Is it time to sell HUL and buy SAIL?
(Aug 5, 2015)
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In this issue:
» Gold may not have lost its sheen yet
» Are real estate developers changing strategy?
» ....and more!
I have been researching stocks for over a decade now. And along the way, have learned some very important investing lessons. However, if given a challenge to pick the one lesson I think is the most important, I wouldn't mind going out on a limb to proclaim that buying cheap pays off in the long run. In other words, valuation does have the potential to cover a lot of sins.
Indeed. The one overriding theme across most of our successful recommendations over the years has been the fact that we never liked paying too much for a stock. This is irrespective of the speculation around its rosy future.
And the opposite is also true. A stock where people have speculated that it has a very gloomy future and is priced at beaten down valuations has nearly always found favour with us. This is provided we are convinced that its long term fundamentals are intact.
Needless to say this hasn't always worked flawlessly. We've had cases where our strict insistence on valuations has hurt our subscribers. It has caused them to miss out on a potential multi bagger. And there have been cases where a stock we thought was low enough to be bought has gone on to go even lower and never recovered. But over a large number of trades, buying cheap has really worked.
We believe value investing maestro Howard Marks has put this point across in a much better way than we have. This is what he has written in one of his widely read memos:
You can invest in the best companies in America and have a bad experience, or you can invest in the worst companies in America and have a good experience.
Interesting, isn't it? And this is what he has to say further.
All other things being equal, the price of an asset is the principal determinant of its riskiness.
Well, we believe it's the same thing as saying valuations matter a lot.
Ok, now how about taking this thought to its logical conclusion.
What we mean is as Marks has suggested, how about taking a view that one should sell the best company in India right now and buy what is considered as one of the worst investments currently.
We believe that the FMCG giant Hindustan Unilever (HUL) and PSU steel behemoth SAIL can serve as excellent role models for each of these types of companies.
Why? Simply because not only is HUL arguably one of the best companies in India but is also priced at high valuations if you ask us. And on the other hand, no one wants to touch commodity stocks with even a ten foot pole and this has made sector stocks, SAIL included, priced so low that it appears they are headed for bankruptcy.
Well, guess what, not just Marks but even history is on our side.
Over the last fifteen years or so, whenever HUL has traded at the valuations at which it is right now, investors have generated average returns of negative 4.6%, give or take a few basis points, over the next three years. What is more, even if the stock becomes cheaper by another 10%-12%, average returns over three years have been close to 4% per year, still nowhere close to being satisfactory.
SAIL, on the other hand has never traded this low in many years. And over the last fifteen years, buying the stock in and around its current valuations has resulted into an average three year CAGR of a whopping 130%! In other words, a twelve bagger in flat three years.
Of course, if predictions were all about imagining the future as an exact replica of the past, the librarians would have been the richest investors. But that's certainly not the case. The environment for both the stocks is vastly different from what it was in the past. We live in different world with different sets of opportunities and challenges. And therefore to that extent, the past price performance of both these stocks is no guarantee of future results.
However, what is also true is that things usually revert to the mean. That which has gone too high has to come down and that which is too low has to go up. And if one believes in this as well as in the fact that buying cheap really works, then it's certainly advantage SAIL over HUL.
However, if its business quality over everything else, then we believe HUL has definite edge. Unfortunately, we will have to wait for few years to find out which one comes out on top.
What do you think? Do you think commodity stocks like SAIL will outperform expensive stocks like HUL over the next 3-5 years? Let us know your comments or share your views in the Equitymaster Club.
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Gold prices have been falling since 2011 and recently hit a five-year low. Factors such as a strong dollar fuelled by expectations of rate hike by the Federal Reserve coupled with resolution of the Greek crisis and the nuclear deal with Iran have quelled uncertainty fears for now. Therefore the utility of gold as a reserve currency has declined. Moreover, even China has not been adding on to its gold reserves in its pursuit to make yuan a reserve currency. All these together have led to a slide in the global demand for gold.
Gold remains the safe haven asset
Data Source: World Gold Council & RBI
Therefore gold as an asset is losing its sheen, it may seem. But nothing can be far from truth. This is evident from the fact that developed economies still rely on gold as a safe haven. Therefore the central banks in these economies hold large proportions of gold. So much so that more than 50% of their forex reserves are contributed by gold. The relentless money printing and low interest rates unleashed by these economies to shake away recession remains firmly rooted on strong reliance on the yellow metal. In comparison, emerging economies such as China, India and Russia hold relatively smaller proportion of forex reserves in gold.
Another asset, real estate, has been in doldrums on account of the economic recession. This has severely dented the financial health of real estate developers. This is mirrored in a report by industry lobby FICCI and Knight Frank India that has stated that the sentiment in the real estate industry turned negative for the first time since the Lok Sabha elections in 2014. Therefore to ward of the slowdown, builders are increasingly focusing on the affordable housing segment. Even the present government has envisaged building six crore homes under the scheme of housing for all by 2022. Out of this, four crore homes are meant to be developed in rural India and the balance in urban India. The Union Budget 2015-16 has allocated Rs 140 bn for this programme.
As per a report by Cushman & Weikfield, real estate developers launched 7,000 units of affordable homes in the country's top eight cities for the June 2015 quarter. This a steep 320% jump from 1,670 affordable units launched in the year-ago quarter. Such steps are the need of the hour given that the real estate developers are saddled with huge stocks of unsold inventory that has led to severe liquidity crunch for them. Apart from this, even the Centre and states need to explore public private partnership to develop public housing.
The Indian stock markets opened the day on a firm note and continued to remain buoyant. At the time of writing, the BSE-Sensex was trading higher by 197 points (up 0.7%). Barring banking, all sectoral indices are trading on a strong note.
"Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."- Warren Buffett.
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|This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst) and Madhu Gupta (Research Analyst).
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