Are all low priced stocks value buys? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Are all low priced stocks value buys? 

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In this issue:
» Benefits of shale gas will take time to accrue
» We pay our respects to Mr Barton Biggs
» Prices of agricultural commodities have soared
» Infra spending target of US$ 1 trillion will not be met
» ...and more!


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00:00
 
Valuations play a very important role while choosing to invest in stocks. A company may have very good business fundamentals going forward, but if the stock is trading at a very high price, buying into it does not make much sense. Does that mean then that all stocks trading at low valuations are worth purchasing? Certainly not. Some stocks trading at low valuations could turn out to be 'value traps'. These are companies that are commanding a low price simply because that is what they deserve. This could be due to issues such as fraud, bad accounting practices, poor corporate governance practices, mismanagement and the like.

So how does one avoid such value traps? This is by taking a good hard look at the fundamentals of the company and the quality of the management. For starters, if the management is focused more on short term strategies aimed at bolstering the stock price rather than long term strategies for growing the business, then that is a warning investors need to be pay heed to. However, only growth and more growth is not the answer. Growth in sales has to translate into better profits and healthy cash flows. Again, do these cash flows have a claim to them in the form of high debt? Because if most of the cash is going towards repaying debt, then there is not much that will be invested into the business. Nor for that matter paid much to the shareholders in the form of dividends.

Others factors also need to be taken into account such as the number of subsidiaries that companies have. Too many subsidiaries make the whole business structure hazy and opaque, all to the detriment of investors. Further, it becomes important to keep a track of the acquisitions that companies make. Do these have the potential to add value to the company? Is the price right and does the management have the bandwidth to effect a successful integration? Over dependence on the government and its policies could also be an added risk as change in policies could entirely impact the future prospects of companies.

In all of this the management plays a very important role in the way the business is run. Because there is no one number that can capture this, all the above mentioned parameters give some idea of the management's intention. That is why we at Equitymaster are conducting a Corporate Trust Poll wherein we have asked our readers to vote for the corporate group that they trust the most. The poll is not over yet. So, we would urge you to go ahead and cast your vote.

Do you think that all stocks trading at low valuations are value buys? Share with us or post your comments on Facebook page / Google+ page.

01:26  Chart of the day
 
India's latest wholesale price inflation (WPI) might have eased a bit in June, but high prices at the consumer level are still a cause for worry. Today's chart of the day shows that when compared to other countries, consumer prices in India are still the highest. Further, with monsoons playing truant in the year so far, the possibility of prices staying firm cannot be ruled out. This is in sharp contrast to China where lower inflation has given the government more headroom to cut interest rates in an effort to spur growth.

*in May 2012, for others it is June
Data Source: The Economist


02:11
 
If we were to name one positive development in the global economy over the past few years, it will be hard to leave out the commercial exploitation of shale gas we believe. Indeed, the availability of shale gas has transformed the energy landscape of the world's largest economy. And is certainly something that the world looks up to with a lot of hope. Especially in view of the fact that how abundant it is in other parts of the world. Optimistic as the scenario may be, it is also important to be practical we believe. And from this standpoint, it will at least be a decade before shale begins to have an impact on the global gas markets and prices outside of the US.

The reasons for this are wide ranging. For some countries like China, geographical locations of shale gas fields and regulated prices are likely to act as the main hindrances. For others like India, scarcity of water and hostility from local people stick out like sore thumbs. For still others like Argentina, political meddling is supposed to be the key culprit. Thus, all said and done, while shale gas is indeed revolutionary, it is not time yet to savour the sweet fruits of the same.

02:57
 
There are strategists galore in Indian stock markets. But it is not every day that they predict bull markets and stock market crashes; which go on to become reality. But one gentleman who is credited for not one but two such feats breathed his last yesterday. He predicted two historic crashes in global stock markets. Barton Biggs represented the days when a strategist's prediction could single-handedly move the market. The founder of Morgan Stanley's research department has over his career span of 30-years warned about the Japanese stock market crash of 1989 and dotcom bubble burst in late 1990s. Like Buffett, Biggs was also initiated into his career after two readings of Ben Graham's Security Analysis. In his latest note to investors Biggs wrote "As investors, we also always have to be aware of our innate and very human tendency to be fighting the last war. We forget that Mr. Market is an ingenious sadist, and that he delights in torturing us in different ways." We pay the legendry investor our respects.

03:38
 
The monsoon has so far disappointed and if rainfalls do not increase soon, it will push up inflation. Even before the drought is yet to make a real impact in the country, people are feeling the impact. Traders are jacking up prices of almost all essential commodities, including rice and dals. The prices of agricultural commodities have jumped sharply in the past month. This is amid expectations of their output being hit because of deficient monsoon rainfall. The India Meteorological Department (IMD) has reported 30% rain deficit so far this season. In addition to crops, some regions are dependent on good monsoons for power generation. Poor rainfall could, consequently, mean lower availability of power and/or use of other more expensive sources. This would further increase food prices. However it is still early days for the monsoons and a recovery in rainfalls over the next few weeks could help reduce or even fully eliminate the deficiency. If that does not happen, consumers could be staring at a bleak future in terms of price rise.

04:16
 
The planning commission had set out an ambitious target of spending US$1 tn on infrastructure in the 12th five year plan. But in light of current growth prospects it seems that target is on the verge of being missed. It may be noted that the target of US$ 1 tn was based on GDP growth expectations of about 9%. And now, since the growth expectations are revised down wards, spend is likely to change. Also, it may be noted that target was given when the rupee was hovering at about 44 to the US dollar. But with rupee depreciating significantly in the recent past, the dollar equivalent spend is bound to impact the target. Now, we know that infrastructure is the backbone of any economy. So, unless the government takes calculative steps to increase spend, growth expectations are likely to remain muted in the near term.

04:45
 
In the meanwhile, the Indian equity markets had a volatile day of trade today. At the time of writing, BSE Sensex was up by 48 points (0.3%). Amongst sectoral indices, auto, IT and power stocks were the only ones on the losing side. Asian stock markets were trading in the positive.

04:56  Today's investing mantra
"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Are all low priced stocks value buys?". Click here!

    6 Responses to "Are all low priced stocks value buys?"

    KRISHNAKANT BATAVIA

    Jul 18, 2012

    No,all low priced stocks are not value buys.

    Like 

    Marinho Godinho

    Jul 18, 2012

    No

    Like 

    RK77

    Jul 17, 2012

    It is good that you acknowledge that all low priced stocks are not value buys. In fact the market generally knows which company is doing well and has good management and therefore decides the premium. However, often the market is manipulated by 'experts' who use media to mislead gullible investors.

    Does the quote apply to Infosys? It does not show consistent increase in earnings per share but continues to earn profit and increase its cash holdings waiting for the right moment to invest. The market does not seem to have much confidence in Infosys management, however.

    Like (1)

    Ram

    Jul 17, 2012

    Hi..I did not quite understand the import of Warren Buffet's quote..I would have normally gone for consistent EPS growth any day...but that's why I am not buffet !! Pls can u help me understand the significance? Thx

    Like (1)

    AML

    Jul 17, 2012

    All essential commodity prices are heading Northwards.Inflation is going out of control.Traders are rigging up prices before full monsoon is yet to be over.Once escalated will not come down to prevailing levels.India is exporting Sugar,Wheat & Rice.May be to imported them next year.Population exodus & inefficient Government policies & their ministers are responsible for current scenario.On top of all this monsoon adding fuel to this.We are agricultural economy & without proper monsoon it will be havoc like situation in next two to three months time.

    Like (1)

    ASHOK PATEL

    Jul 17, 2012

    Pl.note warren buffet commercialize graham theory .He is invented any thing pl.use name of graham ,dody

    Like (1)
      
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