Ignore this and even Blue Chips are not safe - The 5 Minute WrapUp by Equitymaster
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Ignore this and even Blue Chips are not safe

Nov 4, 2014

In this issue:
» Best performing stocks since the 2007-08 market run up
» What stands out in Buffett's investments
» Board independence of India Inc. quite poor
» QE boosts the Japanese index
» ...and more!

 Chart of the day
Taking cues from an article published by a leading business daily today on a topic which we found quite interesting, we thought it would be a good idea to go about running some data screens of our own.

With the help of our database tool, we pulled out the all time high prices and dates of all companies which form part of the CNX-Nifty to see how they have performed. This is especially considering that the benchmark Indian indices are at their all time highs.

What we found is quite interesting. It turns out that only 60% of the stocks forming part of the index touched their all time highs in the calendar year 2014 so far.

Majority of the balance 40% stocks are trading way below their all time high levels - with all time highs touched anywhere between 2000 and early 2012. Only two stocks - Wipro and Zee Entertainment - touched their all time highs around the millennium. Leaving these two aside, rest of the 18 stocks touched their highs in between October 2007 and February 2012.

The following chart shows the returns of the worst performing stocks...

Top 10 worst performing large caps
JSPL - Jindal Steel & Power

As you can see, if an investor had put in money into any of these stocks at their peak levels, and continued holding on to them, they would have still not recovered their investment. And this is at a time when the broader markets are trading at all time high levels. As of yesterday, the Nifty is trading higher by a third as compared to the highs it touched in early 2008.

On the face of it, we would attribute the underperformance of these stocks primarily to a few factors - corporate governance issues, unfavourable headwinds, high debt levels, poor capital allocation skills as well as weak financial performances.

Moving on to the list of best performing stocks - in terms of returns earned from their highs touched in the bull-run which ended in early 2008 - the list goes as follows:

Buying high quality businesses works over longer periods
Data Source: ACE Equity

As you can see, all of these stocks have trumped the benchmark indices over this almost 7-year long period.

As per us, this just goes on to indicate that while in the short run, stocks may show tremendous run ups for various reasons, for such gains to sustain over the long run, what essentially matters is the quality of the business. Factors such as capital allocation skills, health of balance sheet, strong business models - not to mention the favourable tailwinds as well - all combine and play a role in having desired investing results over longer periods of time.

And yes! While investors may have had the feeling that they would have overpaid for certain stocks at the peak of the market back then, the fact of the matter is that the quality of these businesses essentially did provide them with the results that they would have seen today.

In other words, the odds are stacked in our favour despite paying up when investing in high quality businesses.

It goes without saying that paying any price for high quality businesses would not be the way to go. Simple checks such as earnings consistency, quality of earnings, and how the management rewards shareholders, are just some of the few parameters that investors could gauge to figure out whether paying up would be justified or not.

With this, all we wanted to do was highlight what works in investing.

Do you agree with our view of it making sense to pay up for high quality businesses? Or do you have another approach that has worked well for you? Let us know your comments or share your views in the Equitymaster Club.

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Our readers and subscribers are well aware of how we are admirers of Warren Buffett's principles of investing. Now, just the other day, we had talked about how it is increasingly becoming difficult for even Buffett to consistently beating benchmark indices. Indeed, we touched upon how Buffett could possibly have made a mistake by investing in IBM given that it is down around 9-10% from its purchase price.

But we would not like to judge him by one example alone. And an interesting article in the Fortune talks in detail about the 6 best investments that Buffett has made.

One of these is Well Fargo. Buffett had invested around US$ 290 m in the bank in 1990. Now Buffett at that time was not too keen on investing in banks. But the cheap valuations and the strong quality of the bank meant that it was not an opportunity he wanted to let go. And he was right. At the time of investment, the market capitalization of Wells Fargo stood at US$ 2.9 bn. Today it is worth US$ 275 bn.

One of the other investments that we found interesting was Freddie Mac. Buffett had invested around US$ 108 m in Freddie Mac way back in 1988. At the time, Freddie Mac was trading at US$ 4 a share. And around ten years later, this rose to around US$ 70 a share.

But what makes this interesting is not the returns that Buffett made from this investment, but the time he decided to sell it off. Not convinced with the way the Freddie Mac CEO was striving for returns, Buffett sold his stake in the company in 2000. In 2003, Freddie Mac came under fire for misreporting earnings and in the 2008 financial crisis it had to be bailed out by the government.

These examples only further reinforce what we had been talking about earlier. That it, it is critical to invest in quality businesses with a sound management and also give due consideration to valuations.

Infact, for our portfolio service ValuePro too, my colleague Sarit and I have built two readymade portfolios of stocks that meet the 'Buffet would Buy criteria'. These are basically quality companies with strong moats and were trading at a sufficient discount to their intrinsic value at the time we added them to the portfolios. What more, we have also been booking profits in those stocks where we feel the valuations have run way ahead of fundamentals in the medium term. And we are also on the lookout for more ideas that we can consider in the upcoming issues of the ValuePro.

Speaking of management quality, one of the factors that need to be considered is how seriously the management considers corporate governance practices. Now India has certainly made a mark on the global arena by virtue of some world class companies such as Infosys and the Tata Group to name a few. India Inc. in general also has a better reputation than Chinese companies when it comes to disclosures. But there is one area for Indian companies where there is scope for improvement. And that is the independence of the board.

Indeed, as reported in Business Standard, as per a study by Standard Chartered Securities, only 6 companies that are part of the benchmark indices have been found to have very effective boards. Some of these include Infosys, HDFC, Dr.Reddy's, Axis Bank to name a few. The study took into account 80 companies. These included 46 of the 50 companies making up the Nifty, and 28 of the Sensex-30 firms.

In that sense, the results are not very encouraging. An effective and independent board can play a crucial role in protecting the interest of minority shareholders. That is not all. Board independence also means that there can be a free exchange of ideas and it also gives a feeling of whether the management is tolerant of dissent. The aim ultimately is to make sure that one individual or a group of individuals do not entirely drown out opinions of others.

India still has a long way to go in this regard as most companies are promoter run. That said, it cannot be denied that one of the requisites of good corporate governance is strong independence of the board. Ultimately, such companies also command better valuations in the longer run.

The Indian stock markets are closed today on account of Muharram. Asian stock markets were trading mixed. The Japanese index gained around 3% as another round of quantitative easing was announced. Hong Kong and Taiwan were out of favour. European markets have opened the day on a firm footing.

 Today's investing mantra
"A company will be successful if it offers good products and services at a fair price while being run by honest, capable managers. Over the long run, such companies tend to appreciate and go up in value." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat and Radhika Pandit.

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4 Responses to "Ignore this and even Blue Chips are not safe"

Dr.Ravindranath Chowdary

Nov 7, 2014

Firstly, my complements for the two bar charts and highlighting relevant points. Secondly the charts;especially 10 Worst Performing set would look different if drawn even after a year. Therefore no solid deductions can be drawn at this time to guide investing in them. Thirdly, i would request you to share your research findings on them if any. Thanks and well done.

Like (1)

sankaranarayanan .K

Nov 4, 2014

I fully agree with the view that entry point ie the price is very relevant for getting good returns.It is essential to look at the consistency,Management quality and periodic performance.One needs to book loss and get out if staying invested does not make sense.

Like (2)


Nov 4, 2014


Like (2)

Rajeev Arora

Nov 4, 2014

Agree with you.

BHEL was recommended in Stockselect of July 2014. I had invested in BHEL. Though your current view is strong about BHEL, I wonder if I did the right thing to invest in BHEL.

Like (2)
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