Forget Buffett, this Chinese tree will teach you all about investing...
(Mar 24, 2015)
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In this issue:
» Understanding greed, fear and mean reversion...
» SEBI's new move to enable banks to convert bad loans of borrowers to equity
» How did the markets close today?
» ...and more!
Many hundreds of years ago in the faraway lands of the East there lived a renowned master who was widely revered for his esoteric wisdom. One day he called his four disciples and said, "Sons, I believe it is now time to see what you have really learnt from me. I am going to give each one of you a seed. I want you to plant it and water it. When you think the plant is ready you may come back and share your experience. That shall be your test. Just remember all you have to do is plant the seed, water it regularly and keep fertilizing the soil. The seed will do its job."
The four disciples, enthused to perform this simple-looking task, left in four different directions to find fertile patches of soil where they could plant the seed.
Each one was pleased to find a fertile ground where they could carry out the assigned task. The work commenced with a lot of energy and excitement. The disciples watered the seed with a lot of care.
A few weeks passed away.
There was no sign of any plant emerging from the earth where they had sowed the seed. But they had faith in their master's words. So they continued doing what was told to them. In this manner, many months passed away.
At the end of the first year, one of the four disciplines got dejected and resigned from the task. He thought the seed had probably perished. Maybe the master had missed out some critical information. So he just accepted defeat and headed back.
At the end of the second year, another disciple quit after he was convinced that this task had been an absolute waste of precious time. He was angry at his master for making a fool of him.
At the end of the third year, the third disciple still saw no signs of any green shoot from the ground. Passers-by had now started mocking at him for being on a foolish assignment. One stranger who empathized with his predicament remarked that he would have been more productive and appeared less foolish if he had invested his time planting other trees instead. He followed the advice.
Three disciples had already quit. And at the end of the fourth year, the fourth disciple still saw no signs of the plant. He had endured four long years, watering and nurturing the ground with utmost care. Of course, there were moments of doubt, bouts of frustration, feeling of failure. But he held on. He knew that the master was a very wise man. He wouldn't send them on a pointless assignment. This disciple had followed the master's advice very diligently. So he kept going...
Then sometime during the fifth year, something incredibly magical, something that he had never ever seen in his life, began to unfold before his very eyes.
In a matter of just five weeks, he saw a giant 90 feet tall tree standing before him. Yes, 90 feet in just five weeks! He was deeply ecstatic at this culmination of his years of toil and patience.
Let us tell you, dear reader, the tree that the story talks about is no mythical tree. It's the Chinese bamboo tree. It is a very unique plant. Its growth patterns are unlike most plants that, more or less, display linear growth patterns. So it is indeed true that cduring the first four years, there is absolutely no sign of the tree above the ground. And then in the fifth year, the tree emerges from the ground and can go as high as 90 feet in just five weeks.
The Chinese bamboo tree offers many vital life lessons to us. But what is even more striking is the similarity this tree's growth pattern has to the movements in the stock market.
Let's take the Indian stock markets for instance. After the benchmark indices hit their peak in January 2008 and crashed thereafter, the markets dangled sideways for a long, long time. It took nearly six years for the benchmark indices to break beyond the old highs and enter a new bull zone. And as you have witnessed yourself, the markets have witnessed a massive bull rally in the last 12-18 months. Many stocks have doubled... trebled... gone up multifold... during this period.
Just like the Chinese bamboo tree...
You see the similarity?
What would have happened had you picked up fundamentally sound companies over the last few years and just stayed patiently invested? Your investments would have gone up multifold.
On the other hand, if you are one of those investors who gave in to frustration and exited equities because your portfolio was underperforming for some years, you may have realized by now what a big mistake it was. The same mistake that the three disciples committed in the story...
Let us tell you that it is not easy to be like the fourth disciple. It requires a lot of patience, endurance, self-assurance and conviction to keep standing when the people and the signs around you are trying to break your confidence and forcing you to tread the safe path.
The truly great, the truly successful investors have what the fourth disciple had - patience and conviction.
These virtues cannot be acquired overnight. But can be certainly nurtured...
Like the Chinese bamboo tree...
What is your biggest takeaway from the Chinese bamboo tree story? What steps are you going to take today to see your investments blossom over the next 4-5 years? Let us know your comments or share your views in the Equitymaster Club.
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One key learning from the above piece is that returns in the stock market are lumpy in nature, in other words, non-linear. So there could be a couple of years when your stock portfolio gives negative returns. Some years the returns could be average. And once in a while, like it happened last year, you could see you stocks double or even go up multifold.
While this is clearly not a big revelation, most investors have great difficulty coming to terms with this characteristic of the stock market. They tend to deal with stocks as if they were fixed income instruments. They expect positive returns every single year. In fact, they expect stocks to go up immediately after they buy. Any temporary correction in stocks can completely unnerve them. And this is how the worst investing decisions are born. Out of impatience and frustration...
This brings us to the concept of 'mean reversion'. While markets, which are driven by human sentiments of fear and greed, tend to tread the extreme paths of euphoria and depression, they tend to regress to the mean through their self correcting mechanism. As you may have observed, during periods of growth, the markets may get euphoric. Likewise, during periods of slowdown, markets may get too pessimistic and fall sharply. On either side, the human reaction tends to be extreme. This is because of the human tendency to linearly extrapolate the future from the immediate past.
The intelligent investor has a keen awareness of this kind of market behavior and does his best not to get swayed by the irrational forces of the market.
Only yesterday we highlighted the issue of rising debt levels in India Inc and escalating bad assets in the banking sector. The threat is good enough to derail any potential recovery. However, SEBI is trying to devise ways through which the impact of bad assets can be minimized on the banking sector. Through the latest move, banks will be able to convert the bad debts of borrowers into equity without much hassle.
Theoretically-speaking, this step makes sense. The banks can acquire the borrower's equity, push a takeover of a firm or exit at a better price. On the other hand, the companies would be relieved of interest payments.
But there is one big reason why this move may not do much good to the banking sector. Here is the reason... As we all know, much of the distressed debts or restructured assets are in the infrastructure and manufacturing segment. Most of these firms have seen their stock prices severely battered on the bourses. In today's chart you can see the degree of stock price erosion of some major debt-laden companies from infrastructure sector. In a lot of cases, the entire market capitalization of the company is less than the bank debt! In such cases, SEBI's move is unlikely to provide much relief to the banks.
Further, the performance of these firms is poor on account of project and execution delays which at times are beyond their control. And unless things change dramatically at the ground level, the prospects of these firms are unlikely to improve. It would definitely be a challenge for banks to find a buyer for such firms. And banks themselves have little knowledge or expertise to run these firms. Hence, while bankers may expect this regulatory move to help them, it will be a tough challenge to recover their money.
Market Cap Erosion Of Debt-Laden Companies
In the meanwhile, Indian stock markets traded firmly during most of the trading session. However, the gains were pared towards the end with the BSE-Sensex closing 30 points (-0.1%) lower. The sectors leading the gains were healthcare, oil and gas and consumer durables. However, the banking, IT and realty sector indices closed in the red. The BSE-Midcap and BSE-Smallcap indices also closed in the red.
"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks." - Warren Buffett
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