The Return of Risk

Sep 19, 2009

In this issue:
» Shareholders to decide executives' compensation
» Buffett would want to invest in these stocks
» India gets serious on renewable energy
» Textile companies bent on 'diworsification'
» ...and more!

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Guess which categories of stocks have been the biggest gainers of this year so far? The answer - the ones that fell the hardest in last year's crash - 'realty' as a sector, and 'small-caps' as a category. While the BSE-Realty Index has surged by 245% since its lows in March, the BSE-Smallcap Index is up by almost 157%. Compare this to the BSE-Sensex return of around 105% during this period.

Data source: BSE

These facts point that risk-taking has come back to the markets. Stocks that were considered untouchables till about six months back are being treated as darlings today!

Realty and small companies were amongst the worst hit financially during the crisis. While the former actually saw evaporating funds and buyers, the latter i.e., small-caps were more hit by the sentiment. And the result was that a large number of stocks from these sectors lost anywhere between 80% and 95%.

Our belief, and you can call it our biggest worry, is that most of the stocks from these sectors are now pricing in 2 to 3 years worth of recovery. While the financial condition of realty and small companies has definitely improved over the past few months, we are still nowhere near a threshold when a safe prediction about a sustainable recovery can be made.

And the riskiest part is that you, as an investor, might be feeling the temptation to jump into this 'cheap money-induced rally' in realty and small-cap stocks, given that you must have seen your friend/relatives/colleagues make money in them over the past few months.

It's time for some caution, dear friend. While we are scared of realty stocks (for reasons like disclosures, balance sheet mess etc.) we believe that small-caps do provide some tremendous long term wealth generating opportunities. But you need to tread very-very carefully. Buying into 'any' small-cap stock because 'any' small-cap stock is rising can be highly injurious to your wealth!

What is the % allocation between large cap, mid cap, small cap stocks in your portfolio? Tell us

 Chart of the day
Warren Buffett believes that the return that a company generates on its shareholders' funds (also called return on equity) is one of the most important factors in making successful stock investments. Keeping this in mind, we decided to evaluate the long term average ROE generated by the stalwarts of US and Indian financial sector over the past five years and during the recent economic slump. The adjoining chart very clearly distinguishes the wealth creators from the wealth destroyers. It is, however, heartening to see that most Indian entities fare much better than their larger US counterparts. In fact, the likes of HDFC Bank and Axis Bank would probably make even Buffett smile!

Source: Equitymaster Research, Wells Fargo presentation

One of the fallout of the global financial meltdown has been the public outrage over plum corporate pay packages. Be it bankers on Wall Street or senior executives elsewhere, fat pay packages are being frowned upon in the US. And several companies are acknowledging the sentiment. Recently the CEO of Goldman, Lloyd Blankfein, lashed out at big paydays. Now, as per Reuters, Microsoft has approved a proposal to allow shareholders to vote on its executives' compensation, once every three years. However, here's the catch - the votes will not be binding.

We believe that shareholder's should indeed have a voice in setting executive pay. But implementing any legislation to that effect is easier said than done. For example, US congress has been mulling over such legislations for quite sometime, but nothing concrete has happened. People go to great lengths to guard against a pay cut.

With the growing importance of reducing the carbon footprint, the government has announced new tariff norms for electricity from renewable energy sources. As of now only 12,000 MW of India's power comes from renewable sources while the government seeks to double this in the next 4 years. The new tariff norms are a step towards spurring investment in this area as about US$ 21 bn is required as investments only by 2012. As the cost of producing electricity from renewable sources remain high, the tariff per kilowatt hour of power generated from solar power has been fixed between Rs. 13.70 and Rs. 18.80 rupees, while that from wind power stations has been fixed between Rs. 3.76 and Rs. 5.64. In comparison, the cost of thermal power is between Rs. 1.70 Rs. 2.60.

Talk about 'diworsification' and the latest companies following this trend appear to be textile companies. Battered by the volatile movements in currency and the global financial crisis which has hit exports hard, textile companies are looking for other avenues to bolster performance. And believe it or not, they are planning to dabble in property development. Since there has been some revival in the real estate sector (also hit hard by the slowdown), textile companies with huge land banks are evincing interest in the same. With companies such as Bombay Dyeing and Century Textiles foraying into real estate the latest to join the bandwagon is Raymond. While the strategy to de-risk revenues may seem a good idea given the challenging times that the textiles sector is facing, getting into real estate which is not without its share of risks in our opinion does not bode very well for the sector.

While the 'Singur' debacle is fresh on the minds of India Inc., the West Bengal government is not ready to give up. It is ready to offer 45 acres each to IT heavyweights Infosys and Wipro in Rajarhat. The reason? It wants to salvage its reputation with potential investors. Readers would do well to recall that Tata Motors had to shift its Nano manufacturing plant from Singur to Gujarat due to the problems faced with farmers in that locality. That incident severely blemished the prospects of corporate investments in West Bengal.

One wonders whether this be another Singur in the making? The Bengal Chief Minister Buddhadeb Bhattacharjee has maintained that these two companies could generate upto 16,000 jobs so the state government was willing to offer a concession on the ruling market rate for land at Rajarhat. However, we will have to wait and watch to see how the events unfold.

With renewed signs of an accelerated economic recovery, the FIIs poured onto the Indian markets this week (net investment of Rs 53 bn) and that boosted the performance of the domestic benchmark indices during the week. The Indian benchmark index - BSE-Sensex recorded a gain of 2.9% during the week. In fact, India outperformed other Asian markets most of which ended the week lower. On the other hand, the Americas and Europe recorded gains. Leading the pack of gainers was Brazil, which recorded a gain of 4%. UK, France and US followed suit recording gains of 3%, 2.5% and 2.2% respectively. As for other asset classes, while crude oil prices gained 4.6%, gold moved up marginally by 0.7% during the week.

Source: Yahoo Finance, Kitco
Note: Country names are representative of their benchmark indices.
Anyways, women investors, who would like to know how to find some worthwhile investment opportunities in the Indian market might find our special investment guide for women - interesting.

As per CNN, after nearly two years of declines, the net worth of Americans rose by US$ 2 tn to US$ 53.1 tn this year, giving the Americans something to smile about. However, not everyone was smiling as these gains were majorly accounted for by the recent increase in the stock market and not many Americans had any significant investments in stocks. The times are still tough in the US with unemployment being the highest in 26 years.

In fact, Nobel Prize-winning economist Paul Krugman is especially pessimistic about the employment prospects in the US. He believes that the US' unemployment numbers will peak in early 2011. Not a very heart-warming prediction from the master economist. It may be noted that Nouriel Roubini and Bill Gross are also not greatly enthused by the all the talk of a recovery.

 Weekend investing mantra
"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful." - Warren Buffett

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Equitymaster requests your view! Post a comment on "The Return of Risk". Click here!

6 Responses to "The Return of Risk"

Arun Tyagi

Sep 21, 2009

It's very useful to study market time to time and analysis gives us right time to take right step.
Thanks a lot.


dhanaji sul

Sep 20, 2009

plz sent the mutual fund analysis



Sep 20, 2009

Sir I want u to post an article related to ULIP plans of all insurance companies and their performance sheet along with company output and profit/loss.
Name the best fund of the company and the best plan of every company.


C N Annadurai

Sep 20, 2009

The Week end informations are more useful.

What about the mutual funds performance upto October 2009 ?


Ravi Jain

Sep 19, 2009

Its interesting and may be used as a tool to study the market behaviour


dhaval kahar

Sep 19, 2009

hello sir i m dhaval kahar
im small investment so plz in runing month spt which secter and which scrip i m bye ang sell so plz send mi

your faitfully
dhaval kahar

Equitymaster requests your view! Post a comment on "The Return of Risk". Click here!