This is how superinvestors are made - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

This is how superinvestors are made 

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In this issue:
» China meltdown has begun, feels Jim Chanos
» Indian realtors face another financing related issue
» LinkedIn IPO brings back memories of tech bubble
» US economy in worse shape since Depression, says Robert Shiller
» ...and more!

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As far as Warren Buffett is concerned, there is one and only one way to invest. And that is to buy wonderful businesses at attractive prices. But there are times when even the great man is short of ideas. The year 1969 was one such occasion we believe. It was the year which was four years past the 1965 peak of the US bull market but the markets were still expensive as per Buffett. But his clients were in no mood to listen. They were tired of watching Buffett sit on cash and do nothing. Not one to budge from his deeply held investing beliefs, Buffett decided to shut shop. But not before recommending one fund manager, Mr Bill Ruane, to his clients if they wanted to stay invested in the markets.

What a recommendation it turned out to be! By listening to Buffett and investing with Bill, the clients would have made nearly 4 times as much money in a period lasting almost 4 decades than by investing in the benchmark index.

Now, if Buffett recommends someone, you would certainly expect the man to be as prodigious as him. But Mr Bill Ruane was anything but prodigious. He was pretty average in school and had a tough time coming to grips with engineering courses. Nor did he come up with any truly original ideas in value investing. So what is it that Mr Ruane possessed that made him such a superinvestor? A leading value investing portal is running a tribute on the man and has argued that his is a classic case study that success in finance doesn't require extraordinary talents.

What you need instead is a deep seated belief in the school of value investing and the discipline to stick to it come what may. Ruane has laid out four rules that guided his investment career. These are 1) buy good businesses, 2) buy businesses with pricing flexibility, 3) buy net cash generators and 4) buy stock at modest prices. Clearly, not much different from what Buffett follows. And certainly very easy for others to follow as well.

Try and make these principles a permanent part of your investment toolkit. We are reasonably confident that with enough discipline and irrespective of whether you are of average intelligence, you too would have taken a big step towards becoming a very successful if not a super investor.

Do you think it needs above average intelligence to be a superinvestor or is it the strict discipline that matters? Share your views with us or comment on our facebook page.

01:24  Chart of the day
Today's chart of the day is perhaps an indicator of the enormous challenges we face in bringing quality healthcare to India's masses. A doctor per thousand people of the population is a good way to look at where exactly we stand in comparison to other developed nations as well as China. As the chart suggests, forget the developed world, even achieving levels comparable to China is going to test our mettle. India has just 1 doctor for every 1,700 people while China has 1 doctor for every 1,000 people. The developed world is way ahead with Germany having more than 3 doctors for every group of 1,000 people out there.

Source: TOI, UNDP

It seems like we are back in the 1990s, the decade that witnessed a massive tech bubble and an eventual burst. In recent times, we have seen tech companies commanding high valuations. The most popular ones are the likes of Facebook and Skype. Now, the new company to join this bandwagon is LinkedIn, a social networking platform for professionals. The IPO of this company just opened recently at a staggering price of US$ 83 a share. Let us tell you what the shareholders are paying for at that price. At US$ 83 per share, LinkedIn is trading at a price multiple of 980 times its annualised earnings. Yes, we haven't missed any decimal. It's a 980 P/E stock at that price! To add further, it also translates into 20.9 times its sales and an enterprise value of about US$ 7.8 bn.

We realise a few things about human psychology. One, collective memory is short-term. Two, people seldom learn from past mistakes. And finally, history repeats itself, albeit, in a different style.

Hopes of an 'alleged' recovery in the US has led to a rally in equities there. But if one goes by the economic data that gets consistently published, the US appears to be in a worst shape since the Great Depression. Or so noted housing guru Robert Shiller believes. Shiller opines that stocks would gain anywhere between 2-3% during the coming decade. And the reasons for such a dismal performance are manifold. For starters, there is not expected to be any significant resurgence in consumer spending especially since unemployment has remained high. This unemployment rate in real terms has been pegged at almost 16%. Not just that, the housing market has also stayed weak. Thus, even though the recession seems to be technically over, the health of the US economy continues to remain quite poor. Consumer confidence has also significantly ebbed. All of which means that stockmarkets are going to yield poor returns over the longer term.

Is China heading for a meltdown? Well, Jim Chanos, a legendary short seller of stocks has been predicting for months that the dragon nation is heading for economic disaster. Now, with the real estate sector showing some cracks, Chanos says that the downfall has already begun.

Real estate firms are closing down, sales offices are remaining shut, and what is not helping is that the central bank has raised interest rates four times in the past seven months. This was in order to push inflation lower, which is now down to 5.3%. What is worrying Chanos is that the government may be a little too aggressive in trying to curb construction activity. And if they do so, then growth may not just slow, it might actually decline. Well, India is in a similar soup, battling inflation and rising interest rates. Looks like both the Asian dragon and tiger will see some growth pains in the medium term.

From the Chinese realty sector let us now turn to the one in India. It is a known fact that during the heydays, private equity investors poured in huge amount of cheap liquidity into the Indian real estate market. Their strategy was straight forward. "Invest now when the markets are buoyant and then subsequently sell-off when property prices reach the peak". However, it seems that their memory of the recent sub-prime mortgage crisis had started turning a bit bleak. Not so because they were lending to a non-credit worthy borrower. Instead, it had more to do with the sustainability of a rise in prices. And right now, the market is questioning this sustainability.

The correction was bound to happen and it did happen. So now, these PE investors are stuck with their real estate investments. And they have finally made up their mind to exit their holdings. No prizes for guessing what they made out of this investment! But hold on. Who do you think would be willing to buy these investments? It may be noted that these investments had a few clauses which required the developers to buy back some part of the investment from the PE firms. Now, what this means is the cash flow crisis of the developers would magnify further. We believe that the only way to come out of this vicious cash flow trap is to lower the prices. Let's see how long the developers can prolong the imminent.

As per a business daily, Morgan Stanley has a target of 30,000 for the BSE Sensex over the next 18 months. This works out to a return of 64% point to point, average annual return of nearly 40% from the current levels. While we would not comment on the Sensex target, we believe that most Indian businesses will take longer to see their margin growth move into the higher trajectory. While the upsides to sales and bottom line growth is a given over the longer term, investors would be better off keeping the short term return expectations conservative. This would also help you avoid over paying for stocks.

Meanwhile, Indian stock market traded buoyant right from the beginning today with the BSE Sensex up by more than 200 points at the time of writing. L&T and banking heavyweights were seen driving most of the gains. Asian indices closed mixed today whereas Europe has opened the day on a positive note.

04:56  Today's investing mantra
"Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime." - Charlie Munger
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Mar 22, 2012

As per a business daily, Morgan Stanley has a target of 30,000 for the BSE Sensex over the next 18 months. This works out to a return of 64% point to point, average annual return of nearly 40% from the current levels. While we would not comment on the Sensex target, we believe that most Indian businesses will take longer to see their margin growth move into the higher trajectory. While the upsides to sales and bottom line growth is a given over the longer term, investors would be better off keeping the short term return expectations conservative. This would also help you avoid over paying for stocks. --------

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