Can this mathematical genius beat Warren Buffett?

Jul 21, 2015

In this issue:
» FIIs' preference moving towards midcaps?
» Gold hovers around its 5 year lows
» Infosys' better than expected results
» ...and more!

"What are you doing different from your competition?" was a question we had asked the senior management of a small sized IT firm a few years ago. The response - to our surprise - was something on the lines of "We don't know what the competition is up to. We are focusing on our business only."

Considering that the company was pretty much involved in a commoditized business of infrastructure management services, we were eager to know how and what it would be doing to withstand the intense competitive scenario overtime.

What was the outcome of this? Well... we are not saying that it was entirely related to this particular set of Q&A, but this was one of the key reasons for giving the stock a miss. And fortunately, the decision worked in our favour. It turned out that the stock is worth less than a Rupee today. Its price had soared to levels of Rs 750 in the market boom in 2010.

And mind you, this business had come in our internal stock screener as one possessing a strong track record, having strong fundamentals and showing strong growth in the recent years (at the time).

The above incident is the first thing that came to my mind when a colleague forwarded an interesting article to me this morning. The article was authored by Robert Shiller - a 2013 Nobel laureate in economics, is Professor of Economics at Yale University - reviewing a book which was all about how smart computers coupled with smart financial analysts are likely to make the markets more efficient. The mathematical geniuses will ensure that in the process, the alphas - returns above a risk-adjusted benchmark - shrink going forward.

Essentially, the result of computerized world would be that of markets becoming perfect - making it difficult for investors to have superior results over time. In other words, human intelligence will be replaced by computer intelligence.

The fact of the matter is - as the author points out - that technological changes and demographic changes are aspects that will essentially drive the world going forward; and the same holds true for businesses and financial performances too. These things are difficult to capture in algorithms.

A simple decision (like the one we had taken) of saying ‘no' to an idea that one is not convinced with in the first place is something that can do wonders to a portfolio as well.

As Mr. Shiller puts it aptly - "Markets seem to be driven by stories, as I emphasize in my book Irrational Exuberance. There are stories of great new eras and of looming depressions. There are fundamental stories about technology and declining resources. And there are stories about politics and bizarre conspiracies.

No one knows if these stories are true, but they take on a life of their own. Sometimes they go viral. When one has a heart-to-heart talk with many seemingly rational people, they turn out to have crazy theories. These people influence markets, because all other investors must reckon with them; and their craziness is not going away anytime soon."

At the end of the day, prices fluctuations and investment decisions are all a function of humans being wired differently. And as long as humans continue to possess their own brains, nothing is bound to change. Different opinions and different ways to approach problems & opportunities as well as varied risk profiles will lead to different approaches towards investing, factors that essentially drive prices up and down.

"Human judgment, good and bad, will drive investment decisions and financial-market outcomes for the rest of our lives and beyond." - concludes Mr. Shiller.

Do you believe retail investors will be at a disadvantage against smart computers in the future? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The general protocol is that once large caps start appearing overvalued, bottom fishing begins as investors start to search for value in the smaller companies. Is this what is happening in India? Difficult to answer. However, if one were to believe in this protocol, then it does seem true.

As reported by the Economic Times, FIIs have trimmed stake in 20 out of the 25 Sensex companies (that have so far declared their latest shareholding pattern) for the quarter ended June 2015. And what is interesting is that, this (trimming of exposure in Sensex companies) has happened for the first time in the past four years!

Today's chart of the day shows the decline in stake by the FIIs on a QoQ basis.

Are FII abandoning largecaps?

As reported by the business daily, FIIs sold shares worth Rs 97 bn (net figure) between April and June 2015. And it seems that the focus is now shifting to midcaps. A few days ago, the BSE Mid Cap index hit it all time high figure of 11,268 points.

Should this worry you as an individual investor? Well... not really. It should be kept in mind that India is one of the many markets that FIIs have the liberty to invest in. There will be times when they are largely bullish on Indian stocks, wherein their positions tend to become overweight on India. Similarly, there are times when their positions are underweight. These fluctuations are bound to happen. It turns out that FIIs were largely overweight on Indian stocks till some time back, and thus such type of trends should be taken with a pinch of salt and are not something that individuals should be worried about. If anything, one could use the wide fluctuations in prices to their advantage.

The big news in the markets today was undoubtedly Infosys' quarterly results. India's second largest IT firm did not disappoint. Sequential quarterly topline growth was the highest in the last 15 quarters. While operating margins declined sequentially due to seasonal wage hikes and visa costs, all in all it was an excellent performance. The sustained improvement in the company's performance recently can be attributed to the efforts of the management. In no other sector does the senior management play such a disproportionate role in a company's performance.

We have always maintained that the Indian IT sector is undergoing a transition phase. The good old days of 20-30% growth are well and truly behind the sector. In a world of rapidly changing technologies and disruptive innovation, only the companies with the most astute senior leadership will thrive. The rest may struggle to even survive. Under CEO Vishal Sikka, we believe Infosys is taking steps in the right direction with respect to automation, innovation as well as smart use of the cash on the company's books.

Gold prices are back in the news these days. The recent slide in prices on the back of the strengthening US dollar has taken quite a few people by surprise. In rupee terms, the price of Gold had held up quite well for the last two years or so. However, domestic prices of gold too are under pressure now. The recently concluded deal between the EU and Greece has only weakened the Euro, which in turn has given a boost to the US dollar.

Does this change our stance on gold? Not really! We have always maintained that gold should be an indispensible part of one's portfolio. Holding about 5-10% of one's portfolio in gold works well as an insurance from the recklessness of global central banks trying to boost economic growth via money printing. Until they mend their ways, we see no reason to change our view on Gold. Short-term fluctuations in Gold prices should not be a cause of worry.

At the time of writing, Indian markets were hovering around the dotted line with the Sensex trading lower by about 16 points. Amongst sectoral indices, stocks from the healthcare and FMCG spaces were least favoured, while those from the information technology space were in demand. Mid and smallcap stocks were trading weak as well, with their respective indices trading lower by about 0.4% and 0.3% respectively.

 Today's investing mantra
"Both our operating and investment experience cause us to conclude that "turnarounds" seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price" - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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