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Are these currently your top reasons to invest in stocks?

Nov 12, 2014

In this issue:
» What has been fuelling Indian stock markets
» An indicator that investments have not picked up
» How the US companies are deploying cash
» US markets are bound to tank...but not right away
» ...and more!

2014 may very well be coming to an end but is has been a strong one for the Indian stock markets, which have emerged as one of the top performing indices in Asia.

The Modi wave no doubt has been a prime reason for the euphoria in the markets. There are high expectations that this government will unleash a spate of reforms that will bode well for the Indian economy and also help expand corporate earnings.

But this is not the only factor that has been a driver of the Indian markets. External events have also been playing a role and will continue to do so in the months ahead.

Indeed, liquidity has been flush in the global economy as central banks continue to pursue radical policies. The US Fed may well have ended its bond buying program but other bankers are not necessarily following suit. The Bank of Japan recently announced its intention of going in for another round of quantitative easing. And as Europe continues to struggle, the European Central Bank coming out with more expansionary policies cannot be ruled out. Infact, the same can be said of the US as well. Interest rates still continue to hover around zero. In this regard, the Fed has also been quite vague about hiking rates anytime soon.

Hence, with so much liquidity, foreign money will continue to make a beeline for Indian shores in search of better yields.

Given the environment both globally and back home, we will not be surprised if stock markets rally further in the months ahead.

But is that reason enough to invest in each and every stock? Now, determining the next level that the Sensex will reach is not something we believe in doing. What we do know is that every stock has an intrinsic value and investors should consider buying a stock only if it trades at a sufficient discount to the intrinsic value. In other words, this is the 'margin of safety' concept that has been popularized by none other than Mr Warren Buffett.

This is what he had to say, "We insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success."

This is something that I and the team that helps me manage ValuePro strongly believe in. We are very particular about adding only those stocks to the portfolios that not only meet the 'Buffett would Buy' criteria but also trade at a sufficient margin of safety. Little wonder then, that both the portfolios have beaten the returns generated by the Sensex since the time each of the portfolios was created.

Will you invest in the stock markets on expectations that Sensex will rally further? Or will you insist on investing only in those stocks that are trading at a sufficient discount to the intrinsic value? Let us know your comments or share your views in the Equitymaster Club.

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When the Sensex has been rallying because of the 'Modi' factor, it then makes sense to check ground reality and see if things are indeed moving around. One of the things that give an idea of this is whether investments have started picking up. As per an article in Business Standard, alas, this does not seem to be the case. One such indicator has been the slack demand for earth moving equipment. This implies that the construction industry, one of the barometers of the Indian economy, has yet to take off. Indeed, sales of equipment to the industry fell by around 15% in 2013. And 2014 seems to be no different. This is reiterated by none other than Mr Anand Mahindra, MD of the Mahindra group. As per him, the company has seen little improvement in sales of its backhoe loaders and construction kit products.

One of the reasons for this has been high interest rates which has subdued demand and not exactly motivated companies to make capital investments. Capital investment, which accounts for around 35% of the economy, has barely grown since 2012-13. It did grow by 7% YoY in the June quarter, but was down 7.4% QoQ.

So, it is quite obvious that a lot of work still needs to be done at least on the reforms front for the growth of the economy to reach the next level.

 Chart of the day
It's not just in India. Back in the US, the stock market continues to kill it. But when it comes to the economy, the same cannot be said. And with things slowing down across the world, it is expected to impact the US too, especially considering that oil and steel (whose prices are on the downtrend) industries form a big chunk of the GDP.

Also, when it comes to the demand situation in the world's biggest economy, it seems that the consumption is not growing at the anticipated pace.

But yet, the US stocks continue to surge to new highs...

Why is that the case?

Well... the simple answer would be 'financial engineering'.

The slowing economy, the not many avenues to invest capital in a productive manner as well as the access to cheap funds has led US firms to reward shareholders in recent times; as opposed to ploughing back earnings into the businesses and showing real growth.

Today's chart of the day shows the trend in usage of cash by US firms overtime.

US cos to continue rewarding shareholders?
* - Cash acquisitions; BB - buy backs; E - estimates as per Goldman Sachs

As you can see, there has been a major shift over time with less money being ploughed back into businesses and more going out in the hand of investors. And as per Goldman Sachs, this trend is likely to continue for a while as companies seem to be waiting for the overall economy and growth levels to pick up.

While this trend is likely to provide a fillip to the markets for some more time, the fact of the matter is that once this era of easy money comes to an end, and the effects of the slowdown in consumption & lower spending by US households trickles in, all the unreal projections and estimates will have to be scaled back big time. And with valuations of the US stock markets hovering around their highest levels of the past century, the downside risks very much seem to overshadow the upsides in this case.

Continuing our discussion on the overheated US markets, here is another interesting analysis made by a former Goldman Sachs banker. As per this individual, the US markets are bound to 'tank'. But not right away! This is because of the "coordinated" money printing efforts being made by central banks across the world.

As you would know, with the US announcing the end of its bond buying program, Europe and Japan accelerated their bond purchase activities. However, with the only way for interest rates to go is up from here on (considering the ZIRP); and thus putting the central banks' inflated balance sheets at risk. Not to mention the fact that money printing has only given the illusion of the 'wealth effect' amongst the market participants.

Further, the ex-banker also went on to say that "Speculation, once left to individuals and investors, is now federally sponsored, subsidized and institutionalized." This she says on the back of a private large sized US banks stepping in to buy US treasuries in recent times. And this activity only increased as and when the Fed stepped up its efforts of tapering. What this led to is banks paying almost next to nothing to its depositors and earning a cool 2.3% on 10-yr US treasury. In other words, a risk free arbitrage of about 2.3%. And as such, with the Fed stating that QE has come to an end, reasons such as improving inflation and better unemployment figures are all bogus reasons. "During the third quarter, Wells Fargo and Bank of America matched Fed purchases of US Treasuries, keeping the total amount of US Treasuries in QE land neutral." she added.

Well... as per us, these are some very strong views and just goes about indicating how messy the overall situation has become. But one thing is for sure, reversing of this temporary phase of easy money is in all likelihood about to create a lot of chaos, which would eventually be spilled over in markets across the world.

The Indian stock markets were trading firm today on the back of sustained buying activity across index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 94 points, while the NSE-Nifty was up 15 points. Gains were largely seen in auto and banking stocks. Most Asian stock markets were trading in the green with Japan and China finding favour. European markets have, however, opened the day in the red.

 Today's investing mantra
"The extravagance of any corporate office is directly proportional to management's reluctance to reward the shareholders." - Peter Lynch

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

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4 Responses to "Are these currently your top reasons to invest in stocks?"


Nov 20, 2014

Buy both types of stocks but be stock specific.



Nov 13, 2014

Margin of Safety principle is important.

Like (1)

hoshang dehnugara

Nov 12, 2014

buy stocks when they are at discount value compared to their intrinsic value

Like (1)


Nov 12, 2014

It does not make any sense in investing in stocks at current levels when they are clearly overvalued & where the stock market is totally controlled by the whims and fancies of FII's. It is extremely difficult and time consuming for a small retail investor to first identify a stock which is trading below its intrinsic level and then invest in it.

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