»5 Minute Wrap Up by Equitymaster

On This Day - 4 AUGUST 2010
The magic formula of one of India's best fund managers

In this issue:
» One of India's best fund managers shares his secret
» Indian cities need massive capital injections
» If FIIs didn't do it, capex will
» Deflation demystified by a Nobel Laureate
» ...and more!!

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Quite a few studies have proven that value investing trumps all other forms of investing in the long run. In other words, the approach of not paying a very high price for a stock and remaining invested for a long term period is indeed the most successful approach to investing. But most of the financial world, as we know it, does not operate in this manner. All it wants is instant gratification. And even if that comes at the expense to earning subpar returns, so be it. There are simply too many incentives lined up in the short term for people to start thinking about long term. Fortunately for us, one of the most successful fund managers in India today is a true blue long term guy. Meet Prashant Jain, the CIO of one of India's largest mutual fund houses HDFC.

So, what is Prashant Jain's magic formula? In an interview with a leading financial portal, Jain opined that he buys only into business he understands well and while he likes growth and quality, he will never overpay for growth. He further added that he believes in doing simple things well. "Many people don't want to concentrate on cash-flows and numbers like return on equity and this is where they lose out. These are simple things but a very important part of our process", is how the soft spoken Jain put it across.

Sounds eerily similar to the philosophy of a gentleman called Warren Buffett, isn't it. Indeed, people like Mr Jain help in reinforcing our belief in the science and craft of value investing. They tell us that we really don't have to make things complicated in order to achieve outsized returns in the stock market. Just keep doing simple things well and keep focusing on the long term. And there are strong chances that you would come out with flying colours.

 Chart of the day
The economic ground realities over the next few decades are likely to be vastly different from that prevailing now. There is likely to be a shift of economic power from the West to the East. Well, this is going to be true not just on ground but perhaps in the skies as well. As today's chart of the day shows, Asia is likely to own the maximum number of new commercial aircrafts over the next decade. Important to add that Asia's aircrafts in service have nearly doubled in the past decade. However, they are far from done yet. Airlines from Asia, especially from China will continue to be the biggest customers of plane makers in the coming decade.

Source: The Economist

Potholed roads. Traffic jams. Wading to work during rains. All of this is "normal" when you are living in India's biggest cities like Delhi or Mumbai. But it is not "normal" when we talk of the kind of growth that these cities are expected to contribute to. As per leading consultant and research firm, Mc Kinsey, Indian cities over the next 2 decades will house over 40% of the country's population and will generate over 70% of the new job opportunities. However, as per the same report, Indian cities are falling short of delivering even basic standard of living for their residents.

The remedy is that the government would need to do some serious capital spending. To cater to this growth, India would need to spend roughly US$ 1.2 trillion mainly towards infrastructure in the cities. This is almost 8 times what is being currently spent today. But unless this investment takes place, the Indian cities would be the most populous glorified slums in the world. We wonder what kind of first impression that would give to anyone visiting one of the fastest growing economies in the world. Maybe the government just hopes no one would judge the book by its cover.

The general thought is that rising prices (inflation) is a bad thing and falling prices (deflation) is good. The truth, however, is that there is very little that is good about deflation. As economic theory and past experience (Japan) suggests, deflation is destructive for an economy.

As per the economics Nobel laureate Paul Krugman, there are three factors that make deflation such a dreaded thing. One, when people expect falling prices, they become less willing to spend and less willing to borrow. This leads to lower consumption demand and hurts industries. This in turn leads to cost cutting and thus lower wages. Lower wages again means that people consume even lesser. So, it forms like a vicious cycle, or a 'deflation trap'.

With some of the big investors like Bill Gross and Jeremy Grantham fearing the onset of deflation in the US, we see this phenomenon bringing in more fears than inflation. At least in the short to medium term.

If you thought that we are not likely to have another global crisis in the future of the scale that we are witnessing now, think again. Raghuram Rajan, Professor of Finance at the University of Chicago, believes that the inability of governments and people to learn from their mistakes in this crisis means that another crisis in the future cannot be ruled out. He elaborates that the concept of 'great moderation' has been vastly misunderstood. This concept was based on selective interventions on the monetary side. So it was thought that with these interventions there could only be mild recessions. What nobody paid any attention to the excess liquidity, the private sector understood what was going on and took bigger and bigger risks. After all the government balance sheets were providing the buffer.

As a result, the debt as a % of GDP of various countries has been steadily increasing since the 70s. This in turn has escalated to the sovereign debt problems hampering Europe. US' debt position is also in a precarious state. It is obvious that solving problems by providing easy credit is not the solution to a crisis whose very foundations lay in easy credit. This will only worsen matters in the future. At the same time there are no easy options left for various governments. These are challenging times indeed.

Rs 500 bn is the amount that FIIs have pumped into the Indian stock markets since the start of 2010. But the BSE-Sensex, which is often seen as a slave of FII inflows, has gone exactly nowhere during this same period. Many now expect capital expenditure (capex) by Indian companies to do what FII inflows could not - take markets higher. How? Capex is expected to help companies grow their earnings over the next couple of years. This will happen in two ways. One, capex by companies will help them grow their capacity to produce goods and services. This in turn will help them see higher sales and profits once these capacities will come on stream.

Second, capital goods companies will receive a big fillip to their own earnings in the process of executing such capex programs for other companies. As per reports, capex plans in the process of being executed currently stand at Rs 3,000 bn in value. Further, fresh capacities worth Rs 6,500 bn are expected to come on stream during FY11. Notwithstanding any shocks from developed countries, this capex is sure to add to the earning power of India companies over the medium term.

Meanwhile, Indian stock market remained quite wobbly today and were trading marginally in the positive at the time of writing. The BSE Sensex was trading higher by around 20 points at the time of writing. Other Asian indices closed mixed today whereas Europe has opened largely on a negative note.

 Today's investing mantra
"It's easier to debase than take hard problems, easier to kick it down the road. I want to see someone that is willing to lose a re-election in Washington to tackle the hard problems." - Seth Klarman

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