Buffetology: Mantras for Investors

The grand old investor 'Warren Buffet' was in India recently. He has once again reiterated his opinion on India as a compulsive investment destination for any investor. He has returned to India to scout for attractive investment opportunities for his companies. It would be worthwhile to revisit the investment philosophy of the legendary investor.

The term 'Buffetology' has been coined by authors Mary Buffet and David Clark in their book titled 'The New Buffetology'. The greatest contribution of Buffet to the cause of Indian investors has been his passion for bringing the gains from long term investing to the centre stage. Unfortunately, in India the focus of investment has been on making money through short term gains, which is detrimental for the psyche of investment. The idea of long-term investment is treated somewhat like a doctor’s advice to start exercising and eat healthy. Most people agree that it’s good in theory, but few actually get around to doing it. Buffet's life and his success demonstrates that all you need to do is to understand a few simple things and do them faithfully over the long-term, with the long-term measured literally in decades, not years.

Here are a few pillars of the so called 'Buffetology':

• Invest in companies companies with consistently high rates of return on equity, preferably rising.
• Rule No. 1: Never lose money.
  Rule No. 2: Never forget rule No. 1
• Invest in a business that even a fool can run, because some day a fool will.
• Time is the friend of the wonderful company, the enemy of the mediocre.
• Simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
• You only have to do a very few things right in your life so long as you don't do too many things wrong.

Let us derive inspiration from these words of wisdom and create wealth for ourselves through the concept of 'Value investing' propounded by the legendary Warren Buffet.

Pitfalls of a Real Estate Market Crash

Is real estate market in India headed for a crash? The answer is an emphatic 'yes', and the reasons for this conviction are far too many. Real Estate prices worldwide generally follow a lag effect: they are the last to sell off in a declining business cycle and the last to revive in a recovery. The primary reason for this is that a large chunk of the surpluses generated in a booming stock market find their way into real estate investments, leading to an increase in speculative activity in the real estate sector. Stock market decline that started on November 5, 2010 (some may call it a bear phase) is now over 4 months old, but real estate prices are still to witness a significant correction. The real estate prices in India  (especially in the residential sector) have bounced back after the 2008 global meltdown, and are currently ruling at around 20-30% higher than the peaks attained during the 2007 boom. But a severe correction is not far away.

According to the analysis done by property consultants including Knight Frank: dipping sales, inventory pile up, rising debt and jittery investors (in the aftermath of various scams) is a sure shot recipe for an impending crash. The tough stance taken by RBI on roll over of loans to the real estate sector points to the fact that RBI is not comfortable with the exposure of banks to the sector. The developers have themselves to blame for the supply demand distortions in the residential real estate sector. The herd psychology of developers for constructing luxury projects have pushed the residential market towards a state of free fall. Sales in this segment have fallen as much as 70% over the past few months. Most developers have been offering discounts, concessions, freebies to sustain themselves, but there are few takers yet. It is often said that when the roadside hawker starts investing in stock market make no mistake about the market crash, similarly when you find increasing number of SMS in your mobile from real estate agents make no mistake about the impending real estate market crash. Just count the number of messages received by you recently and you would know the answer.

Having convinced about the impending crash in the real estate sector (residential market) what should an investor do at the current juncture:

• Postpone your decision to buy a second house for investment purpose or speculation (no problem if you are buying a first house), you may get a better price six months down the line.
• Do a due diligence on the builder before locking your money into an under construction property. Paucity of finance could delay the projects indefinitely.
• Stay away from real estate stocks (especially those into luxury projects), these beaten down stocks still have a long way to go on the downside.
• Be wary of financial sector stocks: They still are over owned by the market players, but a real estate crash could dent their margins considerably.

Impact of Budget 2011: Gain after the Pain

The big event has finally unfolded: Status-quo has been maintained. Equity markets gyrated in a wide range as the finance minister unfolded the budget proposals and finally settled with minor gains in the end. The budget proposals in totality are good for the long term health of the markets as there are no negative surprises. However, the markets will continue to be guided by national/ international news flow, in the short term, which continues to be negative. Let us analyse the few positives for the markets:

• Surcharge on Corporate tax reduced from 7.5% to 5%. However the tax holiday on IT companies has ended with imposition of MAT on SEZs.
• Disinvestment target set at Rs.40,000 cr., giving investors an opportunity to invest in Public sector companies.
• Foreign retail investors allowed to enter Indian equity market through mutual funds, which is a big positive for the markets.
• Distribution of subsidies in cash by March 2012 to poor users of kerosene, cooking gas and fertilisers. This will help to plug the leakages in Govt. subsidy bill.
• Spending on infrastructure has been hiked substantially by 23% to Rs.2,14,000 cr.

The downside risk to the broader market has been reduced substantially, although there will be adjustment in individual stock prices post the budget impact on their bottom lines. The markets on the downside may find good support in the 5100-5200 range on the Nifty.  Let us analyse the impact of budget 2011 on some important sectors:

• Automobiles: Budget impact is neutral, but higher disposable incomes shall continue to guide growth, but higher crude prices can spoil the party.
• Banking & Finance: The budget impact is positive, interest subvention on home loans and crop loans has been increased. Steady growth in credit will be witnessed with infrastructure funding getting a boost. But margins will be under pressure in rising interest rate scenario.
• Consumer Durables: The duty structure has remained unchanged, but higher disposable income will continue to spur growth. The sector is expected to grow at 15% during the year.
• Infrastructure: The hike in infra spending, 85% of which goes to road development, will be positive for companies engaged in highway development projects.
• Information Technology: IT companies are on the 'Mat' after the announcement of hiking the MAT and bringing SEZs under the ambit of MAT.
• Pharmaceuticals: The imposition of MAT is negative for many companies catering to export sector. Imposition of tax on Hospitals and Diagnostics is negative for health care sector.
• Real Estate: Input costs will escalate with increase in cement, steel prices. The demand-supply mismatch does not auger well for the sector. Only those companies focused on affordable housing in Tier II/III cities could benefit.

Overall, the budget is positive for markets in long run, and any dip in markets will be a good opportunity to accumulate good stocks for the long run.

Countdown to Budget 2011: Economic survey upbeat on economy

The economic survey has pegged India's GDP growth for 2011-12 at 9%. The govt. has given an indication that it will give a big empetus to growth despite the threat of high inflation looming over the economy. The new economic power index puts Indian economy at No.5 in the list of global economic powers behind US, China, Japan & Germany. However, the survey points to India living with higher energy prices, but indicating fiscal and monetary tightening to tame inflation. The biggest contributor to GDP will be the services sector which now contributes over 57% of GDP.

The survey indicates at giving basic banking licenses for MFIs and NBFCs and full license to Corporate aspirants after due diligence. This will help in scheiving the targets of financila inclusion. The survey calls for improving financial literacy among new savers so that the high savings of 34% of GDP could be channelised properly. The survey also points to the Govt. intervention in creating awareness in the pension product.The survey also emphasises the need for developing a vibrant corporate bond market for infrastructure financing. The survey pegs the total infrastructure investments of $450 during the 11th five year plan, with private sector contributing 34%.

The survey cautions against the declining per capita availability of food grains and the falling crop yield. There is a scope for public-private participation in social sectors such as health and education. The survey feels that targeted development of rain-fed areas and effective marketing links could serve as a long term remedy to check food price volatility. The survey argues about the need for a secong green revolution to ensure food security for all. The food subsidy bill of the govt. is expected to rise despite higher deficit, once the food security law is enacted.

Mood of the Nation & Stock Market Movement

I have expressed and maintained a view that India is in the midst of one of the greatest bull phases ever, but the events of the past few weeks have sown the seeds of suspicion in the minds of investors about the sustainability of the 'India growth story'. This phenomenon can be studied with the help of 'Behavioural finance'. Although stock markets return to the mean in the long run, they can show wide fluctuations in the short term. The most objective index to assess the markets is ' Price earnings ratio' which has fluctuated between a high of 28 (during the 2007-08 bull run) to a low of 8-9 (during the crash of 2009). The mean PE ratio is in the range of 14-16, which the markets are currently reflecting. Hence it is safe to assume that the markets currently are reasonably priced. The PE ratio discounting has something to do with the 'Mood of the nation' that gets reflected in the positions taken by investors in the stock markets, leading to volatile movements in our markets in the short term. Let us analyse the factors affecting the mood of the nation currently:

• Functioning of the Govt.: A spate of scams unleashed during the past few months has been largely  responsible for the negative mood of the nation. The establishment of the JPC, to be announced shortly, may lead to a short term reprieve but the investigations of the JPC will keep the political situation on the boil for at least the next 6 months. Opposition will not miss any opportunity to embarrass the govt. as the JPC probe gets underway, leading to policy decisions being relegated to the back burner. During this period markets cannot be expected to show any big up move, which is consistent with the views of the market analysts.
• Union budget 2011: The markets this time have corrected by about 15% in the month preceding the budget and hence may witness a reasonable pre-buget rally, which seems to have started. But considering that the Govt. is faced with a tight situation and is left with a little choice to reduce duties and taxes, the budgetary announcements are more likely to dent the mood of the nation. If the budget is viewed negatively by the markets, the chances of which seem high, a good sell off in markets can be expected post budget. Top performing sectors of the last bull run i.e. Banking, automobiles, IT are not expected to get any sops in the budget.
• India's performance in World Cup: Cricket is a religion in India, and the early exit of the Indian team from the ongoing world cup is sure to bring a pall of gloom on the mood of the nation. Some of you  may wonder about the relationship between cricket and stock markets, but it is interestingly true that a negative result in cricket and that too in a world cup does effect the bullishness in the markets. The hype created around the prospects of India winning the Cup will be largely responsible for a big blow to the mood of the nation in the event of India crashing out early. Given that no host country has ever lifted the world cup till date does not auger well for India's chances. If astrologers are to be believed, India can at best advance to the semi-finals. The line up for the final could be England Vs Srilanka. Srilanka can be given an outside chance as, though being a co-host of the world cup, they would be playing the final at Mumbai which is not a home venue. Things may have been different for India if the final was played in Srilanka. We may see a temporary lull in the stock markets post India's exit. But as a true fan of Indian cricket team I would still pray for India winning the world cup!

Red Alert: China 2nd largest economy, can India be far behind!

The dragon has arrived: China has dethroned Japan as the 2nd largest economy in the world. China's GDP based on 'nominal GDP' calculations at $5.88 trillion has overtaken the GDP of Japan at $5.47 trillion in 2010. In terms of Purchasing Power Parity (PPP) China is already far ahead of Japan. India will take roughly 25 years to overtake the GDP of Japan to become the 3rd largest economy, at the current projections of the growth rates of various economies of the world. However, India's GDP growth rate is likely to grow at over 9% p.a. with a possibility of touching double digits, overtaking the GDP growth rate of China by 2014.

Despite this optimistic scenario on the economic growth front, there is a mood of despondency amongst the masses of India. The negative vibes have been generated because of the happenings of the past few months: primarily due to the unearthing of a series of scams and the perceived inability of the Govt. in tackling the menace of inflation. However, viewed optimistically there is a silver lining in both these negative factors. Corrupt practices amongst the polity as well as businesses have been in existence through the past, but their grabbing the centre stage needs to be seen as a blessing in disguise. The cases against corruption have been progressing satisfactorily and hopefully will reach their logical conclusion within the next few months. This will pave the way for a cleansed polity and fair business practices. Inflation is a concern for the population at large, but the structural shift in the nature of inflation is seen as a positive outcome of the spreading of the fruits of growth to the rural India. The surplus income available with the rural masses is driving the change in consumption patterns of the Indians leading to the runaway food inflation. I am confident that with the augmentation of the supply chain over the medium term inflation will moderate. 

The growth story of India is going to continue for at least a decade or two. The people of India will have to shed their pessimism to reap the benefits of growth. A larger chunk of the $550 million household savings of the people of India shall have to be channelised into productive assets. The over reliance on FII money to propel growth needs to be corrected. The financial system (Financial institutions lead by Banks and IFA's - Independent financial advisers) has a role cut out for itself. The objective of inclusive growth can be achieved by educating the masses of India to channelise their savings into growth assets (equity market/ mutual fund schemes) and be a part of  India's growth story. Investors need to stay invested in these growth assets to reap rich rewards in the medium to long term.

Inflation plays the spoilsport again

Inflation has been spreading its tentacles on the growth prospects of the economy. This has prompted RBI to once again increase the REPO/ Reverse REPO rate by 25 basis points each. What is more significant is that RBI has maintained a hawkish stance, giving rise to speculation that further rate hikes are not ruled out in the future. The markets have taken these indications seriously, as most market men fear the rising inflation and the corresponding hardening of interest rates as a big negative for the markets in the medium term. The continuous slide in the equity markets is likely to continue for a little while longer, given the current economic scenario.

The intermediate downturn in the markets is likely to provide long term investment opportunity if the markets were to slide by another 5-10% from the current levels. Investors are advised to keep their shopping wish list ready to take advantage of the panic situation in the markets. The rate sensitive sectors such as Banks, automobiles, FMCG are likely to take a major hit in the near future, and would thus become attractive bets for long term investment. Another good opportunity for the risk averse investors would to put some money into the tax efficient FMPs being launched by the various mutual funds to take advantage of the double indexation benefit associated with the FMPs now on offer.

However, with the liquidity crunch real estate sector will continue to reel under pressure, which is likely to reflect in the downward movement in real estate prices in the medium term. Real estate prices lag the stock market downturn, hence the cooling off of real estate prices, especially the residential real estate is likely to cool off from the first quarter of next fiscal, as the Realtors will be forced to sell the residential space at a discount given their inability to raise enough resources from the markets.