The idea that could change your investing life forever! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The idea that could change your investing life forever! 

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In this issue:
» Money tightening will help and not hurt US stocks
» Bill Gross' latest investment outlook
» Realty regulatory bill will achieve nothing
» Morgan Stanley looks at the bright side of India
» ...and more!

Eureka moments, called so in tribute to the famous Greek scholar Archimedes, are moments in life that are nearly life changing. And one can't just expect to bump into them one fine day without doing practically anything. The idea is to keep working hard and then one day; an insight comes along that really changes one's life.

We believe that the entire success that Warren Buffett's had in his investing career can be put down to two major insights or Eureka moments. The first one occurred when he was all of 17 years old and happened to read Benjamin Graham's classic, The Intelligent Investor. The book, in his own words, changed his life. Using the principles laid down in the book, he went on to achieve huge success as an investor over the following few decades. However, he perhaps couldn't have come close to the investor that he is today had he not learned another important insight along the way.

And this insight is nothing but a new twist to the definition of value investing. Up until the second insight, Buffett was all about buying dirt cheap stocks. He hardly cared about the quality of firms that he was buying into. However, with help from his partner Charlie Munger and his own due diligence, he came to another very important conclusion. The conclusion that there are certain companies where competition can do them no harm. They have developed such an advantage that they earn above normal profits for years and years to come. And when one does come across such a firm, one should not hesitate to pay a premium price if one is convinced of the quality.

So successful has this strategy been that Buffett's huge success over the later years could solely be attributed to this one important insight. In fact, he even made a confession in his 1992 letter to shareholders that a stock with a high PE or a high price to book value is not inconsistent with value investment. Thus, buying a high PE or high price to book value stock is as much a value investment as buying low PE stocks provided one gets the business model right and does not pay valuations that are way out of whack. A small premium over a cheap stock is perfectly justified.

In case one is looking for an Indian example, a recent article by Professor Sanjay Bakshi has provided just that we believe. Using Nestle as an example, he has highlighted how even at a PE of 68x back in 1992, the stock has ended up giving 20% per annum till date! Even though the stock's PE has come down to 48x now, the growth in earnings has more than made up for the PE contraction.

This does not mean that one should pay a very high PE for any stock that has shown a strong string of results in recent years. One has to be really convinced that the competitive advantage of the company is so strong that it will continue to grow profits at a decent clip and that too using minimal capital. But whenever one comes across such a stock, one should not really wait for its PE to fall to higher single or lower double digits. Don't hesitate to pay a worthwhile premium and this simple trick could do to your investment results what it did to the track record of one of world's most successful investor.

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01:35  Chart of the day
It appears Indian investors seem to be riding a wave of optimism currently. At least this is what a recent survey conducted by us seems to be saying. When asked about where the Sensex will be one year from now, nearly two-third of those who polled believed that it will be significantly higher than the 20k levels it seems to be hovering at currently. Interestingly, only about one tenth of those who polled felt that Sensex will be well below 20k one year from now. Well, as per us, it does not matter much where the Sensex will be one year hence. The idea is to keep buying fundamentally strong stocks at reasonable valuations irrespective of the Sensex levels and staying invested in them for the long run.

Data source: Equitymaster Survey

The Fed has been printing money for quite some time. It has not had much of an effect on the country's economy but it has certainly helped the US stock markets. The flood of money being pumped into the markets has caused stock prices to touch new highs. The fear now is what would happen when the Fed shuts its press? This means that interest rates that have been kept at near zero levels would start to rise. Would that mean stocks would come crashing down?

A gentleman by the name of David Bianco who is with Deutsche Bank, does not seem to think so. In his opinion monetary tightening in the US would help stocks. And he relies on history to prove his point of view. He has pointed out that in the past in most cases when the Fed has hiked rates after a recession, the stocks have reacted positively. The times when stocks prices have dipped were those when monetary tightening was brought about as a response to inflation. Given that inflation is at rock bottom in US, this is not expected to happen this time around.

In our opinion, one should pay little attention to such stories about high co-relation. In the end, it is the fundamentals that move the markets and that's all that matters.

The Indian economy has slowed down considerably in the past few quarters. This would lead many to believe that there is still time for a recovery to be underway. But Morgan Stanley has a more optimistic view. As per an article in the Economic Times, there are two factors which are instrumental in bolstering growth of an economy. One is population and the other is productivity. Population or demographics is not a problem for India. As opposed to the developed world and even some of the Asian economies such as China, the working age population is expected to increase going forward. So the potential for higher growth is very much there. The problem is productivity. Post the crisis, most of India's growth was largely driven by stimulus measures and hike in rural wages. So while demand increased as a result, there were hardly any productivity gains. These measures only served to bloat the fiscal deficit. Leaving not much room for the government to spend on productive areas which is what India sorely needs.

But Morgan Stanley opines that things are improving. The government has begun to take steps to cut down wasteful expenditure; subsidies in particular. Fiscal deficit has been brought down very sharply. The 3-month trailing annualised deficit reduced from 8.4% of GDP in August '12 to 3.8% in February '13. The key here is consumer price inflation. If many of the structural issues with respect to supply bottlenecks are addressed, it will go a long way in bringing inflation down. Once inflation is down, so will the need to import gold. All of which will have a favourable impact on the fiscal balance. Indeed, like in the developed world, India too cannot rely solely on monetary policy measures to propel growth. Some meaningful and long term action will have to be taken by the government.

Finally the government broke through the woods and cleared the real estate regulatory bill that was pending for long. The bill will bring in more transparency. This is likely to help buyers. For instance, the bill has provisions that entitle buyers to receive the full amount along with interest if the builder is unable to give the delivery on time. Further, as per the bill, a builder can start a new project only if he has all the relevant permissions in place. In short, the new bill is deemed to be a universal remedy for all the problems engulfing the real estate sector right now.

However, the truth is far from this. Once the bill comes into force, only new real estate projects will come under its ambit. Thus, buyers who bought property earlier will continue to face the problems they are facing now. Secondly, the bill aims to establish a real estate regulator in every state. While the move seems logical it may be noted that doing this can turn out to be a long drawn process. Lastly, it may be noted that most builders have been thriving till date despite their ill intentions since they have a nexus with politicians. And with politicians having stakes in most real estate projects, the possibility of wrong doing for self interest always exists. A bill can bring in transparency and better governance provided the intentions of the market participants are right. With mala fide intentions, no bill can change the fortune of any sector. And real estate is no exception here.

The economies in the West have been compared to anaemic being innumerable times. That the central banks in the US and Europe are leading the economic to a point of no-return is also well understood. But Bill Gross of Pimco, explains why profits are as critical to the health of the economy as the heart is to the body, in a rather intriguing way. In his blog, the bond fund manager talks about the importance of 'carry' which in layman terms is return on investment. Gross argues that profits cannot be temporary or competed away if capitalism as we know it is to survive.

There are companies that were once immensely profitable but have gone into near oblivion. The likes of Kodak, Motorola, AOL etc lost out to better technology, evolved products and focused management of its peers. But that does mean profitability as a whole ceases to exist. Hence if the Fed believes that by pumping new money it will be able to do away with the risk of zero interest rate regime, it is wrong. The new money will be to the economy what fresh blood is to a body in which the heart has stopped working. We do not think there can be a better explanation to the malaise facing global economy.

Meanwhile, indices in the Indian stock market seem to be trading lacklustre today with Sensex lower by around 32 points at the time of writing. Healthcare and metal stocks were seen facing the maximum brunt. Most Asian equity markets closed lower today while Europe has opened mostly on a positive note.

04:54  Today's investing mantra
"Both our operating and investment experience cause us to conclude that "turnarounds" seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price."- Warren Buffett

  • Warren Buffett - The Value Investor
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    3 Responses to "The idea that could change your investing life forever!"


    Jun 8, 2013

    Dear Sir Thank you for writing in to Equitymaster. We believe that the subscribers of Equitymaster are entitled to honest and unbiased opinions from us and not just a list of stocks to buy. And it is precisely for this reason that we do not restrict our recommendations to just Buys but also include Holds and Sells. The objective behind this is clear- to give recommendations that can safeguard and grow subscribers' wealth. For our recommendations, we tend to focus only on the intrinsic value and not the price. Just as price can go below intrinsic value, it can also go above the same. We do not recommend trying to time the market, and whenever we believe that the stock price is higher than the intrinsic value we would not hesitate to recommend Sell. Please do keep sending us your suggestions and feedbacks. Warm regards. Team Equitymaster.


    Sundaravaradan S

    Jun 6, 2013

    Real-Estate-Regulatory-Bill: Comments:

    All of know there is Corruption at every-level of Indian Life. We Know the Nexus between Politicians, real-Estate Developers, Mining-Industry, every-Industry!
    When do you think these corruptions/Nexus go away???
    Never?! So... do NOT enact any law !Why? Because Politicians do not have Good Intentions and will never have!
    All these may be TRUE! But I would like to think positively! These acts will IMPROVE benefits to common-man...some what better than what it is yesterday. Let us appreciate the Good acts, instead of cribbing about "Nexus"...or "Implementation Issues" etc. Each PERSON should do HIS duty not worry about when implementation will not be done... Then DISSOLVE the Democracy!


    Jagadeshwer Rao

    Jun 6, 2013

    Very true. I sincerely feel that Equity Master research team also has to learn a lesson out of this. Very good stocks with quality and pricing power like Nestle, Britannia, Asian Paints, Godrej Consumer etc., were either ignored or recommended as Sell by Equity Master Team

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