem better placed to deal with any forex outflow crisis than India is.

China's towering forex reserves despite recent shrinkage

3.25

The government seems to be doing whatever it can to get access to funds. One of the key ways to get inflow of capital is the divestment route. But since divestment plans are way off target, some measures are being mulled to smooth sail the process.

Share prices of most PSU companies have declined sharply. To get better prices for shares to be offloaded, the government is looking to make tweaks to disinvestment plans. Using the mode of 'private placements' for instance. Private placements is a funding round of shares which are sold not through a public offering. In short, the government is looking to directly access big investors. As per Bloomberg, "The government currently allows so-called qualified institutional placements, known as QIPs, only among public sector banks."

Apart from this measure, policy makers are looking to reduce the time of notifying investors for offer for sale issues. This step is being suggested to curb the price volatility post the announcement.

Buy backs is another measure being discussed. This step would transfer money from companies to investors; which would include the government as well.

From a perspective of an investor, some of these measures do make sense. This we say because most PSUs' stocks have been beaten black and blue. However, the fundamental question here is whether the government should be running as many businesses in the first place. In fact, Vivek Kaul has been writing about this time and again in his Diary. As per him it does not make sense for the government to run as many as 27 banks just because it has social obligations to meet. In doing so, it is only throwing good money after bad.

4.35

The European markets were the biggest gainers during the week. The benchmark indices in France and Germany rallied as much as 5.7% and 4.7% respectively during the week. The rally was triggered by hopes of more stimulus measures. The European Central Bank President has stated that the governing council 'will not hesitate to act' if the market turmoil threatens the economic outlook. Thus, suggesting measures to bring in more stimulus to revive the economy.

Asian markets too closed the week on a positive note. Stock markets in Japan and China ended the week higher by 6.8% and 3.5% respectively. This came as a respite for investors after a sell off during the previous week, which saw benchmark indices in Japan falling by 11%. The sharp gains this week came in part because markets have tumbled so much this year, prompting some investors to hunt for bargains. Further, China resumed trading after a week's holiday on account of Lunar New Year. The indices rallied in China on hopes for fresh stimulus from China's leadership.

Top oil exporters Russia and Saudi Arabia have agreed to freeze production levels of oil. Reportedly, the Saudi, Qatari, Russian and Venezuelan oil ministers announced the proposal at the meeting scheduled in Doha. However, the deal is contingent on other oil producers joining in. This led to rally in crude prices.

Back home, the BSE Sensex ended the week higher by 3.1%. The earnings seasons have not cheered the markets as majority of the companies missed the consensus estimates for net profits. Further, the upcoming Budget will be the key trigger for the stock markets in the short term.

Performance During the Week Ended 19th February, 2016

4.50 Weekend investing mantra

"You want to see, first, that sales and earnings per share are moving forward at an acceptable rate and, second, that you can buy the stock at a reasonable price." -Peter Lynch

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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1 Responses to "Stocks That Work Even When You Are Dead Wrong"

Balakrishnan R

Feb 20, 2016

It looks we are much worried about China's reserve. With lower crude oil prices, it is understood that there is a saving of about 100 billion USD in about one year. Has India's debt has reduced by this much or is India's reserves increased by this much.

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