It was recently reported that 2 gentlemen, Guy Spier and Mohnish Pabrai, both of whom run their own US based investment funds, spent $650,100 (the amount goes for charity) just to have the privilege of having lunch with Warren Buffett in the month of June. With Buffett!! The man who, putting it in polite terms, is not exactly known to be a spendthrift (when his daughter was born, he refused to buy a separate cot for her and a drawer in the bedroom served as a sleeping place for the baby).And if just by chance anyone thinks that this is a lot of money to spend just to be able to spend a couple of hours with the world’s best known investor, then it is worth knowing that two days after that meal, the auction closed on eBay for next year's lunch with Buffett. The winner, a Chinese money manager named Zhao Danyang, bid $2.1 million.
Peter Lynch, the erstwhile head of Fidelity Investments mentioned in his book that investors would buy one share of Berkshire, just to be able to get the pearls of wisdom contained in its annual report written by Warren Buffett (this was before these reports were put up on the internet by Berkshire). He adds that at $11,000 a share, that had to be the most expensive subscription for any magazine in history.
So while some investors idolize Warren Buffett and his ideologies, unfortunately the majority are swayed by the emotions of the stock market. We examine one such sector in India where the investors forgot to ask ‘how much?’ while buying the stocks.
India ‘Realty’ sector - too much fiction
The ingredients were all there – India’s large population (with 50% under the age of 25) all requiring a place to stay, the lacking infrastructure – ports, airports, roads combined with the one of world’s fastest growing economies. Enough data was provided by analysts in support of the fact that this could be a $0.5Trillion business opportunity from 2007-12. On the other hand, the real estate buyers were in a fix. Property they wished to buy was only available at high prices. Supply was limited. And demand for property increased due to higher incomes and the ability to borrow more from banks. The desire of many private banks and many government-owned banks to gain market share and build their retail, home loan portfolio saw this dramatic run-up in the borrowing capacity of buyers. The story was complete. A rush of IPOs, and the investors swooping in on existing developers in the market. The result is shown in a self-explanatory table below, that shows how these companies fared recently in the market.
So while some investors idolize Warren Buffett and his ideologies, unfortunately the majority are swayed by the emotions of the stock market. We examine one such sector in India where the investors forgot to ask ‘how much?’ while buying the stocks.
India ‘Realty’ sector - too much fiction
The ingredients were all there – India’s large population (with 50% under the age of 25) all requiring a place to stay, the lacking infrastructure – ports, airports, roads combined with the one of world’s fastest growing economies. Enough data was provided by analysts in support of the fact that this could be a $0.5Trillion business opportunity from 2007-12. On the other hand, the real estate buyers were in a fix. Property they wished to buy was only available at high prices. Supply was limited. And demand for property increased due to higher incomes and the ability to borrow more from banks. The desire of many private banks and many government-owned banks to gain market share and build their retail, home loan portfolio saw this dramatic run-up in the borrowing capacity of buyers. The story was complete. A rush of IPOs, and the investors swooping in on existing developers in the market. The result is shown in a self-explanatory table below, that shows how these companies fared recently in the market.
* Public Issue/ Large private placement in 2007
For those who are more graphical oriented, here is a gem that we picked up from an external source. It shows the market cap of the largest real estate company (DLF Limited) in January and the market cap of the ENTIRE real estate companies as of July beginning:
For those who are more graphical oriented, here is a gem that we picked up from an external source. It shows the market cap of the largest real estate company (DLF Limited) in January and the market cap of the ENTIRE real estate companies as of July beginning:
If we were to analyze this, it seems that the problem was not with the companies alone (some of them are world class) or with the market opportunity, which despite all the doom-sayings, are still strong for a country like India. The problem, on one end was economic – when there is pent up demand of a commodity (in this case real estate), large capacity additions will come (both by way of new developers raising their hands to be counted and that of availability of land) such that the supply will force the price to drop. But isn’t that Economics 101? The real problem was that investors forgot this rule and thought that the pent up demand will remain forever.
Please see below: looking at just one company, Unitech, it seemed no price was too much to own the stock. The company was showing outstanding quarterly results with growth in sales and PAT exceeding 100%. Similar situation prompted the large shareholder-owners of some of the listed real estate developers to go in for some audacious land purchases, in process taking large debts. With sales now not as brisk as in the years 2006 and 2007 and cash flows are not as per expectations and committed to large projects, they now need to pay for the new land and the initial cost of development to get the land into some sort of ‘build-able’ shape. With the central bank clamping down on liquidity to manage inflation, loans have become dearer and it is reported that some developers are taking funds from private financiers at rates ranging from 24%-50%. In the last 2 quarters, Unitech has showed negative quarterly growth on both Sales and PAT.
Templeton (who died recently) had once cited a very interesting statistic. At its peak of real estate bubble in Japan in 1980s - the market value of the land underneath the Imperial Palace of Japan in Tokyo was more than the market value of the land in the whole of California! High prices were then justified in the same manner they were justified in India - shortage of space, rise in living standards, easy credit etc.
When it comes to investing, nothing is more important than the ability to think clearheadedly for oneself — and Buffett is unsurpassed on this front. In the late 1990s, he was widely criticized for his refusal to invest in booming tech and Internet stocks, a decision that was richly vindicated when the bubble burst. We may shake our heads at the housing bubble in USA. But we built one right here in our own back yard. Buffett has made a fine art of keeping that kind of distracting noise at bay.
When it comes to investing, nothing is more important than the ability to think clearheadedly for oneself — and Buffett is unsurpassed on this front. In the late 1990s, he was widely criticized for his refusal to invest in booming tech and Internet stocks, a decision that was richly vindicated when the bubble burst. We may shake our heads at the housing bubble in USA. But we built one right here in our own back yard. Buffett has made a fine art of keeping that kind of distracting noise at bay.
India’s stock markets have lost around 40% since the start of the year. Much of it was contributed by fall in sectors where the euphoria was so high, for instance the realty sector. The unfortunate aspect (or fortunate for the alert investor) is that when such an event happens, the other stocks are also affected by the negative sentiments, though not necessarily to the same extent. Buffett is known for his penchant for creating ‘free lottery tickets’ and with market conditions being what they are, there are a number of free lottery tickets available. We just take 2 examples to illustrate our point.
Ramco Industries
This is a company which manufactures asbestos sheet used for construction activity and is part of a larger group with interests in cement, textiles and IT. Being linked to the construction industry, it has shown very good growth rates in volumes, but has been hurt on the RM cost, primarily cement. What is not realized is that the company has a natural hedge because it holds 20% of Madras Cements, a group company. Hence, if the company is suffering from high prices of cement, then its own group company is benefiting from those very high prices. Furthermore, the market in its wisdom is valuing the entire company at Rs 350cr ($80MM) whereas the market value of just its holding in Madras Cements is Rs 600cr ($150MM). And it has a perfectly sound business with annual cashflow from operations of atleast $10-12MM. Free lottery ticket.
EID Parry
EID Parry
Again, part of a large group, this company is primarily into manufacture of sugar, a cyclical sector which has seen better days. The interesting aspect of this stock is that the current market cap of this company is Rs 1500cr ($375MM) but the market value of its holding in a group company, Coromandal Fertilizers is Rs 1100cr ($275MM). On top of it, this company has recently sold a business (unrelated to its sugar interests) to Roca of Spain for a value of approximately $180MM, an amount which it is about to receive. And the base sugar business is coming for free. Which is supposed to be an upcycle soon.
The cornerstone of Buffett’s investment philosophy is not to count on making a good sale. It is rather to have the purchase price so attractive that even a mediocre sale gives good results. What better than to ‘buy’ something for free?
Achieving emotional detachment that investing requires is tough. As we have written earlier, Buffett, epitomizes the disengaged style of investing, avoiding any unnecessary distractions that might impair his judgment. Which is why, he once wrote that he has so much zest for his work that he and Charlie Munger, ‘tap-dance to work’.
At this point in time, the stock market, petrified with fears of sub-prime loans, high oil, inflation, Iran tensions, elections and recessions is awash with such opportunities. The ‘experts’, who we have written about in one of our earlier articles, are busy animatedly discussing whether the market will fall further, or has fallen enough. But such are the interesting times that we live in, that investors who didn’t think twice about investing in companies at 90-100 times earnings (or with no earnings even) are unwilling to look at good companies which are available virtually for free.
The Sensex now trades at a forward PE multiple of less than 15X, which is similar to the US. The BSE 200 and 500 are trading around 13.5-14X and the mid-caps are available for even lower. Everyone expects that India’s GDP growth will slow down to around 7%. Morgan Stanley in one of its reports has suggested that India’s corporate earnings growth will SLOW DOWN to around 18% in the next fiscal year. We are not sure how a fair multiple to a market should be computed, but a 7% GDP growth and an 18% corporate earnings growth, when the world isn’t exactly a bed of roses, doesn’t sound all that bad.
So here is the irony. While some smart investors can spend in millions just to be able to have a lunch with Warren Buffett, based on Buffett’s very principles, there are free lunches available in the stock market and yet there are few willing to take a bite.
The cornerstone of Buffett’s investment philosophy is not to count on making a good sale. It is rather to have the purchase price so attractive that even a mediocre sale gives good results. What better than to ‘buy’ something for free?
Achieving emotional detachment that investing requires is tough. As we have written earlier, Buffett, epitomizes the disengaged style of investing, avoiding any unnecessary distractions that might impair his judgment. Which is why, he once wrote that he has so much zest for his work that he and Charlie Munger, ‘tap-dance to work’.
At this point in time, the stock market, petrified with fears of sub-prime loans, high oil, inflation, Iran tensions, elections and recessions is awash with such opportunities. The ‘experts’, who we have written about in one of our earlier articles, are busy animatedly discussing whether the market will fall further, or has fallen enough. But such are the interesting times that we live in, that investors who didn’t think twice about investing in companies at 90-100 times earnings (or with no earnings even) are unwilling to look at good companies which are available virtually for free.
The Sensex now trades at a forward PE multiple of less than 15X, which is similar to the US. The BSE 200 and 500 are trading around 13.5-14X and the mid-caps are available for even lower. Everyone expects that India’s GDP growth will slow down to around 7%. Morgan Stanley in one of its reports has suggested that India’s corporate earnings growth will SLOW DOWN to around 18% in the next fiscal year. We are not sure how a fair multiple to a market should be computed, but a 7% GDP growth and an 18% corporate earnings growth, when the world isn’t exactly a bed of roses, doesn’t sound all that bad.
So here is the irony. While some smart investors can spend in millions just to be able to have a lunch with Warren Buffett, based on Buffett’s very principles, there are free lunches available in the stock market and yet there are few willing to take a bite.
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