While there is no shortage of doomsayers in India, and to be fair a relative abundance of negative economic indicators, there is some evidence that the rest of the world may be regaining confidence in India as an investment destination. International (foreign) investors have been net purchasers of Indian stocks to the tune of $400mn so far in December and last week were net buyers of Indian equities for five consecutive days, an 8 month record. While these figures have a long way to go before offsetting the massive outflows of FII which India has witnessed since the credit-crunch exploded on the global scene, they do provide some temporary succor.

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Efficient-market theory (or Efficient Market Hypothesis EMH) argues that in the long run it is impossible to “beat the market” because the current price of a stock always factors in all available information.

According to the theory, stocks always trade at fair value and it is impossible to buy undervalued stocks or sell stocks for inflated prices. Therefore it is impossible to outperform the market by stock picking or market timing; the only way to earn higher returns is to buy riskier investments. The theory gained prominence in the mid-1960s and in 1970 Eugene Fama refined it into three distinct forms: weak, semi-strong and strong. (more…)

 As with most sectors, Indian pharmaceutical companies have had a tough year. Rising raw material and energy costs squeezed margins for everyone but  this was accentuated in the pharmaceutical sector as China halted production of intermediate drugs in the run up to the Olympics. The depreciation of the Rupee also hit many of the bigger players who booked large mark-to-market losses on FX hedges and saw their interest outgoings on foreign currency loans rocket.

The net outcome of these factors was an aggregate 7% reduction in PBT for domestic pharma companies, despite a respectable 24% increase in top line revenue, resulting unsurprisingly in significant market sell-offs. The BSE Healthcare Index is 29% down over the last 12 months with some of the larger pharma stocks such as Ranbaxy and Dr Reddy’s Laboratories being heavily sold (50% and 35% respective YTD fall in share price). However, despite this backdrop the future outlook gives some cause for optimism.

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The crash of the Indian Stock Market since January 2008 has been widely attributed to FIIs pulling their money out to meet liabilities and redemptions. According to this article, however, FIIs have only pulled out $12.7bn and still have another $53.7bn, or almost Rs. 270,000 Cr. left in the market. 

A lot of market experts are talking about the market being near the bottom (”Valuations just cannot get any cheaper! The Indian growth story is sound, even at 7%!”) Let’s be clear on this: these falling prices are not about fundamentals - its simply about lack of liquidity. FIIs are not exiting the market because they want to, but because they are being forced to - nobody wants to book such massive losses, and nobody would argue against the fact that as an emerging market India is looking pretty cheap.

The fact that there’s so much FII money still in the market - 80% - is quite scary (more…)

So this is what happened in the US. Banks started giving mortgages to people who had a poor credit record (sub-prime), and clearly couldn’t afford to pay back the loans. They knew this but thought that since house prices would always go up, borrowers could always refinance their loans against the additional equity due to appreciated house prices. Alternatively, banks thought that they could take over the defaulter’s home and sell it for higher than the original loan amount. Of course, what brought the house of cards down was the fact that of course house prices didn’t continue to go up: borrowers defaulted en masse so banks were stuck with a ton of houses (increase in supply of houses), and since they now stopped lending to people who couldn’t afford to pay, demand for houses fell. Falling house prices lead to more defaulting, which lead to a further fall in house prices and so on.

Why wouldn’ this happen in India? Two words: Black money. Property in India is purchased using both declared income, on which taxes have been paid (white money) and undeclared income, on which taxes haven’t been paid (black money). When a borrower takes out a mortgage in India, he’ll obviously only get the loan for the amount paid in ‘white’. However, if he defaults, the bank will take possession of the entire house, which is probably much higher in value because of the ‘black’ component. Only if there is an extremely aggressively fall in real estate prices - so much so that the black component is wiped out (which given our fairly strong domestic economy, is unlikely), do we have something to worry about. 

So black money serves as a protective cushion - who would have though it?

One week ago, this wasn’t likely. 

Even those who were smart enough to recognize that the independent investment bank model was no longer viable thought that Goldman would get acquired. 

There were whispers that the ~ GBP 103 Billion HSBC (the only mega cap bank stock to actually give investors a positive return year to date), would be the one to pick up the franchise. I for one, was one of the people who liked this story – it made sense right? There really didn’t seem to be anybody else who had the firepower at least liquidity-wise to pull off that kind of trade. 

I was naive. I forgot about Goldman. 

Firepower clearly has nothing to do with liquidity. The kind of lobby that Goldman commands is undeniable. How else do you explain the fact that Bear, Merrill, and Lehman were allowed to fail (more…)

Many are loudly criticizing Paulson’s mega bailout fund. $700bn is not a small amount  considering the fact that the global GDP as of 2007 is estimated at around $55 trn (1% of global GDP), and the size of the US economy is around $14 trn (therefore around 5% of US GDP).

People are saying that the US taxpayer is getting squeezed from every which angle to make up for the irresponsibility of mega ‘sophisticated’ financial institutions. Not only is he having to deal with a fall in the prices of his real estate assets, costlier credit, job insecurity and business uncertainty, he’s now having to subsidize something that he doesn’t even understand. This is not entirely true however (more…)

I did a stint at AIG about a year back, helping them with restructuring their UK business into a consolidated entity. They were speaking to Standard & Poors to get a credit rating for the consolidated entity. They got the rating that they were looking for. I wasn’t surprised, the amount I heard about AIG’s gold standard risk management infrastructure and the highly risk averse investment mandate.

Of course this didn’t help much when the $440bn worth of Credit Default Swaps (CDS) that they issued to everybody and their uncle (more…)

A lot of people were criticizing BoA for overpaying for the third largest investment bank in the world at $50bn. Only time will tell, of course, but my feeling is that they did quite well to time the acquisition just days before the secretary of the US Treasury, ex-CEO of Goldman Sachs, Hank Paulson unveiled his plans to save the world through his $700bn US government fund.

After this announcement, most banking stocks that had been so badly beaten down over the last rallied 30% on Friday, and the UK FTSE closed a record 8% up. Such movements are unheard of in mature markets such as the US and the UK. If BoA had waited around, chances are that they would have had to pay more than the $50bn. (more…)

I attended my first Startup Saturday Mumbai event today at the SP Jain Management Institute. I must say that overall I was quite pleased by the entire event. By the end of the event (in our true Indian style, people including the speakers and myself arrived late), 35 odd people showed up. This was a good mix of entrepreneurs, would-be entrepreneurs, bloggers and (unfortunately only) one person from the VC community – Hemir Doshi from IDG VC India. Both speakers were good, but I enjoyed listening to Rang De’s founders’ story more than the talk on the ‘importance of monitoring competition’. (more…)

CMP:  Rs 88.60

Investment horizon: 1 year

In this meltdown of stock market, realty sector is bleeding the most. It is down 65% from its peak. The sector is under performing due to hardening interest rates and rising commodity prices.  Many of the realty are now available at attractive valuations as a result of re-rating in this sector.

One of the growth pick in this segment is HCC. HCC is an integrated group with eight decades of experience and has interests in construction, real estate, and infrastructure development. HCC specializes in technical complex, new age construction in infrastructure projects, as well as EPC, BOT, integrated projects and townships.  (more…)

One of our reader’s comment on Gautam’s post brought up an interesting point, regarding oil and it’s affect on the dollar (and by association the rupee). The question arises: Why has the Rupee done an about-turn against the dollar? The Dollar Smile Hypothesis developed by Stephen Jen at Morgan Stanley helps explain the correlation.

In very general terms, currency valuations are based on the growth rate of the particular nation. Since the US economy has been growing at a slower clip, the dollar should weaken against the global basket of currencies. We have seen exactly that, especially last year where we reached 39 Rupees a dollar from 46. However, a curious thing has occurred in just the last couple months: the dollar has in fact strengthened against the world’s currencies including the Rupee as we can see:

The theory suggests that the dollar has a convex relationship to US economic growth. Thus while it remains (more…)

Like many economies India is going through a period of monetary tightening as the RBI tries to slow demand growth and therefore inflation. Unlike many economies the Indian government bears the lion’s share of oil price exposure, so what caused inflation if not the price of crude?

A recent report by Morgan Stanley’s Global Economic Forum, suggests that lagging infrastructure investment has been a major factor. (more…)

Periods of high inflation often provide a much more difficult investment environment than periods of low inflation. Investors may therefore need to adopt a more active investment style if they are to maximise returns.

When inflation is high, as it is now, there are two basic principles which should be followed. Firstly, buy companies whose earnings growth will be able offset the inflationary effects on P/E ratios. Secondly, be prepared to rebalance your portfolio between inflationary and deflationary strategies, in response to changes in the economic environment.

The inflationary effect on P/E ratios is that they are generally downgraded in times of high inflation. As inflation rises, the inflationary component of earnings growth becomes a more significant proportion of the total. As the price of both inputs and sales increases, profits generally rise in nominal value without any improvement in productivity. So over time earnings growth, which is a key factor in determining stock price, becomes more and more a product of inflation rather than anything else.

Now you might think that all earnings growth would be a good thing. However, investors typically place less value on increased earnings (more…)

There has been a lot of chatter in the market about FIIs staying away from the Indian markets because they feel that the valuations in India are still relatively quite expensive. Index PE ratios, when looked at in comparison to historical levels are a good way to determine how cheaply/fairly/expensively the companies that make up the index are relative to their historical levels.

But first, an explanation of how an ‘Index’ is calculated: There several ways to create an ‘index’ but the method commonly used is the ‘free float market capitalisation methodology’ where very crudely Indices are calculated adding together the market capitalisation of each of the companies chosen for that index based on some sort of criteria, dividing that figure by the sum of the market capitalisation of those companies that met the same criteria in a base year and then (more…)

Manmohan Singh prepared a Working Paper for the International Monetary Fund in December 2007, in light of the curbs imposed by the Securities and Exchanges Board of India (SEBI). It clearly explains the history and origins of P-notes and suggested at the time what the impact of the curb may be.

Some history:

Since 1992, when FIIs were allowed to invest in Indian equity markets after the balance of payments crisis, an offshore market for PNs developed as a primary conduit for foreign investors to invest in India.

The origins of such flows stems from the bilateral tax treaty that India has had with Mauritius. The main provision of the 1983 treaty was that no resident of Mauritius would be taxed in India on capital gains arising from the sale of securities in India. The treaty therefore gave capital gains exemption for investments routed via Mauritius. Despite the uniform reduction in capital gains tax arbitrage that existed from the early 1990s through July 2004, it is interesting to note that there has been a rapid growth in the market for PNs in the last three to four years.

In the decade, short term capital gains have been as high as 40% and long term capital gains as high as 20%. However, since July 2004, the tax treatment on short term (security held for less than 1 year) capital gainshave been reduced to 10%, and there are no taxes (more…)

We haven’t heard much (except Bhave telling some investors that SEBI may allow it, read BS article here) about Real Estate Investment Trusts (REITs) since SEBI released the draft guidelines in December last year - but I think that its a very interesting concept and worth a revisit.

Real estate in India has experienced exceptional growth since 2004-05, with some cities even experiencing a more than 50% price rise on a compounded annual basis. While pundits and the common man alike are slightly nervous owing to double digit inflation, rising crude prices, and a stumbling equity market - leading to a cooling of real estate prices in tier 1 cities, residential and commercial real projects in tier 2 and tier 3 cities are holding firm. 8 months have already passed since the equity market crash of January this year, and while many are forecasting a further drop in the markets, others are talking more optimistically about us already having bottomed out, and the interest rate cycle having peaked. This bodes well for the real estate market, and as inflation and interest rates start coming off over the next 6 months (we hope) - this will lead to a resumption of the real estate bull run.

With this backdrop, Indian investors are slated to have access to real estate investment trusts (REITS) as the country is poised to embrace deregulation and further formalization of its booming real estate market.

The move is driven in part by the demand fuelled by domestic players looking to implement ambitious expansion plans. Reits have been introduced in most of Asia’s leading markets (Singapore, HK and Japan) in the last seven years and the introduction of Indian Reits will prevent the profitable Reit business going overseas. Moreover, as property prices in the the US and elsewhere crumble in light of the subprime mess, foreign investors seeking to allocate their capital to real estate will seek to put their funds elsewhere - e.g. developing economies such as India, where although there has been recent turmoil, fundamentals are strong, and this may be a good opportunity to get in at a bargain. Reits would certainly be a mechanism that simplifies investment (more…)

In many ways the US has recently been facing the kind of balance of payments problems which have been seen many times before, but most often in emerging economies.

For several years now, the US has run a large trade deficit by feeding domestic consumption with cheap imports from emerging economies, most notably China. The large flow of money out of the economy was offset by inward capital investment from Europe, Asia and the Middle East.

Since the credit crunch started to bite, the stability of the US financial system has been called into question by the failure of Bear Stearns and the public difficulties faced by Fannie Mae and Freddie Mac. Coupled with the Fed policy of cutting interest rates to fend off a recession and the gloomy consumer outlook underpinned by housing market instability, the US has become a much less attractive destination for international capital.

Along with low liquidity in global markets, the deteriorating attractiveness of the US has put pressure on the dollar to weaken to keep the money flowing in. These were the main factors behind the dollar hitting lows against the EUR, GBP and JPY in Q1 2008.

However the dollar has strengthened in Q2 and the beginning of Q3, largely due to the weakness of other developed economies; the Eurozone and the UK flirt dangerously with their own recessions and the outlook for the Japanese economy looks little better. Whether the dollar rally will continue depends largely on three factors; firstly, whether the Fed can maintain stability (more…)

I wrote this post after reading an article about behavioural economics on the Fundoo Professor’s Blog:

I recently read an interesting article on a simple variation of the prisoner’s dilemma game: A small amount of money was placed in front of two participants, one was told to choose how to split the money between the two of them, and the other told that if he rejected the offer neither of them would get anything.

The second participant had two possible outcomes; receive no money or accept whatever the other person offered. Rational economic theory would therefore suggest that they should accept any offer that the first participant made. Researches however found that many people would reject offers of 10-20% of the total although they had no economic reason to do so, presumably because (more…)

Given the recent news SEBI considering (but not doing anything yet) about revoking the P-note ban, I thought it might be a good idea to revisit the topic. Thank you to Akshay for passing on info that has helped me better write this post.

In India, only domestic investors, or ‘Foreign Institutional Investors’ (FIIs) - those foreign institutions that have registered with SEBI, are allow to invest into the equity markets directly. Participatory notes (P-notes) allow foreign investors, such as hedge funds, which are not registered with SEBI to invest easily in the Indian equity market.

Practically, the way that P-notes work is that a foreign investor - say a hedge fund - would deposit funds with an FII that is authorized to issue P-notes, who would use the funds to purchase shares as instructed by the hedge fund. The FII would then issue a P-note to the hedge fund, which is essentially a certificate that says that it is entitled to X shares of company ABC, and any capital gains or losses and dividend payments would be passed onto the hedge fund. In return for this service, the hedge fund would pay the FII a fee.

A crude example: If a hedge fund not registered with SEBI wants to buy one share of Hindustan Unilever Limited (HUL), their FII would pick up a share of HUL for Rs. 240 and write a contract that says that in return for a fee and the Rs. 240 paid by the hedge fund, when the hedge fund asks the broker to sell the share they will comply and pay back the hedge the Rs. 240 plus or minus the rise or fall of the share price and the dividends if there were any.

Because foreign investors bought P-notes from reputable FIIs (they knew that they wouldn’t go back on the agreement), and there was a healthy supply of P-notes going around, foreign institutions were able to trade these P-notes amongst themselves.

On October 16, 2007, N. Damodaran, the then SEBI chief issued a decision to curb foreign participation through P-notes as he felt that there was excess money being pumped into the Indian market unchecked leading to volatility - which is always bad thing, especially for the retail investor (more…)

With the emergence of large domestic (Pantaloon’s Big Bazaar) and international players (Metro AG, Tesco, Tesco/Trent- read my post on this, Bharti/Wal-Mart) in large scale organized retail, I got to thinking – how does this affect the margins of consumer product companies such has Hindustan Unilever, Colgate-Palmolive, and Cavin Kare? On one hand, you might see margins (the different between how much you sell for and how much it costs you) on goods increasing due to a lower distribution cost – its easier to distribute 100,000 bars of Lux soap to one Metro AG in one go, than distribute that amount in rural India.

On the other hand, since these stores buy in bulk, they’re in a much better position to negotiate on cost – therefore pushing margins down. Moreover, many of these stores (more…)

When the equity markets are faring poorly due to a bad economic environment. When trying to figure out whether a company’s stock is defensive or not - ask yourself one question - are its products neccessities or luxuries? Can consumers cut back spending on them just because economic conditions are poor and they’ve possibly seen a reduction in wages, or been laid off? Indeed, could the consumption of the goods created by such a company rise in uncertain times?

Sectors that have traditionally been thought of as defensive include Food, Tobacco, Utilities, and Oil. Makes sense - the amount that households can cut back on Food is limited, and indeed, Tobacco consumption tends to go up when times are bad. When input costs rise, these are the companies that can pass on the price rises to the consumer. Therefore, in times of economic uncertainty, equity investors’ money flows into these types of stocks, leading to an increases in their prices.

However, when times are good, the stocks that fall into the above sectors aren’t star performers - for the opposite reason as outlined above, there’s only so much you can eat - indeed margins in the stocks of defensive industries are often quite low.

Let’s look at two stocks that are considered defensive (more…)