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When the Going Gets Tough, the Tough Buy Nestle

May 17, 2016

In this issue:
» Berkshire takes a bite out of the Apple
» Today's market roundup
» ...and more!
0:00
Devanshu Sampat, Research analyst

This is not a stock recommendation.

This is a popular saying among high net worth individuals around the world.

Think back to 2008. Fear was everywhere. Wealthy families wanted to protect their money. They got out of speculative investments. Yet many kept buying stocks like Nestle SA. Why?

Let me share with you what I thought about Nestle India in January 2008. I was in college then. The bear market had just started. Many stocks had fallen more than 30% in just a few days. Traders and investors alike were in a state of shock. Of course, I didn't know that it would get much worse. But I was sure the bull market was over.

I told my friend that Nestle hadn't fallen much. He looked at the chart and agreed with me. But he disagreed with me about what it could mean. I thought it was an important signal. As if the market was telling us that Nestle was a strong stock.

My friend thought it was only a matter of time before Nestle also fell along with everything else. He believed a recession was coming. Stocks fall during recessions, he said.

I forgot about this conversation for a couple of years. Then one day, I happened to see a three-year chart of Nestle India. I was stunned. The stock had hardly fallen during the bear market. In fact, it was way above its January 2008 price!

But how could this be? My friend was right. There was a recession. The market fell 50% in 2008. Why did Nestle do so well? I learned the reason much later.

Over many decades, there will be recessions, political upheavals, banking crises, burst bubbles, wars, oil price shocks, technological revolutions, changes in interest rates...and many other unforeseeable events. But I'm sure we can all foresee ourselves, even when we are old, having a bite of Kit Kat!

That was the reason. I did not reduce my consumption of Kit Kat in 2008. Nor did anyone else.

In stock market jargon, this is called earnings visibility. It simply means that the products or services of some firms are always in demand. These firms do well even in recessions. But to be a successful long-term investor, you don't need to know market jargon.

You need to understand the basics. Remember the words of Charlie Munger: 'It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.'

You can put this into practice right away. Ask these questions:

  • Can this company survive the next recession?
  • Can the sales grow a steady pace for many years?
  • Does the company have to invest heavily just to keep its competition at bay?
  • Does the business need a lot of debt or can it grow without it?
  • Does the management pay out dividends every year? Have dividends increased over time?

Don't think these questions are simplistic. They're not. They lie at the core of successful long-term investing.

But the markets are focused on other things right now... The Maggi fiasco, the 19% fall in last quarter's net profit, the threat of Patanjali...

Now, we're not saying these things are not important. They are. Which is why we have a cautious view on the stock for now. And valuations, of course, must be kept in mind.

But does this change the logic of investing in the stock for the long-term? Or other stocks that share similar characteristics? Your broker will never tell you to buy such stocks and forget about them for the next 20 years. Why not? His livelihood depends on not telling you these things!

But when the next recession comes around...and if such stocks are available at reasonable valuations, don't hesitate to take the plunge. When times are tough, it makes sense to buy the best quality stocks.

Do you agree that high quality businesses will do well during economic downturns? Let us know your comments or share your views in the Equitymaster Club.


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------------------------------

2:15

'Berkshire Hathaway buys US$ 1 billion of Apple shares' is a headline making rounds today. I also came across a title that read 'Apple is now officially a value stock'.

Let's break it down...the company's market cap is about US$ 515 billion. It has about US$230 billion of cash on its books - about 45% of market cap. The stock is down by about 30% over the past year. And it trades at a low PE of 10.5x its trailing twelve month earnings.

So...is this an early Buffett type of investment or the 'problem of prosperity' Buffett type of investment?

I'll let Radhika Nabar, the author of Value Pro, a Buffett style portfolio recommendation service, comment on this in more detail:

  • Warren Buffett had famously said that he does not want to invest in technology companies because he does not understand them. Buffett has always favoured businesses whose earnings are relatively predictable. In that sense, tech companies do not fit the bill, because they have to continuously innovate to survive.
  • And yet, in the last few years, Berkshire Hathaway has been stepping up its investments in tech companies. IBM is a big example. Berkshire has seen losses on this investment so far.
  • And in latest developments, Berkshire has bought shares of Apple. This is interesting considering Buffett's early statements on tech companies.
  • Since the stock of Apple has declined a lot (poor iPhone sales being the prime culprit), valuations have begun to look reasonable, and hence explains Berkshire's interest.
  • But the main reason for Berkshire can be attributed to size. Since the Berkshire Hathaway portfolio has gained scale, small companies requiring little capital don't really add much value to the portfolio. And this could be the reason why the company has been foraying of late not into just capital intensive industries but also now into tech companies.

3:55 Chart of the Day

Latest inflation data has trickled in. And it indicates the first rise in the WPI after a period of seventeen months. The key culprits this time around are food and manufactured products. Food inflation rose by 4.23%, led by higher sugar and potato prices. Food articles have a 14% weightage in the WPI index.

While it may be too early to comment on whether this is a reversal in trend from a long term perspective, there will be a lot of debate on how this will have an effect on interest rates and consumer demand.

Regarding the latter, the chart below helps put things in perspective. It shows the year on year change in volumes for various categories in both the markets - rural and urban - for the quarter ended March in the past four years. In most cases earlier, the rural markets grew at faster pace than urban markets when it comes to volume growth. As the managements of FMCG majors kept saying in unison, rural growth was about 1.5-1.75x that of urban markets. However, all of this changed in the past few quarters given the impact of poor monsoons and slow wage growth.

Consumer Demand: Will The Trend Reverse Next Year?


As you can see in the chart, the urban markets outperformed the rural markets across categories in the quarter ended March 2016.

Can the trend reverse going forward? Well...it becomes difficult to say as a lot hinges on aspects such as the monsoons and the trend in inflation.

But one thing is for sure. Companies in the FMCG space this time around are way more conscious about market share and volume led growth; and will look to absorb the price increases - as long as margins are way above average - in case of an inflationary trend.

4:40

At the time of writing, the Indian markets were trading strong. The BSE Sensex was trading higher by about 240 points or 0.9%. While stocks from the capital goods and oil & gas sectors were in demand, those from the power space were trading weak. Stocks from the mid and smallcap spaces were trading firm as well, with their representative indices trading higher by about 0.44% each.

4:50 Today's Investing Mantra

"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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Equitymaster requests your view! Post a comment on "When the Going Gets Tough, the Tough Buy Nestle". Click here!

1 Responses to "When the Going Gets Tough, the Tough Buy Nestle"

SJ

May 17, 2016

Yes, high quality businesses do well in down turn. There is no doubt about that. And high quality business means strong fundamentals and healthy balance sheets.

I was trying to compare a company with its peers, going by the finacials. There are numerous ratios to gauge the performance of one as compared to others. As a helping hand, could you talk about the most important ratios that determine a buy or a sell recommendation for one company as compared to the other? Ofcourse P/E is there but others that reflect the health, future growth prospects and earnings? And where from do you estimate the forecasts?

Thank you

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Equitymaster requests your view! Post a comment on "When the Going Gets Tough, the Tough Buy Nestle". Click here!
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