Who won the investing battle between 'cheap' and 'quality'?
In this issue:
» The most expensive stocks in India
» Should banks be allowed to hold gold as reserves?
» Is the Modi mania wearing off?
» ....and more!
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Recently, our attention was drawn to an interesting real life experiment between these two methods. And in the drivers' seat were none other than two legendary US investors Warren Buffett and Julian Robertson. The latter may not be a famous name in India but is an investor that even Buffett has great respect for.
The experiment we are talking about took place at the peak of the dotcom bubble. The markets, as you would all know, were highly irrational at the time. And this was certainly not lost on Robertson. Eventually, his frustration got the better of him and he decided to close his hedge fund.
So, what were the stocks in his portfolio at the time? Well, almost his entire portfolio was made up of obscure, troubled companies that only had valuations going in their favour. In other words, the companies were trading much cheaper as compared to the other high flying names as well as the index itself.
Given this scenario, it clearly looked as if Robertson had made the cardinal sin of investing in dud stocks and was therefore calling it quits. Unfortunately, the result would not be known until a few years later.
At the other end was Warren Buffett who was sitting pretty with a multi-billion dollar portfolio, almost entirely loaded with good quality stocks that would make any fund manager turn green with envy.
It was not before six and a half years had passed that a fund manager called Whitney Tilson got curious to know how Robertson's stock picks fared. And what he saw left him stunned to say the least. Despite two stocks going bankrupt, Robertson's portfolio did far better than Warren Buffett's. It outperformed the latter by a factor of 3:1, gaining 120% point-to-point as opposed to the 38% returns put up by Buffett!
Of course, just one example may not be enough to prove that one method is more effective than the other. However, as Tilson highlights, it does look as if investing in beaten down; depressed companies can certainly be stressful but very profitable also. On the other side, paying expensive looking valuations for good quality stocks does lower future returns.
Thus, if one has the stomach for it, cheap, out of favour stocks can certainly end up giving very attractive long term returns.
Does this mean investing in good quality stocks is just not worth the effort? Absolutely not. Quality stocks can certainly be as profitable over the long term but only when bought at valuations that are reasonable. Pay an expensive looking price for them like during the dot com bubble and future returns may not be as remunerative as we just found out. However, investing in quality does make one sleep peacefully at night.
What do you think? Do you think investing in out of favour, beaten down stocks is a better approach than doing the extra hard work of finding a company with good moat and then waiting patiently for the stock to come down to reasonable valuations? Let us know your comments or share your views in the Equitymaster Club.
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Now, what if we do a similar study in India? The results are in the chart below. Stocks like MRF, Bosch and Tide Water are indeed some of the most expensive stocks in India at the present moment. Does this mean investors should not consider investing in them? Certainly not. When it comes to investing, what matters is not the absolute price but the valuations and the long term prospects. And if these are favourable, there's no reason why one can't invest in such stocks no matter how pricey they are.
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By this they mean the absence of any radical ideas or reforms. Specifically, the worry seems to be regarding infrastructure and labour reforms. Industry captains are of the view that that government has not made a clean break with the past. This lack of boldness is the main reason that they have gone into a wait and watch mode. We haven't heard of too many big ticket announcements about investments in new projects. After all why would businesses commit big money when the infrastructure sector continues to remain in a logjam? If things continue as they are, we believe that corporate India's wait for 'acche din' will be a long one.
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There would certainly be a lot of positives in such a move. Holding Gold as reserves would motivate banks to introduce Gold deposit schemes. This would help to circulate the existing Gold stock in the country and would reduce India's dependence on imports. A staggering 22,000 tonnes of Gold is held by Indian households and temples. Putting it to good use in the economy will be a positive step we reckon.
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04:55 | Today's investing mantra |
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3 Responses to "Who won the investing battle between 'cheap' and 'quality'?"
Maharaj Singh
Dec 10, 2014Dud stocks at irrationally cheaper price are better investment if you analyse the cycle of business be careful about the management's honesty and his sincerity to own his business. Sooner or later things will change with a multifold gain to investor so due diligence before investing in dud stock is of paramount importance. Guess who is going to survive in next 5 years and stay away from dishonest promoters you are sure to win. Happy investing in dud but not dead companies.
Zaheer
Dec 10, 2014As an individual always preferring mental peace to stress and anxiety, I would feel better positioned with my investments into 'quality' stocks that offer moderate, but comparatively 'safer' returns than the 'cheap' stocks. I would, however, have a 30 percent exposure to undervalued, not-so-well known, scrips, with a longer term investment horizon to capitalize on their potential higher yields.
DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
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Ajay
Dec 14, 2014But it is not easy too, to find what valuations are good?