The mistake that the best investors make - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The mistake that the best investors make 

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In this issue:
» Loan growth in the festive season to be a disappointment
» Are you being mis-sold ULIPs again?
» Can the fall in commodity prices be a tailwind for India?
» It may be too late to save Europe from deflation...
» And more!

'Why invest in a stock that has already doubled in the past six months?' This is a very relevant doubt in the minds of most investors who are once again testing water with investment in equities. Having already burnt their fingers investing in bad or very expensive stocks in the past, they do not want to make the mistake the second time over. And hence whenever they write in to us with such doubts, we are more than happy to explain.

One needs to be certainly wary of companies that have run up in terms of stock price. However, if one looks at the best stocks that have multiplied manifold over the past decade, even buying these stocks after they have just doubled or tripled would have fetched handsome returns over time. Provided the 'valuations' of the stock were still attractive at the time of purchase. Of course, one had to be an excellent stock picker to invest in such fantastic business at an early stage. But even the best stock pickers make the mistake of letting go of 'opportunities to buy', when stocks run up. Buffett himself has admitted such errors of omission.

So, what is the best approach to long term investing? Is it enough to just buy a stock and forget about it for years? Should you buy only when the stock is available at a big discount? How to identify the best businesses? Is investing a large amount in one go better than investing in a staggered manner? It is important to appreciate that there are very few fixed answers to the above questions. However, some answers are definitely better than others. If you want above average, long term returns from stocks, keep the following points in mind.

First of all, it is important to understand what makes a business great. All great businesses exhibit certain characteristics. Strong cash flows, steady growth rates, stable margins, good return ratios along with low debt are just some of the factors that we look for. The quality of the management also ranks highly in our analysis. Nestle and Asian Paints come to mind. For every Rs 100 invested in these stocks, investors have fetched Rs 1,125 and Rs 2,035 respectively over the past 10 years. But even those who would have not bought the stocks exactly 10 years back and invested in phases whenever the valuations were attractive would have made handsome returns.

Sometimes, due to poor market sentiment, or short term business issues, stock prices of great businesses can remain subdued. But, when the sentiment turns around, so does the stock price. It is important to remain invested in good businesses. Do not be distracted by the noise surrounding markets. For example, if you had purchased the stock of Infosys in Jan 2011, you would have had to wait three years to see positive returns. But it would have been worth the wait.

Thus, the best way to invest in a great business is to adopt a phased approach. If you hold stocks of great businesses long enough, the markets will present you with timely opportunities to buy them at attractive valuations.

Lastly, don't think that long term investing will save you in case of a poor investment. It won't. In the long run, the only thing that matters is the fundamentals of the business. If the fundamentals are deteriorating, it is best to put your money in another stock.

This is by no means an exhaustive checklist. But it will help you to avoid mistakes made by even seasoned investors. We believe adopting such a rational approach will result in excellent long term returns. At Equitymaster, we have put this approach into practice. Our ValuePro portfolio recommendation service, aims to identify the best businesses whenever their valuations are offering a sufficient margin of safety.

What do you think is the best way to get high equity returns? Let us know your comments or share your views in the Equitymaster Club.

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02:40  Chart of the day
We hate to see quarter on quarter growth in sales and earnings for companies. For other than IT stocks, the quarterly numbers have literally no relevance in analyzing performance. We would rather look at the year on year growth numbers to see the performance with respect to the relevant quarter of previous year. But for those who see the quarterly numbers, the second quarter (typically October to December for most companies) is far better than the first. What boosts performance in the second quarter is the festival season. Companies in the retailing, apparels, and consumer durables and electronics space see the maximum sales growth during this period. Not to be left behind, even banks and finance companies make the most out of financing the purchase of these products. Especially when the corporate credit demand is sluggish, financial entities tend to bank upon retail credit growth during festive season to augment their loan book.

However, the second quarter of FY14 has hardly offered any reason to cheer. The months of August and September in 2014, have turned out to be a damp squib in terms of loan growth. And if the loan growth does not pick up in the last 3 months of the year, balance sheet growth for FY14 may not look enthusing. Now, while retail credit demand may depend upon possible softening of interest rates, investors should look for entities that have shown consistent growth over a long period.

No cheer in the festive season?

Our long time readers may know our dislike for ULIPs. Time and again we have highlighted how these structured products are a misfit for investors. Opaque commission structure and the risks of equity volatility are not fully disclosed. Investors are just shown a hypothetical return matrix and are lured away into a trap.

So, when we recently came across an article which propagated ULIP investing we thought of re-iterating our stance once again. We know that high charges were the primary reason why investors lost interest in ULIPs. Most insurance companies know this. Hence, they have started coming out with plans with a low fee structure.

While this is a welcome step what about the inherent flaw in the nature of the product itself? Insurance and investment are separate needs. ULIPs combine them. This results in poor financial planning. For example, does a 60 year old individual need ULIP? Conventional logic suggests his equity exposure should be minimal along with his insurance needs. Even for the younger lot breaking down the investment and insurance needs is a difficult task as they are individual specific. However, ULIPs come with a one size fits all logic. Hence, it is better if investors stay away from them and not get lured by a thin commission structure.

Since the rise of Modi Government to power, Indian economy has witnessed wave of positive sentiments. We have broken the jinx of below 5% growth now. Going higher from these levels will need significant reforms in the economy. And the timing for the same could not have been better as key commodity prices seem to be easing. Take the case of crude oil prices. Heavy dependence on crude oil imports and regulated fuel pricing regime had led to losses for oil refining companies. It has also been a major cause of fiscal mess. However, with crude prices softening and oil companies making money on diesel after a long time, diesel deregulation does seem to be a possibility in the near future. And this is just one example. As an article in Livemint points out, overall commodity prices are coming down, which is a huge tailwind for commodity importers like India.

This trend also offers a great opportunity for the Government to speed up reforms. For example, diesel deregulation in current scenario will be more acceptable now than at a time when crude prices are high. It also means that not making good use of this trend to introduce reforms could be a huge opportunity loss. We hope the Government will make the most of these times and will not drag its feet over announcing and executing reforms.

What happens when general prices in an economy are in a declining mode? Well... such a situation is known as deflation. As explained on Investopedia, the effect of deflation on an economy would be in the form of falling revenues, profits, closing of factories, increasing unemployment levels and the impact of all this on the banking sector. In short, it can have a massive rippling effect on an economy.

And from what it seems, this could be the outlook of the Eurozone. As per an article on Bloomberg, the short term outlook points towards a lot of pressure on the inflation front considering that the European Central Bank (ECB) is looking at taking whatever measures to prop up prices in the medium term. Having said that, there are apprehensions on whether measures used to 'spruce up' growth may actually work as they may be coming a little too late. While the long term inflation expectations have been maintained at 2% - a figure the bank has been holding on for long - it is expecting the downside risks increasing. As per Bloomberg, "Annual inflation was just 0.3 percent last month; it hasn't touched 2 percent since January 2013." These are interesting times indeed.

In the meanwhile, the Indian stock markets were closed on account of Bakri Id. Most of the Asian markets were trading in the green led by Japan and Hong Kong. European markets have opened the day on a strong note.

04:55  Today's investing mantra
"Only when the tide goes out do you discover who's been swimming naked." - Warren Buffett
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2 Responses to "The mistake that the best investors make"


Oct 7, 2014

The warning by you regarding ULIP is timely. Already one can see advertisements in print media luring the citizens to go in for ULIPs as this is the 'right time'.

The second aspect is about the present government's approach to reforms. Whenever and wherever opportunities are seen the reforms have to be implemented like you have said about diesel deregulation. May be the government is waiting for state elections to be over and also look for possible ways of improving their position in Rajya Sabha.


abhay dixit

Oct 7, 2014

Re 60 years old, some may say that he/she can go for 100% debt ULIP.

There is one more inherent defect.If Equity part is doing badly due to poor management of equity allocation, one cannot shift out to a better managed ULIP--- like in MF we can do. When posed this to Salesperson, the standard answer is that move to 100% debt within that ULIP plan!! With this one will miss equity appreciation available in MFs mobility.

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