Are there elephants or rats in your portfolio? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are there elephants or rats in your portfolio? 

A  A  A
In this issue:
» A surprising reason why US markets are falling
» S&P warns India yet again
» Millionaires in India to keep swelling
» Auto sector growth slashed down
» ....and more!

----------------------------------------- India's Downgrade could be Great News for You ---------------------------------

Standard & Poor's, a rating agency, has warned India that its credit rating could be downgraded in the future.

And as a result, stock markets have taken a beating.

The question now is what should you do?

Well, in our view, the best approach is to not give much importance to these warnings...

And instead, maybe think of this as an opportunity to buy into solid stocks that are available for dirt cheap.

After all, the only investors who create solid wealth are those with solid stocks in their portfolios...

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When you are an author of two extremely successful business books, your words are bound to carry a lot of weight. And so it is with Nassim Nicholas Taleb. In fact, no one in business circles calls a highly unpredictable event exactly that. Instead, they all prefer to use the metaphor 'The Black Swan', the title of one of Taleb's most popular books. Well, Taleb would now be hoping that he gives the world yet another catchphrase, 'Antifragile', a term that is also the title of his forthcoming book.

We certainly can't predict whether Taleb will contribute a new term towards the business lexicon. But few of the ideas in the book are certainly worth making a mention. He is of the view that metabolically speaking; an elephant is vastly more efficient than a rat. However, an elephant can easily break his leg or cause significant harm to himself. A rat on the other hand can be tossed around and it will still be fine. In other words, size does lead to fragility as per him.

Now, use this comparison to describe the current problems in Europe and you will see how wonderfully things fit in. Europe was so much better off being diverse, both politically and economically. But then policymakers hit upon this terrible idea of going for a unification i.e. turning it into an elephant. And it has been all downhill from there we believe. Similarly, what hampered China, for most part of its long history, is the top down state as per Taleb. Yet another case where being an elephant led to fragility.

Interesting isn't it? Can the same rules be applied to investing as well? We certainly think so. In the investing world, elephants would be companies that are capital intensive with big balance sheets and also great deal of debt. And they may well be efficient with huge economies of scale. But are they really wealth creating? May be not to the extent required. We would rather much prefer rat like companies that require very little capital to fund their growth and use most of their cash flows to reward their shareholders. In other words, companies those are not big but rather 'antifragile' is what one should look at. So that even if there is an economic storm, they are nimble enough to take shelter somewhere and not get exposed like the big elephants. Thus, it is time you asked yourself whether your portfolio would much rather have elephants or rats?

Do you think it is better to invest in large companies with large balance sheets or you would prefer smaller, more nimble operators? Let us know your comments or post them on our Facebook page / Google+ page

01:18  Chart of the day
We recently read with great surprise about how IMF cut India's GDP growth forecast for 2012 to just 4.9%. In fact, India is not alone. As today's chart highlights, the global financial institution expects all major nations to have a subdued 2012 than 2013. India though is certainly the worst off. We for one though won't read too much into this. Even if growth does turn out to be the way IMF predicts, it is just an aberration as per us and on a long term basis, India's GDP growth should rebound to its long term average of 6%-7%.

Source: Business Standard

The US has seen a crisis that literally shattered its supremacy in the global financial arena. The country's 'too big to fail' banks and financial institutions with their fancy, complicated products were blamed for the debacle. The result was a spew of bailouts that were either voluntarily taken up or forced down the throats of the big institutions. One such institution was JP Morgan. In a recent appearance the CEO of the bank has expressed his anger at the large institutions which received the bailouts.

In his opinion, these financial behemoths literally brought the country down to its knees. And walked away with millions of dollars at the end of it. He has even criticized JP Morgan's bailout of Bear Sterns. In his opinion, the bailout was forced upon them by the government.

But a question to ask here is: was JP Morgan really the 'innocent' victim in all of this? The bank after all made a truckload of money on the deals in the aftermath of the crisis. Given its recent history of trade bungles, the statements by its CEO appear to be an attempt at getting back in the good books of the shareholders.

Kaun Banega Crorepati? The registration lines are now open. But you may not need to get on the show anymore to become a millionaire. As per Credit Suisse's Global Wealth Report, the number of millionaires in emerging economies is expected to jump over the next few years. In China the number could double to almost 2 m by 2017. And right home in India, as many as 84,000 Indians are expected to become millionaires by 2017.

This is a huge increase of 53%! While the Indian middle class is seeing rising wealth, there is still a great deal of poverty in the country. This is reflected by the following statistics. Almost everyone in India (around 95%) has wealth below US$ 10,000. Only a very small proportion of the population (just 0.3%) has a net worth over US$ 100,000. The falling GDP growth rate has seen India shedding US$ 700 bn from its household wealth during mid-2011 to mid-2012 period. This is the steepest fall seen in Asia. It totals 50% of the total erosion that the continent has seen over the period. Well, we just hope that this money has been spent towards productive purposes instead of conspicuous consumption. Anyway, the million dollar question is whether you will be in the top 0.3% by 2017.

Ever since the government opened the floodgates of reforms, stock market investors rejoiced. Particularly the FIIs. They are now hoping for more 'announcements'. But it seems the rating agencies are once-bitten-twice-shy. They are no longer willing to be pacified by reforms on paper. Especially since the political consensus to see the reforms implemented is extremely weak. Moreover, it could be much longer than anticipated before the reforms actually facilitate higher GDP growth. Plus there are problems of inflation, fiscal deficit and corruption. These are not going away anytime soon.

As a result, rating agency Standard & Poor's has once again issued warning regarding India's sovereign rating. The threat this time is to relegate India's rating to 'junk'. This has mostly to do with the doubts about execution of reforms. S&P however promises a better rating if reforms get executed well. That is with improvement in investment climate. Particularly, if foreign direct investment in various sectors is implemented successfully.

Now given that global rating agencies have very little reputation of 'credible ratings', the threats need not panic investors. Having said that, any premature celebrations about the government's reformist attitude are also uncalled for.

The US stock markets have been declining over the past few sessions. Interestingly, this has coincided with Mitt Romney taking a slight lead in the polls after a victorious first debate against incumbent President Barack Obama (readers may recall that Mr Romney is the Republican Party nominee for the US President).

Now, could the falling markets have anything to do with Mr Romney's lead over Obama? An analyst by the name of Mr Jim Bianco has an intriguing theory to explain the connection. He says that if Romney becomes President, the US Fed Chairman Mr Bernanke would be thrown out. And chances are that he would be replaced by monetary economist John Taylor.

It is worth noting that this gentleman has been a strong opponent of quantitative easing (QE). Let's fit all the pieces together and we get an insightful picture. The US central bank's reckless monetary policies have flooded cheap money into the system. It is this easy money coupled with near-zero interest rates that have artificially pumped up the stock markets. Otherwise, why would markets rise despite weakening earning prospects? So now, what could happen if the US Fed is chaired by a hawkish monetary economist? He would quite likely bring an end to the money printing spree and low interest rates. Though we believe this will be good for the US economy over the long term, it would quite likely puncture the bubble in the stock markets.

That the fortunes of the auto sector are closely linked to that of the Indian economy is a fact well known. Thus, if the Indian economy is facing a slowdown, auto companies are bound to face the heat as well. And that is precisely the scenario that the Indian auto industry has been facing for the past several quarters now. Firm interest rates, rise in fuel prices and subdued growth in personal incomes have all had an adverse impact on demand. This has compelled many companies to go in for production cuts. Consequently, sales volumes across segments have hardly grown barring a few. Labour problems at Maruti's plant at Manesar have further compounded woes.

In light of this, the Society of Indian Automobile Manufacturers (SIAM) does not predict a good fiscal for auto companies. Indeed, it has slashed its forecasts for FY13. It expects car sales to grow by just 1-3%, motorcycles by around 5-7% and commercial vehicles (CVs) by 3-5%. Thus, it all boils down to when the economy gets back on track. That said, over a longer term, we believe that the auto growth story is still intact as the government ramps up the development of infrastructure, especially roads.

Meanwhile, indices in the equity market of India traded mixed today with the Sensex higher by around 50 points at the time of writing. Realty and Capital goods stocks were attracting the maximum interest. While most Asian indices closed mixed today, Europe has opened on a positive note.

04:56  Today's Investing Mantra
"One thing I would say is that a common characteristic of many of the stocks that we buy is that everyone hates them. We do that a lot." - Joel Greenblatt
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4 Responses to "Are there elephants or rats in your portfolio?"


Oct 11, 2012

Until you guys specifically mention - which companies are Elephants or Rats? - a lay-person can not do much with your article.



Oct 11, 2012



Vivek Mahajan

Oct 11, 2012

You can ride an elephant...yes ofcourse the pleasure of the ride is accompanied with the risk of falling and breaking your bones. But then can you even think of riding a rat? What is important is the effective management of perceived Risk vs. Reward.


Naushad Patel

Oct 11, 2012

It matters not whether a company has a large or small balance sheet. What matters is that it is a leader in its field and that it consistently pays increasing dividend. Buffets analogy with Coke is one such example

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