All you need are a few ten-baggers... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

All you need are a few ten-baggers... 

A  A  A
In this issue:
» Has the US stock market bubble started to pop?
» Earnings forecasts are toned down almost every year.
» Chinese banks are now being selective in lending.
» Should investors completely rule out the impact of El Nino?
» ....and more

There are more than 5,000 listed entities on the Bombay Stock Exchange. But the top 500 companies form more than 90% of the overall market capitalisation of the BSE. As such, majority of investors, analysts and fund managers focus on stocks from this space. To put it differently, there is abundance of information available on such companies.

So, are most of the remaining stocks not investment worthy? Well, could be. But there would also be a good proportion of the balance 'investment worthy' stocks that would have good growth prospects and decent managements.

US based, Mohnish Pabrai is a well known name in the value investing world. At a recent talk at one of the leading B-Schools in India, he spoke about which type of companies he would focus on if he was an investor in India. His answer was the really small ones; those having market capitalisation of less than US$ 100 m or Rs 6 bn.

Why such companies? Well... to provide the explosiveness to one's portfolio.

Peter Lynch has been credited for originating the expression 'multi baggers'. When he says four, seven or ten baggers, what it essentially means is making four, seven or ten times the money by investing in a particular stock.

And when you think about it, for achieving one's financial goals - provided how realistic they are - one does not need more than a few such "multi bagger" stocks to provide that extra fillip to one's portfolio. And that too throughout one's lifetime. A few good opportunities could pretty much do the job.

This has essentially been Mr. Lynch's secret; as explained by the man himself:

"Well, I think the secret is if you have a lot of stocks, some will do mediocre, some will do okay, and if one or two of 'em go up big time, you produce a fabulous result. And I think that's the promise to some people. Some stocks go up 20-30 percent and they get rid of it and they hold onto the dogs. And it's sort of like watering the weeds and cutting out the flowers. You want to let the winners run. When the fun ones get better, add to 'em, and that one winner, you basically see a few stocks in your lifetime, that's all you need. I mean stocks are out there."

A line mentioned by him pretty much sums up the process, "You have to let the big ones make up for your mistakes."

Given India's strong growth potential, we believe that investors need to have a certain amount of exposure to stocks from the ultra smallcap space or the microcap space; provided it is done by limiting one's exposure to such stocks. Say you have Rs 100 to invest in stocks, the maximum exposure that you should allocate to such companies would be Rs 10 to 15. This is because of high risk associated with investing in the very small companies.

And within this, a good approach would be to have a reasonably diversified portfolio of microcaps to spread the risk that much more. And it goes without saying, that while investing in such companies, one key thing to keep an eye out for - amongst other aspects - is not overpaying.

Do you think it makes sense to have a certain amount of exposure to microcaps? If yes, then go ahead and read full details about this "hidden" strategy that has the potential to help you select a series of winning microcap stock picks...

01:40  Chart of the day
Investors in stock markets thrive on optimism. Hence, sell side firms typically come with an optimistic mindset. However, in order to make money in stock markets you have to be realistic and not optimistic. Nonetheless, let's take the case of optimism forward and see what happens when undue optimism on street meets reality. Many of us would be aware that most firms typically come out with earnings growth forecast of indices at the beginning of the year. However, as can be seen in today's chart, the earnings forecast inevitably stand reduced towards the end of the year. As an example, the median earnings growth forecast for India at the beginning of the year since 2001 has been 16.8%. But by the time the year comes to an end the median forecast drops to 14%. This does not just take place in India but happens in other countries as well. The change in estimates in Korea, Brazil, and other emerging markets can be seen in the chart.

Will EPS growth estimates be revised downwards?
* - Median since 2001; GEM - Global emerging markets;
AEJ - Asia ex-Japan; EMA - Emerging markets Asia; Indo. - Indonesia; Rus. - Russia

This trend as such indicates that most firms are overly optimistic on predicting earnings forecast of their respective indices at the start of each year. And as the year progresses, they tend to tone down forecasts to more realistic levels. This reflects over optimism bias of firms predicting the earnings, which tends to increase the margin of error while investing. We feel that adopting a conservative approach and building in a worst case scenario while forecasting earnings is a better approach to follow.

When we evaluate stocks, one of the most critical factors that we consider is the quality of a company's promoters. We generally avoid companies whose promoters seek to reward themselves by compromising the interests of minority shareholders. One company that fits the bill, in our view, is Suzlon Energy. As you would know, the company's performance has been dismal post the global financial crisis of 2008. The company has been incurring huge losses since financial year 2009-10. The trailing twelve month net loss as of December 2013 stood at Rs 48.2 bn. That's humungous! In FY13, the company, along with its subsidiaries, defaulted on foreign currency convertible bond (FCCB) dues amounting to US$ 200 m. Following this, the company sought corporate debt restructuring.

In a nutshell, the company's business and its financial health are in absolute mess. The stock price has been severely battered. From its all-time high price in January 2008, the stock is down nearly 98%. Now this is what really shocked us... Despite the company's deteriorating fundamentals, the company's managing director Tulsi Tanti has sought a 50% pay hike. Today, the company will ballot shareholders on Mr Tanti's reappointment and remuneration increase from Rs 2 cr to Rs 3 cr. In our view, shareholders must undoubtedly reject Mr Tanti's reappointment. For those who do not own shares of Suzlon, we believe they must refrain from investing in companies with poor fundamentals and self-serving promoters.

Policymakers have this tendency to manipulate data about an economy and give it a rosy spin. Now, in order to prove them wrong, we need not conduct a detailed study of our own. Instead, by simply trying to get a sense of things like prices of essential commodities, job crisis scenario, infrastructure growth etc, it becomes easy to get an idea of the broader trend. And a broader trend is all we need to know. As someone has said, we need not measure the exact temperature of the water in order to understand whether it's hold or cold. A simple dipping of the fingers can serve the purpose.

And it is exactly this strategy that few people in the US are using to underline how the stock markets there could be headed for trouble. Prominent on their radar are so called hot momentum stocks and also the IPO market. On the latter, there are visible signs that the market is indeed getting frothy. An indicator of a bubble is when young companies are trying to access the capital market in great quantities. There have been many such cases in the US IPO market in the past few months. Another worry is how momentum stocks are now starting to fizzle. Three baggers and five baggers of the previous year like Tesla Motors are no longer having an easy ride. However, those who yearn for hard data, even corporate earnings have started slipping and this was evident during the fourth quarter last year. Therefore, be it hard data or an overview of the broad trend, both seem to be pointing towards some tough time ahead for US equities.

China recorded stupendous growth for several years before the current slowdown slammed on the brakes. But this growth came at a price. Indeed, Chinese banks expanded credit at a furious pace increasing the risk of bubbles in various asset classes, most notably property. But as the dragon nation has begun slowing down, the problem of bad debts has also reared its ugly head.

As reported on, companies with issues of high debt and overcapacity are struggling to secure loans from banks. In other words, compared to the unhealthy practice of indiscriminate lending in the past, Chinese banks have now become choosy and selective about whom they wish to lend to. Thus, credit which was so readily available to companies in the boom years has begun to dry up. Interest rates have been rising and obtaining loans is becoming difficult and expensive for Chinese companies. It will be interesting to see the extent of impact this will have on the Chinese economy in the coming quarters.

FMCG stocks are considered as defensive bets in a stock portfolio. However there is no doubt that the stocks are heavily reliant on the rural story. Therefore the fears of El Nino and its impact on inflation and rural economy have already started weighing on these stocks. El Nino is a weather phenomenon that occurs when the Pacific Ocean heats up abnormally. In India, it would drive away rain clouds and put the monsoon and kharif harvest at risk. So investors are worried about whether a poor monsoon will stoke inflation and lower GDP growth.

Well if one looks back in history there is no such evidence. Both in 2002-03 and 2009-10, when the Indian economy was reeling under drought and global economic crisis respectively, El Nino had struck. However in both years, the lower agri production had negligible impact on inflation and overall GDP growth. Moreover, as per an article in Mint, experts believe that several other factors could offset the impact of El Nino. Higher water reservoir levels and excess food grain stocks could offset the inflationary impact from El-Nino to some extent. Thus, while investors cannot completely rule out the impact of El Nino on Indian markets, reacting to the same prematurely may not be a smart move.

In the meanwhile, Indian stock markets pared gains but continued to trade firm. At the time of writing, the benchmark BSE-Sensex was up 68 points (+0.3%). Banking & consumer durable stocks were the biggest gainers whereas pharma and IT stocks were the only losers. Barring China and Hong Kong, all the Asian stock markets were trading positive led by Japan and Singapore. But most of the European indices have opened the day in the red.

04:55  Today's investing mantra
"The four most dangerous words in investing are 'This time it is different." - Sir John Templeton
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2 Responses to "All you need are a few ten-baggers..."


Mar 29, 2014

Ten baggers - Time span

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venkatesh rao

Mar 28, 2014

makes for informative & interesting reading,thank you

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