Stocks that Offer Negative Return Per Unit of Stress - The 5 Minute WrapUp by Equitymaster
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Stocks that Offer Negative Return Per Unit of Stress

Jul 15, 2016
In this issue:
» The real story of RBI's Independence
» Crashing IT stocks
» Are microfinance loans a ticking bomb?
» ...and more!
00:00
Tanushree Banerjee, Co-Head of Research

Even if you are new to investing, you've probably heard the term 'risk-adjusted returns'. But wait...risk does not mean the same thing to everyone.

Experts in finance and mathematics use different methods to quantify the risk of investing. They've coined terms like 'beta', which considers risk as a measure of asset price volatility. And they've invented various formulae to price in that risk while investing.

But then you have investors like Buffett for whom the only risk is the probability of permanent loss of capital.

Some investors consider low-return stocks risky simply because the returns fail to cover the cost of capital.

When you weigh stocks with other asset classes, you at least expect them to deliver higher returns than a risk-free asset. Which is why the minimum annual return expected from Indian stocks is the 10 G-Sec yield plus inflation. This typically ranges 12-15% per annum.

Obviously, that doesn't satisfy some investors.

But chasing higher and higher risk-adjusted returns can lead to dangerous territory. A place where stocks offer negative return per unit of stress.

Value investing guru Sanjay Bakshi urges investors to measure stock risk in terms of return per unit of stress. That's because investors chasing big returns are not just worried about fundamentals, valuations, and volatility. They often take high stakes on factors completely beyond their control. And that can lead to very stressful investing experiences...and less-than-commensurate returns.

Professor Bakshi suggests thinking in terms of return per unit of stress right from the start. When you do, the trade-offs become obvious. High-debt stocks, loss-making companies set to turn around, companies with corporate governance issues, stocks with obscene PEs, and stocks at cyclical highs...become less tempting. However strong the urge to speculate even a small portion of your capital will pale in comparison to the stress you'll take on.

So you settle for stocks that offer a satisfactory return per unit of stress. Long-term investing backed by safety in fundamentals and valuations is far less stressful. The upside visibility on such stocks is in your control.

And they don't necessarily need to be only the largest and safest bluechips. Plenty of small but fundamentally sound companies don't need luck to earn profits. Better yet, their return per unit of stress is always positive irrespective of the movement in the markets.

Do you measure return per unit of stress on your stocks? Let us know your comments or share your views in the Equitymaster Club.

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02:30 Chart of the day

When a few players in an industry earn abnormal profits, others typically join the party soon. This is something that has happened in the microfinance segment (MFIs). The MFI sector saw large number of players entering in a very short period. It came into prominence not only for providing loans to tiny borrowers, which were being neglected by the banking system. But with the steep growth in credit, even investors were eager to put money at high valuations.

The bubble sort of burst in 2010, when the microfinance crisis in the southern state of Andhra Pradesh put full stop to this excitement. Failure in the timely repayments led to large number of suicides among over-indebted clients of some of large MFIs.

The borrower's defaults put question mark on the sustainability of the MFI model. A number of branches were shut and the industry faced a temporary crisis.

But the industry has bounced back since and is once again clocking with robust growth in credit. The numbers are now even higher than before.

Are the MFIs still Over Lending?


Certainly, the sector is once again gaining investors' attention. Particularly after the recent IPOs of Ujjivan Ltd and Equitas Holdings.

However, readers should bear in mind that the customers of the microfinance institutions typically belong to economically weaker sections of the society. There is no tangible collateral or security for loans. The uncertain financial circumstances of microfinance customers carry higher risk of incremental NPAs, provisioning and write-offs.

While the RBI has been addressing the loopholes in the functioning of the MFIs, the sector is not completely regulated. Investors therefore should not get swayed away with the growth prospects of the MFIs. They would do better to invest in such businesses which have sustainable credit quality and are available at attractive valuations

03:20

Who Moved My Interest Rate - a book authored by former Reserve Bank of India governor, Dr Duvvuri Subbarao, is fetching a lot of attention. The reason is that the book seems to reveal the truth behind the RBI's so-called independence in decision making. That the RBI has proven itself to be amongst the best central banks globally is widely acknowledged. But going by the book, the perceived independence has been constantly under threat and has come at a price.

As per business papers, in the book, Dr Subbarao has discussed instances, where he had conflicts with former finance ministers, P Chidambaram and Pranab Mukherjee. Further it also discusses how the UPA government intervened in the RBI's efforts to control inflation and pressed it to cut interest rates.

The issue is of relevance given the unceremonious departure of the latest RBI governor Dr Rajan. The fact that he too like his predecessors did not toe in line with the NDA government's demand seems to have caused the early exit.

Our colleague Vivek Kaul, has been covering the importance of RBI's inflation control measures in-depth in his Diary. And here is what he writes...

  • Over the last five to six decades, countries which have grown at a very fast pace, have had very low rates of inflation.

    There is enough evidence going around to show that. The same can be said in the Indian case as well, when the inflation surged between 2008-2009 and 2013-2014. It ultimately led to economic growth collapsing.

    Extra spending and lower interest rates leading to inflation might help bump up economic growth in the short-term, but over the longer term it clearly does not help. What made the situation even worse was that RBI did not get around to raising interest rates as fast as it could.
04:20

India's two biggest IT firms have declared their June 2016 results. While TCS delivered a decent performance, Infosys faced headwinds in its high-end consulting business in the life sciences sector. TCS delivered 3% QoQ growth in revenues, broadly in-line with expectations. However, Infosys delivered a dull 1.4% QoQ revenue growth. The management lowered the FY17 constant currency revenue guidance to 10.5%-12%.

The bottom-line story was even more divergent. Net profit was flat sequentially for TCS but was down 6.3% sequentially for Infosys. Will such setbacks derail Infosys? The key lies in understanding if one quarter's bad performance due to specific issues can be a cause for long-term concern. We have provided the answer in the quarterly result updates for TCS and Infosys.

04:45

After opening the day on a flat note, the Indian indices registered losses and went on to trade in the red. The BSE Sensex is trading lower by 145 points (down 0.5%) and the NSE Nifty is trading lower by 38 points (down 0.4%). Sectoral indices are trading on a mixed note with stocks from the IT and power sectors leading the losses. Automobile and consumer durables stocks are trading in the green. The BSE Mid Cap index is trading up by 0.4%, while the BSE Small Cap index is trading down by 0.3%.

04:50 Investing mantra

"Great investing requires a lot of delayed gratification." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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2 Responses to "Stocks that Offer Negative Return Per Unit of Stress"

ramesh b

Jul 16, 2016

i hv bought few stocks when there was sellers circuit. i have earned in that.( though invested as gone money.)let me name -prakash steelage bought @ 1.26rs. sold in buyers circuit. 2.prakash construction.there are other few also.

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Superspotter

Jul 15, 2016

Much has been written about today's unemployed youth. A lot of wailing and gnashing of the teeth and through elaborate and threadbare dissection of data and lot of noise, pundits every where, including the ones at Equity Master has placed the burden of employing todays youth at the Governments door step. The writing on the wall is clear they say! Automation is going to rob you of your opportunities...wails one pundit. The other blames new inroads made by technology, another blames globalization, another blames Government's policies, Banks not lending, power shortage, Land reforms, GST etc etc etc..

I wish to add a few lines. Basically Today's youth are lazy. They want huge Salaries, huge benefits and lot of 'me' time. If one goes through the life and times of the successful people, (check Anisa Virji's stories) you will note that none of those people had silver spoons or huge backers. They struggled, made compromises, worked hard, handled multiple jobs, they persevered till they tasted success. Then they built on it.

I am a farmer. I don't get labour. I am willing to pay 1000 rupees a day for some to work 8 hours a day, drive tractors, do hard work on the farm. I also produce many good Agri products. Those products needs to be sold. I need good sales men or women. They can earn up to Rs 50 K a month. DO I get them? Perhaps I am not looking at the right places. The youth who join me disappear with days. The Hard work they need to do is unimaginable for them. One of my workers came to me. His Son had graduated. He is now a BBA. HE asks me if I can help the boy get a job in Infosys. He has heard good things about infosys. Their buses picks up the employees and drops them. They have air conditioned offices. He has now found a good match also for his son. He pleads with me. The bride's family will offer him more if he gets a job in Infosys. Words fail me.

Sum and substance. ..If today's youth is unemployed, he or she have only themselves to blame. The world is full of opportunities. Thousands of Jobs are staring into empty spaces. They can become entrepreneurs. They can provide livelihood to others. The economy can thus prosper. True, it will hurt in the beginning. I had a tough time. I was a door to door sales man. I became a BAnker, then some how turned to IT, wound up as a Director before taking up farming.

I am tired of the Pundits, their revolving chairs and endless cups of tea. They should open their eyes and see, then understand, and then write. What they write, they should read. Then read it again and again before spewing their unsolicited excrement on others. For the same reason, I too may be blamed, but I am not a Pundit. I am a senior citizen, thoroughly disenchanted with the youth. All I can say is that they are now holding the country to ransom. My message to them is simple. Don't look for handouts. Carpe Diem!

Jai Hind.

SS

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