Sunday, August 14, 2011

Investing in Equity in these times

" Be fearful when others are greedy and be greedy when others are fearful" - Warren Buffet

There is actually just one simple rule to investing in equities ‘Buy low and sell high!’. However for the majority of the investors in the stock market, it is this same rule which is the most difficult to follow. When the going is good everyone wants to seem to want a slice of the cake and when the flow of news starts becoming negative, investors flee the markets in droves.

To be successful in investing one should focus more on the underlying value of the sticks and less on news plan. Do not get me wrong, I am not asking you to totally disregard the news on the world economy. If you look at an investor in India, the moment he/she switches on the news channel – he only gets to hear negative news – US downgrade, slow growth in the west despite low interest rates, countries on the verge of default, rising interest rates in India with persistent inflation and all those massive corruption scandals. And all these news items are truly causes for concern. However in the midst of all these negativity we tend to overlook the positive impact of falling crude prices which could actually negate a lot of the above negative factors. And how is that? Here is how:

India is a developing country which is a net importer of crude oil and commodities. What a lot of people tend to overlook is the fact that every $20 drop in the price of crude, the country saves $18 billion per annum viz. equivalent to 1.1 percent of GDP. Lower oil prices means lower fiscal deficit, lower inflation and lower interest rates over time.

Indian exports to the US and Europe are only 6 percent of the GDP. And if you carefully look at the kind of exports we have, it is not materially linked to rate of growth of the western economies. Indian exports have captured market share from the existing players in those markets since they were cheaper (the IT industry and generic drugs industry are prime examples). However about 25% of the growth in exports are linked to the growth in the western economies. I would like to quote Mr. Prakash Jain in his article in Business Line – “Exports were materially impacted in 2009 after the Lehman bankruptcy as the crisis was unanticipated, due to a paralysis in bank lending and a consequent sharp inventory destocking.” This is clearly not the case today.

Scandals were already there, that was the bad news. The good news is that they have now come out to the open. In India major change has always taken place in a crisis. Right from the opening up of the economy in 1992 driven by a balance of payment crisis to increasing diesel prices when the subsidy burden was unbearable!

I would like to conclude this article with this chart which shows major debacles/crisis and the kind of returns investors got when they invested in equities during the time others were fleeing the markets.

There are several reasons to be optimistic about the growth prospects and about improvement in governance and infrastructure in India. If growth persists and if PEs (denoting valuations) are low, then equity returns can’t be too far away!

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