When in doubt, apply this system... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

When in doubt, apply this system... 

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In this issue:
» Ex-Morgan Stanley chief: Fed is distorting the markets
» Eroding purchasing power will continue to impact auto industry
» Will the rupee move away from the 60 per dollar mark?
» Strong reforms needed to rescue the Indian economy
» ...and more!

"The reason our ideas have not spread faster, is they are too simple." These are the words of Charlie Munger, the Vice-Chairman of Berkshire Hathaway Corporation. Here he is referring to the point that people - especially in the investing world - tend to prefer complicated models just because the simple ones may just be too good to be true. In other words, their simplicity tends to make them unreliable or inferior.

In a recent article posted on Gurufocus, the author discussed out the simplicity mental model approach Buffett and Munger take to simplify their investment process. In a broad sense, they use four filters to narrow down their options.

Filter number one would be to understand the business - knowing one's circle of competence and staying in it. Filter two would be to understand and identify the competitive advantage of the businesses. The third filter would be to gauge the managements and stick with only those businesses that have honest and able people running them. Or as Peter Lynch says, "Go for a business that any idiot can run - because sooner or later, any idiot is probably going to run it."

And the fourth filter is to not overpay for even the best of the companies. In other words, buying the stock at a sensible price would be imperative for good returns over longer periods.

It may be noted that this is not the entire system they follow, but is just part of their overall process. And it goes without saying that diving into the details would be required, especially to understand the key factors that affect the various businesses they look at or consider as investment prospects.

In our view, this would be a good method to go about shortlisting stocks - either by eliminating all the ones that do not pass these tests or the other way around.

While these are topics that we have written about multiple times on Equitymaster, we thought it would be a good idea to revisit them, especially considering the very strong response seen for a recently concluded initial public offering (IPO) issue; although the amount being raised was quite less. Nevertheless, the portion reserved for the retail segment of the issue was oversubscribed by over seven times. On an overall basis, it was oversubscribed by over 38 times.

Is the company's business simple to understand? While the company's business may be one of a kind amongst publicly listed companies, its IPO seems to have gotten a strong response on the back of its unique business model. Terms such as niche play on consumption have been used to describe this IPO. Also, given its a relatively new business segment, one that investors would need more time to understand, it seems that this time around (like many instances in the past) investors have gotten caught up with this so called "concept" IPO.

Second, one needs to gauge the factors such as competitive advantages. Answers to questions whether this business will continue to do as well five to ten years down the line need to be figured. What is it that this company is offering that is different from its competition - which could include complementary as well as supplementary services and products - needs to be gauged.

Further, is the company's management good and honest? If so, then move on to the next step. Is the price attractive? From the looks of it, the valuation that the company's stock is likely to command does not make it very attractive, in our view.

Warren Buffett has often said investing is simple but not easy. The key aspect behind this statement is patience - patience to hold on to investments for longer periods or the patience to not do anything when there are less attractive opportunities available. Or for that matter, the patience to wait for the right price for a shortlisted stock. The four-filter system would be a good way for investors to figure out whether their investments make sense for them. For novice investors, it would be best for them to identify their comfort areas - and/or work towards expanding the same - and definitely knowing what and why they are buying.

Do you agree with Buffett and Munger's four filter system for shortlisting stocks? Let us know in the Equitymaster Club or share your comments below.

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01:50  Chart of the day
The elections are on in full swing across the country. The Congress led UPA government is staring down the barrel it would seem. After all, no one believes that this government can come back to power. The reasons for this belief are easy to identify. Corruption, policy paralysis, lack of political leadership and inflation are amongst the key reasons. However, as per an article in Mint, there seems to be an academic debate going on among economists, regarding the economic performance of the UPA.

Will scams and corruption outshine UPA's performance?

On all parameters except inflation, the ten-year rule of the UPA (2004-2014) appears to be superior to the six-year (1998-2004) rule of the previous NDA government. This may be true from a purely statistical point of view. However, most of the poor performance has occurred in the past three years. It must be kept in mind that the BJP had launched an 'India Shining' campaign in 2004, believing that it had done well over a six-year period. The party lost the election, in part, due to the poor economic conditions of 2002 and 2003. Thus voters give more importance to the years just preceding an election than the entire tenure of the government. This thinking could spell doom for the UPA as it did for the NDA in 2004.

Fed has drawn a lot of criticism for its financial experiment that has done more damage to the US and global economy than good. And the latest remark from none other than ex-Morgan Stanley chief almost confirms it. He believes that Fed along with Wall Street and regulators is guilty of negligence and is the main culprit for distorting the markets. We could not agree more. Even during the years of quantitative easing, the authorities have done little to restructure debt and reform regulations. While the new Chairman Janet Yellen has taken a few steps towards tapering, even now, the interest rates are low. This is likely to drive investors to take risks and lead to asset bubbles. Again, monetary policies cannot be a solution to everything that is wrong with US economy. It's time that Fed steps back and US fiscal authorities do their bit to arrest the damage.

The last couple of years have been quite tough for the auto industry. With the economy slowing down, demand for vehicles has waned. Thus, the auto sector has been badly affected because there has been no growth in volumes. This is despite the fact that companies have been launching new products. Thus, those who are hoping for a revival of the auto industry in FY15 will be disappointed on hearing the views of Maruti Suzuki's chairman. Indeed, Mr Bhargava has stated that for the company's auto sales to pick up, the entire auto market will have to grow. And that will not happen if the consumer's purchasing power has eroded. And this is exactly what has happened. Mr Bhargava opines that fuel prices have gone up by over Rs 20 a litre in two years and that the cost of living has gone up and salaries are not growing as fast as inflation. Thus, it is imperative that the new government puts in place steps that will revive the economy and bring back purchasing power. Only then will there be a strong revival in the fortunes of the sector.

The rupee's ascent against the US dollar was rather swift over the past few months. However in the last month the currency has not just recorded losses but also trailed the losses in other Asian currencies. As per Economic Times most economists are of the opinion that the rupee is unlikely to move away from the 60 per dollar mark soon. For the central bank may not want the currency to shift widely from its fair value. Also one cannot forget that the appreciation in the rupee was primarily due to foreign inflows in the equity and debt markets. As investors wait for the election results, the fund inflow has stopped. And if the election outcome is not in line with expectations, then the possibility of fund outflow is also very high. Thus the RBI has been buying dollars at every opportunity. At the end of February 2014 it had added about US$ 15 bn to its reserve kitty. It has been preparing to support the currency in the event of fund outflow post elections. Having said that, companies and investors will have to brace for marginal currency volatility in the months ahead. Wide fluctuations will depend on the election outcome and performance of near term economic variables.

Sensex is just shy of the 23k mark and FII money has been coming into India like there's no tomorrow. All of this on the hopes that the new Government will quickly swing into action and pull the economy out of its misery. The sector most in need of a revival is of course the industrial sector. However, is this as easy as having say a 100-day agenda and boom, all our problems will go away for good? Certainly not if an article in a leading daily is to be believed.

It takes the example of mining sector and highlights how the recent lifting of Supreme Court ban is no guarantee the problem will not recur. Simply because there's no regulatory framework in place. Implementing the same though will require deep institutional reforms. And this is not something that can be achieved in 100 days. Other crucial sectors like construction and real estate too are plagued with the same problems of lack of strong reforms. And until this happens, no government can come to the rescue of the economy we reckon. Consequently expectations need to be toned down to that extent.

The Indian stock markets were closed today on account of General Elections (Lok Sabha). As for the Asian stock markets, they were trading mixed with Japan and China down by about 0.9% and 0.5% respectively, while Hong Kong was higher by about 0.2%.

04:55  Today's investing mantra
"You can't be a good value investor without being an independent thinker." - Joel Greenblatt
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2 Responses to "When in doubt, apply this system..."


Apr 24, 2014

About the IPO, you may be correct as an investor. But you would not suggest that to a trader who is eyeing listing gains. It is certainly not wise to apply Warren Buffet's principles for trading / speculating. Even Rakesh Jhunjhunwala seem to admit making initial chunk of money through short term trades. Does this mean Equitymaster discourages trading.


virendra bapna

Apr 24, 2014


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