05 – GOVERNMENT INVOLVEMENT WITH THE ECONOMIC CYCLE – Mastering The Market Cycle

Generally, the economy works as either a free economy or a communist economy. But the most accepted free economy also needs government interference sometimes. There are interventions made by controlling authorities for shaping the economy and help the economy to grow well.

Central Bank

Central Bank such as RBI concerns managing the economic cycle which is mainly through inflation and employment. Inflation has a two type –

  • Demand-pull where the demand for products increases more than of supply.
  • Cost-push where prices of labor and raw materials increases.

Central Bank involves in reducing money supply in the economy through increased interest rates, selling of securities which resulted in lower demand due to lower availability of money and inflation comes down.

Such an act also hampers the growth of an economy.

When it comes to generating more employment in the economy then the central bank increases the money supply to the economy through reducing interest rates, purchases of securities (quantitative easing), etc.

Central Bank has to maintain a balance between employment generation and limiting inflation.

 INTEREST RATE CUTS: DOES IT PROVIDE LONG-TERM BENEFITS?

Government

The government has a wide area of responsibilities and the economy is one of those. The government has the main tool for managing the economic cycle is fiscal which includes taxing and spending. So, for stimulating the economy, government cuts tax, increases government spending, provides stimulus packages. Government reversely increase taxes, reduce spending and another stimulus when they feel that the economy is overheating.

Also, the government has to look after the deficit which results in the increases in debt levels.

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The above stimulus will invite higher taxes when either economy overheating or debt level of economy crossing limits.

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If higher taxes and lower spending by the government with the fiscal surplus resulted in the lower down of debt level and the fund goes out of the economy. Reversely, lower taxes and higher spending by the government bring more fiscal deficits and that will have resulted in the increasing borrowing levels.

Similarly, currently, Government has cut corporate tax rates in India and this will have resulted in the above process mentioned in rate cut but in a longer period, this lower tax can be increasing a debt level. India is a developing economy that requires higher government spending as well so that that will surely going to increases a deficit and will increase a debt level. But for stimulating growth in the economy it is a welcome step. Otherwise, the economy starts failing. The government has to take appropriate steps whenever requires.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

WARREN BUFFETT’S LETTER – 2007

Warren Buffett’s Letter 2007

Businesses – The Great, the Good and the Gruesome

One of the concepts which are essential to understanding making an investment and value to the business.

WB 2007 01

Many of us focus on the story builds for a particular business and make a hope investing rather than focusing on the actual reality. I always quote- “Stories are for kids, not for investors.” We need to focus on the ability of the company for creating access return on invested capital (Access return means higher than the cost of capital) and that should be sustainable for a longer period of time.

WB 2007 02

Mr.Buffett has always put a huge emphasis on the business which has a moat and earns consistently higher return compared to the cost of capital.

WB 2007 03

See’s Candy as an example of Great business

WB 2007 04

Indian Companies example for Great business

One of the two-wheeler and commercial vehicle manufacturing company

Eicher 01Eicher 02Eicher 03Eicher 04

One of the FMCG Company

HUL 01

HUL 02HUL 03HUL 04

One of the Assets Management Company

HDFC AMC 01HDFC AMC 02HDFC AMC 03HDFC AMC 04

Here, the company does not require to make a huge investment to earn more money. Float itself take care of the major requirement of the invested capital. Many a time float covers working capital as well as fixed assets requirement. Due to such nature, Profit earns from operation majorly gets to the investment and cash so that investment and cash to the company is compound which also provides benefits to the business.

Good Business

WB 2007 05

Good business which does not have float available with the business or least float available with business, company has to invest money which they earn from profit, and sometimes little external funding also requires.

Indian Companies example for Good business

One of the company from tableware industry

La Opala 01La Opala 02La Opala 03La Opala 04

One of the pharma company

Ajanta Pharma 01Ajanta Pharma 02Ajanta Pharma 03Ajanta Pharma 04

One of the Tea manufacturing company

Goodricke 01Goodricke 02Goodricke 03Goodricke 04

Gruesome Business

WB 2007 06

A gruesome business which does not have float available with the business, company has to invest money which they earn from profit, and also external funding requires to earn little profitability, sustaining the business or further growth. Here, huge capital is required to run a business.

Mr.Buffett has quoted an example of U.S. Air, He acquired a preference share of the company in the year 1989 and sold at the year 1998 with a huge gain. After that company gone for bankruptcy for the twice. The airline business is a cyclical business, huge dependence on the prices of crude oil and during the year 1998-99, crude oil prices were at the bottom (near to the price at the year 1988). So that profitability gets improved for the year 1998-99 and after that crude has never come back to those price level, which has affected to the profitability of the company.

Indian Companies example for gruesome business    

One of the telecom company of India

Idea 01Idea 02Idea 03

One of the logistics company

Snowman 01Snowman 02Snowman 03

One of the steel manufacturing company

Jindal Steel 01Jindal Steel 02Jindal Steel 03

WB 2007 07

We have to use a different valuation matrix for each category of the businesses and cannot provide a similar valuation to each category of businesses. We cannot give the same value to pour water and to dirty water. Yes, it is true that we can make process and pour dirty water but for that, we need to bring more capital and many a times, few qualities of water will be lost during the process of dirty water to pour water.

WB 2007 08

We have to sell out our position into the cyclical business at the proper time or else we stuck with the business.

WB 2007 09

Indian company’s example

For how to enter to the cyclical businesses, kindly visit – WARREN BUFFETT’S LETTER – 1987

Now, for taking an exit from cyclical businesses – When margin approaching towards a previous high margin, we should start to exit from a cyclical business. We need to track the price of the commodities as well as quarterly operating margins.

Sugar companies

Balram ExitBalram Exit 01

EID Exit 01EID Exit 02

Cement Company

JK Cement Exit 01JK Cement Exit 02

Warren Buffett’s Letters 1957 – 2012

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