This is what best businesses are made of! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

This is what best businesses are made of! 

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In this issue:
» Economic recovery will take longer than usual this time
» Is the industrial commodity boom over?
» Here's another proof why long term investing really works
» Why's the telecom minister singing a different tune?
» ....and more!

Do you know which is the most lucrative value investment in the world? Well, the letters that Warren Buffett writes for his shareholders every year certainly qualify as one of the top contenders. The wisdom that they impart is nothing short of spectacular we believe. Every time you read them, you come back with fresh insights.

Recently, our attention was drawn to Buffett's letter from the year 1981. This was via a write up on the portal In the letter, Buffett is seen praising a certain gentleman named Tom Murphy, calling him a real managerial 'twofer'.

Before we get to understanding what the term actually stands for, let us see what exactly Mr Murphy achieved to deserve the praise from Warren Buffett.

It appears Mr Murphy has gone down in US corporate history as one of the greatest capital allocators ever. An investment in his firm since the day he became a CEO multiplied a whopping 204 times in 29 years. That's a neat 13x as much money as one would have earned by investing in the benchmark index.

It should be noted that this record was achieved through a mix of shrewd, well timed acquisitions and also running the business with ruthless efficiency. And whenever Murphy did not find acquisitions that were attractive enough, he would simply buy back his own company's stock at sensible valuations. This is not all. In a fitting finale to his illustrious career, Murphy finally sold his business to Disney for a valuation as high as 28 times earnings, a number no shareholder can crib about.

Little wonder, Buffett called Murphy a real managerial 'twofer'. These are the people who excel at being both great operators of businesses as well as great capital allocators.

What we've also done through this short story is highlight the attributes of what we feel is the perfect business. A business where the top managers not only have great operating skills but also excel at capital allocation.

We have seen a lot of good businesses run to ground because managers possessed just one of the two qualities required. And while many of them do realise their mistakes, it's usually at the expense of few years lost, first in facing the consequences of mistakes and then in repairing the damage. Rarely do you get guys like Tom Murphy who juggle the two responsibilities with utmost precision. Thus, when you do, you should make sure that you grab the opportunities with both hands.

Do you think India has many Tom Murphys of its own or there is a dearth of such people? Please share your comments or post them on our Facebook page / Google+ page

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01:07  Chart of the day
Today's chart of the day highlights what kind of multiples investors have rewarded the net worth of India Inc over the last twenty years with. As the chart indicates the average Sensex P/BV multiple over the last twenty years has been 3.5x with the all time high being 7 times during the previous boom and the lowest being 1.7 times. With the current multiple perched at around 3 times, it can be concluded with the aid of history that Sensex valuations are well within the comfort zone. However, another 20-25% rise from the current levels in a short span of time and it could be flirting with danger we believe. While the replacement cost of all the assets would be a much better indicator as per us, absence of reliable data on the same makes book value the next closest proxy.

Source: ACE Equity

There is no doubt now that the Indian economy is in trouble. The next question is- where from here? Will things get worse? Or has India already hit the nadir and things will recover from here on? There has been a lot of comparison between the current crisis and the one we faced back in 1991. The crisis then prompted a slew of big-bang reforms that put India on the growth path. As a result, after GDP growth faltered to 1.4% in FY92, the economy rebounded in FY93 with 5.4% growth. And then from FY94 to FY97, the economy reported average growth of over 7%.

Can we use this argument to say that India will recover in a similar fashion this time as well? As per noted Indian economist Shankar Acharya the answer is no. He provides some very solid reasoning to explain why a quick and sustainable recovery seems unlikely.

Take the external environment back in the 1990s for instance. While 1991 was a gloomy year, the world economy witnessed the US-led 'Clinton boom' 1992 onwards. Look at the world economy now. It's in a total mess. The so-called US recovery is hardly there. The Eurozone is in recession. China is slowing down. So the external environment is not very conducive now. And internally, India has several structural issues to resolve. And neither of the two factors is going to change easily. It clearly seems like India's economic woes are going to last much longer than what we may want to think.

In a world dominated by media, business channels, brokers and the like, most investors have the urge to make quick money in a short period of time. What stock tip can you provide? Where do you see the Sensex 6 months down the line? These are probably some of the hotly discussed topics at dinner tables. For many the lure to time the markets and constantly churn portfolios still exists. So telling an investor to invest from a 10 year perspective rather than a 10 month view is bound to raise eyebrows. But the truth remains that short term investing hardly helps in building shareholder wealth. For this, long term investing remains the norm. This essentially involves having a disciplined approach, expectations of reasonable returns and the initiative to research companies and invest in quality stocks.

Once the value of long term investing is accepted, the question that arises is how long should long term investing be? This question was answered by an article in Business Standard. As per this, those who invested in equities with a 10 year time frame had zero chances of making losses and a 100% probability of making money. In contrast, a one year investing time frame increased the chance of making losses by 33%. This is after considering Sensex data for the past 25 years. Indeed, there is no denying the fact that long term investing will certainly reward the patient investor keen on steadily building wealth.

Apart from stocks what are the other long term investment options worth considering? We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute Wrap Up more relevant to you. Watch this space for more details in the coming weeks!

Commodities have had a dream run in the last decade. Strong demand emanating from China and significant underinvestment in infrastructure led to a commodity cycle boom. However, the scenario has taken a U-turn now. China has been slowing down. Also, various steps/significant investments are being undertaken to address the demand side of commodities. Take the case of crude oil for example. The advent of crude production from shale has changed the entire demand/supply dynamics in the oil space. Also, with huge investments being lined up for shale exploration, it is expected that there will be an oversupply in the long run. And this indicates that prices should correct.

Take the example of another commodity namely iron ore. Significant investment to extract ore from the earth's crust is likely to lead to an oversupply situation in the long run. It may be noted that iron is the most commonly found metal in earth's crust and is abundant. Hence, as more of it is mined, higher is the supply in the market. And increasing supply is likely to hurt prices.

The above two examples have indicated that both crude and iron ore have been through their bull cycle. While other industrial commodities may have their own demand/supply dynamics it appears that most of them have been through their super cycle. With slowing investments, their demand has taken a backseat. On the other hand, increasing supply is likely to make the matters even worse. Thus, it appears that the industrial commodity boom is pretty much over.

The telecom minister, Kapil Sibal, seems to have woken up to the plight of the telecom operators that have seen margins come under pressure and their balance sheets getting stretched. He has reprimanded the Department of Telecommunications (DoT) for imposing such heavy penalties on the telcos. His rationale - such penalties are hurting the operators and are of no use to the government either as the Courts of law stay these penalties in most cases. It is interesting to see Mr Sibal's change of stance towards the telcos. Let us not forget that he is the same Minister who had approved the DoT's penalty of Rs 6.5 bn on Bharti Airtel. So we do wonder on the reason for the change of heart.

It is true that the DoT has imposing fines left, right and centre. Some maybe irrational but there are some reasonable reasons behind the others. And the point is that any misgiving should not go unpunished. Whether the wrongdoer is a large corporate house or a Minister. It is the extent of wrong doing (if any) that should determine whether a fine is unreasonable or not. Not the quantum of the fine. If the telcos have perpetrated a fraud, then by all means penalize them irrespective of how large its name is. Therefore we do wonder as to what the minister is gaining by suddenly taking a U-turn on these fines?

With the RBI tightening liquidity in an attempt to curb speculation surrounding the volatile rupee, short term borrowing rates of banks shot up in the month of August this year. This led to yields in government securities, certificate of deposits (CDs) and commercial papers to surge. On the back of the same rising to double digit levels, investors have moved to increase exposure to Fixed Maturity Plans (FMPs) which essentially invest in such instruments. With the same happening the preference for gold exchange-traded funds (ETFs) has come down, as reported by the Mint. Investors are believed to have withdrawn close to Rs 6 bn from gold ETFs during the month August this year. This amount is believed to be the highest ever withdrawn from gold ETFs. As for the money flowing into FMPs, the same stood at a massive Rs 200 bn during the same month. It is however believed that all of it is not due to fresh issues; includes some switches as well. During June and July the figures stood at Rs 30 bn and Rs 90 bn respectively.

What should investors do? We believe FMP is the 'hottest' asset class at the moment. We do not think it would really make sense for long term investors to chase such themes, as they would be essentially betting on which way the Rupee moves. As for gold, being a hedge against inflation, it would make sense to have a certain amount of exposure (5% to 10%) to the asset class.

Meanwhile, indices in the Indian stock markets have traded weak right from the beginning today with the Sensex lower by 148 points at the time of writing. Consumer durables and IT counters were seen witnessing the maximum declines. While most Asian indices closed in the green today, Europe is trading mixed currently.

04:53  Today's investing mantra
"All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out" - Peter Lynch
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1 Responses to "This is what best businesses are made of!"

H K Prakash

Sep 12, 2013

We do have some. They are not extinct! Deveshwar of ITC? Narayana Murthy of Infy? Godrej of GodrejCP? Mahindra of M&M? The A- Team at Karnataka Bank since 2000? All we have to do is look at their companies' performance. Find out more such persons by looking for companies with consistent growth in turnover, profit, new business development, new markets, etc.
Also our insane Governments (Centre/ State) can help create more by cutting down paperwork and redtape.
Do you know that Peenya, B'lore factories are visited by nearly 60 inspectors in 12 months, all with their greedy hands out? All with the power to seize original documents without cause?
An NRI started a factory near Bombay and took the help of his local friend to run it. He was angered by seeing 5 hands in the factory and 25 in the attached office. His friend clarified "thats why you need a local person with local knowledge, 25 are needed to fill all the Govt forms"!!!

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