The four-word secret to successful investing - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The four-word secret to successful investing 

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In this issue:
» Why the rally in US stocks is dangerous?
» Moody's believes that worst over for India
» Investors pull record money out of gold ETFs
» This could just the start of an era of money printing
» ....and more!

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Have you ever wondered why fiction books sell more than statistical texts? Well, it has to do with the fact that our mind loves stories more than math. Besides, it also excels at being in rapt attention to forecasts of any kind. Make some bold and outrageous predictions before the audience and you'll surely have them riveted. But studies after studies have been done to test the accuracy of forecasts and most of them have come to one uniform conclusion. And it is that no matter how expert one becomes, one's odds at forecasting successfully is no better than throwing darts.

However, just as forecasting is prevalent in so many industries despite its obvious flaw, it is indeed widespread in the field of investing as well. There's this whole cottage industry devoted to predicting each and every macro variable and also the various factors that influence the earnings of a firm. In fact, it won't be wrong to say that most of their time is spent in accumulating information that would help them in their forecasting process. But does the accuracy of forecast really improve? We don't think so. What improves is the confidence that one has in the forecast but certainly not its accuracy.

Thus, what is clearly evident is that when it comes to forecasting, a huge amount of expertise is just as good as a little expertise. Therefore, the key to successful investing is that one should not try too hard in generating as much information as one can. Because at the end of the day, the information is not going to help in improving the accuracy of forecasts beyond a certain point. Instead, one would be better off valuing stocks and buying what's attractive based on the current environment.

It's amazing how this fits perfectly well with the philosophy espoused by value investing legends like Benjamin Graham and Warren Buffett. Anyone who has read a bit of Graham wouldn't help but agree. Graham wasn't a big fan of generating information or making earnings forecast. Instead, he stuck to the simple but powerful rule that one would do very well if one buys a list of diversified stocks based on their statistical cheapness. In other words, just value the stocks based on current information and forget about the forecasts. Buffett, his most famous disciple, also echoes the same thought when he says, don't forecast the rain but do build arks. In other words, hold good quality stocks that can survive in any economic environment. But don't try to predict the latter. Thus, the secret behind successful investing is simple 'Don't try too hard'. To generate information and forecast that is. Instead, have a simple and consistent approach towards valuing stocks and strong returns will certainly follow.

Do you think one should spend more time on simple processes like valuing stocks than trying to predict things like earnings and interest rates? Please share your comments or post them on our Facebook page / Google+ page

01:21  Chart of the day
So, the Dow Jones Industrial Average hit a new high yesterday and the entire financial market is getting excited on this news. But wait a second. Is this the right parameter to judge whether the US economy is really doing well given that there has been so much dollar debasement and stimulus? Certainly not. In fact, it will help to see how the US index has performed vis-a-vis gold in recent times. Today's chart of the day makes an attempt to do the same and it does not look great. Instead of the ratio going higher, it has trended steadily downwards and is currently hovering around multi year lows we believe. Thus, it is clear that the jump in the Dow is more cheap money induced and against real currency gold, the Dow is massively underperforming. So any talk of the good time being back is really devoid of any understanding of how the economy functions we believe.

Source: Ace Equity

If someone could be given the credit of having a myopic view of an economy, it would definitely be the ratings agencies. They were crying hoarse for the past few months that India's rating warranted a downgrade. Now they think the worst is over for India. As per the Economic times, ratings agency Moody's feels that the all major headwinds are behind the country. They even think that the year would see mild positives. This means that the abysmal growth rate that we saw in the December quarter was as bad as it gets. In all likelihood things will get better now. This is why it has upped India's growth forecast to 6.2% for 2013 from the earlier estimate of 5.1%.

The roots for Moody's optimism about India can be traced to the Union Budget 2013. The FM's hopes for the small cuts in the fiscal deficit have given the agency a cause to cheer about India. Though they do admit that the Budget did nothing to fortify India's long term growth. Such a view is nothing but a short term one we believe. Investors would do well to discount such short term views. Agreed that the long term opportunity that India presents is still there. But in order to get the economic cycle back on the uptrend, there has to be a sustained effort at deficit reduction.

Exchange traded funds (ETFs) are a simple way for investors to purchase gold. Rather than physically buying the precious metal you can just purchase a fund which exactly mirrors the price movement of gold. Plus this is a relatively low cost and easily tradable way to invest in the metal. Since these funds were launched nearly a decade ago they have become extremely successful.

But, what happens when investors believe that gold prices don't have any more steam left? Investors can sell just as easily as they can buy. Well, this may be the exact situation currently. Gold prices are now down 18% from their record nominal high in 2011. And since the start of 2013, gold ETFs have dumped 140 tonnes of gold. February saw the largest monthly outflow of gold from ETFs ever recorded. The sell off is part of broader negative sentiment towards bullion. Investors are becoming more confident in the global economy and putting more money in riskier assets. But this may just be a short term phenomenon. And it largely depends on your perception of the future. Being conservative, we would say you continue to allocate some of your portfolio to gold.

FY13 has not been a particularly good year for the auto industry . Indeed, slowdown in the economy, high fuel prices, firm interest rates and higher consumer inflation have all taken toll in some form or the other on the demand for vehicles. Given that the fiscal is almost over, focus has now shifted to how the scenario will pan out for the sector in FY14.

The industry is closely linked to GDP growth. Thus, unless GDP growth picks up, the outlook for the auto sector will continue to stay subdued. And things are not looking too good for FY14 either. For the first six months at least, the demand is likely to remain subdued. Even dealers across the country have pointed out that the demand environment has been poor and deteriorating. Further, footfalls and enquiries have also reduced. In a tough economic environment, consumers are wary of loosening their purse strings for big purchases. Thus, if the Indian economy begins to display signs of recovering in the latter half of the coming fiscal, then that positive impact will be rubbed off on the auto sector as well.

Fed chief Ben Bernanke retires in January 2014. Many hope that this will put an end to the era of cheap money. However, that may not be the case. The US Fed itself may not want to take Bernanke's legacy forward. As it is, his colleagues at the Fed have not always nodded in agreement with his cheap money policies. The Vice Chairman of the Fed, who may succeed Bernanke, is known to be dovish central banker.

However, it seems that there are many more central bankers around the world waiting to fill in Bernanke's shoes. Bank of England and the ECB have already committed to keep cheap credit flowing. But the Governor of Bank of Japan takes the cake. Plagued by over a decade of economic stagnation, the newly elected Japanese PM has virtually promised the most expansionist monetary policy. It is therefore only a matter of time before other central bankers take the mandate of printing money from Bernanke. For those of us worried about inflation and devaluation of currencies, parking small amounts of money in gold is the only redressal.

Look at the Dow Jones Industrial Average. The benchmark stock index has already hit an all-time high. Does this not indicate that a recovery is underway? Can so many people be wrong? Well, we fear that this bull rally in the US stock markets is dangerous. The economy still fares poor on several vital indicators. Household income and confidence has been dipping to an all-time low. The case with employment, wages and salaries and housing is not encouraging either. At the same time, energy continues to remain expensive.

In essence, the US is in a deleveraging cycle after a 40-year boom fuelled by excessive debt. Its economy is going through a correction. As such, the stock rally is not supported by organic economic growth. The US Fed Chairman has been injecting huge doses of money recklessly into the financial system. This has caused stock prices to go up. Mr Bernanke has been hoping that the 'wealth effect' caused by the rise in stock prices would trigger consumer spending. And this in turn would prop up the economy.

That's nothing but wishful thinking. By artificially inflating asset prices, the US central bank has created an illusion of stability. We believe this is extremely dangerous. Any major external shock outside the control of the central bank could bring the markets crashing.

Meanwhile, indices in the Indian stock market are circling around the breakeven point with the Sensex higher by around 30 points at the time of writing. IT and capital goods stocks were witnessing strong buying interest. While Asian stock markets closed mixed today, Europe was trading mostly in the green.

04:50  Today's investing mantra
"Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others which they know nothing about." - Philip Fisher
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4 Responses to "The four-word secret to successful investing"


Mar 7, 2013

How do you refer to the process of valuation in this context? As Girish mentions, a DCF model will require forecasts.

How do you advice on valuation, if one does not forecast. Without forecasting and with only a qualitative view on the company's future, how does one move forward with a buy/sell decision?



Anupam Garg

Mar 7, 2013

wow...m actually 1 of the victims as stated in today's mantra



Mar 7, 2013

Its very obvious that trying too hard wont help much as its not one person who is driving a market but lots of external factor influences in which common understanding of mass is significant one. So one's finest understanding might prove abstruse for other in this way it is preferred to develop and follow an approach which doesn't need excess endeavoring but simplicity (current info) and consistency (everlasting demand) which was ever been observed with past Hoagies.



Mar 7, 2013

Valueing is fine but Some valuation techniques like DCF need forecasting FCF for many many years. Other than asset based valuation techniques (Ben Graham style) everything in investing world involves little or more forecasting. Warrent Buffet is no more value investor in Grham sense. He is what we can call Growth At Reasonable Price (GARP) kind investor. And he uses DCF.

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