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Which stocks will you buy if the markets shut down?

Jul 1, 2015

In this issue:
» Debt levels across various nations
» Is the global credit bubble on its last legs?
» How private banks have grabbed market share from PSU banks
» ...and more!


00:00
Unless you are living far away from civilization, you would have heard all about the crisis in Greece by now. The country is bankrupt, it could be thrown out of the Euro zone, the banking system has shut down and citizens can't withdraw their money from ATMs. In the middle of all this came news that the stock markets too would be shut down for a week. While one feels for the ordinary Greek citizen, this crisis also got us thinking. What would happen if the Indian markets shut down for a week or more? No doubt most traders would be in a state of panic! But what about long term investors? Think about this question. If you knew that markets will be closed for a long time, which stocks will you buy?

Here is one of our favorite Warren Buffett quotes - "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years" . Now don't get us wrong. We are not hoping for a 5 year shut down of the BSE and NSE! But we are interested in finding those stocks that we would love to own even in such an unlikely situation.

You see, even though it is easy to forget sometimes, a stock represents ownership in a business. In the long run, you can only hope to make as much money in a stock as the returns from the underlying business. Great businesses will compound their value year after year. This would be true even if daily stock quotes were not available.

So which stocks should you buy in such a situation? The simple answer is, 'buy the best businesses'. You can then sleep peacefully knowing they will be worth a lot more when the markets reopen after 5 years! How do you identify the best businesses? It is not as easy as it seems. Broadly, you will need to find a company which:

  • Has a business model that is protected by a strong moat (entry barriers, pricing power, switching costs, etc).

  • Possesses a strong balance sheet (little or no debt, good liquidity position, etc).

  • Generates tons of cash internally (which can be paid out as dividends).

  • Earns returns on capital that is far higher than its cost of capital.

  • Is run by a management that is competent, ethical and shareholder friendly.

  • Is trading at a discount to its intrinsic value in the market.
While this is not an exhaustive list, these are certainly the most important points. Consider these two historical examples of a largecap and a midcap; Hindustan Unilever and Page Industries. Shareholders of these businesses have compounded their wealth by 27.5% and 73.9% CAGR respectively over the last five years (excluding dividends)! Would they really have been worried about daily stock quotes? Please note we are not making recommendations here. Rather, we offer the following advice.

Stop studying the markets. Instead, assume that the stock exchanges will shut down for 5 years after you make your purchase. Take the time and effort to study great businesses that you can understand. Finally, buy them when Mr. Market offers you these gems at a discount. The stock price will take care of itself.

Now if all this seems like too much hard work, we have good news for you! Our ValuePro portfolio recommendation service does a fine job of identifying just these types of stocks. Here, you will never find stocks belonging to value destroying sectors like aviation, real estate or telecom. Only the best businesses make it into our two readymade ValuePro portfolios. If you find appealing the idea of compounding your wealth by owning the best businesses, then we believe ValuePro is for you.

Which stocks would you buy assuming the markets will shut down for the next 5 years? Let us know your comments or share your views in the Equitymaster Club.

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02:30
 Chart of the day
Since the onset of the global financial crisis in 2008, large central banks and governments around the world have taken the easy route to recovery. Starting from the qualitative easing program by the US Fed, followed by the bailout packages in the Euro zone and huge stimulus packages by Japan and China, all the measures of pumping money have failed to rein in the slowdown. On the contrary, such unbridled money printing has led to a steep jump in the debt levels of these economies.

The world is awash with debt

Recently, Greece whose debt levels stand at a whopping 300% of GDP, defaulted on its Euro 1.6 bn loan repayment to the IMF. This default, a first by a developed economy, has raised fears of Greece's exit from the 19-nation euro common currency. The ballooning debt levels and near zero interest rates in most advanced economies have put a question mark on the monetary measures available in future if the global recovery falters. India, on the other hand, has been conservative in cutting interest rates to spur the economy. This is also reflected in its debt levels which stand just below 120% of GDP.

03:40
From the chart above, it is clear that the world is awash with debt. Far more than it can handle. In fact there is so much of it, that the developed economies have become addicted to it. Even worse, all this debt has been made available at historically low interest rates by central bankers. This has helped to boost not economic growth but asset prices. This party has been going on for the last six years. During this time the total debt in the US economy has risen by a staggering US$ 10 trillion! The prime beneficiary has been the US stock markets.

But now though we believe the party could be coming to an end. The US Fed is planning to raise interest rates later this year. Nobody can predict with any confidence what will happen at that time. Credit will be re-priced for sure. But by how much? Will individuals, corporates and even governments be able to handle the higher interest burden? Greece may be an extreme example. But in a rising interest rate scenario many developed nations are in a precarious position we believe.

04:05
Back home, there seems to be no end to the woes of public sector banks (PSBs). At the end of March 2015, the bad loans as measured by the net non-performing advances (NPAs) to total advances stood at 3.2% for PSBs as compared to 0.9% for private banks. Even the credit growth of PSB's slowed down to 7.1% in March 2015. Private Banks, on the other hand, reported a strong credit growth of 18.7% in the same period.

Piling bad loans and increased provisioning on restructured assets has also adversely impacted the sturdiness of the balance sheets of PSBs. Thus if PSBs have to tide over the present crisis, they will require additional capital infusion. But the government's decision to recapitalize only the better performing banks is likely to leave behind the smaller PSBs fending themselves. What seems more appalling is that the government has been frittering away precious capital resources under the guise of populist measures. The all-women Bhartiya Mahila Bank that was started by the UPA government around two years ago at an initial capital of Rs 10 bn has not been able to make a mark and is likely to be merged with SBI. There is no doubt that such initiatives are necessary for providing economic empowerment to women. However, the government needs to first work towards making PSBs financially sound and efficient before venturing into new areas that can act as drain on already deficient capital resources.

04:40
The Indian stock markets opened the day in green and continued to trade higher on the back of growth in the core sector index. At the time of writing, the BSE-Sensex was trading higher by 291 points (up 1.1%). Barring FMCG, all the sectoral indices were trading on a strong positive footing.

04:50
 Today's investing mantra
"Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst).

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8 Responses to "Which stocks will you buy if the markets shut down?"

RAJENDRA PRASAD LAD

Jul 5, 2015

i like to buy.
1.Lupin
2.Aaurobindo pharma
3.Ultratake cement.
4.KNR Construction.

Like 

padmanabhan

Jul 4, 2015

L&T,Sun pharma.HDFC,Infosys

Like 

KISHORE AJGAONKAR

Jul 4, 2015

Sir,
What is INTRINSIC VALUE? hOW IT IS CALCULATED?

Like 

sanjay

Jul 2, 2015

BRIRANIA,COAL,HDFC BANK,EICHER MOTORS,MRF,SBI,SKS MICROFINANCE,ULTRATECH,BISCH,CERA SANITARY,L&T,BEL

Like (2)

SANKARAN VENKATARAMAN

Jul 2, 2015

Very good article.Valuepro list also contains scrips which are NOT wealth creators but overall OK.But the Buy/Sell limits are sometimes unrealistic and must be updated every year.
But some recommendations under other heads DO NOT MEET stringent norms of selection for value creation. Recently one stock recommended under Stockselect DO NOT MEET the norms you have stated. In fact it is lossmaking with no pricing power, or moat and promoters are on the lookout for selling it.In another case, the recommendations had to be reversed within a few days due to questionable acts of promoters.
I'm only saying that all research teams should follow the gems of norms you have laid down unfailingly.

Like (2)

Anil Varade

Jul 2, 2015

(1)-Larsen and Toubro (2) Lupin

Like (2)

Surya Samanta

Jul 1, 2015

I am an avid reader of Equitymaster's 5 minute wrap-up articles.
The one in hand by Ms. Madhu Gupta is particularly interesting.
This so because we always like to respond to the idea of living happily ever after.
In a real life situation also it is not that difficult to discern a good stock out of a dozen pedestrian stuff provided you have a rational and unbiased outlook.The main deciding factor is perhaps its cost of acquisition at the time of purchase.

Good things in life are aplenty,only one has to have a refreshed look and apply the mind for identifying the performer.

thanks.

Surya Samanta

Like (2)

axay

Jul 1, 2015

1.p&G
2. Crisil
3. bata india

Like (1)
  
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DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
INTRODUCTION:
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

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DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
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Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
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