Biggest investment tip you'll receive this year - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Biggest investment tip you'll receive this year 

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In this issue:
» Is the Government itself responsible for high food inflation?
» Gold will get crushed, says a famous broker
» Will Sensex reach 30,000 in 2-3 years?
» Offers for sale could hurt the market rally
» ...and more!


00:00
 
Have you ever wondered why despite being in the same industries, some companies get valued much higher than the rest? The one sector that immediately comes to mind is jewelry retailing, which is quite in vogue currently. Here, the market leader Titan Industries is way ahead of the pack in terms of the respect it commands and the valuations it enjoys. Of course, the company has an excellent track record, is very well managed and has the Tata name to boot. But these factors aren't enough in themselves. What matters is what these factors do when they all come together. Well, what they do is they help the company generate strong cash flows consistently, one year after another.

We've seen a lot of people obsess about how a company is able to grow its revenues and profits at a strong pace. And although these attributes are necessary, they are by no means sufficient. What should also be looked into is whether high revenue and profit growth is also leading to greater cash generation. And if this is not the case, then the stock isn't a great investment after all.

We believe it is this very same attribute that makes Warren Buffett call a business a truly great one. And you would be surprised to know that the example he gave of a great business in his 2007 letter to shareholders was not that of his most famous investments like Coke and Gillette. Instead, he chose a relatively lesser known firm See's Candy. And what exactly is the claim to fame of this company? Well, as per Buffett, in the 35 years that they were owners of the firm, they had to make a capital outlay of just US$ 32 m for all the years combined. And what did they earn in return? Well, a pre tax earnings of a whopping US$ 1.35 bn!

And this is exactly what one should look in a business as per us. The ability to generate more and more cash over and above the capital re-invested in the business. Something that companies like Titan Industries or for that matter, blue chip like Nestle and Castrol have done over the years. They have grown alright, but even after investing for that growth, they've had a lot of cash left over to be distributed to shareholders or put to some other productive use.

To conclude, we really can't emphasise this point enough. All we can say is if there is one factor that has a bigger influence than any other in where the share price of a company will end in the long run, it is the ability to generate cash flows in excess of the growth need of the companies and the use that this extra cash is put to. Investors would do well to consider this as one of the biggest investment tip they'll receive this year.

Do you think a company's cash generation ability is the most important factor in evaluating its stock price over the long term? Please share your comments or post them on our Facebook page / Google+ page

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01:33  Chart of the day
 
How far is the 30,000 level on the Sensex? Well, 2-3 years if one goes by the option that received the most number of votes in the recent Equitymaster Survey. It should be noted that we asked our readers one simple question about when do they see the BSE Senses touching its all time high of 30,000? As already highlighted, most of the votes of the more than 16,000 people who took the survey, went in favour of the coveted level being reached in 2-3 years. Not far behind were the ones who felt that it will be at least 4-5 years before the levels will be breached. Well, the Sensex currently trades at a PE of around 17.6x which is not that expensive as per us. Thus, if the PE was to remain at these levels, the earnings will have to grow by around 14% for the Sensex to reach 30,000 in three years. Well within the realms of possibility we believe.

Source: Equitymaster survey


02:13
 
High inflation has been a big roadblock to India's growth in recent years. And one of the key drivers of this high inflation has been rising food prices. Who is the real culprit for this? You think the real reason is poor monsoons last year? You couldn't be further from the truth if you think so. The real culprit appears to be none other than the UPA government. And the problem at hand is not food shortage. But a problem of plenty!

Let us explain. The Food Corporation of India (FCI) buys rice and wheat from farmers at the minimum support price (MSP) set by the government. These food grains are then distributed by the government through various programmes via the public distribution system. Apart from this, the government also procures food grains to maintain buffer stocks. These buffer stocks are kept so as to be in a position to deal with any unexpected shock that could disrupt supplies. There is a minimum buffer level that is needed. This is understandable.

Here's the irony... What happens when you're hoarding too much buffer stock? You end up creating an artificial scarcity in the market. As per an article in Business Today, the government has been hoarding more than twice the minimum food grain buffer needed. Sometimes as high as three times! The result is that despite the abundant supply, food inflation has been persistently high.

02:55
 
The slowdown in China and weak global economic prospects may have hurt the prices of every other metal. But the correction in price of gold finds its roots in speculative trends rather than fundamentals! As per an article in Global Economic Trend Analysis, Hedge funds are least bullish on gold in more than five years. The 30% correction in the price of the precious metal has led to money managers cut their long positions on gold. But that is far from having an impact on the fundamental demand supply dynamics of gold. With neither the US nor Japan giving a clear signal of ending the monetary easing, liquidity is here to stay. Needless to say, jobless economic recovery and steep inflation will only make the currency risks seem more real. Hence if not as a hedge against inflation, do make sure that you own some gold if you already don't. Having to brace your portfolio against currency risk is no longer a risk for fund managers but retail investors as well. And gold can very well help you with that!

03:28
 
The Indian pharma industry has come under considerable fire post the debacle that is Ranbaxy. Willful fraud has been going on at the company for many years. Because of this questions have been raised on the quality of generic medicines being produced by all Indian pharma companies. And the first to join the backlashing bandwagon have been none other than global pharma majors. Indeed, it is a well known fact that Big Pharma has always been anti-generic. This is because the presence of generic drugs in the market considerably erodes the value of branded drugs leading to lower sales. Hence, they have never failed to point out to the inferiority of generic drugs.

Although the irony is that these very companies have forayed into the generics space because their original R&D pipeline has been dwindling. Further, whether generic drugs meet quality standards is determined by the US FDA. The latter in recent times has become stricter in terms of reviewing applications. The thing is that an already debt laden US is also burdened with high healthcare costs. And only cheaper generic drugs have the potential to bring down these costs as compared to the more expensive branded drugs. There is no doubt that the Ranbaxy fiasco is bound to tarnish India's reputation. However, we still believe it would be unfair to brand the entire industry on the basis of the wrongdoings that one company has done.

04:11
 
The Ministry of Finance had issued guidelines for minimum public shareholding for all listed companies - 25% for private companies and 10% for public companies. For private sector, the deadline to meet these is June 3, 2013 and this is only a few days away. For public companies, the same is August 8, 2013. As reported by the Economic Times, these offers for sale (OFS) are believed to be worth about Rs 135 bn. Of this, more than 70% will be done by private players. While the daily also reported that the flood of OFS' could dampen the ongoing market rally - on account of market liquidity going towards subscribing to these - it should naturally not be a cause of concern for a long term investor such as yourself. In order to make their respective OFS' comfortably subscribed, promoters would be pricing them lower to the market prices. As such, one could use these opportunities to buy into good companies. All this, provided that valuations are not out of your comfort zone!

04:42
 
Meanwhile, indices in the Indian equity market were trading lacklustre today with the Sensex lower by around 9 points at the time of writing. Auto and FMCG heavyweights were seen attracting the maximum interest. Amongst Asian indices, Japan suffered heavily yet again and closed a huge 5% lower. Other Asian indices also closed lower. Europe has however opened on a positive note.

04:53  Today's investing mantra
"Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies."- Warren Buffett

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    5 Responses to "Biggest investment tip you'll receive this year"

    N.M.R.Shreedhar

    May 31, 2013

    Definitely, ability to generate cash is perhaps one of the most desired attributes--in fact,the ability to generate Free Cash is an important metric in the evaluation of a stock. btw, answering Mr.Sunilkumar Tejwani's question, I understand that Buffet recently bought a significant stake in Heinz, that too at very attractive terms to Berkshire Hathaway-- (one news item wondered whether Berkshire will be able to pull off such a deal in the absence of Buffet) -- maybe you can do an article elaborating this. regds

    Like 

    sunilkumar tejwani

    May 30, 2013

    I don't know why you are obsessed with Warren Buffet. Ask him if he has found any blue chip in the making in the recent times. He is a vested interest in the U.S stock markets. And remember Titan has been making money but has been venturing in to unrelated areas to make more money, this may back fire in the long run. In the short run, it may make superlative profits because of an opaque industry called eye ware.

    Like (1)

    S.N.Daw

    May 30, 2013

    When a business generates huge cash on regular basis, it means that the shareholders are also the owners of the cash as per the shares he/she holds. shareholders may enjoy the cash in terms of dividends/bonus/right issues/preferential stock or in the form of expansion of the company both in organically or inorganically. Ultimately everyone who owns the company gets benefited. A well managed with a clear long term visionary company can only achieved the goal.

    Like (1)

    AML

    May 30, 2013

    Very good analysis of Inflation created by Govt. of India - UPA. Purchase at MSP & distributing the same thing at at steep low one does not make economic sense. This is only senseless gimic to get votes in election. Millions of tones of foodgrains is wasted in warehouses which are not modern or capable of preserving in proper manner.Conclusion is absolutely right, that Government is a real culprit to blame for inflation.

    Like (1)

    Raphjo

    May 30, 2013

    Which broker said that gold will get crushed ?

    Like (1)
      
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