Your best stocks ideas could come when these 4 risks collide!

Mar 30, 2015

In this issue:
» Is e-commerce making the same mistake as Indian IT?
» Who is the main debt culprit?
» Telecom companies in India add trillions to their debt!
» ...and more!

There was a time when the managements of IT companies offered near precise earnings guidance. For an investor looking to invest based on next quarter's EPS, there could be nothing better. Or at least most investors thought so! And hence these companies fetched valuations that were at a significant premium to most other sectors.

Certainty and earnings visibility are factors that investors derive comfort from. The more near term the comfort that much immediate is the gratification. And therefore most investors count on quick returns, large companies, sun rise sectors, established business models and well known managements to assure them of good investing decisions. However, the fact is that buying into certainty when everyone else is doing so can never be your best investing idea!

So if you are looking at buying stocks that can bring in the multibagger returns for your portfolio, you need to look for mis-priced risks. And how do you do that? Well, as Rahul Shah pointed out in a recent edition of The 5 Minute Wrapup, investors often misread risks. They tend to overestimate the carnage to be much, much severe than it actually is. However, in reality, what go down a lot are stock prices and not their long term intrinsic values. It is scenarios like these that offer the best opportunity to buy real long term values at deep discount.

And when do such opportunities occur? Recall 2002, 2008 and 2013. A combination of company, country, currency and commodity risks put together made market sentiments a heady cocktail of investor panic. While this drove out most investors looking for near term certainty, only a small group of investors benefitted from the same. And these were investors looking for real long term value. There were able to look beyond the darkness and buy into risks with sufficient margin of safety. Needless to say that when the tides turned and certainty seeking investors came back to the markets, the calculated risk takers were heavily rewarded with rich premiums for their discounted stocks.

In fact as per Prof Ashwath Damodaran of Stern School of Business, the best valuation lessons are not taught by valuing the most profitable companies in the biggest bull runs. They are instead taught by the companies that are in the darkest of times. We cannot agree more with him for our own valuation of Tata Motors in December 2008, when the company was near bankruptcy stood testimony to our value investing principles.

Therefore as much as the media and managements would like you to believe, the best time to invest is not when there is too much certainty and optimism all around. You would rather wait for the 4 risks to resurface and allow markets to offer you an opportunity to take calculated risks at attractive bargains.

Until then, keep your hands off stocks that promise too much certainty and price in too much optimism!

Do you invest in stocks at a time when promise too much certainty and price in too much optimism? Let us know your comments or share your views in the Equitymaster Club.

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There is yet another reason why we would like to remind you of the heydays of Indian IT sector. The optimism that these companies would employ lakhs in the years to come and almost wipe out unemployment in the organized sector. Well, this optimism did hold true for a few years. IT companies in India did employ graduates and post graduates across streams and did become the biggest and best employers. All was good until it came to a point where the cost arbitrage that formed the basis of the IT outsourcing story, began to suffer. With its growth linked to manpower addition, the IT sector began realizing the importance of 'non-linear' growth strategies. And with that came the embargo on excessive hiring.

It seems that India's e-commerce industry, that is currently in the midst of huge investor optimism, is not willing to learn from the mistakes of the IT sector. The blue eyed boy of India's e-commerce story, Flipkart, plans to add 2 million jobs in 2015. Nearly 60% of the additional hiring will be in the logistics and warehousing segment. However, we wonder whether in doing so the company will be able to retain its cost advantage that forms the basis of its business model. And we will not be surprised if sooner or later, the ecommerce sector too gives investors a reality check on margins and return ratios.

  Chart of the day
Time and again, we have stressed the perils of high debt levels. Whether it is individuals, corporates or countries, borrowing beyond one's means to repay is a sure recipe for financial disaster. However, while individuals and corporates may learn from their mistakes, governments it seems, do not. While debt was the cause of the great recession of 2008-09, governments continue to add debt to their balance sheets. Shockingly, the rise in total global debt in the last seven years was more than the rise seen during the boom years from 2000-07!

As can be judged from today's chart, governments clearly deserve most of the blame. It is indeed astounding that instead of implementing austerity, economic reforms and debt restructuring, politicians believe that the solution to a debt crisis is to take on more debt. It's quite clear to us that all this has only made the problem more severe than ever before. When the next economic downturn comes around, the stresses on government balance sheets will be huge. All the more reason to hold some Gold in your portfolio we believe.

Biggest rise seen in Govt. debt since 2007

Staying on the debt issue, the telecom sector in India can be an excellent case study in corporate debt. The telecom spectrum auction has expectedly yielded a windfall for the government and has provided a lot of clarity to the sector. The record total bids of about Rs 1.1 trillion will certainly help the government achieve its fiscal deficit target. But what about the companies involved and consumers? The news is not good for either. The top three Indian telcos, Bharti Airtel, Vodafone India and Idea Cellular, have had to fork out Rs 29.3 bn, Rs 29.9 bn and Rs 30.3 bn respectively. While the telcos do not have to pay the entire amount upfront, the strain on their balance sheets will be significant. Overall, the total debt of the Indian telecom industry can rise by about Rs 3.5 trillion due to the auction payouts. It will dampen profits as well as cash flows in the years to come.

This is why we believe that consumers will have to get used to higher mobile bills soon. Telcos will increase tariffs in a phased manner to counter the impact of the auction on their finances. However, with the entry of Reliance Jio to the sector later this year, it will be tough for telcos to raise tariffs beyond a point. Thus, interesting times lie ahead for the sector from both an investor's as well as consumer's point of view.

Meanwhile, the Indian stock markets have traded well above the dotted line today on the back of broad based buying across all sectoral indices. The BSE-Sensex was trading up 480 points (1.75%) at the time of writing. Capital goods and FMCG stocks are leading the gainers. The midcap and small cap indices have outperformed with gains between 2-3%. European indices have also opened on a positive note.

 Today's investing mantra
"To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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1 Responses to "Your best stocks ideas could come when these 4 risks collide!"


Mar 30, 2015

Telecom sector may have gone into debt by receent auctioning of spectrum,but these companies have a clear field in their kitty for next twenty years. Companies with decent cash flows have not to worry .They can service heir debt and still have decent profits.Small companies shall get merged in long run.Only big players can be left in this field.

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