It’s now
clear to the entire world, that we as a country have been swimming naked. If
you look at the last 50 years of our history, the 2003-2008 period looks more
like an aberration or accident. We benefited from a wave of liquidity and
enthusiasm for the BRIC countries (including India) and as a result were able
to grow in excess of 8%, inspite of not having the institutional structure
(such as a responsive bureaucracy) to support it.
Now the tide
(liquidity and enthusiasm) has gone out and the visible symptom of years of
mis-management is the crash of the rupee. I am extremely pessimistic about the
macro picture and the ability of our political system to fix it.
….and yet my
finger is itching to press the buy button !!!
No, I am not
blind to the risks and as depressed about the country as any other Indian. Let me
explain my reasoning behind this apparently contradictory stance.
What are the
options?
Let’s define
the problem – The main outcome of the currency crash and other macro problems
on the common investor is a further rise in inflation. We are likely to see double
digit inflation for some more time. This is likely to destroy the real value of
our capital if we do not find means of protecting or growing it.
So if you
have some capital (equity, real estate, cash
or FD) with you, what are the options for it ?
If you decide
to hold cash or some form of an FD (which seems to be the safest bet), you have
to keep in mind that the real return (after deducting the 10%+ inflation) is
likely to be negative. For reference – do a search on East Asian crisis of the
90s and other such events in the past. You will realize that any form of fixed
income investment did far worse than other alternatives.
The second
option is real estate. I have been pessimistic about real estate for a long
time and with low gross yields of 2-3%, think it is overvalued. However if one
has the skill to find some undervalued property and can hold on to an illiquid
investment for some time, then this could be a possible option. At the same
time, if you are thinking of using a loan to finance it – forget about it. If the
currency rate continues to depreciate, we may see a further rise in interest
rates (which has already
started) and the loan which you are planning (or already have), may become
even more expensive.
The next
option is gold. This seems to be a good option as it is likely to hold value in
real terms as the currency continues to depreciate. I think there is some truth
in it – though I don’t think I understand how to value gold and hence I am not
likely to go for it. In addition, gold at best is a defensive option (will
protect principal, but unlikely to grow it in real terms over the long term)
I know that
readers of this blog already know where I am going with this logic – equities.
But before I get there, let me digress a bit.
I think the
number one asset to invest at any point of time is you. If you invest (money
and time) in developing your skills and become really good at whatever you do,
then macro factors are unlikely to impact your earnings in the long run. If you
are a talented, the market will pay you for what you are worth (and more of it
in a depreciated currency).
The last option, which seems to be the most
risky is equities. The reason it appears to be risky is due to the vividness of
the risk. If you own a stock and inflation rises, the impact is visible
immediately. On the other hand, options such as cash or real estate seem to be
safe as we do not get a quote on it daily. However that is just a false sense
of safety as the real value is eroding silently. A fixed deposit or debt
instrument in the last five years has lost value due to inflation and so has
real estate (if it has not appreciated by more than 12% per annum).
The case for
equities
One can
easily point out that equities are no better as the index has dropped in the
last five years and hence the loss is even higher in real terms. That is true
if you have been invested in the index for the last few years. At the same
time, there are several companies such cera sanitaryware or crisil which have
done quite well during the same period.
The key point
is this – if you are an investor who can evaluate stocks (as quite a few
readers of this blog are), then a carefully selected portfolio of above average
companies (defined by high return on capital and good management) has done quite well in the last five years
in spite of the extreme macro environment.
Let’s look at
the same point mathematically – If you are able to buy a company, which is
earning around 20% return on capital (and can do so for the next 3-4 years),
one is likely to double his money in this period (unless the economy implodes
completely) if the valuation remains the same. Finding such a company is not
easy, but if the market keeps dropping, one is likely to find good companies at
attractive prices
There are
some caveats to the above suggestion –
- You have some
amount of skill in finding good companies. Investing blindly worked only from
2003-2008.
- You have the
patience and courage to hold onto stocks when the market is collapsing and
everyone around you is heading for the exits
- You don’t
need the money in the next five years. If you are retired or need money in the
near term, please don’t think of putting it in the stock market.
My plans
I keep a wish
list of stocks – these are companies which I would like to buy, but the price
was never attractive in the past. One such company was crisil, which
I bought in 2008 and have held on to it since then. There are a few other
companies such as ITC , Marico (and more) in the list which I am watching. If the
market keeps dropping, my wish may come true.
In summary,
if you want to protect your capital from the impact of inflation, you need to
find investments which have the capability to generate a 20%+ return on capital
and are priced reasonably. If you look at the history of various asset classes
across countries and time periods, equities come closest to it.
----------------
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.
6 comments:
Nice perspective as always. Well certainly the rupee has taken an unexpected hit and economy is going through worst phase, I was surprised that you didn't backed any infra companies which are healthy but going through prolonged bad phase. Also, I would like to hear your views on Mastek, a software company regaining its lost ground and is graham's play with cash on books equal to market cap. If turn around happens as expected, the returns should be healthy.
Regards,
Vikas Kukreja
I think now ( or was 2-3 weeks ago) a distressed investment strategy would have helped picking some good stocks to hold. Eg MCX
Offcourse distressed strategies focus on debt and the key is to use the same principles with an innovative valuation methodology if applied to equities.
An excellent post,this is the opportunity a value investor waits for.
When there is blood on the street,fear in the market,this can create distortions in price which can be very favorable for the discerning investor.
Hi Rohit,
I liked your comment:
'If you invest (money and time) in developing your skills and become really good at whatever you do'
Related to above comment, What would be your thoughts on a person working in product development in embedded/electronics kinds of domain in MNCs (like HP, Juniper etc.)? Is it worth while pursuing skills in such careers? Also, your opinion on overall IT careers (services or product development)
Thanks
-Raj
Hi Rohit,
Do you invest outside India?
If yes, through which broker?
icici seems to have stopped that & kotak is asking for 6.5 lakh deposit.
Regards,
Amit
hi Rohit,
Can you help me understand why Bajaj Investment Holding Co. which owns ~30% of bajaj Auto and ~40% of Bajaj Finserv is selling for only ~8500 crore. Instead if someone independently purchases ~30% of bajaj Auto and ~40% of Bajaj Finserv, he will have to shell out ~21000 crore. Apart from these two mammoth ownership, Bajaj Investment Holding also owns several other investments and the company is debt free.
thanks,
Nitin
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