Is this the best way to invest in a new stock? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Is this the best way to invest in a new stock? 

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In this issue:
» Realty developers start feeling the heat
» Another challenge before new RBI Governor
» Is our GDP growth underreported by 15%?
» Is Larry Summers the right man to head US Fed?
» ....and more!


00:00
 
When we think of wealth creating companies, what come to mind are usually the tech companies. The Intels, the Googles and the Microsofts of the world. Hardly anyone talks about Wal-Mart we believe. Yet, the retailing giant is perhaps the biggest wealth creation story of the past few decades. A fact that Warren Buffett can hardly ever forget. Wal-Mart's continued success day in and day out is a grim reminder to the Oracle of Omaha that he let go of a great investment opportunity by delaying his investment until as late as 2005.

Yes, that's correct. Buffett did have Wal Mart in his sights during the early stages of company's growth. But he never ended up investing in the company. Little wonder, Buffett calls Wal-Mart easily his biggest mistake of omission.

The reason this mistake of Buffett never comes up for scrutiny all that often is because it does not show up in his track record. The financial statements of Berkshire Hathaway make no mention of it. But it did teach Buffett and his partner Munger a big lesson we believe. Or may be reinforced a principle that they already knew from before.

And this principle answers to the name of identifying the right opportunity cost. Of course, Buffett would have invested the money he did not end up investing in Wal-Mart in something else. And this would have even given him above average returns. However, as he rightly assesses, the returns came nowhere close to what he would have earned from Wal-Mart. Thus, the opportunity cost for him is not the dollar cost of investments he actually ended up making. But it's the value of investments he didn't make, in this case Wal-Mart, because he used his funds to buy something else.

If this sounds confusing, allow us to make you perform a simple exercise every time you are contemplating a new stock purchase. Do not just look at the investment from an absolute return perspective. In other words, people usually have a cost of capital in mind and if the new investment is capable of beating the same, we go ahead and make the investment. Instead, weigh the new investment against the best stock you already own.

Buffett and Munger weigh every investment that they are contemplating against their favourite company Wells Fargo. They are of the view that if the new investment does not look better than Wells Fargo, then it is better to buy more of Wells Fargo or alternatively, do nothing. So, all they do is shift the frame of reference when it comes to arriving at opportunity cost. This enables them to buy only the most attractive stocks at the most attractive prices possible. Our readers are also advised to look at investing this way and we are confident that it will lead to much better investment decisions.

Do you think investing by taking into account opportunity cost could lead to much better investment returns? Please share your comments or post them on our Facebook page / Google+ page

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01:30  Chart of the day
 
Do you know which country sends the highest FDI into India? Well, no prizes for guessing that it is indeed the tax haven Mauritius. As the chart highlights, Mauritius was the source of FDI into India that was more than four times as high as the next largest contributor, Japan in FY13. Although India's FDI inflows from the island nation fell in FY13 on a YoY basis, the fall was nowhere as steep as the one witnessed in other major destinations like UK and Japan. A fact that could be attributed to the low growth and high inflation in the Indian economy. When the figures would improve is anyone's guess we believe.

Source: indiaspend.com


02:01
 
Whenever there is any talk about a country's economy, the most discussed term is Gross Domestic Product (GDP). The term refers to the monetary value of all finished goods and services produced in a country during a given period of time. Let us share some interesting statistics that have been reported in the Indian Express. About 50% of India's GDP comes from the informal sector. That is, other than by incorporated enterprises or companies. And this sector employs about 90% of India's workforce. In 2005, India had about 42 million enterprises. That's a massive number. On the other hand, India has less than a million companies. Do you think it is practically possible to measure all the economic activity in the country? Absolutely not! As such, the national accounts team relies on a lot of assumptions and past surveys to estimate economic growth.

And there is a fair chance that a lot of important data points may get missed. For instance, productivity improvements often do not get reflected. In fact, the author goes on to argue that there have been significant improvements in productivity over the last five to six years. And since the GDP numbers do not reflect this, the GDP growth for 2012-13 may be underestimated by about 15%.

We believe that author has certainly raised some valid concerns about the authenticity of GDP numbers. There is often too much focus on the bigger enterprises. To really understand India, it is very pertinent to understand the millions of small businesses.

02:46
 
India made a big announcement day before yesterday when it announced that Dr Raghuram Rajan would be the next chief of its central bank. Now all eyes are turned towards US where a similar decision needs to be made. The decision there is who will succeed Ben Bernanke as the next chief of the US Fed. Before we get into the discussion on the candidates, let us point out that the Chief has a tall order before him. The person would need to work out a way to turnaround the US economy without spurring inflation and help it deal with the consequences of the huge QE program. Basically the person has to be a brilliant captain to steer the ship of US out of the crisis stricken waters. And a person who has come up as a favorite is Prof. Larry Summers.

He is a person who emerged as a star in 2008 during the banking crisis. But while he may have displayed keen intelligence at that time, many question his effectiveness during the current crisis. The reason - he is a follower of the passive monetary policy. This means that he prefers the theory of setting an interest rate to accommodate fiscal policies rather than setting an inflation target. And his idea of the interest rate is to keep it at near zero levels. That has not really helped US till now so the likelihood of US benefitting from it in the future is remote. In addition to this Prof Summers also faces criticism of being too pro Obama government. Let's not forget that President Obama's policies are majorly to blame for the crisis that US is in currently. Therefore having a Fed Chief who agrees easily with everything that the President says may not be a great choice after all.

03:40
 
Realty players so far have been living in an unreal world of their own. They were under the impression that property prices can remain at consistently elevated levels even when the fundamentals do not support this. And now, the ground reality has finally begun to dawn on them. In a weak macro environment, property sales have remained sluggish. So there is not much revenue coming on that front. On top of that, funds are also beginning to dry up. Indeed, banks have become stricter in lending to the sector and have demanded more collateral from these companies if fresh loans have to be disbursed.

Most real estate players are beginning to feel the heat. Because of the liquidity crunch and poor sales, many of them have begun defaulting on interest payments on loans. The only reasonable option available to them is to push sales by lowering property prices. And if this happens, it will certainly be good news for property buyers. Especially for many who have still to buy their first home and are not able to do so because of such exorbitant prices.

04:13
 
As if a swiftly depreciating rupee, bloating current account deficit and high inflation were not enough. The new RBI governor has much more to deal with that he must have envisaged. The latest alert is on the health of Indian banks. As per Firstpost, rating agency S&P has in a detailed report highlighted the deteriorating quality of banking entities.

Having analyzed the June quarter performance of PSU banking entities, this report is no surprise to us. In fact one can safely say that the condition of asset quality of PSU banks in particular is much worse now than it was in 2008. And the possibility of upward movement in interest rates makes the chances of further deterioration in asset quality more real. While the real culprit has been the restructured assets, the government's arm twisting policies are equally to blame. The onus of ensuring that problem of NPAs does not become a system wide malaise falls on RBI. And therefore Dr Rajan will have to ensure that the RBI takes a firm stance.

04:45
 
Meanwhile, indices in the Indian equity markets traded strong today with Sensex higher by 137 points at the time of writing. Realty and metal stocks were the ones enjoying the maximum gains. Amongst global indices, while Asian markets closed mixed today, Europe is trading mostly in the positive currently.

04:55  Today's investing mantra
There are two requirements for success in Wall Street. One, you have to think correctly and secondly, you have to think independently- Benjamin Graham
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5 Responses to "Is this the best way to invest in a new stock?"

Dilip

Aug 9, 2013

Very good compilation of important news of financial sector.

Like 

Rajanikanta Verma

Aug 9, 2013

One should take opportunity cost into account but simply investing in a Company whose shares one already has (like Wells Fargo in the illustration given) could result in over-investment in a Company. As Equitymaster repeatedly stresses, one must not have more than five per cent in any one company. Diversification is important too.

Like 

SKundu

Aug 8, 2013

Regarding the opportunity cost: If we follow this then doesn't our asset allocation formula go out of the window?

Like 

Manjith Gambhir

Aug 8, 2013

"Buffett calls Wal-Mart easily his biggest mistake of omission. "

I don't think this is accurate. If i am not wrong, It was Bill Gross who passed up an opportunity to invest in Wal-mart and called it his one of the top 2 mistakes of omission.

Like 

V C SHAH

Aug 8, 2013

AS FOR UNDERREPORTING OF GDP - I BELIEVE THAT ESPECIALLY WHEN ONE COMPARES THE GDP DATA WITH THAT OF THE WESTERN WORLD, INDIA'S GDP IS GROSSLY UNDERSTATED. TO GIVE AN ILLUSTRATION - ALMOST EVERY HOUSEHOLD IN INDIA COOKS ITS OWN FOOD AND THERE IS NO WAY THE VALUE ADDITION TAKING PLACE IN THE INDIAN KITCHEN WILL BE CAPTURED IN THE GDP. TO GET AN IDEA OF HOW MUCH THIS CAN BE - A QUINTAL OF WHEAT IS PRICED AT ABOUT RS. 2000. THE CHAPATIS THAT THE HOMEMAKER MAKES THEREFROM WOULD BE WORTH AT LEAST TEN TIMES THE PRICE OF WHEAT - CONSIDERED AT THE PRICE OF CHAPATIS AT AN INEXPENSIVE RESTAURANT. SAME IS TRUE FOR CONVERSION OF FRUIT INTO JUICE WHICH HAPPENS LARGELY IN THE INDIAN HOUSEHOLDS WITH TRADITION OF CONSUMING FRESH FRUIT JUICE. SUCH VALUE ADDITION GETS CAPTURED IN THE WESTERN WORLD IN THE FORM OF REVENUES OF THE PIZZA HUTS, MCDONALDS, TROPICANA ETC. NOT SO HERE IN INDIA EXCEPT ON THE MARGIN. WE ARE NOT A POOR COUNTRY - WE PRODUCE OVER 200 MILLION TONS OF FOODGRAINS - A PER CAPITA AVAILABILITY OF 200 KG (TAKING POPULATION AT 100 CRORE. THE COUNTRY IMPORTS OVER A THOUSAND TONS OF GOLD EVERY YEAR - AND FOR DECADES. GDP AS REPORTED CERTAINLY DOES NOT CAPTURE OUR TRUE WORTH. IT IS A PIETY THAT WE ALLOW OURSELVES TO BE LOOTED BY THE WESTERN WORLD BY AN UTTERLY SKEWED EXCHANGE RATE OF OVER RS 60 TO A DOLLAR EVEN AS THE PURCHASE POWER PARITY RATE IS 1/5TH THEREOF. IS THIS NOT A NATIONAL ECONOMIC EMERGENCY THAT THE RUPEE HAS DEPRECIATED BY OVER 20% IN THE LAST ABOUT 18 MONTHS? WARRANTING DRASTIC STEPS SUCH AS PUTTING AN EMBARGO ON GOLD IMPORTS FOR SA THREE YEARS (EXCEPT STRICTLY FOR EXPORT OF JEWELLERY)? CAN WE NOT RECALL SHASTRIJI'S CALL TO THE NATION TO SKIP ONE MEAL A WEEK?

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