What? Fundamentals are strong? - Views on News from Equitymaster

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What? Fundamentals are strong?

Dec 6, 2004

Leading long-term investor Warren Buffett had once remarked, "It is only when the tide goes out that you can see who is swimming naked" In these times, when the Indian stocks markets are on a seemingly incessant run upwards, apart from quality stocks, even those companies that are 'not worth their weight in salt' have seen their stock prices run up. And this calls for the much-needed caution from the investing community. When one talks to someone who has speculated in such stocks, what one hears is, "fundamentals are strong," or "growth prospects are promising"! What one fails to understand is that as stocks like these rise with the rise in the markets, the chances of falling harder increase for those who have speculated in them (remember the 'invisible' dot com companies of the 2000 crash?).

While we are not trying to take the role of a 'doomsayer' or, for that matter, 'spoilsport', what we are concerned about is the fact that markets are seemingly not taking into consideration the various risks that cloud the horizon. For instance, one of the biggest factors that are helping Indian markets currently is the incessant flow of FII money. However, it is important to note that the pressure on the US dollar on account of the huge US current account deficit has the ability to deepen further.

A rapidly depreciating US dollar may have inflationary effect on the US economy, which might further result in the Federal Reserve raising interest rates faster than expected. With job recovery, consumer spending, manufacturing index all showing good numbers off late, a faster US economic growth has increased the chance of faster rise in interest rates in the US. And this might be a big reason for the 'much-touted' FII money to reverse direction and move towards the much safer US treasury bills and bonds. What more, the rise in US interest rates might also lead to increasing pressure on the RBI to raise interest rates in India.

Conclusion
When economies and industries grow, benefits accrue to both good and bad companies. But as times get tough, and as the real test of companies' strength begins, grain can easily be differentiated from the chaff. While investors have behaved irrationally (sad, but that is true!) at more times in the past than one, those who have identified their risk-return profile well in advance and have set their faith in fortunes of quality companies, have seen their investments multiply. They would, indeed, continue to do so. By maintaining prudence, the chances of going wrong and thus losing money reduces dramatically.

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