Do you fall for this common management trick?

We humans have evolved to possess absolutely first rate linguistic skills. Our math skills in comparison look significantly underdeveloped. So much so that most of us come across as useless in something as basic as fractions. An evidence of this is routinely found whenever we go out shopping during the discount season. Imagine being faced with the prospect of choosing between a 50% increase in quantity and 33% discount in price. Most of us could end up choosing the former even though the two offers are exactly the same. Or take the hypothetical example of choosing between a 33% extra free and a 33% drop in price. While on the surface they appear the same, a deeper look would reveal that the discount is a better proposition than the increase in quantity.

If you thought such tactics are adopted by retailers and shopkeepers alone, you are certainly wrong. For even the field of  stock investing is known to use this trick and rather generously at that. Take the practice of issuing bonus shares or implementing a stock split. You will routinely hear management talk about how the share price of the company is on the higher side and how doing a stock split will make it more affordable for small investors. Not only this, even stock bonuses are given under the garb of rewarding shareholders for their long term association with the firm.

To make matters worse, investors more often than not fall for this trick and even send the stock price of the company under consideration soaring. What they fail to take into account is the fact that although their number of shares may have gone up, the share price is reduced proportionately. This thus leaves their total investment the same as before. Besides, the management that focuses mostly on bonuses and stock splits rather than trying to improve the long term profitability of the company should always be viewed with suspicion. The management's efforts at all times should be directed at improving the fundamentals of the company. For if profitability improves, share prices will automatically follow. Trying to artificially improve the share price through frequent bonuses and stock splits is not the mark of a good management we believe. And investors should always steer clear of such companies.

Borrowings of top 10 corporate group in a country

                                                          Source: The Economic Times

There have been reports doing the rounds that the  Indian banking system could potentially be sitting on significantly more NPAs (non performing assets) than those being reported. Above chart is perhaps one of the key reasons behind the same. As highlighted, the concentration of loans to top corporate groups is the highest for India amongst some of the other countries of the world.  This is not to say that most of these loans would eventually turn bad but such a high level of concentration is certainly risky for the long term health of India's banks and efforts should be made to lower the same.

This word is a cancer for India's economic health!

Most of India's state owned enterprises are currently on life support. Even by conservative estimates, these contribute at least 15% of the country's GDP. Hence there is little to explain on the critical state of India's economic health. The Indian government has left no stone unturned to ensure that the profitable PSUs bleed as much as unprofitable ones. As a result, not just the railways and state electricity boards, but also listed companies are piling up losses. Companies across sectors have not minced words about their dire state of affairs. Be it energy major Oil and Natural Gas Corporation Ltd. (ONGC), power major National Thermal Power Corporation (NTPC) or banking major State Bank of India (SBI). However, blinded by its political compulsions, the government sees little option than destroying public wealth.

But one quick fix solution that the government has adopted over the past few years has become the cancer for the economy's health. It answers to the name of debt 'restructuring'. Loans taken to fund agricultural losses, bleeding PSUs and loss making infrastructure projects have had this single remedy. The financers have been allowed to 'classify' the loans as standard as against writing them off as NPAs. Being just an accounting gimmick it allows the government to project all parties being financially sound. The loss making PSUs and the banks that have lent to them get away without taking the losses upfront. Moreover the PSUs get to borrow more despite their dire state of finances. If this was not allowed, several electricity boards, PSUs in oil, aviation and financial sectors would have declared bankruptcy by now.

But despite the risks of such a malpractice the government is set to put its seal on yet another 'restructuring' initiative. As per Bloomberg, a draft proposal by power ministry has sought to restructure US$ 35 bn (Rs 1.9 trillion) worth of loans. Held by power utilities, restructuring of these borrowings by banks will supposedly avert a power crisis in the country. Part of the loans will be transferred to state governments as well. Not that the financial condition of the state governments is any better. But with cash losses having widened 15 times over three years to Rs 288 bn, the state electricity boards are unlikely to find any lenders otherwise. The state governments are equally to blame for their stoic approach to raising power tariffs for years. As a result, the difference between the average cost of supplying electricity and the average tariff has almost doubled in last 11 years. Meanwhile transmission and distribution losses remained stagnant at 27%.

We believe that by offering an easy lifeline to such incompetent entities, the government is sealing the future of Indian PSUs. It is only a matter of time before the 'restructuring' bug devours what is left amongst India's so called 'navratnas'.

Market share of Indian aviation companies

                                                                    Data source: CAPA

The government has denied any plans to stall the operations of cash strapped avaition company Kingfisher Airlines. More concerning is the fact that it will alow the airline to be airborne, even if it means compromising the safety of passengers. Meanwhile the competitors of Kingfisher are looking to grab a share of its pie in the aviation space. As seen in today's chart, the likes of Indigo and Jet Airways that control 46% of Indian aviation space, can be key beneficiaries of some competition being grounded.

Are Indian banks' bad debts bigger than what is stated?

The global financial crisis did not affect Indian banks the way it impacted global banks. The major reason for this was the strict set of Reserve Bank of India (RBI) regulations that these banks had to adhere to which prohibited extensive use of securitization and derivatives. But that does not mean that Indian banks are completely out of the woods. Indeed, they are facing problems of another kind. Notably that of bigger bad debts.

The Economist points out that India has a bigger bad debt problem that is not in line with what is stated by the rather stable level of banks' official 'non-performing' loans. But the quantum of this debt is difficult to judge because many have been labelled as 'restructured'. This means that the terms of the debts have been softened, but they are not formally recognised as bad debts. These restructured loans were estimated at US$ 43 bn in March this year amounting to around 2% of India's GDP. Restructuring loans by itself is not such a problem simply because the borrower has not defaulted but simply requires easing of the terms of repayment. But the important thing to note here is that this facility should not be misused. For instance, take the case of struggling airlines such as Air India and Kingfisher Airlines. Both of them are saddled with massive debt. While they may not have technically defaulted so far because of restructuring of these debts, they are certainly in no position to service or repay the debts.

Also, the burden of these debts has been greater for public sector banks than their private peers. The Economist has estimated that 93% of restructured loans are on the books of public lenders. They tend to be in poorer shape than their private rivals on account of lower capital levels, lower profitability, higher bad debts and lower provisions held against those bad debts.

However, it would be too early to presume that the  problem of restructured loans could blow into something very big. At least we hope that the central bank which has been rather vigilant so far will ensure that this issue does not blow out of proportion. Moreover, since Indian banks (even PSUs) are comparatively better capitalized as compared to their Western peers, they are in a better position to tide over difficult times. Having said that, a consolidation in the sector cannot be ruled out. Overall, what banks need to ensure is that they do not stop lending to genuine borrowers just because they have been bitten by a few bad ones.

Commercial vehicles are the most cyclical

                                                                 Data Source: SIAM

It is well known that the  auto sector is cyclical as its performance is largely dependent on the growth of the Indian economy. But the degree of cyclicality within segments tends to vary. Chart shows that commercial vehicles (CVs) are the most cyclical as compared to either passenger vehicles or 2 wheelers. And in CVs, the medium and heavy CVs (MHCV) are more cyclical than LCVs. This is largely because MHCVs are largely used for the transportation of various goods across the as well as in construction acitivities and so the performance of these sectors have a large bearing on how the CV industry operates. Indeed, in FY13 so far given the slowdown of the Indian economy, MHCVs have faced the maximum brunt as can eb evined by the dip in volumes.

India third largest importer of Iran crude oil

                                                               Data source: The Financial Times
                                                                      *First quarter of 2011

The US has been imposing sanctions on Iran in order to curb its nuclear programme. But an article in Financial Times points out that curtailing Iran's oil exports may be difficult. This is because Iran is a major exporter of oil, accounting for about 5.2% of the world's total output in 2011. As such, sanctions on Iran can have significant consequences on world oil prices. Today's chart of the day shows the countries that are major importers of crude oil from Iran. Emerging economies are among major importers of crude oil from Iran. It must be noted that India is free from US sanctions as the latter had granted exemptions to over a dozen emerging economies in June 2012.

Investing in 'new age' sectors can be dangerous!

"What industry will be the next growth driver in the 21st century and what do you see that supports that? " legendary value investor Warren Buffett was once asked. Can you guess what answer he must have given? He simply said, "We don't worry too much about that." He went on to elaborate with the example of the automobile and the airplane industry. It was impossible back in the 1930s how much these two industries would impact the world. They have indeed been a great boon for society. However, for investors both these sectors have been absolute disasters. Of the 2,000 automobile companies that had mushroomed during that period, only a handful have survived. The fate of the airline industry has been even worse, with perpetual losses of billions of dollars.

The fate of a much-touted emerging sector has reaffirmed that Mr Buffett's wisdom has no expiry date. We are referring to the solar energy equipment sector. It goes without doubt that the world has little choice but to gradually switch towards sustainable and renewable energy sources. And solar energy is definitely a sector with very high potential. But does a high growth sector necessary translate into shareholder wealth? In this case, the answer seems to be no.

The global solar photovoltaic demand surged from a little over 7,000 megawatts (MW) to nearly 20,000 MW in 2010. And as per certain estimates, the current global demand stands at about 30,000 MW. But you would be surprised to know that the Indian solar manufacturing sector is on the verge of collapse with over 80% of the units shut down. In fact, not just India, the sector is facing severe headwinds across the globe. What's the reason? The answer is extreme optimism. Currently, the manufacturing capacity is two times the demand. Over enthusiasm about the industry's high growth prospects led players to set up huge capacities. But in recent times, the sector has been facing the brunt of the crisis in the Eurozone, one of the main markets. Dormant demand in India coupled with intense competition from Chinese counterparts made matters only worse.

Whatever be the fate of the solar equipment manufacturing industry, there is one very crucial lesson that investors need to take home. Be very careful while putting your money in the so-called 'new age' sectors purely on basis of huge growth potential. At best, avoid investing in sectors that do not have a sufficiently long operating history. Another important lesson is to let go of the urge to predict the future. Stick to the basic of value investing. Invest in stocks with strong fundamentals, solid past track record and sufficient future growth visibility.

India leads in FII inflows in Asia this year

                                                     Data source: The Economic Times

Above chart shows that Indian equity markets witnessed the highest inflow of FII (foreign institutional investors) funds in 2012 so far. Foreign funds have invested nearly US$ 11 bn in Indian stocks during this period. A significant portion of the funds poured in between January and March and then resumed in July. While FIIs have been net buyers of Indian equities in the current year, domestic institutional as well as retail investors have been net sellers. Among other Asian peers, South Korea witnessed the second highest FII inflows of about US$ 6.3 bn. 

In India, the demand for office space has slowed down

The global slowdown has impacted the demand of office space in the country. Due to the slowdown, many multinationals especially from the IT and banking, financial services and insurance (BFSI) have started consolidating their operations in the country. And this is reflected in falling absorption rates across the country. Absorption rate is the rate at which available homes are sold in the market during a given time period.  It may be noted that during the first half of 2012, the absorption of office space has declined by 32%. The absorption rate in National Capital Region (NCR)-Delhi dropped to 21%while that from Mumbai dropped to 19%. Apart from global slowdown, high interest rate and property prices have been another dampener.  Due to the slowing demand, the supply has also been impacted. In fact, it has fallen by approximately 52% in the first half of 2012. And the situation is unlikely to improve in the second half as well. After the residential downturn, it seems now even the commercial segment is facing the heat.

In India, these sectors doubled shareholder wealth in last 4 yrs

Stock investing is all about identifying and adopting a goal and sticking to it with discipline. The goal could be anything from earning x% returns to holding the stock for your period. The important thing is to identify what works best and stick to it without compromise. But an important question that any investor would have in mind is which investment philosophy works best?

An article carried by Business Standard appears to be addressing this question. It has identified 8 sectors where investors have been able to double their money. But investors have been able to do so only by holding on to the stocks over a period of 4 years. The sectors include tobacco, FMCG, tyres, auto, pharma, auto ancillaries, banks and fertilizers. These sectors have seena robust financial performance even during the not so good times. And this performance has translated to healthy gains for investors who remained committed to them.

The driving force behind the performance of these sectors was healthy domestic consumption. With rising income levels particularly in the rural sector, consumption has been growing in recent times. As a result, these sectors have seen their top lines outperform the overall economic growth. At the same time the ability to pass on increases in costs, keeping their administrative costs under control and maintaining their brands has helped these companies in growing their bottom lines as well.

On the other hand the "in the news" sectors like infrastructure, construction, sugar, etc have actually doled out negative returns for the investors during the same period. Though they have seen a growth on the financial front, but neither has the performance been outstanding. Nor have they helped investors in any way. With compounded annual returns ranging between -1% to -33% over the past 4 years, these sectors have actually destroyed shareholder wealth.

This leads to one key learning for investors. Something we always keep talking about. That is that in order to earn healthy returns over long term, it is essential to identify businesses with strong fundamentals. And having identified these it is necessary to hold on to them for a long time period. Investing in hot news items rather than the stronger business fundamentals can only lead to one thing. And that is losses.

Transport benefits most in diesel subsidy

                                                        Data Source: Business Standard

The Government of India has drawn a lot of flak recently for its inertia with regards to fuel price reforms. As per a study done by leading financial daily, subsidies doled out on diesel are finding their way mainly to transportation sector and that too in private hands. Today's chart shows that transport sector accounts for nearly 67% of the subsidy benefits. Prominently, the truckers and cars account for nearly 45% of the total subsidy bill. On the other hand, the agriculture sector, on which the Government rests its case accounts for a mere 12.3% of the subsidies. With a flawed subsidy system leading to dieselization of economy, one should expect the share to go up. The argument that linking diesel prices to market prices will lead to inflation doesn't hold water either. Higher fuel subsidies and huge fiscal deficit are feeding the vicious circle of low growth and high inflation anyway. If it is well being of the farm sector stalling reforms, there is a better way to take care of it. The sector will be better off using direct cash subsidies and strong price support system. It's time that the Government stops coming up with lame excuses and bites the bullet of fuel reforms.

Will India learn from this biggest banking scandal?

Cartelisation! Over the last one year, this has been one term that has got many Indian companies penalised by the Competition Commission of India (CCI). The allegations have been that firms within the same industry colluded together to manipulate prices.

But this is too trivial compared to what we are just going to tell you about. Imagine a cartel of big global banks manipulating the global financial system. We are referring to the Libor banking scandal. For a lay Indian, this may not be quite a popular term. But in the global financial system, it is a very crucial pivot. For starters, Libor stands for London interbank offered rate, the rate at which banks think they can lend and borrow money themselves. Libor is a globally accepted benchmark interest rate for over US$ 350 trillion in financial products.

Regulators are said to be of the view that the manipulation of the Libor interest rate was the result of "organised fraud". As per news agency Thomson Reuters, Barclays paid a hefty fine of about US$ 453 m to authorities in the US and the UK to settle allegations that some of its traders had colluded with employees at other banks to manipulate Libor. Several other financial institutions are reportedly under the scanner of regulators for their alleged role in the fraud. This comes as another striking evidence of the threat big banks and financial institutions pose to the health of the global economy. But they are not the only ones to be blamed. Such scandals also reflect the negligence of the regulators. What were they doing all this while? Worse still, these are the same too-big-to-fail institutions that the central banks rescue in times of crisis.

What lessons does this financial scandal have for India? It must be noted that in 1998, the Mumbai inter-bank offer rate, referred to as Mibor, was set up on the lines of Libor. The Mibor acts as a benchmark rate for all interest rate swaps, forward rate agreements, floating rate debentures and term deposits. Though most key interest rates in India are benchmarked by the Reserve Bank of India (RBI), the Libor scandal may be a reminder for the Indian central bank to ensure adequate checks and balances to ensure that a similar fraud does not occur in India. Already discussions are underway to switch to an actual screen-based traded price of Mibor as the current system could be susceptible to manipulation. We really hope the Indian bank regulator and the banks initiate appropriate steps to avoid a similar disaster in our country.

Does India really need a sovereign wealth fund?

Sovereign wealth funds (SWF) enjoyed a lot of interest from investors and policy makers alike during the heydays prior to 2008. So much so that it even caught the fancy of otherwise sedentary Indian policy makers. SWFs did have appeal until 2007 since several countries seemed to be making money through canny investments.  Particularly the oil-rich countries like Norway, the UAE, Saudi Arabia and Kuwait. As per Business Standard, all these funds have assets of close to US$ 500 bn. But how relevant is the idea of having such a fund for India is the question!

Well, for one, our policy makers are keen to have such a fund. Even if that means pulling out Rs 10 bn from budgetary resources. But that very idea reeks of imprudence! Most obviously, India does not have a large amount of money from natural resources that it needs to invest. Nor does it have a sustained current account surplus, such as China runs. The budget deficits are everyone's knowledge. The RBI is opposed to the idea of using India's falling forex reserves for capital investments. And rightly so. It has therefore been suggested that alternatively the government would raise money from the market. Or use surplus cash lying with public-sector units. With our government already having destroyed enough investor and tax payers' wealth, this could be the last nail in the coffin!

Indias trade deficit with China a big worry

                          Data source: Ministry of Commerce & Industry, Department of Commerce

                                                              *April to December 2012

Today's chart shows India's trade imbalance with China. While India's imports from China have been growing steadily, our exports to the dragon nation are not growing at the same rate. This has been the biggest contributor to our economy's overall gap between exports and imports, leading to a high current account deficit. It is worth noting that India's current account deficit was at an all-time high of 4.5% of GDP (gross domestic product) during the quarter ended March 2012. The steep depreciation in the rupee has been one of the adverse impacts of the wide trade deficit. This has become a major concern for the Indian government. If some solid steps are not initiated to correct the trade imbalance, it will pose a serious threat to the long term well-being of the Indian economy.

What Hitler can teach us about investing?

Rewind back in time to 1944. The long drawn World War II was nearing its end. With massive forces of the Western Allies pushing from the West and Soviet armies closing in unrelentingly from the East, Hitler's defeat was a certainty. But would he accept the reality? No chance. He continued to delude himself with the idea that he could strike a counter-attack with his two reserve armies and win the war. Similar was the case with Japan around that time. It had lost terribly in the Pacific against the Americans. Yet it lived under the illusion that the enemy would not be able to invade its homeland. We obviously know what the end result was in both the cases.

What is the reason for this kind of irrational behaviour? A certain gentleman by the name of Mr Christopher Mahoney offers an insightful explanation. He opines that it is very difficult to accept defeat in a long war. The human mind refuses to accept the brutality of defeat and suffering. In its own defence, the mind tends to delude itself in an alternative reality.

But is this tendency only specific to wars? Certainly not! Take the eurozone crisis for instance. The actual crisis is much bigger than what most policymakers are willing to believe. They still think that through policy intervention, they can save the euro from disaster. The President of the European Central Bank (ECB) Mr Mario Draghi recently declared that he would do "whatever it takes" to save the euro. To point the truth, nothing that the ECB has done so far has solved the crisis any bit. There is no tangible rescue plan so far that is likely to lessen the Eurozone's woes. The fact of the matter is that the euro is an inherently flawed financial instrument. Secondly, the Eurozone economies afflicted by the sovereign debt crisis have little choice but to face the consequences of their past excesses. There is no quick pill to escape pain.

Forget the Eurozone. Even many investors behave in this irrational manner when faced with massive losses in their stock market investments. Of course, stock price volatility owing to prevailing market sentiments must be certainly ignored. But there is strong reluctance among investors in accepting investment mistakes and booking losses on stocks whose fundamentals have turned sour. Even after facing huge losses on them, they continue to hold on. The vain hope being that the stock price will reverse and they will recover their losses. This, they believe not because the fundamentals say so. But because the alternative reality is very difficult to accept.

Drought may not severely affect India's growth

                                                              Data source: Business Today

India is facing a drought. This has finally been confirmed by the government. The culprit is the El Nino weather pattern which is expected to reduce the rainfall in the July to September period. The last time India had suffered such a drought was in 2009. As more than 50% of Indian agriculture depends on the monsoons, rain plays an important factor when it comes to food production in India. Food prices have already started heating up as rainfall started to fall short of average. If this continues, food prices would most likely hit new highs.

However, the current drought may not affect India's GDP (Gross Domestic Product) growth as much as it did in the past. Today's chart of the day shows that agriculture's contribution to India's GDP has been consistently declining. In the past, a drought tended to severely affect India's economic growth. But despite 2009 being a drought year, the GDP growth in the financial year 2009-10 (FY10) remained robust.

Will India's problem be China's gain?

Over the past few days, loads of print spaces were devoted to India's pitiable power sector. How the country's super power dreams have sunk into darkness was the most widely read headline. Not just in domestic but also in the international media. But unlike the ego brushing West, the Chinese have a more practical way of dealing with this news. They did not criticise Indian policy makers. Nor did they ridicule India's ambitious plans for the power sector. They are in fact quietly trying to make the most of the opportunity in disguise.

The Chinese companies in power equipment space are well positioned to feed the unmet demand in India.  Some like Shanghai Electric, Harbin Electric and Dongfang Electric have already established themselves in the country. They are competitive on costs and are giving local equipment suppliers, including Bharat Heavy Electricals Ltd (BHEL), a run for their money. As reported by Firstpost, Chinese players are expected to participate in projects set to generate an additional 40,000 MW of power over the next few years.

India has missed every capacity addition target since 1951. Despite this, nearly 30% of the total planned infrastructure outlay over the next five years is on the electricity sector. Transmission and distribution losses still account for 27% of power generated! It is time India takes some concrete steps. One is to facilitate private sector participation in the power equipment space. That, along with partnership with Chinese players, could be the only way to reduce our electricity woes.

This is how a good investor becomes great!

The Olympics are currently underway in London. So what better way to start than take an example out of the world's biggest sporting extravaganza? You see, all the champion athletes who compete in the games seem to put in the same amount of training hours and possess a similar level of work ethic. Yet, at the end of it all, there is only one winner who walks away with that elusive gold medal.

And here in lies the biggest mystery we believe. If all the participants pass through virtually the same work routine, why is it that some achieve success and others remain perennial underachievers? Most of us would put the reason down to some inborn talent.

However, a recent research in this area has shed light on a completely different reason behind this phenomenon. It has argued that if one wants to get good at something, how a person spends one's time is far more important than the total amount of time spent. Thus, the number of hours and the amount of sweat that one puts behind an activity is only a weak indicator of performance. What matters is that one should closely watch where one fails and then learn from the mistakes. In other words, unless we are constantly pushing ourselves to the limit and continuously monitoring our performance, we are never going to improve in our chosen field. On most occasions, we do our activities in our comfort zone. But true progress happens when we move out of there and get into the zone of learning.

Can this approach be used in investing as well? It certainly can but we believe it will require a small twist. As a financial blog points out, unlike sports or music, there is this problem of not getting an immediate feedback in investing. Whenever we make certain long term investing decision, its results will be known only after a time lag of 2-3 years. This could thus lengthen the whole process of learning. Fortunately, there is a solution at hand. And it says that we can become much better investors by studying the past investment made by successful investors. By recreating the situation when the other successful investors made their investments, we get a chance to understand what exactly must be going through their minds when they made their investments. You can then compare your conclusions and your logic behind investing with theirs and thus keep getting continuous feedback. Done over and over again, this approach has a much greater chance of turning you into a great investor than the one you currently seem to be using we believe.