Do you invest in what you don't understand? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Do you invest in what you don't understand? 

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In this issue:
» Did Coal India make false promises in its IPO?
» Nature driving the commodity boom
» Cash rich emerging markets driving global M&A
» Nobel laureate condemns India's growth fixation
» ...and more!!


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00:00
 
Principles of value investing have helped create legends of the likes of Warren Buffett and Peter Lynch. The principles are simple and easy to understand. Pick a sound business that is available at cheap valuations. And then hold it till such time the value is realized.

But the most important principle is to invest only in what you understand. This means to stay within your own circle of competence. As Buffett puts it "Everybody's got a different circle of competence. The important thing is not how big the circle is. The important thing is staying inside the circle." As simple as it sounds, it is the most difficult principle to follow. And wandering away from it can cause investors the biggest harm.

A case in point for this is that of the emerging market guru, Mark Mobius. While Mobius has enjoyed tremendous success with his investment techniques in Asia, his emerging market fund has not done so well outside of the region. In fact, the geographically diverse Emerging Market Fund has ranked only 103 out of 236 funds over 10 years in total returns.

So does it mean that Mobius has changed his style of investing? No he has not. He still sticks to his principles of picking value buys. However, it may be possible that he has just stepped outside his circle of competence.

Do you stick to your own circle of competence while choosing your investments? Share your views.

00:58  Chart of the day
 
Today's chart of the day gives a picture of the percentage of urban population in the BRIC countries. India has the lowest percentage of urban population. One of the reasons for this is the slow creation of job opportunities in the urban areas. The government has taken out several schemes like NREGS, etc. to create employment opportunities in the rural areas. However, it has woefully lagged behind when it comes to doing the same in the urban areas. Private investment takes care of this but it has not been adequate. Perhaps India's shift from being agriculture dependant to becoming manufacturing and services oriented could change things a bit.

Data source: CIA World Factbooks, 2010

01:26
 
Just a couple of months back, we heard the management of Coal India spelling out its grand targets for the future. But that was the time the company launched its IPO, which is till date India's largest. So it was obvious for the management to be more cheerful than ever. The biggest problem we had with the IPO back then was that the management was expecting to do all the things over the next five years that it has never done in the past many years. Things like raising prices faster than in the past, raising the production of high priced washed coal faster than in the past, growing its sales and profits faster than in the past, and moving into international markets that it has not done in the past. Anyways, the IPO was over-subscribed many times. And the stock made handsome listing gains.

But it is delivery time now for the company. And the first signs that we get aren't very enthusing. As per a Wall Street Journal report, Coal India has already lowered its future outlook. The company is likely to fall short of its production targets for this year (FY11) and also the next. While the management is laying the blame on the environment ministry for not giving it all the clearances, these problems aren't new for the company. But these were well covered up at the time of the IPO.

Instances like these go very well to show why investors must not take a management's words on face value. And this is especially in case of companies that are coming out with IPOs. As Warren Buffett once said, "The future is never clear, and you pay a very high price in the stock market for a cheery consensus."

02:35
 
Reports of onion prices in Maharashtra doubling in a week has caught the fancy of the media in recent times. Probably because other commodities like cotton, copper or rubber are not consumed by the 'aam aadmi' on a regular basis. But prices of food and non food commodities alike have been on fire over the past few months. In some cases, it was due to demand overhang. In others, it was due to delay in capacity addition or low production. But there is another factor that has the potential to play havoc with commodity prices. One that is often ignored and takes us by shock! We are referring to vagaries of nature.

Not just in India but globally, poor or excessive rains, storms and other weather related uncertainties have unduly pushed up commodity prices. The case of onion prices shooting up is also due to excessive rains. Iron ore and coal mines in Australia have had to stop production due to excessive deluge. A drought in Russia fired up wheat prices. Thus, the demand supply dynamics go for a toss when human efforts are put to a standstill by nature. It is probably one of the most underestimated risks that can impact prices in the long term.

03:15
 
We seem to be stuck on our country's GDP growth rate. We read growth forecasts everyday and keep congratulating ourselves. We don't stop there. We keep comparing our growth rate with China. In our vanity, we even hope to surpass China's economic growth rate.

Amartya Sen, the world-renowned scholar and Nobel laureate for economics finds this fixation "very stupid". He points that such comparisons between the two rising economies are dangerously misguided. Our policy elites are blindly obsessed with achieving higher growth targets. But it is important to understand whether that also translates into improved human development indicators. He suggests greater attention be given to feeding the population. Especially given the high food prices currently. Sen says that higher growth is a "positive thing" in the context of social justice and poverty reduction. Directing greater public revenues towards health and education is also vital.

We quite agree. For the facts are quite alarming. According to the 2010 HDI, India ranks a low 119 among 169 countries. On the other hand, China has been ranked higher at 89. It is not surprising that Indians suffer some of the severest nutritional deficiencies in the world. Stunted development affects about half of the nation's young children. We need to pose ourselves some important questions. Is this India's "demographic dividend'? Do we expect to grow on the strength of an undernourished population?

04:10
 
M&A activity has intensified this year and emerging markets have played a prominent role in fuelling this activity. For instance, companies in developing countries struck an impressive 2,570 deals. This has been worth a total of US$ 503 bn in the year to date, reflecting a 43% increase over last year's. As a result, global M&A deal value rose by 16% in the year so far. What is more, this robust trend is expected to be mirrored in the next year as well. M&A activity has escalated for a variety of reasons. Companies now have more cash on their balance sheets. The pressure to curb costs is still there and thus for many, the need to consolidate is still higher. The emerging markets are seeing more of this activity simply because the sluggishness in US and Europe has not yet abated. Having said that, we believe that the valuations may not be as attractive as they were when the crisis was at its peak. And so it will be interesting to see whether managements will be willing to pay a much higher price for the acquisitions that they make simply because they have the money at hand.

04:35
 
In the meanwhile, the Indian markets were trading marginally higher during the post noon trading session. The BSE-Sensex was up by about 36 points or 0.2% at the time of writing. Most of the sectoral indices were trading in the green today with realty, metal and FMCG stocks leading the pack. On the other hand, stocks from the auto and capital goods spaces were the top under performers. As for the rest of Asia, the sentiments were largely negative as China and Japan ended lower by about 0.9% and 0.2% respectively. Hong Kong, however, ended the day slightly higher.

04:52  Today's investing mantra
"The only time to buy that which you don't understand, is on the day with no 'y' in it'." - Warren Buffett
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13 Responses to "Do you invest in what you don't understand?"

Digambar Kulkarni

Dec 23, 2010

Achieving competence in a small field or circle is a job of a LIfe Time!

Expert advice must be obtained and used.

What do you do for your health problems? You go to a Doctor; go to a Specialist and decide about your treatment.

Your success depends on selecting a correct specialist and following his instructions meticulously.

You cant learn all that all the Specialists know in a lifetime even if you are a superman.

Like 

padmanabhan.s

Dec 23, 2010

its always good to invest in the business that we are well aware of so as to avoid the pitfalls later.... but then what is risk taking all about ........ if u are fairly sure of something but do not know much about the business as its in its nascent stage then it is better to follow your gut feeling and take the risk ........ it may work sometimes but not always .....so it has to be a calculated risk appetite that helps in investment a fair amount of study and also a fair amount of risk taking appetite.

Like 

KRISHNAKANT BATAVIA

Dec 23, 2010

It is a very tough thing to do. For example, in 1993 we knew nothing about information technology. It turned out to be one of the biggest wealth creater. Had one invested well in IT in early stages, their entire future would have changed.

Like 

smita naidu

Dec 23, 2010

yes, I only invest in something if I understand it, infact I need complete knowledge, otherswise I will never ever and I also feel that everyone should follow the same strategy,, cause money speaks, so trust urself and ur knowledge only while investing to avoid pitfalls.

Like 

GOMS.KRISHNA

Dec 22, 2010

I HAVE UNDERSTOOD THE IMPORTANCE OF STICKING TO OUR CIRCLE OF COMPETENCE (when it come to investing) RECENTLY. I WILL STICK TO IT IN FUTURE and also SOCKS OR STOCKS BUY WHEN MARKED DOWN

Like 

v.v.rao

Dec 22, 2010

The increase in commodity prices especially food items have been partly due to trading on exchanges as wells as speculation due to weather conditions and other traders which are not directly involved in business of commodities. Only registered firms and business enterprises dealing with commodity business should be allowed to open accounts of commodity exchanges. It should not be open to all individuals who are just trading on exchanges for short term gains. This is one of the main reasons of increase in cost of the food items. The regulators should make necessary arrangements to bar all individual investors who are not directly dealing with the business of commodities.
Government should remove all important food items from the trading platform of commodity exchanges. Government should make necessary steps in this direction to prevent artificial inflation of food prices.

Like 

Krishna

Dec 22, 2010

we do not travel in teh route we don't know, also elephent and rats aren't alike? So moral story is do what u know best else be cautious or avoid when it is risky.

Like 

rk77

Dec 22, 2010

Yes I do invest in what I do not understand completely- stocks, mutual funds etc. I do not understand why an expert like equitymaster goes wrong in its assessment of some stocks and others. I do not understand how it comes up with some winners . Yet I invest based on his advice (not always sometimes I go by own reading of the market). If one waited to understand life and only then live the time would be over very soon. I agree with Allaudin that one could try to go beyond the circle of one's competence in order to grow and achieve something.

Like 

sethu

Dec 22, 2010

To compensate for this lack of COC,one subscribes to Analsis of equityMaster.But of late i find the analysts of equity master are going out of their COC under the false assumption that they had acquired needed COC while analysing the stocks.

Like 

Agnel Pereira

Dec 22, 2010

Referring to your report on GDP growth rate and Prof Sen's comments, some years back, I had coined a new term, General Development of People for Gross Domestic Product, to be the real yardstick of progress of a country. Though it was an imaginary concept without mathematical tools applied, and although something like a HDI exists, it would make sense to divide India's GDP growth by regions, states and between urban and rural areas. Per Capita Income is also such a wasted tool that gives a very low indicator for the richest and very high one for the hungry, starved, orphans, homeless and malnourished.
A part of the blame should go to the government which does not have a mechanism, as in the west, to take care of the needy - medical aid and old age pensions are just a couple of examples. Instead India has relied on subsidies that benefit rural rich (mostly politicians) than the needy. so there is no uniform development of people resources.

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