Here's why 'junk food' stocks can make you rich! - The 5 Minute WrapUp by Equitymaster
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Here's why 'junk food' stocks can make you rich!

Mar 31, 2015

In this issue:
» Another global crisis seems just around the corner
» India Inc's appetite for foreign debt continues to rise
» No upgrade in India's rating just yet
» ...and more!

Given his stellar investing career and the nuggets of wisdom that he doles out, Warren Buffett's actions are always a matter of great interest. And not surprisingly, there is a good amount of buzz with respect to one of the companies in the Berkshire Hathaway portfolio. Just recently, Heinz merged with Kraft Foods in a deal that makes it the fifth largest food and beverage company in the world. Berkshire Hathaway had bought Heinz in 2013 and along with the equity firm 3G Capital is funding the Heinz-Kraft merger.

This merger led to quite a few amusing articles talking about Buffett's junk food portfolio and how nutritionists are warning diners to be wary of the same. Consider this. If you look at some of the products of the combined entity such as Velveeta cheese, Jell-O, Tomato Ketchup, Ore-Ida fries, bagel bites and the like, these are foods that contain high sugar and high salt among other things. But that is not all. If you have tracked Buffett's portfolio over the years, the companies in his portfolio boasted products such as aerated soft drinks, candies, burgers etc. Coca-Cola, See's Candies, Burger King in other words.

Does the Oracle of Omaha really care? No. Nutritionists might look at these products as 'junk food'. But what Buffett is interested in are 'brands'. One of Buffett's core investing principles is to look for companies that have an economic moat or competitive advantage. And one such competitive advantage for companies is 'brand power'.

It is not just Warren Buffett who stresses on the importance of brands. Mr Rajiv Bajaj, MD of Bajaj Auto, has also been vocal about how branding is important if a company wants to maintain its competitive edge. The idea, according to him, is to create brands rather than products. Because branded businesses are ultimately profitable businesses. This is what he had to say in a leading financial magazine, "Western logic (of managing a company) used to be top-down and eastern is bottom-up. We believe a company should be managed implicitly by the brand, and the brand is the centre of the company. It is not about a vertical or horizontal hierarchy. It is actually about a centre-out approach."

Typically, a strong brand ensures great customer loyalty which translates into healthy demand for a company's products. Such companies do not need to depend on capital investments or capacity creation to grow revenues and profits. Indeed, these businesses typically tend to be so strong that they throw up a lot of cash. So there is hardly any debt on the books and strong cash generation means that the dividend payouts also remain healthy. So it is hardly surprising that Buffett continues to remain obsessed with companies that have strong brands.

Our ValuePro service, which believes in putting Buffett's investing principles into practice in the Indian context, is also constantly on the lookout for companies that boast of great brands. We have identified quite a few of such companies and they have found their way into the portfolios. And the hunt for more such companies and their brands continues. Why not consider taking a look at the companies that have become part of both the ValuePro portfolios?

Will you consider investing in companies that focus on creating strong brands? Let us know your comments or share your views in the Equitymaster Club.

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The Great Depression of the 1930s was considered to be the worst financial crisis till the 2008 global financial crisis came along. A gap of around 75 years between the two. Now, it has been six years since the 2008 crisis but the way things are going, we doubt there is going to be a wide gap before the next crisis erupts. Indeed, the next debacle could very well be around the corner.

A lot of this has to do with the cheap money policies of the central banks of the US, Europe and Japan, which have completely distorted global financial markets and pricing of assets. Greece continues to plunge deeper and deeper into a crisis. Oil prices have hit 6-year lows. The US dollar has strengthened even when the economy is weak. As reported in Newsmax Finance, borrowing by developing countries surged 40% to US$ 17.3 bn in 2013. And the dollar gaining over these currencies has only compounded their woes further.

The US is also in a tricky situation. Asset prices have been soaring. But inflation has been falling. So whether the US Fed will raise interest rates continues to remain debatable. The Fed chief Janet Yellen's unwillingness to do so now only heightens the uncertainty. Meanwhile, government debt around the world has risen to unsustainable levels as most of them tackle the problem of debt with more debt. All of this only means that the possibility of an even bigger crisis going ahead cannot be entirely ruled out.

  Chart of the day
While the policy makers around the world grapple with the possibility of another financial crisis, how should investors in India prepare for the same? There are two ways to look at this. The first would be the impact on the stock market. The second would be the impact on business fundamentals. Big moves in India's market are triggered by FIIs and they will surely head for the exit at the slightest sign of trouble. This would no doubt cause a correction in the markets, perhaps even a big one in the event of another global financial crisis. But what would happen to the fundamentals of corporate India? We believe there are reasons to be cautious.

India is no longer a closed economy. As India continues to integrate with the world, corporates will be exposed to ever increasing risks. One of the biggest is the risk of high foreign debt. Borrowing in foreign currency is risky even for exporting firms that have a natural hedge. However, as the chart shows, India Inc has thrown caution to the wind. Foreign debt has grown at 15.6% CAGR over the last 6 years, far higher than India's GDP growth. At the end of 1HFY15, the foreign debt burden stood at US$ 161 bn. Many corporates have not hedged this exposure due to the recent stability in the currency. Investors should be aware that if the Rupee were to depreciate in the event of a financial crisis, India Inc would be caught on the wrong foot.

Will foreign debt hurt India Inc?

Corporate India may be optimistic about India's economy but rating agencies are not so gung ho. Standard & Poor (S&P) has stated that it won't upgrade India's sovereign rating just yet. S&P has cited the absence of substantial and quality reforms as well as the slow pace of government's fiscal consolidation efforts. While we are not fans of global rating agencies, in this case we agree with S&P. The government has certainly shown the right intent but it has not yet moved aggressively on reforms.

With inflation still a problem and fiscal consolidation likely to be slow, it is unlikely that India will be upgraded from its current rating of BBB- (stable) any time soon. However, we believe that investors should not lose any sleep over this. India's rating remains investment grade and that is enough for now. What is important is the pace of economic reforms. The sooner the government can get inflation and the fiscal deficit under firm control, higher is the chance of an upgrade. As the government will complete the first year of its term in a couple of months, we believe it should now step up the pace of reforms.

Meanwhile, the Indian stock markets have traded above the dotted line today on the back of strong buying interest in auto, energy and pharma stocks. The BSE-Sensex was trading up 140 points (0.5%) at the time of writing. Capital goods and IT stocks were facing selling pressure. The midcap and small cap indices were outperforming the benchmark indices with gains of 0.8% and 1.3% respectively. Asian indices have closed mixed with Taiwan leading the gainers and Japan leading the losers. European indices have opened flat.

 Today's investing mantra
"Wide diversification is only required when investors do not understand what they are doing" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit.

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