Should you avoid such stocks in your portfolio? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should you avoid such stocks in your portfolio? 

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In this issue:
» Will the drought affect RBI's decision on interest rates?
» India's demand for gold makes US glitter
» Big builders can no longer bully home buyers
» Environment clearances to come faster?
» ...and more!

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When we look at the fundamentals of stock, something that we give a lot of importance to is the business model of the company. The business model and the product segment define the safety moat for the company. If it is operating in a niche segment with very little competition, then it derives pricing power. And this power helps it to keep its head above the water even when the tides turn unfavourable. But what happens when the product segment is so niche that it has no demand at all?

We recently met a company like that. The company is in an unusual product segment. And in the hope that the demand for the product will pick up, the company has been expanding its capacity for quite some time. As things stand currently, the company's production capacity is nearly double that of the total demand in the country. Now the management is actively trying to educate its customers of the various uses of the product in the hope that demand would pick up and idle capacity would be utilized. Considering that the company is not in a branded product segment but is actually manufacturing a commoditized product is not helping the situation. It is not that the company's top line and bottom line are not growing. In fact it boasts of some healthy return numbers as well. However, the past track record is not really translating into a healthy future. The idle capacity and the missing volumes have started taking a toll on the growth rates.

Investors do come across such companies from time to time and are at a cross road to figure out the next step. If one goes by the past track record, these companies present an excellent investment case. But if one were to look at the future plans, the picture appears bleak. So what should an investor do in such a case? It is true that niche product segments can and do make compelling investment cases. But expanding capacity without any definite growth indicators in the demand is actually a foolish thing to do. Such companies may present a very rosy picture about how demand will grow and they are the ones who can capitalize it. But the truth is that they are just trying to justify their mistakes.

It would be better to dig further and figure out just exactly how and when the demand would pick up if ever. Otherwise the investor's money would just remain stuck forever. A company operating in a super niche product segment in the hope that demand may pickup could be a very risky position to defend in the long term.

Which factors do you consider before investing in a company that operates in a super niche product segment? You can also share your comments with us or post your views on our Facebook page / Google+ page.

01:10  Chart of the day
Forex or foreign exchange reserves are an important resource for the central bank of a country. It can be used by the central bank to help the domestic currency. When the domestic currency weakens in the international markets, the central bank could use its kitty of forex reserves to repurchase the domestic currency from the international markets. This can help in stabilizing the currency's value. Therefore, we thought of evaluating the position of India vis-a-vis its BRIC peers in terms of forex reserves. Interestingly, India lags behind all the other BRIC countries in this regards. It must be noted that large forex reserve balance can be used by a country to manipulate its exchange rates to provide itself a more favourable economic environment. Something that China has been accused of by other developed nations. And with a reserve in excess of US$ 3 trillion, it is quite understandable as to why it has come under the firepower of such accusations.

Source: Financial Express

It has tried its best to convince the government about the latter's role in reigning inflation. But to no avail! Once again all eyes are on the RBI to use it armory to tame price rises. Investors and consumers have been waiting for almost a year now for the central bank to ease up liquidity. Earlier this year, the Reserve Bank of India (RBI) also considered a loose monetary stance. It said that the onus of freeing up supply side bottlenecks was on the government. With that one would see a substantial impact on price levels. However, with rains playing truant, the RBI is once again left with little redress. In India, food prices contribute heavily to headline inflation. Hence that prices will spiral with the drought conditions worsening is a given. Hopes for policy changes and their economic impact are too farfetched for the time being. Consumers and investors would therefore do well to brace themselves for tighter liquidity.

India's love for gold dates back thousands of years. The yellow metal has been the revered financial asset of the Indian people. And it continues to be so even today. The statistics say it all. 25% of the gold sold globally is purchased by India. As per a recent report, Indian households hold gold worth more than US$ 950 bn. The Indian government and the Reserve Bank of India (RBI) are not too happy about India's high gold imports. This is because it adds further burden to India's already high current account deficit. But someone on the other side of the globe is all smiles. We are referring to the US and the other countries in the Americas. This region is set to become India's biggest gold supplier. There are several reasons why this is very likely to happen. Though China is the one of the biggest producers of gold, it uses a significant chunk of its production to build up its national reserves. Moreover, there are high entry barriers for private miners in the dragon nation. Ditto for Russia. Certain gold reserves in Europe are facing environmental hurdles. Other big producers such as South Africa and Australia are becoming unpopular due to high taxation and high cost of production respectively. That puts the Americas in an advantageous position. What favours this region even more is the fact that they hold the biggest share in the significant global gold discoveries between 1997 and 2011.

It is common knowledge that the collusion between big business and politics is one of the biggest challenges before us. Any idea where this collusion is at its worst in terms of wreaking havoc on the common man? It is real estate indeed. Isn't it ironical that despite having progressed so much in terms of GDP growth, the number of slums in our metro cities has only gone up? Who else to blame for this state of affairs than the big builders who - arguably in connivance with the politicians - have put the dream of owning a modest house beyond the reach of most of us. It is alleged that current laws seem to be loaded heavily in favour of builders. So much so that the buyers have no other choice but to remain a mute spectator even if the builder goes back on his promises.

Amidst such a sorry state of affairs, we wonder if there is any hope for the hapless buyers. Thankfully, one such ray of hope finally emerged when last year; the Competition Commission of India (CCI) delivered a landmark ruling. The CCI found DLF Ltd, India's largest realtor, guilty of using its dominant position in the relevant market to impose unfair terms on home buyers. And although DLF appealed against the ruling, it has been disallowed the use of contentious clauses in its agreement with buyers. We just hope that other such victims of builder apathy and arrogance take inspiration from this ruling. And give a fitting reply to whoever tries to cheat them of their hard earned money.

A number of major development projects including power, housing, mining, etc, are pending with the Ministry of Environment and Forests (MoEF) for clearance. One of the biggest hurdles to speedy implementation of these projects is the delays in obtaining the necessary clearances from the environment ministry. In a move to speed up clearances, the MoEF has put in place a plan to hasten the entire process. The ministry is planning to open up regional offices to eliminate reasons for delay in processing forest clearance. It will also streamline the environment clearance process by analyzing projects based on technical analysis. It will also start e-filing of forest clearance applications in the next 18 months. This comes at a time when project developers have repeatedly taken up issues relating to the inordinate delays due to rampant corruption at various levels. While fast-tracking project approval is one way to reverse the declining investment rate, the government should speed up the reforms process to get the economy back on track.

In the meanwhile, after opening the day in the green, the Indian equity markets continued to trade above the dotted line. At the time of writing, Sensex was up by 241 points (1.4%). Among the stocks leading the gains were ICICI Bank and Tata Motors. With the exception of China and Malaysia, other major Asian stock markets have closed the day on a positive note. European markets too has opened the day in the green.

04:55  Today's investing mantra
"The worse a situation becomes, the less it takes to turn it around, the bigger the upside" -George Soros
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1 Responses to "Should you avoid such stocks in your portfolio?"


Jul 31, 2012

Regarding Real Estate, what is needed is a Real Estate Regulator, along the lines of SEBI, IRDA, TRAI etc. This is required to ensure fair practice dealings by builders as well as a uniform policy for whole of India regarding built up houses.
Purchase of residential houses for the purpose of investment or speculation should be viewed negatively. Capital gains from residential property sale should be taxed heavily, even as much as 100%. If the person wants to buy another house by selling an existing one, then a deduction in gains to that extent may be given, but not more.
Why isn't HDFC chairman coming out with such ideas? Housing is a necessary good and investment/speculation in it (beyond necessity) is allowed, whereas owning gold doesn't harm anybody else and he wants people to not buy it! Both our politicians as well as industry leaders are failing us.

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