So did you miss the bus?

On 28 August 2009 Investorstreet suggested a BUY on Gold keeping in mind the Chinese Gold Cycle.

Had you invested in Gold as on that date, you would currently be sitting on a return of 39.72%, which by no means can be termed as an average return on any investment, even equity for that matter.

So did you miss the bus?

What is Stock Rigging?

Stock rigging is a phenomenon that attempts to pump up a company's stock price by floating favorable news about the company's earnings or future prospects. It actually encompasses a number of activities rather than just one. So say that if an individual with enough contacts in the markets and resources wants to rig a stock X. he will first spread positive rumors about the stock, such as a huge merger or FDI investment or great future growth numbers etc. Then he would use analysts as a medium to extend positive recommendations about the stock. In the process he would create speculation in the market and the stock price would shoot up. This individual can be a part of a cartel of investors, may be a promoter or some other entity.

This is why you would notice that there are certain stocks which only move on news or at the end of every quarter when strong numbers are posted or a positive guidance is set by the management of the company.

Can Debt Improve the Bottom Line?

Academicians have long argued that Debt if used to its fullest can be a great source of cheap money and savings for an organizations but also say that most companies are not able to optimally use debt due to several limitations such as availability of cheap debt, lack of credibility or market conditions. Most companies see debt as something that has a fixed service obligation irrespective of cash flows and as such carries high risk.

So is it true that companies are cautious with debt? Historical trends for companies borrowing seem to prove otherwise. Over 97% of the companies listed in BSE have exposure to debt of which over 83% have a Debt Equity ratio of over 2.3:1

But this is not abnormal as long as the company sees the earnings derived from such borrowed capital as worthwhile. Lets see the kind of benefit that a company can derive from debt. Let us say that by investing a Rupee at a 10% return produces a 10paise profit. Now by borrowing an additional rupee at 5% interest, the profit can be boosted to 15paise which is a 50% increase.

Another aspect is the tax benefit due to the deduction on interest paid. For a company with no debt and thus no interest deductions, a one rupee earning might eventually shrink to 67paise due to corporate taxes, but if the company has a significant interest deduction then the earnings would correspond to almost a rupee. This means that the tax shield from interest buffers out the taxes paid in the long run.

Making Sense of Chaos

Chaos Theory has more to do with mathematics and quantum calculations in particular than finance. But in spite of this, its relevance to the field of investments is very deep. Let us try and understand how Chaos Theory helps understand why markets are unsystematic, irrational and volatile but still manage to excite millions who try to predict its behavior. The basic interrelationship for Chaos Theory and finance lies in understanding its connection with Law of Large Numbers. Chaos Theory in Capital Markets states that the market behavior is guided by complete randomness or the absence of any order. This is because the theory sees the universe and everything in it as forces acting in a random and order-less manner and as such everything in the universe has to follow the same pattern.

Now if we relate this theory with the Law of Large Numbers then it states that any random occurrence with a large number of repetitions tends to move towards normal distribution. So over a large observation of occurrences the chaotic and random events tend to form a rational picture and eliminate and noise. But because for this rationale to be visible, the events required to be observed might be close to infinity, any predictions made to judge the outcome are never accurate. But this does not mean that they cannot be close to accurate or actual. This is the main reason why future predictions on stock prices and earnings of companies are never accurate but several times close to it. The accuracy largely depends on how many factors acting in the chaos chain have been considered in the prediction.

Now let’s come to the key point. Why are we talking about this? Try and understand that because predictions rest on the principles of chaos and law of large numbers, they should never be unrealistic, especially when a very small duration of time is considered. So when an analyst tells you that he predicts a stock providing 20% returns in 6 months, ask yourself a question whether the time span taken into consideration is enough to identify a close to accurate trend and the success rate banked on such limited a short duration is too optimistic or not? Now add to this the assumptions made in the model used and you will see that the analyst could be off the mark by much more than 20%. Here is something else you probably don’t know. The target price of a stock is provided to you based on some model that uses estimated future earnings and cash flows. Now in doing so, there are at least 5 assumptions used in any model. Statistically, by making 5 assumptions that are correct 95% of the times, the overall prediction can only be correct 77% of the time.

The long and short of the post is that Capital Markets should be used to take advantage of Market Cycles over a long period (Usually greater than 5 years). Whenever you enter the market for short term gains, statistically there is a 73% chance that you would not meet the prediction. How much the deviation from the prediction will be, depends on how many assumptions you have taken and how many of them are wrong.

Auto Sector Outlook: SELL on Tata Motors

The Auto sector is perhaps one of the worst hit during the global economic downturn and the Maruti results were not encouraging with the company accepting that sales growth numbers of 20% would be impossible to achieve in the near future. The outlook for the sector remains negative and the sector will witness a growth of 5%-7% at the best. Keeping in line with the previous recommendation on Investor Street, we are still Bearish on the sector with the reassessment for the ranking due in April.


SELL call on Tata Motors due to a 34% fall yoy in sales to Rs 47,586 million on 31.7% yoy decline of volumes, mainly in the CV segment. The company incurred a huge net loss of Rs 2,633 million driven by a steep decline at operating levels and a forex loss of Rs 2265 million as compared to a net profit of Rs 4,991 million in Q3 FY08.

A Good Time to Buy

"A well positioned investor has real assets, usually in the form of real estate, for protection against inflation, cash for emergency purposes and living for at least six months without a job, fixed income, both short and long term, weighted for the investor's perspective on interest rates as well as need, and stocks, with stocks consistently providing the best return over a long period of time."

That's what Ted Allrich had to say about a practical diversified investment portfolio. An investor needs to understand that this portfolio is not built overnight but is a gradual process. And what contributes the maximum to this portfolio? STOCKS...stocks that are well analyzed and based on strong long term fundamentals and are held on to as a mode of investment for years. Not stocks that are bought to make a quick buck. So right now when the P/Es for quite a few good stocks are at record lows along with a discount to the book value, it is safe to say that this is the best time to buy stocks as a mode of long term investment. If you were to invest in an Index stock for at least 5 years, then your yearly average return would be at least 10% and if you think that stocks are a bit too much for you, then go for Systematic Periodic Investments in small sums in Mutual Funds.

ICICI Bank: Over Rs 3000 Crore Exposure in Maytas?

This is an SMS that I got from a VP of a top brokerage house in India:

"Banking sources say ICICI Bank has the largest exposure of over Rs 3000 crore mostly in guarantees for Maytas Infrastructure assuming timely completion of projects it bagged. Work on these projects is said to have come to a standstill for want of working capital. Take care if you hold ICICI."

If this is what a majority of the market gets to hear by Monday, then GOD help the ICICI stock. Only the next few days will tell whether this is a rumor or a fact.

Derivatives: Hedging or Speculation?

An interesting discussion on whether derivatives act as a means to hedge or a tool for speculation was partly left incomplete due to lack of time and hence I am taking this discussion forward here. The argument that hedging for many companies is a speculative medium though they try to portray it as a means to hedge their risk exposure is true if looked at from one school of thought. Take for example a company that has invested in bonds with a fixed interest feature. Now if the company enters into a derivatives contact to trade on interest earnings then one might arguably say that the company has no Price Risk or risk from Fair Market Value and hence is indulging in reckless risk exposure.

But there is another school of thought to this. Hedging is done to cancel out unwanted risk or pass it on to others so as to reduce the overall risk exposure. Now, whether one considers a derivative exposure as hedging or speculation depends on how one defines risk. Many analysts consider “Loss of Profit” as risk and hence advocate derivatives exposure to reduce Loss of Profit. Though it might seem that it is fueling speculation and I agree that it does to some extent, the objective with which one enters into derivatives exposure is not enough to decide whether it’s hedging or speculation. Rather it is how you define risk and what you consider as risk for yourself.

Why Is the Stimulus Not Working?

IBM, Microsoft, Lenovo Ericsson and HSBC combined cut close to 17000 jobs and this was despite the $819 billion stimulus package approved by the House in US. Things are no better in India. India Inc is expected to cut close to 27000 jobs by March this year after all the sweeteners the central bank has thrown at them.

So why are such large scale layoffs happening even after liquidity infusion in the economy? The problem still remains that mere indirect and direct liquidity infusion will not put business back as usual. Firstly, the lack in global demand is pushing the margins at which large companies could afford to operate initially due to the huge volumes. With these volumes hit, sustenance itself is becoming a difficult thing. Second is the problem with short term liquidity and inventory hold up cost. Banks are reluctant to lend working capital readily as they suspect a rise in bad loans and the inventory hold up cost is too much for the companies to counter without the sales happening. Lastly, quick cost saving initiatives in order to cut down on expenditure usually are the easiest to achieve by laying off duplication in work and cutting jobs. This as a part of Rapid and Sustained Cost Management is seen as a short term approach which affects the long term growth of the organisation. But for many companies, employee remuneration amounting to as much as 20% of the total cost, it is a forced choice.

Moreover, economists are of the opinion that the liquidity being infused in the country will show its effect post the first half of 2009 but this alone will not be able to get business rolling in the country.

The Satyam Saga: A Story of Numbers

The Chart above says it all. Satyam's numbers on returns as compared to peers, never looked suspicious. The Debtors consistently kept rising from 2005 to 2008 from Rs 780 Cr to Rs 2854 Cr and so did the Cash Balance and the Net Profit. The company never showed a loss since 2004, not even in a single quarter.

Real Estate Outlook 2009

2008 was the worst year for Real Estate and the BRIC nations did not have the worst of it. In fact, US and Western Europe were the worst hit. Most builders saw their share value drop by over 76% since the housing bubble burst. As per a research by Reis, mall vacancies hit a 10 year high and are expected to worsen in 2009.

So what’s in store for real estate markets in 2009, particularly in India. The story of juggernaut growth for BRIC nations has failed to prove itself. Till early 2007, the world used to believe in the “decoupling theory” of the BRIC nations, a phenomenon that states emerging markets can maintain growth independent of any major disruptions in the US economy.

What real estate experts unanimously agree on now is to look for countries with strong middle-class growth and stick to housing and retail with a unshaken focus on long term. In India for instance DLF, Unitech and HDIL learned the price one has to pay for being overly aggressive. Their stock prices were slaughtered in 2008. Real estate in India is a scenario of oversupply in the retail space and companies are diversifying exposure to core infrastructure now.

Sam Zell, chairman of Equity Group Investments and Equity International does not consider India as an avenue for investment in the near future. His funds are more tuned to Brazil and China. Why? He says that bureaucracy and lack of transparency is the key problem with real estate development in India and projects don’t work out the way they look on paper. It’s too much of a hassle for an investment which would give him more returns in China and Brazil. He sees immense potential in China and Brazil because they would always be shielded to economic turmoil to a large extent since Mortgages contributed to 4% or less of their GDP as compared to 65% in US and 74% in UK.