Oh! So You Have Full Faith In Your Broker? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Oh! So You Have Full Faith In Your Broker? 

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In this issue:
» Goldman Sachs' huddle meetings to be under scrutiny
» Another top PSU looking to tap IPO market
» Current RoE of India Inc lowest in recent years
» Top stock market expert feels US S&P 500 way past fair value
» ...and more!!

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We have always wondered how brokerage houses, where trading desks have become principal drivers for profits, maintain their sincerity while disseminating long-term research. After all, if long-term research is all that they could provide, the clients wouldn't be required to trade a great deal and this would obviously hamper their profits.

The solution? How about asking analysts to give out both, trading tips as well as long-term research on the same stock? One for their trading clients and the other for the long-term guys (remember, long-term here would mean a maximum of one year!)?

As per The Wall Street Journal, securities regulators in the US have sought more information about weekly meetings that take place in Goldman Sachs as critics have complained that its distribution of trading ideas to its traders and major clients are hurting other Goldman customers who aren't privy to the same information and are relying on the firm's long term research to make decisions.

Things aren't very different in India as well, with cases of brokerages colluding with their top clients and fleecing the ignorant retail investor being unearthed with constant regularity. So, the next time you get any stock idea from a broker (directly or through a business news channel), please ensure that there are no vested interests at work. Glancing through the fundamentals of the company under consideration would be a good starting point.

00:57  Chart of the day
Return on equity, or RoE, is considered as one key differentiator between good and bad stocks. A sustainably high RoE signifies high quality, and volatile or low RoE rings caution bells. One reason stocks in India were given high valuation during the boom years of FY04 to FY07 was that Indian companies were earning the best RoE among their emerging market peers.

However, as today's chart shows, the average RoE for Indian companies has fallen considerably (to 17.3% in FY09) from the peak of 24.1% reached in FY07. With profitability remaining under pressure for at least the current fiscal year (FY10) as well, do not expect the RoE to rise again. And this will keep under pressure the valuation that investors assign to Indian stocks in general.

Data Source: CMIE Prowess

Jeremy Grantham, one of the most respected voices in investing globally is not very bullish on equities these days, especially in the US. Speaking to The Wall Street Journal, the man who was among the select few to rightly call a bottom in March 2009, now believes that the S&P 500 has zoomed right past what Grantham considers a fair value, based on earnings estimates and historical price-to-earnings ratio.

In fact, Grantham believes that markets are going to remain sluggish for as much as seven long years as they compensate for the long-era of overpriced stocks. "We have had two bubbles in the past that were really good for corporate profits. Now things are unlikely to be anywhere near as good as people have gotten used to, because we are not going to have a bubble to help us," is how the director of asset allocation of Grantham's firm GMO, chose to put it across.

We wonder what could have been Grantham's view on Indian equities. As far as we are concerned, with the huge run up in the indices since the lows of March, even Indian equities aren't looking very cheap either. But since GDP growth and in turn corporate profits are likely to come in much higher than those of the developed world, annual returns in the region of 10%-12% over the long term may not be too much of a stretch.

Looks like the worst of the banking crisis is not over as yet, according to Richard Bove of Rochdale Securities. Bove, a well respected banking and financial services analyst and known for his blunt assessment of companies he covers, is of the opinion that 150 to 200 more US banks will go down under in the current crisis and the industry's payments to keep the Federal Deposit Insurance Corp (FDIC) afloat could eat up 25% of pretax income in 2010.

Already, 81 banks have failed in 2009 so far. As a result, the FDIC, which insures deposits, turning to non-US banks and private equity funds to shore up funds looks increasingly imminent. Just to put things into perspective, three large failures this put together cost FDIC approximately US$ 11 bn. And what is more, the fund had US$ 13 bn at the end of March. Precarious state of affairs indeed!

Just goes to show that despite the so called green shoots being seen in the economy, it is still a long way off before the US can completely break away from the shackles of the financial crisis that has almost brought the world economy down on its knees.

On the heels of NHPC's Rs 60 bn IPO, which was subscribed more than 23 times, comes the IPO of another public sector undertaking next month. As per a leading business daily, upstream oil and gas company Oil India has set a price band for Rs 950 to Rs 1,050 and plans to raise around Rs 28 bn from the offering which will open on the 7th of September and close on the 11th of September.

The company intends to utilise the money in exploration and production projects with a capital expenditure requirement of around Rs 45 bn over the next two years. It may be noted that Oil India planned the IPO last year but postponed it due to the stock market meltdown.

In our opinion, the issue is well timed from the company's perspective, with both crude oil prices and stock market indices recovering from their lows. But is it attractive enough from an investor's perspective? Well, we will have to get into more details before we make any comment.

Wall Street has discovered a way out from bad debt and risky mortgages. The solution probably sounds familiar as it involves repackage old mortgage payment and selling them as new products. However, according to Herbert Kaufman, Arizona State University economics professor, this strategy may help solve one of the lingering problems of financial meltdown.

In recent months, banks have started bundling good bonds with some not-quite-so-good bonds. The newly repackaged bonds receive AAA ratings, a stamp of approval that means they're the safest investment one can buy. The junk bonds which are left over are being sold for pennies to the dollar to investors. The difference is that this time the investors are aware of what they are buying. The risk is, if the housing market slips even more, even the AAA-rated investments may not prove safe. The deal also relies on the rating agencies, which misread the risk at the heart of the subprime mortgage crisis, to get it right.

After opening in the red, the Indian indices staged a good recovery and were trading just above the dotted line at the time of writing. Stocks from the power and the commodities spaces were lending some support. However, mixed trend was witnessed amongst key Asian indices as only a few of them managed to close in the positive. Europe on the other hand, has opened on a negative note with most indices trading in the red.

04:48  Today's investing mantra
"A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett

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5 Responses to "Oh! So You Have Full Faith In Your Broker?"

Rampal Singh

Aug 25, 2009

Chart of the day is most interacting information i have every read in any daily newsletter. Keep the good work up.



Aug 25, 2009

Return on equity, or RoE, chart is quite interesting. It stimulated grey cells.

Can I have some views on following?

Will it help to do little more analysis
of RoE based on quarterly results?
And compare the same with say Nifty PE.


ankit saraf

Aug 25, 2009

comment on chart of the day:

I think the comparison of Indian equities with other emerging countries equity should be done.



Aug 25, 2009

"A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results." - Warren Buffett

This is quite interesting.
I would like to know when was this said? In very recent past? Or may 20-25 years have already passed, and one needs to get alerted!




Aug 25, 2009

Dear Sir,
The presentation of Return on Equity well informative
and documented .

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