Move over Value Traps. Here comes the 'Value Graveyard'
(Aug 14, 2015)
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In this issue:
» Movement of rupee over last 68 years of independence
» The hurdle to India's highway dreams
» Roundup on markets
» ..and more!
Thanks to aggressive ecommerce startups, big discount deals are the order of the day. We are now so used to the deals that anything without a discount tag hardly seems to offer enough value for money.
The human mind is wired to focus on one thing at a time. So a big minus on the price tag can easily divert your attention from everything else.
All you can focus on is getting the deal cheaper than everyone else, and it's easy to overlook value. That is exactly the bait the ecommerce companies have laid for you.
The discount bait is even more enticing when looking for deals in stocks. That is because such a purchase not only whets your appetite for something cheap, but a discounted stock can fetch big returns for your portfolio.
The practice of deep discount investing owes much to legendary value investor Benjamin Graham. Graham was propagating net-net and cigar butt stocks when the discipline of value investing was still in its cradle.
According to Graham, to fetch net-net bargains, you look for companies trading at less than two thirds of the net-net value (a combination of cash and net current assets).
The idea is to buy the company at a stripped down value compared to the assets on its balance sheet. Therefore, the discounted value, being steeped in fundamentals, has merit.
For cigar butt stocks, you look for relatively poor quality stocks available at throw away prices. Without the safety of fundamentals, such a value hunt can be very misleading. And loss making.
Keep in mind that both net-net and cigar butt stocks are a product of bear markets.
During bull markets, so many investors are chasing stocks, even weak ones, that deep discount valuations disappear. And that's when the hunt for deep discount stocks gets very risky.
Typically, stocks trading close to book value during a bull have serious business or management issues.
If you missed the early phase of the bull run, you might be tempted to look for a late but discounted purchase. In doing so, you have every chance of landing yourself in a veritable Value Trap.
You might be further lured if you spot large companies correcting sharply in an otherwise bull market. You are so enticed by the correction that the deteriorating fundamentals skip your notice.
The guys over at Oddballstocks conducted a study on large companies that have seen huge market cap corrections during bull runs.
In most such cases, it is not just the poor performance of the stock but the questionable actions of management that prices to crack.
However, according to the study, investor activism and regulatory crackdown eventually cause management to come around. So the possible change in management approach and the sharp price correction offers investors the opportunity to buy stocks from the ‘Value Graveyard'.
I would be skeptical about such an approach. Such innovations in value investing need to be tested across markets for a long time. Else they could raise a stink!
A look at the key financials of stocks at their 52-week lows will tell you why.
Balance sheets loaded with debt and return ratios lower than cost of capital are fatal signs. Companies sporting such fundamentals are doing nothing but destroying shareholder wealth each day they are in business.
The price correction, however steep, cannot be linked to sensible value investing. Speculating on a turnaround too is fraught with risk.
Merit in buying stocks that have shed more than half their market cap in months?
Source: Ace Equity
So do not follow innovative methods to find discounts in overpriced markets. Stick with the tried and tested orthodox approaches.
Aggressively endorsed discount deals are best left to ecommerce companies.
Have you ever used innovative methods to look for discounted valuations in stocks? Let us know your comments or share your views in the Equitymaster Club. your comments or share your views in the Equitymaster Club.
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The trend of rupee's depreciation against the US dollar since India's independence has sustained across governments. In 1947, a dollar bill could be bought for mere Rs 4.76, versus its current value of Rs 65. However, the Indian economy was quite unsettled at that time. The year 1990-91, the period of liberalization, was the year when rupee saw sharp fall against the dollar. Since Independence, India witnessed several upheavals on the economic, political and cross border front. Along with this, the macro-polices, continued to influence the currency movement.
Take the recent example of China devaluing the Yuan. A weaker Yuan will make China's exports more competitive and imports more expensive. This step has impacted major currencies of emerging markets including India. The Indian rupee has today sunk to its two year low of Rs 65 per dollar. Increase in volatility of rupee-dollar rate impacts the trade policies of the country. This in turn impacts GDP growth.
Devaluing the domestic currency during depressing economic conditions has been an important tool for policymakers. While such moves provide temporary relief to an ailing economy, its widespread usage could lead to currency war.
Re/$ movement during tenure of govts since independence
Every year the government in India allocates trillions of rupees towards infrastructure development. Despite such gargantuan allocation, the poor pace of infrastructure development is well known. To add to the woes, here is another development.
As reported in Business Standard, the cost of buying land for highways has zoomed up by 70% in last three years. What's more, a sharp rise was seen in last one year with prices moving up almost by 50%. As per the official data, the cost has increased from an average of Rs 7.8 m a hectare in 2012-13, to Rs 9 m a hectare in 2013-14. This further increased to Rs 13.5 m a hectare in 2014-15.
We are aware of the spiraling land prices in the country. And such a trend will of course result in an increase in the cost of constructing highways. Further, as the Modi government has brought Land Ordinance to replace the 2013 Land Act, the price of acquiring land is expected to surge further.
India's growth opportunity will remain muted unless the infrastructure is put in order. And land reforms are key to not just manufacturing but also infrastructure development. So a correction in land and real estate costs is critical to India's economic recovery.
A last word on real estate prices. Vivek Kaul, my colleague at Daily Reckoning, has recently published a new report where he takes a view that “real estate prices are headed down”. I strongly recommend you read that report (I have!)... It contains some of Vivek's best writings on real estate. To claim the report and get Vivek's Daily Reckoning issues where he continues to share updates on Real Estate among other things, just click here... (it's a one click sign up).
The Indian stock markets were trading strong today on the back of sustained buying activity in banking, auto and commodity stocks. At the time of writing, the BSE-Sensex was trading higher by around 440 points, while NSE-Nifty was up by 145 points. Both the midcap and smallcap indices are also trading strong, with the BSE-Midcap and BSE-Smallcap indices up by about 2.07% and 1.52% respectively.
"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett.
|| Today's investing mantra
Editor's note: There will be no issue of The 5 Minute WrapUp on 15th August on account of Independence Day.
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|This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).
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