There’s a pattern to it


Director, Banyan Tree Advisors

December 20, 2011

Once you can identify the underlying trends that make or break companies, it’s easy enough to spot the winners.

Watching children grow is quite a delightful experience. Among the many facets of a child’s growth, I find the way they observe and identify patterns a beautiful thing to watch. It’s fascinating to watch the first time they start to observe patterns and digest them — like noticing that the sun rises and sets every day. Or a few years later, when the child starts
to notice that the phases of the moon repeat themselves. Or that stars too rise and set like the sun.

There is, in fact, a school of thought that believes that knowledge is all about recognising patterns that happen around us, and using them to predict future happenings. But this column attempts not so much to discuss the meaning of knowledge as to sharpen your skills as investors.

And what of corporate pattens? As you watch companies over a period of time, you will slowly start to notice that they have an underlying pattern. Every profit-making company normally has an underlying larger macro pattern that it is riding on. The importance of an investor understanding the macro trend underlying a company’s fortunes cannot be

Take the current software boom for example. In simple terms, a typical engineer sitting in the US gets paid $80 per hour and over the past five years, companies have found a way of getting the same work done in India and charging customers $22 per hour and still managing to make super normal profits. Does it sound simple enough?

No wonder the Indian software industry is growing at 60 per cent. In this case, would you invest with the Indian software industry or with a similar company in the US doing the same job? The No. 1 company riding this trend has gone up 2,000 times since it went public 10 years back!

Or take the case of the readymade garments industry. Ten years back, I was able to get a pair of trousers stitched for about Rs 100, whereas today, I can’t dream of getting it done for anything less than Rs 250. Tailoring is more expensive today (including the cost of two trips to the tailor and the possible risk of the tailor making a mess of it occasionally) than buying readymade trousers. No wonder some readymade garment businesses are growing at above 25 per cent. So, will you invest in a tailor or in a readymade garments company?

The same thing happened in the steel and plastics industry. About 15 years ago, plastic entered India in a major way. The advantages of plastic over steel are numerous – plastics are lighter, they don’t rust, they look better and sometimes last longer. Most important, plastics started getting cheaper. In the same period, the stock price of Reliance went up 10 times and that of Tisco dropped to 10 per cent of its original value.

Take the case of the pharmaceuticals industry. Over the past 50 years, the average life expectancy in India has gone up from less than 40 to over 65. Over the next 50 years, this trend is expected to continue. And it’s a chicken-and-egg story whether the people have benefited from the pharmaceutical companies or the other way around. Wouldn’t you find a high level of comfort investing in pharmaceutical companies?

The home and the world. Or take an interesting social trend. The joint family structure has been dissolving into the nuclear structure over the last 20 years. Even this trend will affect the investment climate. Without getting into a discussion on the moral or social issues that the trend reflects, what you can notice is that packaged foods companies
have benefited a lot. What pickles do you have at home? Your grandmother’s or one of those branded pickles?

The point is simply this. When you go about choosing a stock to invest in, it might be useful to understand the underlying trend the company is riding on. It’s like boarding a bus — you can’t just check how good the driver is; you also need to know in which direction the bus is heading.

If you can trace the trend for a single unit of the product the company is dealing in – such as the cost of readymade trousers vs tailor-made ones — it would help you understand the true story and keep track of any developing trend.

At the least, it will tell you whether it is an exciting story or not.