CategoryViews on news

I have been reviewing the results of some companies and a few points are standing out

– raw material cost, over heads and labor costs are now increasing faster than sales
– Net margins are stable or coming down. Profit growth has slowed
– Debt may start getting repriced soon. As a result interest costs could start increasing

Maybe this is not news. However the above has the following implications

– valuations for the market and several companies is still based on the low inflation, high growth and high ROE environment of 2002-2007. If we have stagflation (high inflation and low growth), we could see prices drop sharply.
– Some companies in response to high growth, have taken on large amounts of debt. If we have stagflation, these companies could get hit very badly. The stock price for such companies could plunge sharply.
– In contrast companies with strong competitive advantage and low debt can maintain margins due to pricing power of their products and low interest costs. Such companies may see lower impact to their stock price.

I am not predicting a long period of high inflation and low growth and cannot be sure if we will see drop in stock prices. History (mid 1990’s) gives us a clue. During mid 90’s in response to high inflation, RBI hiked the interest rates to around 15% and we had a period of low growth from 1997-1999. Stock market returns were also poor during this period.

Does it mean that we should sell our stocks and wait for the clouds to clear. I would say no. The future is never crystal clear. It never was and never will be. What we can, however be sure is that good companies, with strong sustianable competitive advantage, will do well in inflationary and recessionary times.

What such times gives us is low prices due to the pesimissm. These low prices can be used to invest in good companies at attractive prices to build a good portfolio. However this is not easy and not for the faint hearted. If the inflation drops and the growth picks up quickly , then the returns could be good in the short term. However if economic situation takes time to turnaround, then be prepared to wait for a long time for the returns to materialize.

US is in recession, Rupee is going to appreciate, wage cost is increasing, IT industry is doomed over,gone ..ok I am exaggerating. This was roughly the view just 1 month back.

I was running a few filters around that time and a lot of IT midcaps came up in the list. Some of these companies were 500 Crs+ companies selling at 2-3 times PE and 3-4 year lows. I listed a few ideas here. Since then there has been a complete change in the outlook.

The initial runup in the stocks seemed to be a correction of over-reaction in the prices. However as soon as Infosys and other results started coming out, there seems to be panic buying happening. Stocks like NIIT tech have gone up from 90 to 135, patni from 200 to around 280. So most of the IT midcaps have seen a 30-40% runup.

So whats the point, you may ask. Well I have always had a dilemma. Once I figure out that a sector or stock is undervalued, how fast should I react in building up a position ?

Based on this episode with IT midcaps, a big position,quickly would make sense. However that is a retrospective approach based on after the fact. Most of my picks go into a coma for quite some time and I typically analyse the stock further in detail for months together and build my position over the course of a few months. This approach helps as I am able to average down my cost, get a better understanding and build a decent position.

However this approach fails me in sudden runups. However in view of my overall time constraints and my need to do a detailed analysis, I prefer to take my time and build my positions. I would rather lose a few quick gains than compromise on my approach and repent later for the sloppy analysis.

In case you are wondering, I did build a position in NIIT tech and Patni computers around the major lows. This was however pure luck. It is quite possible that the opinion may change again and the prices may drop back again and i may get an opportunity to add to these positions or build new ones. Unfortunately I have no abilities to predict the future and do not follow an approach based on one. The downside to the run-up is that these stocks are no longer compelling no-brainers at current prices.

As an aside, I am seeing articles popping up saying capital goods and real estate sectors are overpriced and IT seems to be undervalued. Now you tell me !!

I generally avoid a macro view on stocks. It is quite difficult (for me) to analyse a macro event and then come to a stock specific conclusion.

However there seems to be broad trend of dollar depreciation (that not news 🙂 ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).

Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows

– IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
– Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
– Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.

I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.

I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback 🙂

Deepak has posted on the current news around ICICI.

See – ICICI’s Disclosure See-Saws: Openly Making Fools Of Us

Following is my comment . You can read the discussion and all the comments on his blog

Deepak – Although it would be good to have more disclosure, it may be risky for a bank to do so also.

In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year’s berkshire hathaway AR for some discussion on this)

So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).

I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.

Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.

disclosure – i am neither long nor short this stock

Additional points

The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.

The list of Indian companies going global is expanding rapidly. I am not referring to the IT services /BPO companies which had a global model to start with. I am referring to companies like asian paints, Tata motors, Auto component industries, Pharma companies like Ranbaxy and banks like ICICI  etc.

Clearly the factors for success in the global market would be different from those in India (more in some industries than other). It is difficult to come up with some unifying logic on the factors as each company, its market and strategy is different.

A company like asian paints is expanding in countries like Singapore, Thailand etc but avoiding the developed markets. It is leveraging its capabilities in distribution, channel management, sourcing but not extending its brands. On the other hand ICICI targeting the developed countries, but specifically Indians. It is leveraging its brands, technology etc to expand in these markets.

The common thread I have been able to see among these early globalisers is that these are successful Indian companies who are leveraging their existing capabilities into these global markets. However these companies appear to be defining their strategy clearly by identifying a niche in the global markets and attacking that niche with the distinct capabilities they already have.

For example, Ranbaxy has used its reverse engineering skills and low cost production base to attack the generics market (although some of these pharma companies are getting into drug discovery too).

Auto component companies are using the low cost and engineering talent to become the sole / preferred suppliers for Global auto companies. Another interesting point I noted was that most of Auto component companies have their own niches within the product groups.

I personally think understanding and evaluating the strategy of these companies for these Global markets would be very critical to come up with a proper valuation and a buy/ pass decision.

Any hasty / overly optimistic assumption would mean that one would end up paying for the likely growth potential with no margin of safety if the market also believes in the same thing

Read this article on cnet.com. The article talks of the challenge which google is posing to Microsoft.

Found the following comment interesting. Interesting to see how established business models are getting disrupted constantly , for ex in Telecom, in the desktop space (where Microsoft had a complete monopoly).


Microsoft, it seems, is faced with a classic “innovator’s dilemma,” as author Clayton Christensen put it in his groundbreaking book that defined why tech giants usually miss the next wave of innovation. Microsoft execs made what looked like the right decisions at the time. As a result, the cash came in. The core product, Windows, became bigger and more complicated, and getting updated versions became harder to get out the door.
Plotting the counter-offensiveThe burden of that success, as the theory in the book goes, makes it harder to respond to the next generation of tech innovators. Years ago, Microsoft and Apple rattled IBM. Now Google, some believe, has a chance to rattle Microsoft by providing a cheaper, easier-to-use alternative. “Every other time Microsoft was attacking from below,” said one former executive. “Now (Microsoft) is being attacked from below and they don’t know how to deal with it.”


Can’t think of an equivalent scenario in India. But models which are undergoing a lot of change are retail, the auto industry – auto parts, Pharma industry (we seem to be playing a role in impacting the global industry ). Good to realize that in most of these sectors, Indian companies are acting as the disrupters or would be disrupters.

Looks like a typical buffett move. A company with strong brands such as Budwieser, oligopolistic industry , very high Return on equity for the company, strong distribution, a product / business model which will not change (who is going to stop drinking beer ??) and hence predicable.

seems the only disadvantage is the mcap of the company is small so BRK cannot take a very big position