Saturday, October 25, 2008

What is Long Term Investing..

I am now seeing a lot of earning downgrades and rating downgrades notes. What happened to looking out 5-yr growth stories? Oops. Sorry investors. We lost you 70%, and now we realize that we can't see where the world is going next week, let alone five years. Unfortunately, the world is not linear, it accelerates and decelerates, and right now it has gone off a cliff.

As Buffett said in his last letter, "When the tide goes out, we see who is swimming naked. We find Wall Street was a nudist beach." He can add the entire Indian sell side and buy side community to the list. They have been happily ensconsced in their 8% growth rate assumption and not even once tried to figure out what is happening around in the world. It was all too macroeconomic, India was decoupled and they wanted to go to company specific detail. 90% of them wouldn't have still heard of CDO and CDS.

Long-term investing doesn't mean that we need to project 5 years out and do a DCF etc. It is all hogwash. Who knows what the right discount rate is? What we need to figure out is

(a) What is the history of the company?
(b) What did the company do when faced with similarly tumultous times - remember 1997 and 2001?
(c) What is the capital allocation policy of the company - the most important decision that long term investors should care about. How does the company raise capital? Does the company use excess free cash to do stupid acquisitions, hoard cash on balance sheet, or return to shareholders?
(d) Is the company reasonably valued on cyclical adjusted EPS and ROE's?

And in these times, I will also add
(e) What is the debt maturity profile of the company. What is its capital structure?

It is widely known that Buffett spends less than 15 min to figure out whether he wants to invest or not. The reason is simple - he knows the history well, and he bets on his knowledge of history. History might not repeat itself, but it is the best guide to the future. The only way to look forward is to look behind.

Kamal Nath and Chidambaram are doing a great disservice right now by insisting that everything is fine and the rupee movement is an aberration. It is not. Currency movements are self-fulfilling prophecies. They need to get together with other Asian countries, particularly Japan and China asap, to intervene in the currency markets. Developed countries are intervening in banks, emerging markets need to intervene in currencies.

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