The one page secret to beating the markets - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The one page secret to beating the markets 

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In this issue:
» Jim Chanos has a whole new reason to be negative on China
» The best performing asset class in India in last two decades is not gold
» Collectively, the BRIC has greater purchasing power GDP than the US
» Stock market returns and the war game effect

Well, all investors typically talk about a few investment books out there that have had the biggest influence on their lives. We are sure even you have few investment books that hold a special place in your heart. However, we were left slightly bewildered when an editor on a leading finance portal tweaked this subject a bit. In other words, he did not recommend an investment book but instead only a particular page of an investment book! Yes, that's right. As per him, an investment strategy outlined in that page is all that one needs in order to beat the markets by a comfortable margin over the long term.

The page however, in fact the entire book, came into existence shortly after the epic stock market crash of 1929 and goes around by the title Security Analysis. And the page that is being referenced is none other than the first page of Chapter 43 as per the editor. We will spare you the details and let you know that the page highlights a simple strategy of buying stocks at less than 75% of their liquidation value. In other words, stocks selling at less than the working capital minus all liabilities of the company.

Of course, most value investors would be aware of this strategy. But they would be under the impression there has been so much advancement in computing power and availability of information since then. Therefore such bargains have become virtually non-existent. That's not the case though. The author goes on to highlight a back testing done between 1980 and 2009 where all one did was invest in such kinds of stocks and held the remaining money in treasury bills during years when such opportunities were sparse. How did it perform? Excellent to say the least. The portfolio of stocks selling below liquidation value handily beat the market. It returned close to 19% per annum as opposed to 11% returns notched up by the benchmark index.

We believe that the success of this strategy and other equally simple ones where stocks are bought after taking into account a sufficient margin of safety is a big slap in the face of people who believe that simplicity does not work. And that one has to resort to sophisticated methods of stock picking in order to beat the markets.

Nothing could be further from the truth though. The strategy outlined by Graham tries to take advantage of the irrationality of the human mind which will perhaps not change ever. Consequently, as long as the human mind vacillates between fear and greed, such opportunities will present themselves from time to time. All that one needs to do is have the temperament to be fearful when others are greedy and vice versa. Of course there will be periods when such an approach will lag the overall market. However, if one is willing to endure this, there's very little that can stop him from beating the markets over the long term we believe.

As a matter of fact, our own experience running a product based on these principles has been very encouraging to say the least. The returns that some of the stocks have given have surpassed even our expectations. We are just five months into the new service and already five of our recommendations have returned more than 100%. And there are another five which are up anywhere between 50%-80% so far. Of course this excludes a couple of positions that we've already closed after the stocks logged in gains of more than 50% each within a matter of three months!

We are reasonably confident that over a five year period, the new service, which we are calling the Microcap Millionaires service should be able to beat the Sensex by a comfortable margin.

What do you think? Do you think the simple investing strategies outlined by Benjamin Graham are still relevant in today's world? Let us know in the Equitymaster Club or share your comments below.

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01:30  Chart of the day
As per the latest IMF study, the total weight of emerging markets in the GDP of the world on a purchasing power parity basis has seen a sizeable shift. It highlights how as against 51% in 2005, the emerging economies now account for close to 56% of the global purchasing power GDP as per the latest survey. And with the emerging economies growing at a faster rate than their developed counterparts, we won't be surprised if the share goes up further in the coming years. Today's chart highlights where the GDP of the four BRIC nations on a purchasing power parity stand vis-a-vis the US. Here, while India has a lot of ground to cover, we won't be surprised if China surpasses the US over the next few years.

US vs BRIC in terms of purchasing power GDP

Politics and economics are very intricately connected. They tend to influence each other in ways that could be very complex and far-reaching. For instance, the prospects of the Indian economy have been seriously compromised due to political corruption. High inflation, poor standards of living are to a great extent a result of rampant corruption in the country.

China, on the other hand, seems to be facing a diametrically opposite challenge. We came across an intriguing interview of American hedge fund manager Jim Chanos. Chanos has been keenly following the political and economic development in the dragon economy and has figured out something that is quite worrying. He is of the view that the Chinese economy could be heading toward trouble on account of new Chinese President Xi Jinping's very aggressive anti-corruption drive. It may seem a bit baffling; after all, how can strong measures against corruption affect the economy? Chanos believes that many things such as apartment sales, luxury products, etc. were largely bought with dirty money. And it is now beginning to impact consumption. This may indeed be bad news for an economy that is struggling to transition from an investment-driven export-oriented economy to a domestic consumption-driven economy.

One would imagine that strong economic policies should ideally put asset classes that are linked to the economy in the limelight. And rightly so! Asset classes like equities and real estate tend to fetch premium valuatioins with higher liquidity. This is beacuse more and more investors seek a share of the pie expecting higher growth rates. However, the fact that gold outshone realty and equities over the past decade tilted the balance in favour of the yellow metal. Its positioning as 'safe haven' asset class which even central banks cling to in times of crisis, worked in its favour! However, if ones goes back two decades and studies assets classes since India's economic liberalization, the results are very different altogether!

A study by published by Firstpost has revealed that asset classes like real estate and equities were the biggest beneficiaries of the liberalization policies. A firm called Cians Analytics studied returns from assets including equities, gold, fixed deposits, G-Secs and real estate since 1991. Real estate outperformed every other asset classes during the 23-year period with an annualized return of 20%! Equities came in second with annualized return of 15.5%! However, while these returns may seem mouthwatering, the fact is that the return from equities adjusted for inflation came down to just 7.1%! Hence the takeaway for investors is that equities and real estate investment in india are certainly a must-have in your portfolio. Especially, if you expect the economy to do well. However, without having at least a small portion of your portfolio in gold, you may subject your returns to stagflation risk or some such risk related to an economic crisis.

If there's one subject that by far dominates most discussions related to the market for listed businesses, it is - Where is the market headed next? Wil it go higher? Or will it fall from here?

A recent Forbes article likens asking such a question to playing a game of Tic Tac Toe (fondly called Xs and 0s). That's because there's just one way to win a game of Tic Tac Toe against anyone of even normal intelligence - not to play the game at all. And so is the case with so many people in the stock market all trying to do the same thing i.e. trying to predict where the market is headed next. The only way to win the latter is, like with Tic Tac Toe, not play at all.

However, stock market predictors have been playing the equivalent of Tic Tac Toe for as long as the stock market has existed. And despite all these years at it, good sense has still not prevailed. In fact - and this is the good news - you can use this fallacy to boost your investing returns. How? By refusing to play this game. That is, by refusing to make investing decisions on the basis of predictions of future stock market movements.

Meanwhile, global markets largely firmed up backed by strong performance of Asian indices. However, the US markets were down by 0.8% on ongoing worries over geopolitical unrest after downing of the Malaysian Airlines passenger jet over Eastern Ukraine last week. Even the European indices particularly Germany and France ended on a weak note weighed down by fears of the impact of tougher sanctions against Russia. The sanctions may include closing Russia's access to European Union capital markets, embargo on arms sales to Russia and restrictions on supply of energy and dual-use technologies. But the UK markets were up by 0.6%.

The Asian markets were on a roll led by China and Hong Kong registering gains of over 3% each. Strong manufacturing data kept markets upbeat in China. The stock market in India after hitting all-time highs for straight two days retreated on profit-booking by FII's and domestic funds to log a weekly gain of 1.9%. The Japanese markets were up by 1.6% even as the consumer price index eased to 1.3% in June hitting a six-year-high of 1.5% in April. The Bank of Japan has largely met its target of keeping interest rates low to fuel spending in the economy.

Majority of the sectoral indices in the Indian markets ended the week on a negative note. Power (down 3.4%), Realty (down 2.8%) and capital goods (down 2.2%) were the biggest losers. IT (up 4.1%), FMCG (up 3.6%) and pharma (up 2.6%) were among the few major gainers during the week.

Performance during the week ended 25 July, 2014
Source: Yahoo finance, Equitymaster

04:45  Weekend investing mantra
"There seems to be some perverse human characteristic that likes to make easy things difficult.". - Warren Buffett
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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1 Responses to "The one page secret to beating the markets"


Jul 26, 2014

There are many secrets are at work in the market. One secret dominates at any one time. There is no one golden secret that works for all the time. Any secret one may be knowing/using can be ranked its success by a percentage That is to say that a particular secret's success is defined as a percentage.

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