The Time We Realised Even a Large Cap Like BHEL Can Be a Ticking Time Bomb - The 5 Minute WrapUp by Equitymaster
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The Time We Realised Even a Large Cap Like BHEL Can Be a Ticking Time Bomb

Apr 7, 2016
In this issue:
» Bank deposit growth at five-year low
» Sectoral stocks that fell the most post RBI's policy move
» ...and more!
0.00
Rahul Shah, Co-Head of Research

After his heroics on Sunday, Carlos Braithwaite's fan base has certainly gone up a 100x. To unleash those sixes when he did was extraordinary.

In investing, it would be the equivalent of buying a Warren Buffett stock at Ben Graham valuations, an extra-ordinary occurrence. Rare as it may be - if you buy the right stock, you end up with mind-numbing gains.

Page Industries is the closest we've come to buying a Buffett stock at Graham valuations. Well, it wasn't exactly trading at Graham valuations. But it was certainly quite cheap given the growth runway ahead of it. We are glad we pulled the trigger. Our Hidden Treasure subscribers were sitting on gains of a massive 3,629% last I checked.

Unfortunately, we have also done the opposite. We recommended BHEL in our ValuePro service back in July 2011. That is, we gave Buffett valuations to a Graham stock.

Wait, is BHEL a Graham stock? Well, it depends on when you're asking. Between March 2006 and March 2013, the average ROE of the stock was close to 30%. Even Buffet would be excited by that number.

But between March 2001 and March 2005, the average ROE dropped to 12%, with single-digit ROEs in two of those five years.

If you're considering recommending a stock during a slump, thinking it has moat characteristics and assigning it a valuation accordingly, you may want to think again. The stock could have entered a Grahamian phase and will continue to go lower for the next couple of years before it goes up again. The moat that you relied on may not have been a moat after all.

The ValuePro team has developed an important thumb rule to avoid false moats. They check the valuation history of the stock going as far back as possible. And also whether PE multiple is the right way to value such stocks.

For if the moat is illusory and the earnings are volatile, the stock can also trade below book value during times of extreme pessimism.

This was certainly true of BHEL as it stayed below book value for a long time between 2000 and 2002. A stock with a real moat like, say, HUL or Nestle may never go below book value. But if the moat is illusory and the company has a tendency to earn below-average returns on equity, then it helps to check whether the valuations assigned are appropriate.

After all, we may not be able to buy the stock at its exact bottom. But we should be sure we are not assuming too optimistic a scenario. In investing, it always pays to err on the side of caution. For even a large cap like BHEL could prove to be the proverbial time bombs in your portfolio.

Thankfully, the ValuePro team hasn't made too many such errors. And this is why both of its portfolios are beating the benchmark indices since the service's inception in 2009. And by learning from mistakes such as these, it should be able to perform even better going forward.

Have you ever bought Ben Graham stocks at Warren Buffett valuations? Let us know your comments or share your views in the Equitymaster Club.


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2.32 Chart of the day

The banking industry has been going through rough weather in recent times. But its troubles are not restricted to the lending side. Its growth in deposits - the most basic 'raw material' for a bank - is at a fifty-year low. At the other end, growth in lending is beginning to pick up after five years of slack.

Bank deposit growth at a five-decade low

A direct offshoot of this situation is its impact on interest rates in the country. If both the slowdown in deposit growth as well as the pick-up in demand for credit were to continue, banks may resort to increasing deposit rates.

Further, yields on government bonds could also rise as banks reduce their appetite for buying government bonds. Thus, while many are waiting with bated breath for rates to come down in the economy, this particular problem banks may face could bring down the efficiency with which RBI rate cuts are passed on to borrowers.

3.25

A report in the Mint spots an interesting correlation. Stocks from sectors that had risen the most since the announcement of the Union Budget on 29th February are also the ones that fell the most after RBI's interest rate policy announcement this Tuesday.

The central bank cut the benchmark repo rate by 0.25%. This was an obvious disappointment to some investors in the market. Why? Perhaps because their expectation were set higher. Post the budget, the government seemed determined to stay within the fiscal consolidation targets set earlier. It then also cut small savings rates.

This set the stage for expectation of a larger cut in rates by the RBI during its policy meet. Since this did not happen, the rate sensitive sectoral stocks that had seen the most buoyancy post budget, also fell the most post the RBI policy announcement. This effect was seen the most in stocks from sectors such as realty, metal, banking and auto.

4.30

You perhaps already know that on 22 April 2016, we will be celebrating our 20th anniversary. One this occasion, we'd love to hear from you! In case you wish to share your experience with Equitymaster or read what some of our valued long time subscribers have to say about us, please do so here.

Here's what a Carlos de Souza, an Equitymaster Wealth Alliance Member from Mumbai, had to say about his experience with Equitymaster:

  • Equitymaster has been a great source of investment knowledge for me over the past 20 years. The thing that sets Equitymaster apart is their honesty in calling the market & picking winners. They are not always right, but they are ethical. Kudos to all at Equitymaster especially Ajit Dayal and Vivek Kaul.
4.48

The Indian stock markets were trading on a weak note today on the back of sustained selling activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading down by around 55 points. Losses were largely seen in telecom and consumer durable stocks.

4.56Todays' Investment mantra

"Our criterion of "enduring" causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism's "creative destruction" is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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1 Responses to "The Time We Realised Even a Large Cap Like BHEL Can Be a Ticking Time Bomb"

Sadasivan

Apr 7, 2016

The following may be the cause:-
A SECRET REGULATION of the FSB was agreed upon by the GG 20 Nations in the G 20 meet in Australia,November 2014.The two subsequent years had less Deposit 'growth"..
Please google for:-
Global bankers coup Ellen Bbrown

Like (1)
  
Equitymaster requests your view! Post a comment on "The Time We Realised Even a Large Cap Like BHEL Can Be a Ticking Time Bomb". Click here!
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