INFLATION

Inflation is defined as a sustained increase in the general level of prices for goods and services.

There are several variations on inflation:

• Deflation is when the general level of prices is falling. This is the opposite of inflation.
• Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!
• Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

Causes of Inflation

Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.

Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

While leaving aside the debate on whether India should adopt CPI (Consumer Price Index), rather than the current WPI (Wholesale Price Index). Let’s find in detail how inflation rate is calculated in India; which is the WPI based inflation rate.

Mathematically, inflation or inflation rate is calculated as the percentage rate of change of a certain price index. The price indices widely used for this are Consumer Price Index (adopted by countries such as USA, UK, Japan and China) and Wholesale Price Index (adopted by countries such as India). Thus inflation rate, generally, is derived from CPI or WPI. Both methods have advantages and disadvantages. Since India uses WPI method for inflation calculation, let’s go in to the details of WPI based inflation calculation.

How is WPI (Wholesale Price Index) calculated?
In this method, a set of 435 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various strata of the economy and are supposed to give a comprehensive WPI value for the economy.

WPI is calculated on a base year and WPI for the base year is assumed to be 100. To show the calculation, let’s assume the base year to be 1970.

Let's calculate WPI for the year 1980 for a particular commodity, say wheat. Assume that the price of a kilogram of wheat in 1970 = Rs 5.75 and in 1980 = Rs 6.10

The WPI of wheat for the year 1980 is,
(Price of Wheat in 1980 – Price of Wheat in 1970)/ Price of Wheat in 1970 x 100

i.e. (6.10 – 5.75)/5.75 x 100 = 6.09

Since WPI for the base year is assumed as 100, WPI for 1980 will become 100 + 6.09 = 106.09.

In this way individual WPI values for the remaining 434 commodities are calculated and then the weighted average of individual WPI figures are found out to arrive at the overall Wholesale Price Index. Commodities are given weight-age depending upon their influence in the economy.

How is inflation rate calculated?
If we have the WPI values of two time zones, say, beginning and end of year, the inflation rate for the year will be,

(WPI of end of year – WPI of beginning of year)/WPI of beginning of year x 100

For example, WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is 109.72 then inflation rate for the year 1981 is,

(109.72 – 106.09)/106.09 x 100 = 3.42% and we say the inflation rate for the year 1981 is 3.42%.

Since WPI figures are available every week, inflation for a particular week is calculated based on the above method using WPI on the later week and WPI on the previous week. This is how we get weekly inflation rates in India.

Warren Buffett's secrets of success

'The first rule is not to lose. The second rule is not to forget the first rule.'

• 'Wide diversification is only required when investors do not understand what they are doing.'

• 'Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years.'

• 'We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.'

• 'Our favourite holding period is forever.'

• 'If past history was all there was to the game, the richest people would be librarians.'

• 'Why not invest your assets in the companies you really like? As Mae West said, 'Too much of a good thing can be wonderful.''

• 'Your premium brand had better be delivering something special, or it's not going to get the business.'

• 'You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.'

• 'We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own assets.'

• 'Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable.'

'Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.'

• 'The investor of today does not profit from yesterday's growth.'

• 'Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.'

• 'I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.'

• 'I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.'

• 'I always knew I was going to be rich. I don't think I ever doubted it for a minute.'

• 'We enjoy the process far more than the proceeds.'

• 'You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.'

• 'I buy expensive suits. They just look cheap on me.'

• 'Let blockheads read what blockheads wrote.'

• 'I do not like debt and do not like to invest in companies that have too much debt, particularly long-term debt. With long-term debt, increases in interest rates can drastically affect company profits and make future cash flows less predictable.'

• 'My grandfather would sell me Wrigley's chewing gum and I would go door to door around my neighbourhood selling it. He also sold me a Coca-Cola for a quarter and I would sell it for a nickel each in the neighbourhood, so I made a small profit. I was always trying to do something like this.'

• 'A public-opinion poll is no substitute for thought.'

Naveen Mutnal's: Warren Buffet's Secrets of Succes

Naveen Mutnal's: Warren Buffet's Secrets of Succes

Warren Buffet's Secrets of Succes

Warren Buffett, Chairman of Berkshire Hathaway, is arguably the world's greatest investor. He is also a great philanthropist: last year he declared plans to give away over $37 billion (Rs 151,700 crore) in charity, to the Bill & Melinda Gates Foundation.

But he is not just a man with a large heart and a matching wallet. Also known as The Sage of Omaha, he is also full of wisdom and wit.

Here are some of his gems of advice for investors who look at the stock market to make a fortune, culled from various publications, his speeches and writings:

• 'Never invest in a business you cannot understand.'

• 'Always invest for the long term.'

• 'Remember that the stock market is manic-depressive.'

• 'Buy a business, don't rent stocks.'

• 'Price is what you pay. Value is what you get.'

• 'Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.'

• 'I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.'

• 'Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those who take the subway.'

• 'Buy companies with strong histories of profitability and with a dominant business franchise.'

• 'It is optimism that is the enemy of the rational buyer.'

• 'As far as you are concerned, the stock market does not exist. Ignore it.'

• 'The ability to say 'no' is a tremendous advantage for an investor.'

• 'If you're doing something you love, you're more likely to put your all into it, and that generally equates to making money.'

'My idea of a group decision is to look in the mirror.'

• 'Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.'

• 'The smarter the journalists are, the better off society is.'

• 'Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.'

• 'Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing.'

• 'You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right - that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else.'

• 'There seems to be some perverse human characteristic that likes to make easy things difficult.'

• 'In the short run, the market is a voting machine but in the long run it is a weighing machine.'

• 'It's only when the tide goes out that you learn who's been swimming naked.'

• 'Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don't have the first, the other two will kill you. You think about it; it's true. If you hire somebody without the first, you really want them to be dumb and lazy.'

• 'There are three kinds of people in the world: those who can count, and those who can't.'

• 'It takes 20 years to build a reputation and five minutes to lose it.'

Billion dollar investing tips from Warren Buffett

Invest in Businesses, Not in Stocks

"Whenever we buy common stocks for Berkshire's insurance companies (leaving aside arbitrage purchases), we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay." -- Warren Buffett

This is the cornerstone of Buffett's investment style. Whenever he evaluates an investment opportunity he analyses it as a business and not as a stock. This makes him look closely at the company's fundamentals, earnings prospects, financial health and management. Conversely, this style of evaluating a business prevents him from buying a stock just because it is going up even though it has dubious prospects. A lot of investors tend to buy stocks based on tips from friends, acquaintances or brokers. By adopting Buffett's approach, you can save yourself a lot of grief later on.

Only Buy Businesses that You Understand

"Did we foresee thirty years ago what would transpire in the television manufacturing or computer industries? Of course not. Why, then, should Charlie and I now think we can predict the future of other rapidly evolving business? We'll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight?" -- Warren Buffett

Buffett has a track record of generating 21 per cent annually compounded returns over a 50-year time frame, a feat matched by very few investment managers. Though technology companies delivered some of the best returns during this period, Buffet has never owned one for the simple reason that he could not understand the long term prospects of these companies and evaluate them thoroughly. So the next time you get a tip to buy a "hot" company that you do not understand, you should ask yourself: "If the greatest investor in the world will not invest in something he doesn't understand, should I?"

Buy Companies with Defensible 'Franchise'

"As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: 'Competition may prove hazardous to human wealth'." -- Warren Buffett

Most of Buffett's portfolio companies, such as Coca Cola, Gillette (now Procter and Gamble), American Express and Washington Post, are businesses which have a significant hold over their market. This is because they have inherent competitive advantages, whether it be a highly recognizable brand, or near-monopoly status in a geographic area. Such companies can typically raise their prices without fear that customers will walk away. This in turn produces fantastic earnings growth and, consequently, great investment performance. So, before you make an investment in future, try to understand whether the company you are investing in has a strong and defensible market position and whether it can raise prices if it needs to.

Hold for the Long Term

"We are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate . . . we do not sell our holdings just because they have appreciated or because we have held them for a long time." � Warren Buffett

Buffett's companies have generated enormous returns for him. For example, his investment of $10 million in 1973 in the Washington Post Company had grown to more than $1 billion by 2003. While a lot of us may be able to do this occasionally, Buffett has generated such returns with startling regularity. One of the reasons he is able to do so is because he holds for the long term and is not quick to enter or exit businesses. In fact, he stuck with WPC for two years even though its price fell below his purchase price because he understood the fundamentals of the business and believed that it was undervalued. Even once it became profitable, he was not quick to exit because he believed that it had greater potential. He held it through several bull and bear markets and no greater proof is needed than the return he achieved to show that he was right in holding it for so long.

Ignore Short-Term Fluctuations in Price

"Charlie and I let our marketable equities tell us by their operating results�not by their daily, or even yearly, price quotations�whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it." � Warren Buffett

The stock market has a tendency to overreact on both the upside and downside. Often the market ignores the fundamentals of a business and reacts sharply to news flow. Sometimes entire sectors become either unduly depressed or overpriced. One of the key pillars of Buffett's approach is to ignore short-term fluctuations in price. He does not sell a stock because the market suddenly decides to drop. Neither does he buy one because it is going up. Once Buffett has calmly evaluated the fundamentals, he will buy the stock if its price is right. If the stock dips after he has purchased it, he does not worry so long as its fundamentals are good. Had he gotten jittery due to short-term price fluctuations, he would have been a lot less richer than he his currently.

Buy Good Businesses When Prices are Down

"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they feel elated when stock prices rise and depressed when they fall. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." � Warren Buffett

On 19 October 1987, all global stock markets crashed. The Dow Jones Industrial Average actually suffered a decline of 22 per cent, the greatest single-day drop in its history. Every stock on the market fell. Most people sold their holdings in panic that day. Buffett, however, was buying! He made the single largest stock purchase of his life that day. While all others around him hit the panic button, Buffet bought 10 per cent of Coca Cola for $1 billion. Not only was it his largest single stock purchase, he also became the single largest shareholder in the company. In his analysis, Coca Cola had a great business, great long-term prospects and the ability to expand because of globalisation. If the market was willing to sell it at an unreasonably cheap price, he wanted to scoop it up with both hands. And scoop it up he did! Coca Cola became one of the most successful investments in Berkshire's portfolio. By 2006, Buffett had made over $11 billion on Coke since he bought it.

Don't Be an Active Trader

"Indeed, we believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic." � Warren Buffett

Buffett is an atypical investor not only because he is highly successful, but also because he does not even look at stock tickers. He believes that trading too much is a tax-inefficient and costly approach to investing. Consequently, he has a very low turnover portfolio, very low brokerage charges and has not paid very much in the nature of capital gains taxes.

Do Not Over-Diversify

"If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantage, conventional diversification makes no sense for you." -- Warren Buffett

A striking aspect of Buffett's portfolio at Berkshire is the small number of stocks in it. This number has rarely exceeded 10 stocks. Buffett believes that there are very few outstanding investment opportunities at any given point of time and that one should invest enough in each of those to make a substantial difference. In contrast, most people fill up their portfolios with more than fifty stocks. As a result, even if a stock appreciates 100 per cent, the impact on their net worth will only be 2 per cent. Investors who want to generate truly outstanding returns should identify a small number of great businesses at the right prices and invest a significant amount of their money in each of them.

Invest Only When There is a Margin of Safety

"Margin of safety" is a slightly difficult concept to understand. It can be loosely defined as the difference between value and price. If the value of what you buy is higher than the price you pay for it, you have a high margin of safety. If the price you pay is greater than value, you have a low margin of safety. When the margin of safety is high, the investor need not worry about short-term fluctuations in price and can buy more if he or she has the resources to do so. Also, if you are investing in a situation with a significant margin of safety, you are likely to make a higher return because you are buying at a relatively low price.