Is This The Right Time To Buy Net-Net or Desert Island Stocks? - The 5 Minute WrapUp by Equitymaster
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Is This The Right Time To Buy Net-Net or Desert Island Stocks?

Nov 12, 2016

In this issue:
» Has Donald Trump's win been a big boost for metals?
» A great bet on oil prices
» Global market roundup
» ...and more!
Tanushree Banerjee, Co-Head of Research

BSE Sensex ended one of the most eventful weeks of 2016 about 450 points lower. The last trading day of the week saw a correction to the tune of 700 points. And we are hardly done yet.

Like we had predicted, Tata, Trump and Fed will continue to keep markets edgy for a while. Demonetisation is expected to worsen the nervousness.

Investors looking for value are sure to find seemingly discounted stocks in the coming days. There will be stocks at 52 week lows. There will be stocks at low price to earnings multiples. In fact, at some point of time, there will be stocks with market cap much lesser than their cash and assets. But looking for value alone may hurt. And buying net-net stocks may land you in trouble.

Giving more importance to earnings quality than valuations is now more important than ever. And it is not just the current cash flows, margins and return ratios that matter. Consistency in earnings quality will determine whether the stocks will be able to tide the gargantuan uncertainties.

As Rahul Shah has pointed out, the markets are expecting the GST implementation and crackdown on black money to be the watershed moments in India's economic history. No doubt, these will bring out epic positive changes in the way the economy runs. But to have an impact anywhere closer to the liberalisation of 1991, there needs to be structural changes.

Businesses that leverage the tailwinds of this massive economic megatrend to expand their moat will certainly benefit. There may be new areas of business that may be far more productive and competent. Especially in the context of changed global business and political scenario. And traditional businesses may fail to create shareholder value even if bought at deep discounts.

Buffett and Munger had an interesting solution for such times. They suggested selecting stocks imagining that it would be the last investing decision before migrating to a desert island for ten years. So of course one needs to be very selective about the sustenance of the business model. But apart from that, one needs to pay a price for the stock that he will not regret.

Our Hidden Treasure team calls stocks selected in such manner - Junior Bluechips. And they have laid out the full details of such stocks in their special report.

02:60 Chart of the day

Donald Trump's win certainly shocked global markets. No one seems to have a clear idea what will happen next. Will his policies trigger a recession? There is a lot of fear and uncertainty in the markets. In such times, we would expect cyclical stocks to be hit the most.

A case in point is the metal sector. If markets were expecting a recession, then these stocks should be down in the dumps right now. But is that the case?


The BSE metal index is on a roll. It is up by two-thirds since the February 2016 low. The Sensex is up by about 26%. In fact, the out performance is ever more stark if we consider the last two months. The Sensex has been declining since 8th September and it's down 8.3% since then. Surprisingly, the BSE Metal index is up 7.2% during this period!

This is true globally as well. As per an article in Livemint, the Bloomberg Industrial Metal Index, is up about 15% in the last month and a half.

Commodities On The Upturn?

What explains this?

Markets are betting that Donald Trump's win will raise US demand for industrial metals. This could be possible if the new president follows through on his pre-poll promise of massive infrastructure spending.

The question for investors is this. Should you bet on such things? The answer clearly is no. This is purely a sentiment driven rally and cannot be expected to last. Betting on Donald Trump's policies would be the height of foolishness we believe.


The rule of supply demand economics have caught up with oil. Few years back, oil, also called black gold, lost its sheen. And there was a time when it was trading below the price of a bottle of water.

Its recent price chart may make it hard to believe, but oil is the commodity that is said to have triggered many wars. After all, it is literally the main fuel for the economies to grow and be more productive. And remains a finite resource with asymmetrical geographical distribution.

With the slowdown in the overall global economy and hence oil demand, and rise in the OPEC and non OPEC output, oil price has slipped. If OPEC does not cut output, International Energy Agency (IEA) expects oil glut in 2017 which could increase pricing pressure.

Honestly, we don't have a clue where oil price would be in the short term. But we do know that crude reserves are finite. The time taken to create a barrel is much longer than time taken to consume one. And it takes significant resources in terms of time, money, technology and manpower to dig oil.

So just going by the rate at which oil is burnt, and the fact that incentive to extract oil is lower at low oil price, in the long term we expect oil price will go up.

If one has patience, at current oil price (that have led to depressed valuation of upstream energy companies), there could be some bargain buys for the long term value investor. In fact, only last month, the StockSelect team has recommended a stock that could be a great bet on oil price recovery and comes along with an inbuilt margin of safety.


After weeks of debate over US elections, the outcome shocked the global markets. After a jittery start to the week, the unanticipated win of Donald Trump as the US President, was welcomed by the major markets. The US indices registered gains of over 5% for the week, closing at record high levels in last five years.

On the emerging markets front, the US election results too boosted the market sentiments. However, the last trading day of the week, witnessed sell off. Asian markets stumbled as the rally in the dollar dampened demand for emerging market assets. Further, low visibility regarding the new geopolitical trade polices added woes.

On the commodity front, both crude and gold witnessed sharp plunge, and were down by around 6% each for the week gone by.

Back home, while the global financial markets are trying to gauge the outcome of the US presidential elections, India got busy assimilating PM Narendra Modi's announcement on demonetisation. The announcement to ban Rs 500 and Rs 1,000 notes weighed on many sectors and kept Indian indices under pressure.

04:50 Weekend Investing Mantra

" You only have to do a very few things right in your life so long as you don't do too many things wrong." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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