The investment secret almost everyone overlooks! - The 5 Minute WrapUp by Equitymaster
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The investment secret almost everyone overlooks!

Dec 27, 2014

In this issue:
» The best performing stock market in 2014
» Is this the best time to buy emerging market stocks?
» SME stocks: Myth or reality?
» ....and more!

The name Albert Einstein has become somewhat of a synonym for true genius. And why not? When you are the discoverer of one of the two pillars on which most of the modern day Physics rests, you deserve every accolade that comes your way.

But if you thought Einstein's preparation that eventually led to his discovery was the most complicated thing ever, you would be grossly mistaken. There were no reams and reams of paper involving complicated mathematics. As a matter of fact, his knowledge of mathematics was elementary at best.

And he had no science labs to conduct extensive experiments. For he was merely a clerk at the Swiss patent office sifting through tens of patent applications every single day.

Consequently, the answer to how he got his unusual insights lies somewhere else. And in Einstein's own words, it wasn't the complicated stuff that helped him. Instead, what turned the world of Physics upside down was Einstein's obsession for simplicity. In other words, he grasped the simple point that had eluded all the other experts!

Elaborating further, Einstein was simply of the view that he was able to sort of separate the essential from the non-essential and thus ignore all the noise around a subject. Put differently, his spectacular achievement did not come from processing all the information he had at his disposal but instead from his ability to say 'No' to almost everything that came his way and focus only on the fundamentals.

Does this sound like Warren Buffett & Munger speak? Indeed it does. After all, these two gentlemen have stressed on this important point so many times.

'We have a passion for keeping things simple' is what you'll often find Charlie Munger say in one form or the other. And if you go through the annual letters that Buffett writes to his shareholders, there's hardly anyone who would disagree with the fact that no one makes investing look simpler than the Oracle from Omaha.

Unfortunately, this is the point that most investors don't get about these two great investors. They think these people possess some unique insights and have super human brains. The reality though is something else. Their great track record stems more from keeping their brains uncluttered and ignoring most of the noise out there. That way, they are better able to pick up only a few sensible things to do.

Now, this is something our ValuePro team is perhaps beginning to excel at. Given the mandate of picking Warren Buffett like stocks, it has built up a database of what they feel are the best 80-90 companies out there, the ones that meet almost all the parameters put down by Buffett. Thus, depending on which stock is best placed from a risk-reward perspective, they have created couple of portfolios, one comprising of large caps and the other mostly mid and small cap based.

This way, by narrowing down the list to only the best 2%-3% of the entire investable universe, they can truly focus on what's important and forget about the rest. And it is clearly showing in the results what with both the portfolios giving market beating returns to subscribers.

What do you think is your strategy for keeping things simple and blocking out the noise? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
Sticking with the concept of simplicity, we are coming towards the end of 2014 and it won't be hard to guess which was the best performing stock market during the year. With emerging markets like China and India growing faster than any other major developed nation and with liquidity tap remaining wide open, it was the two Asian behemoths that indeed emerged as the top choice for investors. As the chart highlights, while Chinese stocks went up nearly 50%, Indian stocks are up close to 30% so far in the year.

However, while China has toppled the Indian indices during the year, there's a question mark over whether the trend will sustain in 2015. For all you know, India, if it gets the big picture policies right, may actually end up besting the Chinese dragon over the medium to long term.

Indian stocks second best in 2014

It was only a few days ago that we wrote about the mind boggling valuations of some of the stocks forming part of the BSE-SME Index. Now, Business Standard, a leading daily has shown how stupendously some stocks forming part of the index have risen in the past year or so. The top five performing stocks have risen in the range of 337% to 1098% in the past one year. As was written by us earlier, the price to earnings ratios of some of these stocks - based on FY14 profits - are in the range of 648 to about 23,000 times!

It seems that the multibaggers from this index have now come under the SEBI scanner. "Sebi (Securities and Exchange Board of India) is examining if speculators and persons acting in concert are behind the huge movements in these stocks," is what the business daily has reported.

Now one may be tempted to invest in such companies considering the annual returns of comparable indices such as the BSE Small Cap or for that matter the BSE-Sensex have been in the range of 68% and 29%. However, we would recommend investors to be cautious and well understand the fundamentals of the businesses before making such a move. Not to mention that valuations - which are seemingly sky-high at the moment - need be taken into consideration as well.

Okay, so most of the top performing markets in 2014 are from developing nations. However, we must keep in mind the currency depreciation w.r.t the US dollar. When measured in dollar terms, most emerging markets have done poorly compared to the US markets this year. As the year draws to a close, many are wondering how emerging markets will fare in 2015. If we are to believe Bloomberg's latest research, there are good days ahead.

While analyzing performance of world markets (in dollar terms) since 1970, they found an interesting pattern. Every time the US markets outperformed in any given year, the rest of the world always caught up the next year! Does this mean that FIIs will flock to emerging markets like India in record numbers in 2015? We would not like to jump to an early conclusion just yet. In 2015, as always, investors will be best served if they focus on the basics and follow the simple but timeless investing advice. Buy fundamentally sound companies at attractive valuations for the long term and ignore the market noise.

Most of the global stock markets closed the week on a positive note. The US indices closed at record high levels. The Dow Jones breached the 18k level during the week for the first time. The recent rally is a result of strong economic data, as well as global economies taking various steps to spur the economic growth.

Japan's inflation slowed for the fourth month in November. Even the industrial production and retail sales witnessed unexpected drops. These trends point toward further weakness in the economy. These are trends indicative of the pressures on the government. The government is slated to unveil a stimulus package in the next few days.

Chinese markets too witnessed buying activity. Drop in money-market rates and speculation that the government will take more measures to bolster the economy boosted the market rally. China's stock market closed up by 1.6% during the week.

The Indian stock markets closed marginally down by 0.5%. foreign institutional investors (FIIs) continued their selling activity in the week gone by. Among the sectoral indices this week, realty and BSE Mid Cap stocks were the leading gainers, while capital goods and consumer durables stocks registered maximum losses.

Performance during the week ended December 26, 2014
Data Source: Equitymaster & Yahoo Finance

 Weekend investing mantra
"There seems to be some perverse human characteristic that likes to make easy things difficult."- Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah.

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