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Want 'assured' returns in the stock market?

Jun 15, 2015

In this issue:
» A lesson from Bernie Madoff and Berkshire Hathaway
» Huge quantum of food grains in India damaged in the last two years
»  Public sector banks to sell of NPAs to clean books
»  ...and more!

Editor's Note: My colleague Rahul Shah is all set to reveal his "Money Multiplier" formula. And I strongly recommend that you don't miss it! After all, it isn't every day that we get to hear an astute research analyst reveal his secret formula behind his most profitable recommendations. So block your calendar for Today, 5 PM for this mega event! And yes, if you have any questions for Rahul, just post them here!

Every morning, one of my rituals is to have a cup of tea and read the newspapers. Being an analyst, naturally I tend to browse the finance dailies as well. Today then, I came across an article in the Economic Times, about how the SEBI is probing a major investment scam that has come under its scanner. Here, gullible investors were being lured through SMSes and WhatsApp messages with the 'promise' of 'multifold returns' in options trading.

Scams that rely on the concept of 'promising mouth watering' returns to investors are not unfamiliar. There have been several such schemes introduced in the past. What is worrying though is that many people seem to fall for them.

Let us say a potential investor is offered '100% guaranteed returns' if he invests in this or that scheme. There are two aspects to this. One is the number; 100% return is certainly bound to catch his fancy.

But here we would like to focus on the other part that becomes equally hard to resist; the promise of a 'guaranteed' return. Why is that?

Let's face it. Nobody likes to suffer losses in any aspect of one's life. And when it comes to money and investments, losses become particularly hard to bear. For many investors, losing money on a single stock causes much heartache. This is even when many other stocks in their portfolios have generated quite handsome returns.

Hence, for these investors, the lure of 'guaranteed' returns sets their eyes glittering.

But what if we were to tell you that there is no such thing as a guarantee. Certainly not in the field of stock investing. For here, what matters really is the 'approach' to investing. This means that zeroing on fundamentally strong companies having businesses that you can understand, healthy financial track record and a sound management. Moreover, these businesses have to be bought at the right price.

This is the approach that will ultimately deliver healthy returns in the long term. But mind you, it will not be hunky dory all the way. Your stock portfolio will go through ups and downs. It will not move in a linear fashion. But if you have the conviction in the stocks that you have picked then near term swings in your portfolio are of not much consequence when you look at the bigger picture.

Just to reinforce this point further, I would like to draw your attention to an interesting article written by the authors of Morgan Stanley Investment Management and published in the Mint. This article has compared the returns generated by Madoff's scheme vis-a-vis those generated by Buffett's Berkshire Hathaway.

Bernie Madoff, as you would recall, has been imprisoned for running what is now famously known as the Ponzi scheme. Now, there was this fund called Fairfield Greenwich's Sentry Fund, which invested its entire corpus with Madoff. According to the article, in almost 18 years of running the fund, Fairfield beat the S&P 500 index by about 2% annualized. Further, it claimed 92% positive return months, with annual volatility of only 2.5%. The latter is quite low when compared to the S&P 500 index's volatility of 14%. On paper, it all seems very good. But we all know that Bernie Madoff's scheme was all a scam and there were no real investments to speak of.

Look at Berkshire Hathaway's performance. Its book value has outperformed the S&P 500 by 9.5% annualized over its 50 years of existence. However, it has not been good going during all the years. It has lagged the index in 11 of those years. But more importantly, Berkshire Hathaway has outperformed the index in every year in which the index yielded negative returns.

So you see what ultimately matters is safety of capital and the focus on earning decent returns on the stocks that you invest in rather than going in for that non-existing 'guaranteed' return. Need we say more?

Do you agree that there is no such thing as 'guaranteed returns' in stock investing? Let us know your comments or share your views in the Equitymaster Club.

While the monsoons brought a sigh of relief from the grinding heat in some parts of India recently, the threat of a below normal monsoon still continues to loom. If we have a drought-like situation this time around, it will be a second year in a row that we have poor monsoons. This poses serious consequences for the agriculture sector in India and rural incomes. On a wider scale, poor food production on account of bad monsoons, would drive food prices higher and hit the pockets of the masses.

Monsoons and food production are one side of the food supply chain. The other important factor in the chain is food storage. And this is a big concern area for India. We came across some shocking details about how thousands of tonnes have been damaged in the last couple of years. Apparently, The Times of India found out through an RTI application that about 40,000 tonnes of grains have been damaged in Food Corporation of India godowns across India over the last two years. Some of the major losses are attributable to natural disasters such as floods and cyclones. But the quantum of damage also reflects poor storage, transit losses and pilferage. This is indeed a worrying fact for a poor country like India which houses the highest number of hungry people in the world. A United Nations report estimates the number to be around 194 million!

While monsoons and natural disasters are beyond human control, factors that we do have control on should be well managed. Particularly, food storage and logistics in India need a major overhaul.

 Chart of the day
The banking sector is a good barometer of the state of the overall economy. When the economy is in pain, it gets reflected in the books of banks. The public sector banks, in particular, are the most vulnerable lot. In recent years, there has been a substantial jump in their non-performing assets (NPA). The banks have been taking various initiatives to clean up their books. But the process is going to be long and winded.

As per an article in Business Standard, public sector banks have put non-performing assets (NPA) worth Rs 140 bn on sale. Of the total quantum on sale, India's second largest public sector lender Punjab National Bank (PNB) alone accounts for a hefty share of Rs 50 bn. The reason for its high quantum of bad loans has been its high exposure to stress sectors such as infrastructure, steel and construction.

The chart shows public sector banks (PSB) that have put up their NPAs on offer to ease the pressure of stressed loans on their balance sheets. It must be noted that other PSBs had earlier sold off their NPAs through a similar exercise. After the RBI relaxed some rules, the sale of stressed assets has been gaining pace. As per a recent study by credit rating agency CRISIL, about Rs 120-140 bn worth of loans are likely to be purchased by asset reconstruction companies (ARC) during the financial year 2015-16. This reflects that stressed assets are not easily absorbed by ARCs. There are several reasons for this. The banks and the ARCs may not agree on valuations. In addition to capital constraints, recovery rates also tend to be low. As such, the book cleaning exercise of banks may not be quite smooth.

Rs 140 Billion Worth Bad Loans On Sale

The Indian stock markets are trading on a firm note today. At the time of writing, the BSE-Sensex was trading higher by 226 points (+0.85%). The sectoral indices that led the gains were healthcare and auto. However, the banking index was trading lower.

 Today's investing mantra
"I call investing the greatest business in the world ... because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Ankit Shah (Research Analyst).

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1 Responses to "Want 'assured' returns in the stock market?"

ramesh dawre

Jun 15, 2015

Sir, in the chart of the day why the first largest public sector lender is not included? Thanks.

Equitymaster requests your view! Post a comment on "Want 'assured' returns in the stock market?". Click here!
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