Buffett like story of 'Coca Cola Millionaires' - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Buffett like story of 'Coca Cola Millionaires' 

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In this issue:
» Will technology put highly educated workers at a disadvantage?
» Is India's road sector showing some promise?
» Telecom stocks at 52 week highs
» The dangerous legacy of Greece crisis
» ...and more!

Buffett's fascination with Coca Cola and the fortune that he made by investing in the beverage giant in 1988 is nothing short of a legend. But not many are aware that a handful of investors in an obscure town in Florida started becoming 'Coca Cola Millionaires' 5 decades before Buffett. Interestingly, their investment in the company was not by any stroke of luck. Instead it was the value investing skills of shrewd banker named Pat Munroe that put the 67 odd investors on the path to riches.

As per New York Times columnist Joshua Kennon, the banker spotted the opportunity in Coca Cola's stock way back in 1920's. Coca-Cola had gone public at US$ 40 per share in 1919. However, a conflict with the sugar industry resulted in a 50% crash shortly thereafter, when it reached US$ 19 per share. While the company's profits, return ratios and cash flows were mouth watering, the stock was trading less than the cash per share in the book.

The banker, Mr Munroe encouraged his depositors in the town of Quincy, Florida to buy the stock of Coca Cola. He also convinced them that though there may be short-term market fluctuations, the stock and the dividends earned from it could be very enriching. True to his words, the farm town was relatively unaffected during the Great Depression. The local economy was supported by Coca-Cola dividends when farm income dried up. Later, at a point of time, Quincy became the richest town in terms of per capita income in the entire United States.

Thus the sanctity and track record of the key principles of value investing extends beyond legends like Warren Buffett. What investors need to realize is that value investing can be practiced fairly successfully even with smaller proportions of investments. Also few good stock picks could make a substantial difference to their portfolio returns. The focus therefore should be on getting few things right and avoid making big mistakes.

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01:35  Chart of the day
Close to a million students will be graduating from engineering colleges this year. For a talent starved nation like India that should be good news! However, as per Economic Times, nearly 20- 30% of the engineering graduates run the risk of remaining unemployed. According to data from AICTE, the regulator for technical education in India, there were 1,511 engineering colleges across India in 2007. These churned out around 5.5 lakh graduates. However, the demand for engineers from the US$ 110 bn outsourcing market led to thousands of new colleges taking in lakhs of more students. As a result both the number of institutes and graduates has more than doubled. Without a check on quality of education, most of the engineers are unlikely to find takers in the job market.

Source: Economic Times, AICTE

Apparently, The McKinsey Global Institute has released a report that lists a dozen new technologies that may be disruptive for workers and their industries. And guess who's losing sleep over the report? Well, its the Nobel Laureate Paul Krugman. Writing in The New York Times, Krugman has opined that highly educated workers are just as likely to be ejected from their jobs as less-educated workers once the new technologies come into play. He therefore questions the logic of students going into debt in order to acquire new skills. After all, once they acquire the skill, it could well turn out that those skills will not be needed any more.

So, how do the policymakers get around the problem? Well, Krugman is of the view that there should be a strong social safety net, with guaranteed healthcare and a minimum income. Although he did not explicitly mention it, we believe Krugman is strongly leaning towards socialism. He wants the poor to be compensated by way of increasing taxes on the rich. Thank god this idea did not occur to people when the first ever wheel was invented. Had that been the case, there's every chance that we could still have been in the Stone Age. We believe that standard of living improves only when we become more productive. And disruptive technologies help us towards that endeavour. If it comes with temporary pain to few people, so be it. This is a far better way of organising society as per us rather than practice socialism.

Once in a while, most companies within a sector tend to follow a trend. Something that they do blindly, given the vast opportunities everyone seems to foresee. But then when the tides turn, it tends to teach a lesson to most. It was not long ago when construction companies were jumping over each other bidding for BOT projects. But given the difficulty in building and operating them, a lot of money was blocked and lost over time. Thereby impacting profits; leading most players to want to dispose projects in order to unlock the blocked cash. With this, the road sector was one that was impacted on an overall basis. And the government's target of allotting projects of 9,000 plus kilometers was nowhere close to desired level. However, there seems to be a change in mood off late. Wanting to revive the road sector, the government is looking at making one key change in the funding model. From being a PPP (public private partnership) where in the developer finances the project himself, the government is considering funding part of the project. With that, it takes on the risk of the project itself. Earlier, the target was to build 60% of the projects in the PPP model. But now, it seems the government is willing to fund majority of the projects in the new model. Will this help revive the sentiments of the sector? We believe so, given that funding has been a big factor for investors staying away.

Just a few months back, telecom stocks were in the news for all the wrong reasons. Companies were getting punished by tax claims. Regulatory issues were hurting every company. Margins were getting depressed as costs were soaring while revenues remained under pressure in a highly competitive environment. But in recent times most of the telecom stocks have been on an upward move. Some are trading close to their 52 week high. So does it mean that the issues that the sector faced in the past have now come to a happy end? Have the fortunes for the telecom stocks turned for the better? We believe that this is not the case. In fact if anything, investors should be more cautious when it comes to telecom stocks than what they were before. The thing is that the regulatory risk still exists. The current surge in share prices has been due to the announcement by the regulator that the operators can customize their tariffs for national roaming subscribers. This is just one issue. Other issues related to spectrum pricing, license renewals, etc have not yet been dealt with. In fact those issues actually add to the risk in the sector which we believe is very high. Add to this the recent depreciation in the Indian Rupee. Let's not forget that most of the telecom operators have a high quantum of debt in foreign currency. As such they stand to lose when the currency depreciates. Such issues make the stocks very risky in the short term. Therefore buying them at such expensive valuations would be a mistake.

Has pharma R&D lost steam in India? It would certainly appear so. Global pharma players such as Pfizer Inc, GSK Plc, Novartis and the like typically spend around 15% of sales on R&D. But most of this is done in the developed world. India hardly figures as an investment destination for global pharma trials. Why is that? The primary reason for that is the uncertain regulatory environment. India traditionally had been following the process patent law. This allowed many of the domestic companies to perfect the techniques of reverse engineering. And this spawned the launch of cheaper generic drugs in the country. Although the country in 2005 shifted to the product patent law, implementation has been patchy at best. With considerable uncertainty relating to the validity of patents, most MNCs are wary of investing huge sums in the country. As far as domestic companies are concerned, the progress on the R&D front has been quite slow. Given that new drug discovery is a high risk, expensive and time consuming process, most of the domestic companies have once again shifted focus on doing R&D for generics medicines. Thus, even though the R&D spend may have increased, the amount towards new drug discovery has not really risen. Indeed, it does appear that unless the patent law in India matches the standards of the developed world, MNCs at least will not put much money into doing research in India.

Among the Eurozone nations, Greece was the first one to be struck by the financial crisis. The approach to the Greek crisis was crucial. The reason being that it shaped the response to the crises that followed in other Eurozone nations. When the crisis befell on Greece, the response was austerity. In economics, austerity refers to measures taken by government to reduce budget deficits. It could include spending cuts or higher taxes or a mix of both.

It's been over three years since the first bailout package was announced for Greece. As it has turned out, the response has failed. Austerity appears to have been a terrible mistake. The biggest failure seems to be the way the Eurozone and the International Monetary Fund (IMF) handled the events. All the forecasts made by the IMF programme for Greece went awfully wrong. The recession turned out to be worse than expected. Moreover, unemployment soared to 27% of the labour force.

Overall, it seems policymakers have been totally inept at handling the crisis. This raises some pertinent questions? What should be the role of the state in an economy? How much government intervention is necessary, if at all? Should central banks and international institutions have so much power? Should market forces be allowed to play themselves out? There is no clear answer to these questions. But the role of public institutions certainly needs some reconsideration.

Buying interest in select commodity and telecom heavyweights helped the key index in Indian equity markets feature as the only gainer in Asia besides Japanese Nikkei today. The BSE Sensex was trading higher by around 19 points at the time of writing. Other major Asian markets closed lower while markets in Europe have opened in the positive.

04:50  Today's investing mantra
"If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker but not your partner." - Warren Buffett

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