10 "Must Knows" for 2009 - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

10 "Must Knows" for 2009 

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In this special issue of the 5 Minute WrapUp, Equitymaster answers the 10 questions that are on top of your mind.

1. What next? For how long will the markets behave the way they are behaving right now?
We do not know exact answers to all these above mentioned questions. And we would not even try to give you vague answers. The ongoing worldwide financial turmoil is a creation of years of monetary and financial mismanagement. And it will take some while for the issues to be resolved. There simply seems to be no end in sight and no safe place to hide. We are not sure which way the markets will move in the short run. In fact, given that the issues will still take time to resolve, do not be surprised if stocks continue to slide from their current levels.

However, we believe that shares of companies with solid businesses and visionary managements at helm have been punished as badly as shares of companies with doubtful credentials. The former bunch is trading at discounted prices because of the Mr. Market's pessimistic mood.

As such, if you decide to buy these quality stocks today, we believe you will be more than pleased in a few years that you pulled the trigger.

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2. Have we seen the death of investing in equities?
Ultimately, what is investing all about? Investing in general, or for that matter investing in stocks in particular is based on a need - to create a pool of funds for...
  • gifting your wife her first world tour on your 25th anniversary,
  • providing quality education for your children,
  • leading a comfortable post retirement life,
  • and honoring any other financial 'commitment'.
Till the time we have these needs awaiting our actions, investing will survive...and so will investing in stocks.

3. Will India be able to brave a global slowdown?
India today is a part of the globalised economy and as such, will be impacted by the turmoil that is global in nature. The country also has to worry about other issues like weak governance, rampant corruption, terrorism and poor infrastructure that have the potential to derail the growth rate. On the contrary, the fact that there are multiple engines of India's growth - rising spending on infrastructure, offshoring and consumption - and also the fact that we are less dependent on the western world for our GDP growth gives us confidence that the economy will be able to whether the downturn in a better manner.

4. Are Equitymaster's long-term projections of earnings for companies under its coverage likely to change significantly in view of the recent slowdown?
Not significantly, but yes the projections will change/have changed. The crisis and its impact on Indian companies have been more severe than what we had initially estimated. Plus there has been a sharp depreciation in the value of rupee, which has led to many companies reporting forex losses. While such losses are notional and will reverse with the reversal of the currency (i.e., appreciation), the fact is that these will have a bearing on the companies' FY09 earnings and beyond. Then, companies have also been impacted due to a severe tightening of liquidity and strain on their working capital financing. This has led to delays in manufacturing and lost sales opportunities. Overall, while we maintain our view on most of the companies under coverage, we have factored in the impact of the crisis that has engulfed them. Subsequently, the target prices have been revised downwards.

5. Large-caps? Mid-caps? Small-caps?
The allocation of large, mid and small cap companies in an investor's portfolio must be based on several factors. This includes the investor's age, risk profile and investment tenure. While a higher allocation to large and mid cap stocks is best suited to investors belonging to the middle age category and with a lower risk profile, higher allocation to mid and small cap stocks is best suited to investors belonging to the younger age category and with a high risk profile. However, it is important to make sure that a single stock (whether large, mid or small cap) must not form a large chunk of a portfolio. Generally, a stock should not form more than 5% to 6% of one's portfolio. The portfolio, as a whole, should be well diversified.

6. Should I buy now? Or wait for the bottom?
An analysis of the history of the stock markets has revealed that different bear markets have bottomed out at different times and there has emerged no definitive trend on the same. Hence, an attempt to time the market or in other words, waiting for the markets to bottom out and then start investing is not likely to prove successful. Efforts should be made instead to look for stocks that are trading well below intrinsic values and then waiting patiently for as much as 3-5 years for the market price to converge with the intrinsic value of the stock.

7. Should I sell now?
'No' if the stock of a company, which has the capability to deliver value in the long term, is down because the markets are down. 'Yes' if you believe that you made a mistake in the first place. And there is no point buying more of a troubled company at lower prices just to average your cost. Ultimately, the decision to 'sell' a stock should not be determined by the market sentiments but by the investor's assessment of the valuation of the stock.

8. All stocks are cheap. So which all should I buy?
The intrinsic value of any asset, be it stocks, bonds or real estate is nothing but the discounted value of cash flows that can be taken out of the asset from now until eternity. This method of valuation is popularly known as the DCF method. Hence, the DCF analysis should be performed on stocks that the investor considers cheap and consider investing in those that give the maximum upside with respect to their market prices. However, we would like to add that future cash flows are a function of factors like the company's balance sheet, its management and most importantly, its competitive advantage. Hence, these factors need to be carefully evaluated while arriving at the future cash earnings of the company and thereby its intrinsic value.

9. If stocks are so cheap, should I borrow and buy?
JM Keynes, the noted macro economist once said, "Markets can remain irrational longer than one can remain solvent." Thus, since it is difficult to predict the time frame within which markets could return back to rationality, it pays not to have an asset liability mismatch. In other words, an investor taking a 3 year debt on the assumption that markets would head well and truly northwards by then, would have to resort to forced liquidation to pay back the debt even if things take a turn for the worse. Thus, no matter how attractive the opportunity, it pays not to resort to leverage.

10. What about gold?
Gold is no doubt an important asset class and is believed to be a very good hedge against inflation. However, unlike good quality stocks that pay dividends or bonds that pay out interest every year, returns from investment in gold can only accrue from the sale of asset. Thus, there is no income to fall back upon if the market for gold remains non-conducive for years at a stretch. Hence, exposure to gold in one's asset allocation should be limited to just around 5% of the total assets in our view.

04:45 Weekend investing mantra
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets." - Peter Lynch

If there are any questions that you want us to address in The 5 Minute Wrapup, please do write in to us.

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