How to obtain perfect knowledge on a stock? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

How to obtain perfect knowledge on a stock? 

A  A  A
In this issue:
» The need of the hour for China
» 'I don't understand gold prices', says Bernanke
» IT index scales a new high
» Are Indian law makers overpaid?
» ....and more!

Are you one of those investors who settle for nothing less than perfect knowledge about the stock you intend to purchase? In fact, does this desire border on obsession? You make it a point to study the industry, the competitive dynamics, get in touch with people running the company and even former employees if required. You don't just stop here. You diligently pore through financial data going back years and even look at historical stock price trends. To conclude, you try to ensure as far as possible that you've covered all the bases before eventually pulling the trigger.

There is nothing wrong in this approach we believe. To understand why one is buying a stock is the single most important factor in investing. However, like everything else in life, there is a trade off involved here as well. As legendary investor Seth Klarman points out, the value of in-depth fundamental analysis is subject to diminishing marginal returns. In other words, the first few hours spent studying a company are worth far more than the subsequent hours spent. Another way of explaining this is the famous 80/20 rule. You see, the first 80% information that you need to make an investment can be put together in just 20% of the time.

Thus, the point is that spending too much time in researching a stock could backfire quite often. Simply because like time and tide, low stock prices also do not wait for anyone. By the time one completes a detailed analysis on a company; stock prices could have already begun their upward journey, eventually robbing it of its status of being a value investment.

The idea of diminishing marginal returns in information certainly has merit. But what's equally important is knowing what constitutes first 80% of the information and what constitutes the remaining 20%. Unfortunately, there is no easy answer to this question. In fact, we doubt if there is any universally acceptable answer to this. The only thing that can speed up this process is learning as fast as possible from one's own experience and also the experience of other great value investors.

Therefore, one should go back in time and thoroughly analyse one's own decision making processes and also those of other great investors to know what information is worth focusing on and what is purely a noise. What we are sure about though is the fact that there is no such thing as perfect knowledge. No matter how much time one spends, one can never be assured of a guaranteed return on a stock. Therefore the idea should be to capitalise on an opportunity fast and do enough research to know that one is not way off the mark. Of course mistakes will still creep in. But there's always margin of safety and portfolio diversification in order to minimise them and maximise risk adjusted returns.

Do you believe in the 80/20 rule in the field of investing or you believe that perfect knowledge is indeed possible? Please share your comments or post them on our Facebook page / Google+ page

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01:27  Chart of the day
There is always a feeling in India that Indian lawmakers seem to be overpaid in view of the absolutely slow pace of work they are so accustomed to. It appears as if it takes forever for files to move from one place to another. However, as today's chart of the day highlights, Indian lawmakers are also way overpaid as opposed to other countries when one considers the ratio of their salaries to the GDP per person in India. As highlighted, salaries for Indian lawmakers are nearly 8 times higher than India's GDP per person. This contrasts with the 2-4 times GDP per person that lawmakers in rich countries get paid. Of course, there is a lot of income inequality in India and hence the higher ratio for India some would argue. However, try linking these salaries to the performance of law makers and may be it will be hard to justify even the current level of salaries.

Source: The Economist

As per an article in the Economic Policy Journal, the Fed Chairman Ben Bernanke made a statement that he does not understand gold prices. Maybe that is not a surprising statement given that Ben Bernanke could very well be the reason why the precious metal has gained so much allure in recent times. Indeed, the US Fed has unleashed massive quantitative easing programs hoping that this would pull the US economy out of trouble. That has hardly happened. All it has done is increase money supply which has found its way into asset classes forming bubbles there and raising the likelihood of inflation. In the process, these moves have pretty much increased the chances of paper currencies being rendered worthless in the future.

This is where a tangible asset like gold has found favour, because it acts as a hedge against all these eventualities. The frightening thing is that Ben Bernanke does not appear to have learnt a lesson. In fact, in that very article, he has defended his money printing practices citing that other regions such as Europe and Japan are doing it as well.

Thus far, the large cap IT companies reported good numbers for 1QFY14. Infosys surprised the Street by reporting a 7.8% QoQ growth in sales. And Tata Consultancy Services (TCS) maintained its steadiness by reporting a 9.5% QoQ growth. The sales growth of both companies was boosted by respectable growth in volumes. Decent numbers were also registered by the mid and small cap IT companies. The positive effect of the reported results boosted the stock prices of other IT companies as well. Accordingly, the BSE IT index scaled new highs on Friday, reaching very close to its 52 week high.

We remain confident about the long-term growth story attached with the Indian IT sector. However, we would recommend a bottom-up approach with a keen attention on valuations before picking up respective stocks from the sector.

People's Bank of China's step towards liberalizing interest rates was cheered by the markets. Removing the floor on lending rates is a positive step towards the much required financial reforms. However, the ceiling on deposit rates has been left unchanged. The ceiling on deposit rates benefits commercial banks as it forms a free source of funding. But depositors earn negative returns on their deposits. This in turn affects the household savings. And this can be construed as an act of financial suppression. Therefore, liberalizing deposit rates is the need of the hour for China. This could also lead to a boost in consumption growth, a scenario that China is so looking forward to.

Moreover, China's aversion towards shadow banking is helping in containing systemic risks, but affecting depositors. This is because depositors will have to turn to the traditional banking system and save their money in the low-yielding traditional bank accounts. Thus, policymakers in China need to take a coherent decision. The interests of both the depositors and the lenders need to be protected. Liberalizing deposit rates at this juncture will go a long way in rebalancing the China economy.

The Indian government has been trying hard to increase foreign investors' interest for a while now. While the response seems positive, it is nowhere close to desired level. For foreign companies, the government's dilly dallying with regards to clauses and regulations seems to be a major concern. It is believed that India lags behind its emerging market peers when it comes to attracting FDI. As per the US chamber of Commerce, the key reason for the same is the poor intellectual property (IP) policies.

Cancelation of patents, rampant piracy! These are just some of the factors that have been keeping foreign innovators away from the Indian market. As such, the faster the government works towards strengthening India's IP policies, the more attractive FDI destination the country becomes. In fact this measure would have another development we believe. That of inculcating a culture of innovation within country, something which India has not been well known for!

Meanwhile, the major global stock markets ended the week in the green led by stock markets in Brazil and France. The stock markets in US gained 0.5% over the week. As per economic data, the factory activity in the Mid-Atlantic region seems to be picking up in early July. Also, new claims for jobless benefits came down last week. The US Fed chairman Mr Bernanke gave mixed statements about its stimulus programme. He said that the US central bank expects to start scaling back its huge bond purchase programme later this year. However, he also suggested that the plan could change if economic outlook deteriorates. The coming week for the US markets will be busy as companies report interim results.

The stock markets in China led the losses (down 2.3% over the week) due to economic concerns and lack of policy action to stimulate growth. Most of the European stock markets ended the week in green boosted by Mr Bernanke's cautious tone on tapering. Among other stock markets, Brazil led the gains (up 4.1% over the week).

The Indian equity markets closed the week in the green (up 0.9%) with shares in the FMCG and IT sector leading the gains. However, stocks in the banking and realty sector witnessed maximum losses. During the week, in an attempt to support the rupee, the Government raised FDI ceiling in 12 sectors. The earnings season has started in full momentum and going forward it will continue to influence the markets.

Source: Yahoo finance, Equitymaster, Kitco

04:52  Weekend investing mantra
"Asset-heavy businesses generally earn low rates of return - rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses". - Warren Buffett
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3 Responses to "How to obtain perfect knowledge on a stock?"

monish gaur

Jul 25, 2013

pareto's law can not be extended to equities, after all what angel broking, moswl etc know is so much different from sukhaniji and other techies which is again so different from tulsian. but the fact rightly summed up by modi is that so much of analysis does not bear any fruit in a paralysed, voting skewed governance wherein so many scams took place and which in hind sight lacked vision. I mean both governance and scams, haha.Yet, I firmly believe that PC can do magic and that is because he is able and capable, his measures will best ward off this modiwave besides bringing semblance to markets. come to think of all this analysis, even experts are down 20 to 30 percent, we mortals who stuck on in stock market rather than realty are having 50 percent or more burn injuries......remeber the last time these commentators used to say Sintex will cross 72, see upside in X,Y or Z. Now nobody, I mean investor listens to commentators, instead one remembers Sharma,one of the biggest bear who made lots of dosh in united spirits and his advice to stay away. I mean a trader today has any day done so much better than investors, that investing by retail will only start after a doomsday......happy investing, stay away ....


Shamal Parab

Jul 21, 2013

As you rightly pointed, it is very difficulty to establish perfect way of analysing a company. No company works perfectly and no information can provide you a perfect way of judging a company. Yes, you need to know few critical components of the company you invest but majority of your decision is driven by your own sentiments / judgement / guts. For example, if a company is providing good dividend and the share price is high, your mind will always think whether the company will provide the same results in future. This uncertainty is a vital element which we try to predict by studying company's past and present.


S. Sridharan

Jul 20, 2013

Seen your email and it is nice.

Please note that "Perfect knowledge on stock" cannot be possible nowadays, because Stock Market involves various
risk factors that cannot be predicted. Stock Market is now
having 80/20 rule which means 80% Gambling and 20% Truth.
In this scenario, how can you expect one to have perfect
knowledge in stock?

My opinion is that you can have an 'excellent knowledge' in stock (nearer to Perfection) and we are not GOD to have
Perfection in anything.

Thanks & Regards.

S. Sridharan

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