Are charts not for you - the value investor?

Apr 17, 2015

In this issue:
» Meteoric rise in e-commerce valuations
» The problem with India Inc's debt laden balance sheets
» Why higher GDP growth may not create enough jobs
» ...and more!

Our friends at Profit Hunter have been doing a brilliant job of studying the mindset of a trader. And in a couple of recent videos, Asad Dossani explained why even a trader has enough learning to take from a long term investor's mindset. So while it is true that the approach and mindset for trading and investing ought to be distinct, it is not that you should do only one of them without the other. In fact as long as your risk appetite, investment tenure and approach are well aligned to the objectives, the learnings from each can help you be very successful in creating wealth.

But do you think it is only the approach and mindset that are distinct in trading and value investing? Well, certainly not! After all, how many times have you seen traders poring over annual reports? And how many value investors understand the nuances of the stocks and bands in technical charts? So the tools adopted for the two approaches are also distinct. But that again does not mean that the trader should never 'read' about the company or that the value investor should never touch any chart with an eight foot pole.

In fact with their graphical representation, charts bring an amazing clarity to our thought process. So why not put it to good use? Just that you should be looking at the right kind of data with the right perspective. The charts that I often insist my team members to take a look at are the long term price versus valuation movement ones. Especially during a period of skepticism or euphoria looking at such a chart helps you get grounded to reality.

If you don't believe me, take a look at the chart for Bharat Forge. The stock having gained almost 190% is one of the top gainers over the last year. No doubt being one of the largest exporters of auto ancillary the company has a lot going for it. In fact with the change in its strategy to focus on order wins from both domestic and global OEMs, it is no longer reliant on the vagaries of Indian automobile industry. Without doubt investors have reason to cheer! But what kind of premium would you want to pay for that cheer? Should you be doubling the multiple that the stock deserves because of the high growth expectation?

Well, that is exactly what the market seems to be doing with Bharat Forge. And within a matter of a year the price to earnings multiple of the stock has doubled from 25 to 50! Whether the stock deserves such valuations is a discussion for another day. But as a value investor such greed for the stock should make you cautious about the frothiness in valuations. And no matter how large the company's market share or market cap, the risks to valuations cannot be sidelined.

So as long as you are looking at long term fundamental and valuation data and putting that into perspective with the qualitative moat and management of the company, charts should be your friend.

They cannot just help you pick the right stock at the right time but also tell you which ones to throw out.

Do you make use of charts to take decisions on value investing? Let us know your comments or share your views in the Equitymaster Club.

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Speaking of valuations, the unlisted e-commerce businesses take the cake! This segment has captured the imagination of investors like no other. Many Indian e-commerce firms have attracted huge amounts of money from venture capitalists and private equity funds. These investors have bet on these firms despite most of them being loss making. On the expectations of high growth, the companies are valued at significant premiums. Say for example, as per an article in Mint, the valuations of Flipkart have moved up to US$15 billion from less than US$ 3 billion at the beginning of 2014. Investors have pushed up these valuations as Flipkart commands major market share and has stupendous topline growth.

But make no mistake. While the companies have been generating stupendous growth on the topline, at the bottomline they are far from breaking even. We are of the firm belief that the bottomline always trumps the topline. No matter how fast a company's sales may grow; investors should avoid loss making firms or ones with poor profitability. And whenever these e-commerce entities decide to get listed investors should be very wary of the valuations at which the shares will get offloaded to them.

Signs of recovery and shadows of doubt, both are visible in the Indian economy. While there has been some activity on the side of reforms, spurt in investments is a must for Indian growth story to proceed further. However, huge debt of India Inc and pile of bad debts in the banking sector are blocking the wheel of recovery. Even if the interest rates come down, the burden that both India Inc and banks are reeling under is unlikely to provide much tailwind.

It is not just the corporates that deserve to be blamed. Lack of clear policies and project delays have led to capital stuck in the projects, swollen balance sheets and dried revenue streams and profits. A fair share of blame goes to banking system as well, especially public sector banks that instead of limiting the risks have come up with non selective restructuring mechanisms that have done more damage than good. Most of this debt lies with the firms in the infra segment.

Overcoming these challenges is not going to be easy. In rising markets, fresh fund raising may give some relief, but will not translate to recovery for debt ridden firms. For a long lasting solution, both SEBI and RBI will need to be proactive and sharpen the regulatory oversight. Until then, investors will do well to avoid companies with huge debt and check the capital allocation skills of the management before trusting them with their hard earned money.

  Chart of the day
Now, even as policy makers look for 'new normal' in India's GDP growth rate and promise job creation, India's historical statistics do not offer much hope. Moreover, the controversial land acquisition bill seems to thwart the possibilities of job addition all the more. As per the proponents of the bill, the landless poor (such as tribals and backward classes) will get employed in industrial corridors. However, as per an article in Mint, it will be nothing short of a miracle to create 300 million jobs in industries, given India's manufacturing track record. While agriculture employs half of India's workforce, the industries have employed barely about 14%. And going by the elasticity in employment to GDP growth, which has declined over the decade, it is unlikely that even a slightly higher GDP growth will solve the employment problem.

Employment elasticity in India on a downward trend

The Indian stock markets were trading in the red at the time of writing. While the BSE Sensex was down by 129 points, NSE-Nifty was down by 90 points. However, most Asian equity markets were trading in the green at the time of writing. European stock markets, opened mixed today.

 Today's investing mantra
"No formula in finance tells you that the moat is 28 feet wide and 16 feet deep. That's what drives the academics crazy. They can compute standard deviations and betas, but they can't understand moats." - Warren Buffett

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

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Equitymaster requests your view! Post a comment on "Are charts not for you - the value investor?". Click here!

1 Responses to "Are charts not for you - the value investor?"


Apr 18, 2015

Stock investing with out the aid of charts and tech analysis is like driving the car in the night with out headlights;ideally a combination of fundamental and tech analysis will enable to pick the right stock at right time and avoid right stock at wrong time and wrong stock at wrong time. Historically, it neednt be necessary that only big bang names will do well, in fact, relatively less heard stocks can give whopping returns, case example: Kaveri seeds

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Equitymaster requests your view! Post a comment on "Are charts not for you - the value investor?". Click here!
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