One power every CEO absolutely craves for
(Jun 4, 2015)
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In this issue:
» Could poor monsoon rains impact stock prices this time?
» Stock prices hit by the curse of debt
» ...and more
There's a restaurant right below our Mumbai office building. And its quite a hit with a lot of our office staff. In fact, why just us. The wide variety of Indian cuisines it serves attracts many office goers in our vicinity. As far as I am concerned, I also love to tuck into their South Indian fare every once in a while.
Last Saturday evening was one such occasion. Except this time I learnt a big investing lesson. Or let me put it this way; a big investing lesson was reinforced.
So as I was half way into polishing off a delectable dosa, there was a mini-commotion of sorts near where I was eating. Turned out, it was the restaurant staff. They were busy bringing down this gigantic menu board. The board, as you would have guessed by now, is something that displays all the items on offer and also their rates.
At first, I thought the lighting that gives the board visibility at night might have become faulty. And therefore the board has been removed in order to do the repairs. However, to my surprise, off went the staff, carrying the entire menu board with it, only to return few minutes later with the exact same replica.
I didn't quite get it. If the wiring wasn't a problem, why was the board removed and whisked away? And far as I can tell, it didn't require a painting or a cleaning job either as everything on it was quite legible. Then as I was glancing through this newly laid board, my eyes stopped at the item I had just ordered. The memory of the money I just spent was still fresh. Consequently, I could immediately sense that the next time I order the same dosa, I will have to shell a few extra rupees more! It all finally started to make sense. The reason the menu board was changed was because the hotel had decided to revise upwards the prices of all of its offerings.
This was of course not the first time I had seen the restaurant revise its prices. During the few years we have been operating out of this building, I have seen prices of most things in the restaurant go up a minimum of 2-3 times. However, what surprises me is the nonchalance with which this revision is carried out. And why not. For the customers hardly seem to complain about the price rise. On the contrary, the serpentine queues at the food ordering counter just keep getting longer with each passing year.
What the restaurant owners perhaps don't realise is the fact that they are pulling off a miracle even the mightiest companies on this planet find hard to conjure up. As this event was unfolding before my eyes, my mind was taking me to a Warren Buffett quote from a few years ago. The quote was effectively an insight he shared about the kind of business he looks to invest into.
And what was this insight? Well, it was his observation that the single most important decision in evaluating a business is pricing power. So, if you've got the power to raise prices without losing business to a competitor, you've got a fantastic business. But if you have to have a prayer session before raising prices by 10%, then you've got a terrible business.
Indeed. There will be very few statements that can sum up the hallmark of a great business as succinctly as this I believe. You see, every business faces risks of one kind or another. However, if there's one common enemy or one villain for all the businesses put together, it is the demon of inflation according to me. And the most effective way to slay this is to be in charge of a business where there's some sort of pricing power available.
As I shared this finding with Radhika Pandit, the editor of ValuePro, our service that specialises in selecting stocks as per the Warren Buffett philosophy, her eyes lit right up.
She could instantly draw the parallels between some of the biggest recommendations she has made over the years and the central role that pricing power had played in most of those recommendations being successful.
As a matter of fact, few of her recommendations that have not done well have mostly been companies where pricing power got eroded over time or was just not there to begin with.
Therefore, the next time you are trying to identify good, solid stocks for the long term, ask yourself whether the management can change the menu board with the nonchalance that I witnessed. In other words, whether the management has to have a prayer session before raising prices by 10%? If the answer is yes, then you are better off avoiding the business according to me.
What do you think? Do you think having pricing power is the biggest wish a CEO can possibly ask for? Let us know your comments or share your views in the Equitymaster Club.
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While the contribution of agriculture to India's GDP is estimated to be around 13-14%, it employs over 50% of the country's workforce. Given that the agriculture sector in India is still highly dependent on monsoon rains, rainfall patterns are a key variable impacting the overall economy. And what impacts the economy has a bearing on the stock markets as well. Historically, there has not much correlation between monsoon patterns and market movements.
Are things going to be different this time around? Could a likely bad monsoon adversely impact stock market sentiments?
The recovery in the economy has been slower than expected. While the RBI cut repo rates by 25 basis points, RBI Governor Raghuram Rajan's tough talk on further rate cuts caused market participants to dump stocks. The markets have witnessing a sharp decline post RBI's policy announcement on 2nd June. As per Rajan, the biggest uncertainty for the Indian economy is a weak monsoon. This could cause food prices to shoot up again and push inflation higher than targeted levels.
The other point worth noting is that if the monsoons remain deficient this year, it will be a second consecutive year of poor rainfall. And this can have severe implications for the economy.
After RBI Governor Raghuram Rajan raised inflation expectations because of the likelihood of poor monsoons, the Indian stock markets went into a downward spiral. Over the last two trading sessions alone, the BSE-Sensex has shed almost 1,000 points (down 3.6%).
In fact, in yesterday's trading session (3rd June 2015), some stocks were battered quite severely, in the range of 10-30%. The chart of the day shows that stocks from the BSE-500 that were worst-hit in yesterday's market sell-off. The interesting thing to note is that most of these companies, except Unitech Ltd, are highly leveraged.
We believe that here lies an important take-away for investors. Be careful about the financial health of the companies that you are investing in. At Equitymaster, we avoid recommending companies that are heavily burdened with debt. The sharp fall in stock prices of many debt-laden companies does vindicate our conservatism.
The Worst-Hit BSE-500 Stocks in Yesterday's Bloodbath
*As at 31st March 2015
After trading close to the dotted line during the morning, the Indian stock markets caved in during the post-noon trading session. This would be the third consecutive trading day when the markets have been taken over by the bears. At the time of writing, the BSE-Sensex was down 207 points (+0.77%). The sectoral indices that led the losses were metal, consumer durables and auto.
"All intelligent investing is value investing - acquiring more than you are paying for. You must value the business in order to value the stock," - Charlie Munger
|| Today's investing mantra
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How has 2015 turned out for the auto sector so far?
With the fall in the Sensex, most auto stocks have also seen a decline in prices. However, two stocks have managed to buck the trend.
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|This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst) and Ankit Shah (Research Analyst).
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