|»5 Minute Wrap Up by Equitymaster|
On This Day - 18 APRIL 2013
Which investor are you? A Hedgehog or a fox
In this issue:
We believe it was the Greek poet Archilochus who first introduced these animals into the world of philosophy. 'The Fox knows many things but the hedgehog knows one big thing' is what he is believed to have said. So very true. Simply because for Hedgehogs, it doesn't matter who the enemy is. They will always roll themselves into a ball of spikes and get ready to charge at the predator. Thus, all they know is just one thing. Foxes however are Foxes we believe. Wily operators, there's hardly anyone more opportunistic than them in the animal kingdom. Any wonder that they are totally opposite to what Hedgehogs are.
We believe the investing world too is split into hedgehogs and foxes. There are investors who revel in knowing the one big thing and will bet their entire fortune on it. These are Hedgehogs of the investment industry. Then there are the Foxes that are as flexible as they come and just don't mind taking different bets at different times.
Any famous investor that can come the closest to being a Hedgehog? How about Warren Buffett? Since the time he first came in contact with it, Buffett has been a zealous practitioner of value investing. Barely have we seen him follow something else. Thus, it can safely be concluded that most of his fortune has been made by being a Hedgehog of the investment community i.e. doing just one thing and doing it better than anybody else.
At the other end of the spectrum is someone like George Soros. When it comes to changing opinions as fast as one can say fast, there isn't anyone better than Soros we believe. As opportunistic as the Fox, he has excelled in pursuing trends across asset classes and across economies. Thus, he is easily one of the most successful hedge fund managers in the world.
Thus, the question that begs itself is what should one aspire to be, a Hedgehog or a Fox? Well, we believe it pays to have characteristics of both these animals. Let's go back to Warren Buffett. You really think he's been a Hedgehog all his life? That's not true. Anyone who's followed him closely knows he changed his style over time. From being an investor in just statistically cheap companies, he switched over to buying quality companies by paying small premium for the quality involved. Besides, he's not been averse to making some unconventional investments whenever opportunities have presented themselves. Like his investments in derivatives and even commodities like silver. Thus, he's not just a Hedgehog but a fox as well. Similarly, there have been many a occasions where Soros has suffered reverses simply because he would have been better off being a Hedgehog but instead chose to become a Fox.
Thus, as Bill Gross of PIMCO once pointed out, the secret is to be both a hedgehog as well as a fox because the combination produces successful long term outperformance with risks that are market-like. We cannot help but agree.
The two economists in question are Carmen Reinhart and Kenneth Rogoff. In their 2010 research paper, they had found that economic growth tends to slow drastically when a country's sovereign debt exceeds 90% of its annual economic output. This study has been influential across the world. Many policymakers have cited this study to defend cuts in government spending.
But here comes Thomas Herndon, a 28-year old student at the University of Massachusetts Amherst's doctoral program in economics. He found some very basic errors in the spreadsheet used for calculations. At one instance, he found that a few countries were omitted from calculations of the average. Moreover, in the case of New Zealand, the two economists had used data for just one year, 1951. This skewed the results quite a bit. In fact, Herndon did his own calculations with the same data and found that the impact of high government debt on GDP was much milder than what the report projected.
The two famous economists have admitted to a "coding error" in the spreadsheet. But could such basic errors be purely a result of oversight? We certainly are not convinced. Moreover, the student's findings also put a question mark on their central thesis on debt and economic growth. And this in turn would lead to an entirely new debate on this pressing issue.
For instance EPS growth and high ROE could be misleading. That is if they are not examined for what has caused this growth in earnings. Or what has caused the higher ROE. If these are driven by non-operating and non-recurring items, then the growth could be misleading. Again when it comes to using valuation multiples, we need to keep in mind that multiples in general are relative. So if we say that a P/E multiple of 20 is expensive, then as an investor we need to question "as compared to what"?
Valuation multiples should be used as relative multiples. It is better to use an acceptable valuation band to say what is high and what is not. This band should be derived using long term growth rates and returns. Most importantly, valuation multiples should not include the value of intangibles and non recurring items. If you follow these simple rules, there is a higher probability of getting fundamentally strong companies in your portfolio.
In the international markets, most companies are facing issues to clear the pending backlog. Some have also run out of inventory. In fact, in overseas markets some retailers have started charging premium due to inventory shortages. Thus, in effect, only a customer who is willing to pay slightly higher than the prevailing market price can get gold there. We believe this proves the yellow metal's value as an investment avenue. A slight correction in prices and you see investors flocking to buy the same. Thus, the faith in the metal and its safe haven status seems intact. In fact, situations like these help investors to pick up the metal at more affordable prices.
But things are not as rosy as they appear to be! As an article in Firstpost rightly suggests, falling commodity prices do not mean we are out of the woods! For the CAD problem can be solved only if the rupee dollar rate remains stable. If the rupee stays weak, or it declines, India's imported oil gets pricier. Again, the falling prices of gold in international markets have meant higher demand in India. This too could pressurize the CAD. The metric to look out for is therefore foreign capital inflows. If these get attracted to India's fundamentals, only then could there be a meaningful impact on the currency rate and CAD. Until then, it would be too early to rejoice!
"You can't predict, but you can prepare"- Howard Marks
Editor's Note: Please note that The 5 Minute WrapUp will not be published on 19th and 20th April, 2013 on account of holidays at Equitymaster
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement
Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407