Consensus(hmm..) Vs Curious?
Consensus Today – I invest in Equity over Debt.
Curious Buddy – Why?
Consensus Today – it’s HDFC to choose b/w the two.
Curious Buddy – Googles “ synonym of HDFC “
Curious Buddy – Great! What all Businesses you like?
Consensus Today – I like to own businesses that fund the Debt of the rest of the corporations in the industry or Debt of the people working for the corporations.
Curious Buddy – But you said it’s a HDFC (no-brainer) to choose b/w the two “Equity Vs Debt “, then why not buy Equity of corporations they fund instead? Are these businesses which finance Debt are out of favor among investors community? and trading at a significant discount to their book value?
Consensus Today – No, you are a fool or what? I am consensus I don’t indulge in “out of favor”, In fact, I don’t understand what it means.
Curious Buddy – But then why you expect businesses finance debt will outperform Equity of the businesses they are financing?
Consensus Today – Equity returns of HDFC bank is != debt returns of its loans to corporates. They can make 20% roe by making 10% Yielding loan to a corporation with 15% roe. (Thanks Pranav Kumar, twitter – @6pranavk )
Curious Buddy – True, but you are paying 5-4x times book value for HDFC bank as well and the corporate with 15% ROE is trading 1x book value that no one talks about.
Consensus Today – Because banks grow 2x of GDP, PSU to Private and All profits are front-loaded, Lots of accounting flexibility – losses can’t be pushed technically infinitely deep into the future. Hence 20% CAGR forever.
Curious Buddy – But that doesn’t answer why it’s a better bet today Vs rest of the industry equity.
Consensus Today – Why ? what else do you need?
Curious Buddy – Okay, If banks grow 2x of GDP that means more money into the hands of rest of Corporates and People working for them and if the rest of Businesses are taking money from businesses you like then there are 3 possibilities
- They took money from banks because they see the possibility to generate higher returns over their Cost of Capital. (Equity outperforms Debt).
- They will default (Banks won’t be paid back)
- Corporates working for banks – They will barely survive to pay down their debt (banks recovered money).
So, you have only a 33% (case C) chance of doing better than Equity holders in the business you financed that too barely. So, by your logic, if banks grow 2x of GDP then why not corporates they are funding on an average should do much better than 2x of GDP for their Equity holders?
Consensus Today – I invest in Retail Banks.
Curious Buddy – Why on Retail Banks?
Consensus Today – They are much safer.
Curious Buddy – How? It’s the same thing, your banks are financing the people who work for “businesses you don’t finance” to consume the products made by “businesses you don’t finance”.
Consensus Today – HDFC outperformed the market for 20 years.
Curious Buddy – Yes Bank outperformed the HDFC bank for 10 years too.
Consensus Today – Warren Buffett bought banks as well.
Curious Buddy – Yes, he was buying them when they were on the brink of default during 2008-09 financial Crisis i.e, against the consensus, and he made a mistake or two also in that process.
In Fact, he said –
And he advised this as well –
Wait a min, I forgot you said you do not understand what “out of favor” means. You wouldn’t have done the same during the financial crisis anyway.
Consensus Today – You are biased against banks, you ask too many questions. I don’t want to talk to you.
Curious Buddy – No, I was just being Curious.
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