Which four-letter word should investors bank on: MODI or MOAT? - The 5 Minute WrapUp by Equitymaster
Free Reports

Which four-letter word should investors bank on: MODI or MOAT?

Nov 3, 2014

In this issue:
» What does the airline sector teach us about moats?
» Corporate India's debt burden has worsened!
» Some PSBs to remain headless for a while
» Shouldn't PSUs be privatized?
» and more...

A little over a year ago, investors were prepared to write off the Indian stock markets. Most key economic indicators were showing negative signs.

Then somehow, towards the end of 2013, there seemed to be a wind of change. Market sentiments changed. Anguish gave way to hope. The one key event that proved to be a game changer for the markets was the 2014 general election.

Markets went up zooming in the run up to the election. They have continued to scale new highs after the new government came to power.

If we asked you to attribute this drastic change in market sentiment to one four-letter word, what would be your answer? We can almost hear a unanimous answer - 'MODI'!

Yes, we agree this is the first time in 30 years that India has a single party majority at the Centre. This should allow faster decision-making and lesser policy logjams. Yes, the government does seem focused on the development agenda. Yes, Modi does have a track record of good governance and business-friendly initiatives in his home state.

So if all goes well, that is, if the Modi government is able to successfully carry out its development and reform agenda, it could unlock great value in the economy. Obviously, this would translate into immense wealth creating opportunities for investors.

But hey wait... This does not mean you buy any stock at any price and expect Modi magic to do wonders for you.

Our experience with the smallcap recommendation service Hidden Treasure has taught us some very valuable lessons over the years. No government, no amount of policy reforms can salvage a business with poor fundamentals. Positive sentiments can sustain stock rallies only in the medium term. Eventually, bad businesses will meet their fate. And investors will lose hard-earned money.

So if you were to ask us that one four-letter word that would make you a successful investor, our answer wouldn't be Modi.

Our answer would be MOAT!

Moat is nothing but competitive advantage. This one key factor ensures long tern durability of profits. We have observed that good businesses are often oblivious to governance and policy. This is the reason we prefer paying a fair price for a solid business rather than buying an average business at seemingly cheap valuations.

Take the airline sector for instance. If there is one purpose that it has served for investors, it has been in the form of a lesson on moats, or rather what happens in the absence of one.

You would be surprised to know that the very shrewd Warren Buffett, too, once fell into the trap of this industry, learnt his lessons the hard way and pledged never to touch airline stocks again. The reason is that airlines have high fixed costs and almost negligible pricing power. Add to this intense competition and the vagaries of the markets. This lends them to either wafer thin margins or no profits at all.

Today morning we came across an interesting article by Bloomberg that just goes on to validate the view mentioned above. Apparently, investors have lost money on 6 of the 10 initial public offerings by airlines in Asia during the last five years. In fact, you would be shocked to know that the combined losses of all the listed airline companies in Asia stood at US$ 1.8 billion last year.

Well, that is what we would call an inherently bad business. Can any policymaker change that? We do not think so... So every time I and Richa, along with the Hidden Treasure team get down to decide which companies to meet next, we have the 4 letter word 'Moat' firmly etched on our minds.

Do you think you are relying too much on the 'Modi' wave for your investment success? Let us know your comments or share your views in the Equitymaster Club.

--- Advertisement ---
Strike it Rich" with these small caps...

Small Cap investments offer a huge money-making potential...

If you're able to pick out the right businesses at the right time of their lives, you could truly "Strike it Rich" with small caps.

In fact, we've been picking out such "Strike it Rich" Small Caps for a select group of investors for more than 6 years now.

And here's how we've performed:

250% in 2 years and 1 month
288% in 2 years and 5 months
160% in Just about 2 years
217% in 3 Years and 11 months
177% in Just about 2 years

Interested in finding out how you could get such solid and high-potential small cap recommendations as well?

Just click here for full details...

 Chart of the day
So moat is certainly a key investment criterion that we look at. Another important thing is to avoid companies with too much debt. We normally prefer companies that have a debt to equity ratio of less than one. In the current scenario, that makes the stock selection process slightly tough for us.

Despite the renewed optimism about the Indian economy, the corporate leverage statistics do not paint a bright picture. The combined debt to equity ratio of BSE firms at the end of FY14 stands at around 1.28 times. To give you a perspective, the same stood at 0.9 times five years ago.

High debt along with the economic slowdown has adversely affected the debt servicing capabilities of the firms. While companies across market cap are facing this issue, one must note that it is likely to bring more troubles to the companies in the small and midcap segment. And it is not just the individual firms that will bear the brunt of their financial profligacy. It has even exposed Indian banks to huge risks. What makes things further complicated is that India's concentration risk is among the highest in Asian countries. As suggested by an article in Livemint, the top 15 corporate groups in the country account for 16.6% of the bank credit. This compares to 13% five years ago. A lot of these groups belong to the infra and mining sector, where we have a long way to go before we can claim a recovery. Hence, investors would do well not to lose sight of fundamentals while investing on the recovery theme.

Today's chart of the day shows corporate groups that have witnessed massive escalation in their debt burden over the last five years. Have their sales and profits grown at the same rate? The answer is no. A fast growing debt profile combined with struggling profitability is nothing less than a recipe for disaster.

Debt Burden A Key Threat To India Inc

High debt is not the only issue Indian public sector banks(PSBs) are grappling with. We have in the past highlighted the problem of deep-rooted corruption at Public sector banks. Banking is one sector that reflects economic health like no other sector does. But despite being the most in the need of reforms, the banking sector does not seem to be getting due importance in Mr Modi's regime. The Government's decision to scrap selection of Chairman and Managing Directors is a case in point. The decision is likely to lead to some delay in these crucial appointments. Will the move add credibility and efficiency to the way state-run banks operate in our country? We would suggest you not to harbor high hopes in that regard. This is because the constituents of the new selection panel will be the same. With no accountability sought from the authorities who have, in the past, selected people like Mr SK Jain - the tainted ex-CMD of Syndicate Bank, we wonder if the new process will make significant difference.

Some of the not-so-apt decisions of the Modi government for Public Sector Banks are finding their way to other sectors as well. We are here referring to the plan to shift Government's holdings in PSBs to a holding entity. With this move, it will be the latter and not Government that would raise money to recapitalize banks. As per an article in Hindustan Times, the decision is not likely to be limited to state-run banks alone. It will apply to non-banking PSUs as well. The Government believes these steps will improve accountability and autonomy for these firms.

While the move may reduce bureaucratic interference to some extent, it leaves a lot to be desired for PSUs. Public sector firms, as one can draw comparisons, have been inefficient vis-a-vis private sector peers. The managements of the respective PSUs often have little say in key business matters and are often made to follow the government's decisions. It requires no mention that the interests of shareholders tend to be compromised to suit the government's agenda. With such issues looming over the state run firms, the decision to create a holding company will hardly do anything to improve their efficiency. It is time that the government considers privatization for these firms, except for the ones of strategic and systemic importance. PM Modi has often said that the government has no business in being in business. Will he walk the talk?

Well, the point we have tried to put across in this e-letter is that investors should not depend too heavily on one man's leadership for their investment success. Instead, you will be better off giving all your time and attention to identifying companies with a durable MOAT.

Meanwhile, benchmark indices continued to remain subdued today with the Sensex trading marginally lower by a strong 31 points at the time of writing. Stocks from the auto and consumer durables space were the major losers. Both Asian as well as European markets were trading mixed.

 Today's investing mantra
"Now if I get the urge to invest in airlines, I call an 800 number, and I say: 'Hello, my name is Warren, and I'm an air-o-holic. Sometimes, it takes them 10 minutes to talk me out of it, sometimes more." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Ankit Shah and Richa Agarwal.

Today's Premium Edition.

Which of the three IT behemoths deserve your attention?

How attractive are they in terms of valuations?
Read On...Get Access

Recent Articles

Sintex's Auditor Resigns. How You Can Protect Yourself from Such Stocks July 20, 2018
While the attack on the bad corporate governance is an overhang in the near term...this can be a game-changer in the years to come.
These Are the Best Stocks for the Next Decade July 19, 2018
The start-up eco-system is disrupting each and every sector that we know of. How can Indian investors benefit from this?
Our Next Recommendation... from the Superinvestor Who Buys Right and Sits Tight July 18, 2018
At Smart Money Secrets, we're finally recommending a Buy on a stock bought by one of our superinvestors - Pulak Prasad.
Your Rescue Plan from the Cave of Poor Quality Stocks July 17, 2018
And there will be no getting trapped with Amtek, Vakrangee, or Manpasand like stocks.

Equitymaster requests your view! Post a comment on "Which four-letter word should investors bank on: MODI or MOAT?". Click here!

6 Responses to "Which four-letter word should investors bank on: MODI or MOAT?"


Nov 5, 2014

Sure it is MODI, because today the world is looking at him, to draw the line of investment in India. The Investors have confident in his way of leadership and command.



Nov 4, 2014

This is with reference to the discussion about the vacancies in the top management cadre of PSBs.My suggestion is that a statutory body (in the model of UPSC) of eminent persons in the field of Economics, Banking and commerce should be constituted for selection of Top Executives in banks.They shool create a pool of qualified persons from which the government should appoint persons as and when vacancies arise.The pool of eligible candidates should be from within the banking industry as well as eminent persons from out side.In order to be dynamic and creative ,the selected person should have at least 5 years left before retirement.Political patronage should not influence the selection process at any stage.This organisation should be used for selection of Top management candidates for vacancies in all public sector undertakings as well



Nov 3, 2014

Dear Ankit and Richa,though I still havent covered my losses but I hope that hard work of EQTY MST team will help me tide over my losses due to my wrong choise of penny stocks to make quick money.pl recommend companies with sound moat and solid future growth.Thanks



Nov 3, 2014

Yes,we can rely upon modi ji bcoz

1.Master Mind of Modi in business
2.Ability in delivering
3.Freedom of decision
4.Reliability of people on him
5.And cool confidence he has.
6.His commitment
7.As per view he is going to save out going fund in mass
due to inhouse mfrg.in future of major big items.
8.He knows how to save govt money (people can not waste lavisly govt money under hiis regime)

Many thing are there is can not be seen in one sight.

Long Terms seems to be very good for india

Like (1)

sandeep k raote

Nov 3, 2014

'MODI' now these 4 words were responsible for market rally but you will be surprised that due to these same 4 letters will be responsible for its drastic fall. When investors will wake up after 2-3 years (may be?)from their dream of 'ACHHE DIN'.

Like (1)

M M Amalsadvala

Nov 3, 2014

Sorry Sir, it is very very degrading to write this article with the inclusion of the name of Our revered PM MODI and inviting response on the subject.
Your Office has no business to Involve our PM in any of your subjects.
Regret to draw your attention and have to suggest withdrawal of the Article in Toto. It you find my reporting with distaste - Call for general consensus.

Like (1)
Equitymaster requests your view! Post a comment on "Which four-letter word should investors bank on: MODI or MOAT?". Click here!