An insightful health-wealth analogy - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

An insightful health-wealth analogy 

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In this issue:
» Who is the real culprit of the Eurozone crisis?
» Real estate brokers turn developers
» SBI witnesses a rush of safe-haven seekers
» Slowdown in economy takes toll on job market
» ...and more!

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Let us ask you a question... What is the secret to good health? Eating nutritious food? Regular exercise and yoga? Eight hours of good sleep?

Well, these factors certainly add significantly to your health and vitality. But there is another equally important element that cannot be ignored. We are referring to taking steps to minimize health risks. This would include avoiding junk food and all those habits that can be detrimental to your health.

All health-conscious people tend to operate a set of filters when they pick their food. Some common filters that come to mind are- avoid fried food, avoid unhygienic roadside food, avoid stale food, avoid processed food with artificial flavours and harmful preservatives, avoid tobacco, cigarettes and alcohol, etc. The list could go on. So, if you take care of the risk of health hazards and illnesses that could arise from a wrong diet, half the battle is won. Once the health risks are taken care of, good health tends to follow.

Now, before you start wondering whether we have changed our profession from being stock experts to health experts, let you tell you that we have not. The reason we brought up this topic was because we found the analogy between human health and financial health very striking.

Let's extend the idea we discussed above to stock investing. While it is true that all investors put money in stocks to earn multifold returns, chasing gains alone is not enough. It is much more important to ensure the safety of capital. A famous saying goes thus: "Focus on the downside, and the upside will take care of itself." The very same idea resonates in Warren Buffett's famous quote: "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."

So the key idea of value investing is mitigating downside risks. How can an investor evaluate risk factors for different companies operating in different sectors? An ideal way to go about this is to prepare a set of risk parameters and evaluate the company on each of them. At Equitymaster, we have developed our own risk matrix that helps us understand and evaluate the riskiness of businesses. This helps us eliminate businesses that bear very high risks.

What, according to you, are the most important parameters to evaluate a company's risk? Please share your comments or post them on our Facebook page / Google+ page

01:20  Chart of the day
The Indian equity markets have been quite volatile over the last few years. Several risk factors in the domestic economy along with uncertainty in the global economy have taken a toll on equity investments. As a result, retail investors have been rushing to exit from equity mutual fund scheme. As per an article in Business Standard, the month of May 2013 saw the highest ever number of equity folio closures. The chart of the day shows the months with the highest folio closures. During the financial year 2012-13, equity mutual funds witnessed over 4.5 million folio closures.

The main reason for retail investors exiting equity mutual funds is the lacklustre returns delivered by most schemes. As per Business Standard, annual returns have been a paltry 6-7% over the last five years. This has caused many investors to shift to debt schemes which offer relatively better returns.

Data source: Business Standard

The Eurozone crisis. So caught up have we been in things like rupee's depreciation and our own current account imbalances that we've forgotten what's happening in the Eurozone. This does not mean that the crisis there has ended. Not by a long shot we believe. In fact, an insightful piece by a gentleman named Michael Pettis has just identified a couple of ways in which the crisis can come to end. Mr Pettis argues that there are only two options in sight, either Germany rebalances or Europe breaks apart. And this stems from Mr Pettis' accusation that it was Germany who forced Eurozone into the debt crisis it finds itself in today. The accusation is no doubt a bit harsh on Germany. But Mr Pettis does have strong logic to back his claims.

He is of the view that it all started in the early part of previous decade when wages in Germany were forced to grow at a rate lower than its GDP. This led to decline in consumption and a consequent rise in savings rate and finally to a huge current account surplus. The German banks were thus forced to invest the excess money in peripheral Eurozone nations like Spain and Portugal. Since the manufacturing sector in these countries wasn't as competitive as that of Germany, the excess money went into speculative activities like stock market and real estate and led to huge asset bubbles.

And this is the tale of most peripheral nations as they could not use tools like currency depreciation, interest rates or trade intervention by which to block German exports. Thus, the bubbles kept getting bigger and bigger and when they finally burst, it led to wealth destruction of the highest order. No wonder Mr Pettis feels that the only solution is for Germans to increase their consumption or for countries like Spain to break away from the Eurozone.

Safe haven. At a time when investors have every reason to worry more about safety of capital rather than returns, bank deposits have turned a safe haven. More so if the bank in question is the largest government bank in the country. As per Economic Times, State Bank of India (SBI) is seeing an unprecedented accumulation of funds in its deposit accounts. The situation is similar to that in 2008 - post Lehman crisis era. Then too, the bank's deposits were most sought after. Not just retail investors, but also corporate, particularly cash rich IT heavyweights were shifting funds from private and MNC banks to PSUs then.

SBI is also the obvious choice for most depositors living in semi-urban and rural areas given the bank's unmatched franchise. The recent specter of ponzi schemes has also led unsophisticated investors to opt for bank deposits instead. SBI currently has excess liquidity to the tune of Rs 500 bn. Whether the bank can utilize the funds to stimulate credit growth remains to be seen. However, investors would do well to ensure that they have adequate diversification in terms of bank deposits as well.

The real estate market may be in a downturn right now. But there are no signs of downsizing. Downsizing means builders leaving the business for its lack of viability. This was pretty much expected because of rising regulatory hurdles and financing constraints. However, forget downsizing, you would be surprised to know that there is a fresh set of competition planning to enter into the market. This competition is from broker-developers.

Considering most brokers have firsthand experience of dealing with clients they know their requirement. Also, being into the real estate broking business for long, they have gradually gained experience to deal with the constraints that the sector presents. Their own on-ground experience in dealing with properties has made them well equipped to deal with such situations. As such, they have decided to venture into the development business. Most of them have started development on a small scale. However, since they are well-networked and have good experience in the market, gradually they may pick up as well.

This is a perfect signal that we are at the tip of the real estate cycle. Markets attract new participants when the profitability in the sector is high. This lures new entrants. However, with new entrants coming in, competition intensifies, margins drop and the cycle turns. We believe this is what is likely to happen with real estate sooner or later.

Given that the Indian economy has slowed down considerably, it is hardly any surprise that it has had some negative impact on the job market as well. According to the Manpower Global report and published in the DNA, the job employment outlook for the September 2013 quarter is the worst in 8 years. It is not that hiring is not happening. It is just that the pace at which it is taking place has slackened. Employers have reported an outlook of +18% for the quarter. This is a decline of six percentage points quarter-on-quarter (QoQ) and 28 percentage points year-on-year (YoY).

Not surprisingly, the industrial, the construction and the Mining sectors have seen job prospects dim. However, the retail and services sectors could see an improvement in hiring. Typically hiring is at its weakest in the third quarter of the fiscal. So if the second quarter does not show improvement in hiring trends, the outlook for the fiscal itself will be weak. It goes without saying that once the economy begins recovering, there would be an uptick in new hiring as well.

The Indian equity markets traded well above the dotted line throughout the day. At the time of writing, the BSE-Sensex was up by about 270 points (1.4%). Buying activity was witnessed in stocks across the board with those from the consumer durables , auto and metal sectors leading the gains. Stock markets in other major Asian economies ended on a firm note as well. Japan and China ended the day higher by about 1.9% and 0.6% respectively.

04:50  Today's investing mantra
"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."- Paul Samuelson
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