Not good enough to buy profitable companies! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Not good enough to buy profitable companies! 

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In this issue:
» The Wal-Mart indicator for the US
» Egypt after Arab spring
» Even UK loses the 'AAA' tag
» Black money unearthed this fiscal
» ...and more!

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Jorge Paulo Lemann. Does the name sound familiar? For most of us this was an obscure name until recently. The gentleman who answers to this name was just another Brazilian financer until he teamed up with Warren Buffett. Buffett's latest buy, ketchup maker H.J. Heinz Co, was part funded by his private equity fund. What makes him and other small economy entrepreneurs like him special is that they wield as much 'corporate power' as the Fortune 500 CEOs do.

An article in Businessweek highlights the transitional state of corporate power. Allow us to elaborate further. Emerging-market entrepreneurs are finding their place under the sun. They are the ones who are introducing unprecedented competition into every sector of global business. In fact emerging economies are now home to more than 1,000 companies with annual sales above US$ 1 bn. Even foreign direct investment (FDI) from developing economies has outpaced FDI from rich countries for more than a decade. But the ability to wield corporate power is no longer limited to a few. This is nothing but the ability to influence the way consumers, competitors and markets behave. In effect the power to make and retain super normal profits.

To say that power is shifting from one continent or country to another tells only part of the story. Nor is it true that Internet and other technologies have taken away abilities of businesses to stay ahead of the race. But the truth is that startups and blue chips today have almost equal ability to attract talent and create iconic products. It is therefore of paramount importance to judge which profitable companies can remain as profitable for a prolonged period.

Apple will be Apple if and only if it keeps coming out with iPhone-like iconic products. Else there is nothing stopping it from going into oblivion. Remember even companies like Kodak and Xerox were once iconic. But inability to keep up with competition brought them to their knees. While the former became bankrupt and sold patents the latter too came dangerously close to bankruptcy territory.

Thus investors have an important take away from this. Invest only in companies that have simple but addictive products. Or ones that have immense innovation skills to retain super normal profitability year after year.

Do you think it is sufficient to look at current profitability of companies before buying the stocks? Let us know your comments or post them on our Facebook page / Google+ page

By the way, Equitymaster's Advanced Stock Screener allows you to screen stocks based on long term trends in profits.

01:35  Chart of the day
It is believed that the financial health of Indian companies is not as vulnerable as that of their Western counterparts. But on certain parameters they fail to feature favourably even when compared to the subprime crisis era. Take interest coverage ratio -a measure of a company's ability to pay interest on outstanding debt, for instance. As per data from Mint, for the 3,500 companies listed on BSE, this ratio has dropped from 5.9 times in December 2007 to 2.7 times in the quarter ended December 2012. Plus the deterioration has been for stocks across market caps. For mid and small cap stocks in fact, the interest coverage ratios have been lower for about seven-eight quarters now. Investors therefore need to be rather watchful about the debt and cash flow position of companies.

Data source: Mint

Most of us Indians have this constant complaint over how we as a country are not doing enough. And the benchmark for most of us is the Chinese juggernaut. We lament how our Asian counterpart has left us far behind. However it sometimes helps to look at nations that have been worse off than us. It kind of puts things in perspective you know. It is with this in mind we read how the country of Egypt is trying to come to terms post the Arab spring there. It is desperately wooing the help of industrialists that fled the country following the revolution. It is in serious need of foreign capital and is hoping that the infusion of the same by its own entrepreneurs could make others also do the same. Whether it achieves the same remains to be seen. But it does serve as a reminder to us that things are after all not that bad in India.

An interesting barometer for an economy is to see what the lower and middle income class people are buying. If their purchases fall, it clearly indicates that the larger part of the population is seeing tough times. This indicator is showing troubled times for the world's largest economy US. Wal-Mart, the largest retailer in US has given a subdued forecast for its sales. Given that Wal-Mart is the place where the lower and middle income groups shop, it indicates tough times in the US. The country has been gripped by the slowdown since the outbreak of the crisis. This has led pay levels to either remain flat or grow at a very slow rate. At the same time inflation and tax rates have been going up. Adjusted for inflation, household income has actually declined by 1.5% YoY in 2011. And the picture does not look too bright for 2012 either. As a result households have been cutting down on their consumption, which is clearly reflected in the lower sales forecast of Wal-Mart.

The US Fed and policymakers have been printing money through their numerous QE programs.The reason given by them has always been the same that this money will stimulate the economy. But all it has done is to stoke inflation and asset prices. And that is killing consumption, the essential requirement for a growing economy. There appears to be a disconnect between the policymakers and what is actually happening in the economy. If the US wants the economy to grow, then it needs to stop the sound of its printing presses and listen to its people. Unless it does that, things are not going to get better.

The United States suffered a setback when credit rating agency S&P boldly downgraded the country's sovereign ratings from its pristine triple-A rating in August, 2011. Less than two years later, Great Britain is in the same boat. The country suffered its first ever sovereign ratings downgrade from a major rating agency. And, this time it was Moody's who delivered the blow. Weak prospects for British economic growth have derailed the economy's deficit reduction plans. This downgrade comes as a major blow to Finance Minister, George Osborne who vowed to defend Britain's AAA rating when he came to power in 2010. But, maybe this humiliating blow will spur the Bank of England to resort to bond purchases in order to jumpstart the economy. Britain now joins the lowly ranks of United States and France in having lost its AAA rating from at least one major agency. The big question is whether Australia, Germany, Switzerland and Canada are next? Well, we sure hope not.

Black money has been the bane of the Indian government for quite some time now. Indeed, so serious is this issue that it speaks of a parallel economy in existence. For instance, searches conducted by IT department during 2011-12 led to the discovery of undisclosed income of about Rs 14,017 crore. The figure for 2012-13 (upto December 2012) stood at Rs 6,799 crore. More serious is the issue of the money stashed abroad. Here India has been renegotiating its Double Taxation Avoidance Agreements (DTAAs) with other countries. The idea is to bring its Article on Exchange of Information at par with international standards. It goes without saying flight of such capital has to be given the urgency it deserves. Efforts have to be made to stop it at all costs. These would mean undertaking some much needed financial reforms. For starters, the tax system needs to be made simpler. Further, the base needs to be probably widened. All of this to ensure that instances of tax evasion are reduced. The sooner the government does something meaningful on this front, the better off the country will be.

It was a mixed week for the global stock markets. Japan and European nations were among top performers while US ended the week flat (up by 0.1%). In the US, stock markets shed all gains registered during the first half of the week amid disappointing economic reports announced later. In India, investors traded very cautiously ahead of the Union budget to be announced next week; thereby causing the Indian stock markets to close the week down by 0.8%. Also, weak global cues came to haunt the investors towards the latter part of the week.

Source: Yahoo Finance

04:50  Weekend investing mantra
"Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market." - Warren Buffett

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    4 Responses to "Not good enough to buy profitable companies!"

    Anupam Garg

    Feb 23, 2013

    ok...this quote of Warren is seriously a tough 1 to follow


    h j oza

    Feb 23, 2013

    Black money convert into white money through stock exchange. In CTR TTJ ITR etc. their are reported cases that assesse,new investor, have 100%or more profit in share dealing in 13 months,no long term capital gains tax,zero tax. One question.. Incometax authorities shoud see the case of share purchaser who have purchased the share on high price from above share dealers.In my opinion, they might have booked loss and save the income tax. In above transaction govt. lost tax from both the dealer.



    Feb 23, 2013

    As in earlier views on other article i will retain my view that no strategy is fool proof any any strategy could make you person in headline but still for an active investment strategy profitability is one of the criteria for buying decision where passive strategist could wait for limited and rare company coming up with addictive product with everlasting demand but everyone is neither Bill Gates nor George Soros.



    Feb 23, 2013

    not enough at all .! more important is Company's products , business model and above all trustworthy management,

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