Today there is a scramble for equities and this mad rush is understandable given the crazy heights reached by the stock indices. It may be necessary to pause and ask some questions. First, is this the best way out for an individual? Second, can we invest everywhere as all stocks appear to be going up?
To get answers, Saurabh Mukherjea and his co-authors come up with this cracker of a book called Diamonds in the Dust. It not just answers your questions but also tells you how to go about the task. And mind you, it is not easy as it is advisable to go through an adviser.
This book is a must read for any stock investor as it is written in easy-to-understand language. They start off by telling you that to win in the market, you must be patient, and this is not the place for a novice who is looking for short-term gains. Therefore, you should bat like Rahul Dravid, which means not just being patient but also plan out your investment.
Their view is that equity is the way to go as they bust certain myths on savings. Gold is good but is positively correlated to equities and hence there is no advantage of diversification. Debt funds are sub-optimal, and you may not be better off over the long run when compared with low rewarding bank deposits.
Real estate can get you something like 3-4% as rentals, but given the cost of borrowing is 7%, you are not better off. It is different in the West where you get similar returns, but the cost of capital is lower.
Now they recommend equities but start off by debunking the two theories we like to talk about, because they do not hold well in India. The first is the efficient market hypothesis and the second is the CAPM—Capital Asset Pricing Model— which does not quite work.
So, if these two known models are not working, how should one go ahead? Here they talk of ‘crushing risk’ and point out four risks that underly most companies. The one they harp on a lot is accounting risk, as notwithstanding all the efforts made by all regulators, companies still misrepresent their books.
Similarly, there is a revenue risk that comes in when the product dealt with is not an essential. Marico and Asian Paints are safer bets because their products have a steady demand.
Then there is profit risk, which all companies face as we spend too little on R&D and prefer ‘imitation’ which is cheaper. But the innovator loses out on the first-mover advantage soon. Last is liquidity risk where little trade takes place on the exchanges.
The authors talk a lot of a consistent ‘compounding formula’ which involves clean accounts, competitive advantage and capital allocation which are the drivers of share value at the end of the day. Here their research shows that 80-90% of companies are in category ‘A’ where the return on capital employed can never exceed cost of capital for an extended period of time. There is another 5-10% which is ‘B’ class which can grow by 10-12% consistently which can be considered. But their bets are on just the 1% set of companies which they classify as ‘C’ which can get you above 20%. The book takes you through the subtle nuances of what one should look at when investing. Always see who are on the Board of Directors and see if relatives of the owners dominate. Look at the cash flow from operations and cash flows on investments—the former should exceed the latter for sure. Contingent liabilities and related party transactions should be looked at in detail, which their company Marcellus does in detail. There are other interesting red flags that they point out, like a company which often hires investment bankers should be looked at with caution. Similarly, whenever a P& L account is impressive while the balance sheet isn’t, one should take a pause.
Marcellus looks at 11 accounting practices when analysing companies and the authors’ take is that 70% of banks and NBFCs have poor accounting standards. That is quite a revelation especially when we think of riding the wave and making equity investments in this sector.
They do give tips on their favourites. Companies which get their competitive advantage due to ‘innovation’ like Asian Paints and HDFC Bank are good takes. The same holds for Garware tech Fibres. The ‘brand’ works well for HDFC AMC and Page Industries. In terms of what they call ‘architecture’, TCS and Pidilite score. From the point of view of ‘strategic activities’, Abbot and Divi Labs are winners. The list does go on, and one can peruse these pages to get a better sense of the good companies to buy.
This book also goes through all the scams that have taken place starting with Satyam and through the Amtek Auto, Cox and Kings, Yes Bank, DHFL, etc. Hence, if one wants to know how things went wrong and what one could have seen through, there are separate boxes explaining these signals. While one cannot still blindly buy into the stocks which the authors call ‘C’ class, one definitely has been provided the framework that should be applied when evaluating such investments. And most importantly, one must take a long-term view and not a shorter one when picking the diamonds in the dust.
No comments:
Post a Comment