Does Long Term Investing Really Work in Indian Stocks?

As equity investors, we have been fed on over-dose of long term investing benefits, compounding wonders, those 16% kind of returns y-o-y on BSE Sensex, all Richie rich stories from the developed world etc. It’s very easy for me to do a post on any of these topics loading you with quotations from Buffett, Graham, Munger etc. Then you would find many stereo type equity blogs talking about legends who professed “Hold it forever” kind of approach if you get hold of a good quality stock. 

I want to however begin the year 2014 on a more sober note with some hard questions. The question is does it work in Indian context? Does your portfolio beat retail inflation rates?

Now see this link from the Business Standard with the headline – “Many blue-chip stocks fail the inflation test” - The marquee names include Colgate, Hindalco, three Tata group companies (Tata Steel, Tata Global and Tata Chemicals), Ashok Leyland, SAIL, BPCL.  Investors in these and many other stocks would be surprised to find that their returns have been trailing retail inflation rates. Sensex itself has given returns of 2.11% CAGR net of retail inflation over the 20-year period.

This thought is certainly very disturbing for all advocates of long term investing in Indian equities. 

Point # 1 is if 20 years is not the proverbial long term, then what is? In any case we have seen in last 5-6 years of recent market memory that returns in many so called blue chip stocks have been stagnating or even negative. So merely giving “time” to stocks is not enough. Just allowing businesses run their course and doing SIPs may or may not work. Don’t be blind about the process you are following. Your current SIPs in Infosys, TCS, ITC, Asian Paints etc may or may not be able to beat the inflation in 2033, who knows…

Point # 2 is stocks like Colgate, Hindalco and Tata Steel are quality businesses from respectable business houses if you are looking at a multi-year cycle that is long enough to smoothen out the effects of cyclical industries like metals. 

Point # 3 is we are talking with survivorship bias. Actually, this is the most significant aspect for me. In other words, we are talking only about those businesses that have survived all these 2 decades and still not been able to beat the high retail CPI inflation that is prevailing in the country. On top of that, these are marquee names in India Inc. These are not some down the road type of companies where the odds of beating the average returns would anyway have been low.

Point # 4 is the real purchasing power in hands of the shareholders in these companies has been diminishing when they intended to preserve or enhance it in their retirement years. That was the central idea of such long term investing horizon in first place, right? But believe me, none of the institutional or PMS guys would highlight such hard questions lest their income & interests get impacted.

Ok, what do we then do? 

That’s the logical question – what do we then do? Go back to fixed income securities and good old bank FDs. No, that is not the answer. By no means that is the problem diagnosis or the prescriptive remedy to cure the ill. 

Equities, in my view, are a great way to enhance your purchasing power (net of inflation) provided you are reviewing what is happening to the business on a regular basis. Watch it every quarter, monitor the results, and check whether things are working out for the business and fundamentals are supportive of your investment thesis or not. My humble advice is don’t be a slave of some dumb process of SIP, keep reviewing the results. After this reality check, we may end up holding for very long term, that’s fine. Then you won’t be disappointed after 5, 10 or 20 years. You’ll have solid returns for having done that ground-work. On the flip side, if business and stock is not working out for whatever reasons, let there be no attachments – emotional or financial – just get out of it. We are only human, and make our share of mistakes. I never believed in holding forever theory anyway.

In either case, direct equity investing is for seasoned investors who have the core skills, temperament and staying power to reap rewards in the longer haul. If you are saying you don’t have the basic knowledge and traits required, I would say it’s better to engage a pro or somebody whom you can trust rather than burning your fingers, besides capital and time. Even with that, monitor the results regularly, can't leave investments in auto-mode.

Another sedate, less glamorous, advice on first day of this new year is to keep learning more and more so as to emerge better investors. Let’s all grow as investors, our investment growth will take care of itself.

With best wishes to all of you for a happy and prosperous 2014 and beyond!

Is There a Price Bubble Building in Consumer Stocks?

All the time, I get the question consumer stocks are trading at such rich valuations and is there a bubble building up there? I did a post on same topic in 2011 here.

“Stay away” from these is the advice from some of the analysts. Graham worshippers and “Value investors” say these stocks are absolute no-no, and cannot be justified anyway you look at them.

There can be no two opinions about ultra-expensive valuations of consumer plays. At the same time, it can be intriguing to see every other investor taking shelter in these names despite such pricey tags. 

I, however, think it is important to appreciate the overall landscape in which consumer facing stocks are being evaluated by the markets:

1. Infra companies pack has been a disaster in their capital allocations and many of their acquisition and other decisions haven’t been financially prudent. Government alone cannot be blamed for policy paralysis and their sorry state.
2. Cash flows in power and capital goods companies are unreliable, or missing in some cases. Well established names of yesteryear are languishing at lows. A recent article on BHEL gave insight into the real situation, so much for a Navratna enterprise.
3. PSU stocks have not come out of overhang of OFS and dilutions, the woes of fundamentally strong companies like Coal India, NMDC and MOIL etc in mining sector are well known. Oil & Gas sector has some minor positive with reduction in diesel subsidy but it will take long before that makes any real impression on the stock prices.
4. Auto majors like Maruti have to stop production for a couple of days every now and then to cool off the supply mismatch. Entry of one Honda has changed the 2-Wheeler market dynamics for our Bajaj auto and Hero.
5. Pharma is a mixed bag. For an ace like Sun Pharma, we also have to live with a Ranbaxy that acts as dampener. Still, market is giving high multiples to well performing Pharma guys so long as they are performing.
6. Banks are somewhat of a divided house where many PSU banks are saddled with asset quality issues and trading well below book. Private peers are already priced in overvaluation zone in excess of 2-3 times book.
7. IT with some exceptions (HCL Tech, TCS, Mindtree) have failed to live upto promise of  volume growth. The stock uptick seem to be on account of currency moves rather than real operating performance.
8. No point discussing about real estate and the likes.

All the above tentativeness in market leaves us with consumer facing businesses in FMCG and Consumer durables. Yes, we are talking about the likes of Nestle, HUL, ITC, Colgate, Britannia, Bata, Asian Paints, Berger Paints, Pidilite, Dabur, Emami, Bajaj Corp, GSK Consumer, Tata Global, Godrej Consumer, Marico, TTK Prestige, Hawkins, P&G, Gillette and so on.

Now, question is what is distinguishing these from the rest:

a.  Consistent cash flows, debt free (most of them), incremental capex is funded internally, no dilution,  high capital return ratios and decent pay-outs.

b.     Market very well knows that Nestle cannot grow at 30%+ anytime in near future but still gives it PE of 40. Such companies are like oasis in desert where “Predictability of Earnings” is the real PE decider not just the earnings growth.

c.   Domestic consumption stories are here to stay. A large middle class and growing number of consumers add to it. They can reduce some discretionary spend in inflationary times, ultimately that has to be realized in the market. After all, Chinese folks may not succeed selling hair oil and toothpaste in India.

d. Established consumer companies have strong brand power, distribution network and geographical penetration. Most of this is irreplaceable moat.

e.   Gestures from the parent shareholders to hike their stakes even at current levels like in GSK Consumer and HUL boosts market sentiment for investors (why will promoters not raise their positions when they have business growth compared to home turf, they take away high royalty payments of 1-3% and of course the dividends).

f.     In this kind of scenario, where do you think an emerging market fund looking to put money to work in India will invest, if not in these consumer stories?

In short, these consumer stories may have their ups and down and occasional performance blips. Broadly, this theme will continue to deliver earnings and premium multiples accorded by the market may not significantly shrink going forward. These are uncertain times and the way macro-economic scene is panning out, there may be bouts of sustained selling. That will again make participants look for defensives. 

No wonder, consumer facing businesses will keep the markets interested!

Which stocks should you pick in current fall?

We have witnessed midcap carnage in last one month or so, with concerns looming over some companies having pledged shareholding and margin calls getting triggered. A non-event making Union budget and FIIs having concerns over TRC issue did not help the sentiment, and we may lose further stream on the way down. Rather than dwelling over the macro direction, it’s better to focus on the actionable for an individual investor in any given situation. Most midcaps and small caps are beginning to look attractive. Decision point for an individual investor therefore is what to buy, if at all.

I would divide the stock universe at present juncture into three categories:

1.      Quality stuff– Most blue chip stocks with formidable market position have not seen much price action. Their financials and business dynamics are what they were. To give you a flavor I’m referring to strong companies across market caps like ITC, Nestle, HDFC twins, Pidilite, Colgate, Asian Paints, Titan Industries etc. which have remained relatively stable. Argument for buying these stocks as a portfolio choice at this stage can turn out to be a good decision, in case indices drop another 10% from here, these stocks are not likely to suffer as much. The counter-argument for these stocks being a bad decision is that they are already quoting at very high valuations and upside here will not be much when market rebounds.

2.      Beaten down – Here I’m referring to stocks that are damaged price-wise in the last few weeks. There may be concerns over pledged shareholding of these stocks and sometimes of margin calls over these holdings. In few of them there could be issues of corporate governance and suspicion over some of the actions or transactions. As an indicator of this category, we have names like Arshiya International, Opto Circuits, Core Education, Alok Industries, ABG Shipyard, Zylog Systems, Onmobile Global, PC Jewellers, IRB Infra, GMR Infra etc. Market does not give benefit of doubt in many cases and price action has been pretty severe.

3.      Down but not out – These are stocks where price decline in the last few weeks has been significant but the fundamental strength and standing of the businesses are intact. In other words, these companies stocks have also fallen but more in solidarity with the markets and their midcap peers, rather than any specific negatives on part of their business, promoters or management. One of the beneficiary themes could be exporters who are benefited by a weakening rupee. Domestic consumption themes with strong earnings visibility and robust cash flows are the others that look attractive.

If you have been following posts on this forum for sometime, you would be able to make out stocks in which one of the above three categories I’m going to recommend to buy at the moment.  Yes, it’s the third “Down but not out” since I believe the positive surprise would be the maximum in this category over the next 1-2 quarters. There is a good likelihood that Q4 results would be favourable for companies where business quality has not deteriorated and bounce-back could be swift. It is this category that can beat the consensus estimates in a decisive manner, if not in the next few months certainly over the next few quarters. This is a good time to invest in equities, let’s not miss out on the opportunity.