The government surprised the markets last month by cutting corporate tax rates to 25.6% from 34.9% (all inclusive) earlier. All else equal, the future profits of a company currently operating on a full tax rate should increase by ~15% and therefore the intrinsic value should also go up. However, the reality is a bit complicated. We share below our thoughts on the impact of tax cuts on different companies.
Avoiding Landmines: The Panama Pump
In 1969, Eddie Antar opened a consumer electronics store in New York. Eddie’s stores (later renamed as Crazy Eddie) became popular for selling electronics at deep discounts to their competitors.
Investing in the Era of Platforms
The proliferation of internet has enabled a new breed of businesses called Platforms to thrive. Over the last two decades, several platforms have emerged (YouTube, Uber, Airbnb, Google, Facebook, Apple etc) and decimated many traditional businesses. As per a 2017 Credit Suisse report titled “Technology killing Corporate America”, average age of an S&P 500 company has come down to 20 years from 60 years in the 1950s. It is therefore important to understand the investment implications of the era of Platforms.
Moat + Long Runway = Buy at any price???
2018 has been a year of significant de-rating in multiples of several mid and small cap stocks. However, many businesses with strong moats have been able to avoid the fate of the rest of the market. In most of these cases, stock returns over the last few years have been even higher than the earnings growth. Valuation multiple expansion has been a big driver of returns for these stocks.
How Bad Is This NBFC Liquidity Crisis?
With the recent default on Commercial Papers (CPs) by IL&FS, all NBFC stocks have fallen. NBFC has suddenly become a swear word. While there are concerns on liquidity management of specific NBFCs, there are no solvency concerns as yet. However, this has again given rise to extreme debates such as whether there is even a need/place for NBFCs when so many banks exist. The perceived risk that investors associate with investing in NBFCs has suddenly shot up. And this has happened before too – many times. Let us go back in time to see how things panned out then.
Quality & Governance Matters!
2018 has been a tough year for the broader markets. While the Nifty 50 is up, both the small and midcap indexes have taken a beating. Even among the small and midcap stocks, there are clearly diverging trends. Good businesses with strong moats have fallen far less than poor quality stocks which lack any significant moat. Even among poor quality stocks, there have been diverging trends. Poor quality stocks with governance issues have crashed 50-90% from their peaks.
OTT Disruption In The Indian Media Sector
In January 2018, Netflix announced that it had crossed 54 mn subscribers in the US (i.e. 1 in every 2 US households). Netflix achieved this within 10 years of the launch of its over-the-top video streaming services (OTT[1]).
The last couple of years has seen a similarrapid rise in OTT platformsin India that did not exist few years back –
Investing in PSU Stocks
One of the major events of the last quarter was the announcement of a massive bank recapitalization plan by the central government. Over the last few years, PSU banks have been saddled with extremely high levels of bad debts which has eroded their capital position, limited their ability to compete with private banks and impacted overall credit growth in India.To ensure that the asset quality problems at PSU banks do not impact the economic growth, the government has proposed a 2-lakh crore PSU bank recapitalization plan.
How we generated “Alpha”
This section will address queries that our readers had on how we could outperform in a rising market despite 1) being conservative/risk-averse in our investment strategy and; 2) holding an average of 25%+ cash in the portfolio.
- Being greedy when everyone was fearful
During large parts of last year, we preferred to remain in cash rather than buy stocks at exorbitant valuations. There were long periods when we did not buy or sell a single stock. We used this time to research and build a pipeline of stocks we would buy if prices fell to attractive levels. This discipline of being patient and staying true to our value investing philosophy helped us create a large alpha.
Luck vs Skill
We are close to completing our first year of investing at 2Point2 and this is a good time to take stock of our performance so far. Since inception, we have generated 34.74% in returns compared to 11.64% of the Nifty 50 and 24.74% of Nifty Midcap 100 index. The overall performance has been quite good on both absolute and relative basis. This calls for a celebration. But, maybe not.
Consider the game of cricket. If you aren’t a good player, it is certain that you would struggle to even make it to the gully cricket team let alone dream of being part of the Ranji or national team. Thus, cricket is largely a game of skill. On the other hand, investing (over the short term) is an activity which has a high component of luck. Over the long term, the role of luck diminishes substantially in investing. However, sometimes luck can play a role even in a reasonably long investing period.
