One Word that Explains Why Only a Few Succeed in the Stock Market
As long as the economy is growing and we have a stable government, past data suggests our equity investments will be fine.
In my previous article, I shared a data point — ‘Those who stayed invested for 15 years, earned more than 12% returns almost 9 out of 10 times.’
While at the face of it, it may sound simple but in reality, staying invested for so long is probably the most difficult thing to do. Most experienced equity investors will vouch for this. Even today, inspite of so many awareness camps, majority still look at the stock market as a get-rich-quick scheme and get out at the first sign of trouble.
Contents:
- Equity — The Most Misunderstood Asset Class
- One Word That Distinguishes Successful Investors
- Gaining Conviction — Looks Impossible But It Isn’t
- Where Do I Get My Conviction From?
- Your Biggest Fear…
- Conclusion
Equity — The Most Misunderstood Asset Class
Most conservative investors allocate a significant portion of their wealth to bank FDs, real estate and gold, as they are perceived to be safe inspite of the poor inflation adjusted returns. In contrast, even though equities are the best bet against inflation, investing in this asset class still remains a stigma for many.
We live in an environment where myths around the pros & cons of various investments proliferate. Those old grandmother stories of how a flat bought for few lakhs got sold for crores is a common discussion thread in most households. Naturally, real estate is seen as a great investment though people look at the returns in absolute terms, from point to point. Plus they get to own something tangible in their hand.
The mistake people make while computing property returns is they fail to account for the investment tenure and additional costs like registration fee, maintenance, brokerage, insurance, property taxes and loan interest. When counted for, returns will be barely in single digits. Add to that the illiquidity factor and the lack of transparency in finding the true value or price.
Following chart clearly depicts the equities outperformance compared to other asset classes over the last decade [Research Credit:@TheOddball]:
As shown in the chart above, from 2011–2021 average inflation has been 6%. Real estate annual return is 10% while equity mutual fund return is 13.5%. Adjusted for inflation, real estate gave 3.76% (even lesser when additional costs included) while equity mutual funds returned 7.1%. This is inspite of the 2011–2021 period being an economically moderate period given the large scale bank NPAs, demonetization, GST implementation and pandemic crisis.
A quick double check on the NHB website revealed that over the last five years real estate annual returns have been just 3–4% (in metros like Mumbai, Delhi and Bangalore. Ofcourse, there can be variations due to a variety of reasons, one of them being the location and period of purchase.
Forget about the price appreciation, even the residential rental annual yields are around 2–3% in most Indian cities. In contrast, the cost of a home loan for residential real estate customers is in the vicinity of 7.5% per annum. Not appealing any more, right.
And then who says it is risk free…This area of business is tainted with so many frauds by developers, brokers. People sometimes bet their life savings waiting for a property to be delivered. The title can be disputed, the land or flat can get grabbed, developer may slip indefinitely on delivery timelines, the tenant may refuse to get out etc.
Equity is not a preferred asset class by many as it is perceived to be a risky asset where some people get lucky. Risk perception comes from volatility. Equity prices and mutual fund NAVs are updated on daily basis. So anyone who is monitoring his portfolio on daily basis, the sense of capital loss during market downturns gets reinforced. This is unlike the real estate market where low liquidity combined with its non-transparency, means investors are often unaware of the loss in capital value during downturns.
All investments must be analyzed on three parameters risk, return and liquidity. Equity prices do fluctuate more than that of real estate but they also provide higher returns, higher liquidity and are totally safe as they are tightly regulated by SEBI. Past performance confirms that.
One Word That Distinguishes Successful Investors
Inspite of the volatility in equities, mature investors hold their ground and see market falls as an opportunity to invest more. Question is what renders them that courage?
It is “Conviction”. Equity investments require conviction and patience. Stock markets are tied to the growth of an economy and since economy is a slow mover, one needs to give time to the investment for good returns. But people want instant gratification. They get influenced by the ‘get rich overnight’ stories, invest based on tips, lose and then label stock investment as a gamble. The thing is you can hardly make any money if you keep trading in and out of the market. Trading is not investing.
So, first important point to remember is economic growth and equities are inter-related.
Keep reading, as I slowly unfold the basic premise of equities. By the end of this article, you would have understood why some are unmoved by the falls.
Why a Country’s Performance Matters in Investment?
Whether we like it or not, performance of our investments are highly dependent on how the country as a whole performs; this is especially true for long term investments.
If the country we reside in happens to default on its borrowings and suffers from never-ending geopolitical and civil unrest, something similar to what happened in Sri Lanka, will the investments do well?
Or imagine a situation where your country is at the cusp of major economic reforms, like the economic liberalization in India that started in 90’s, with business friendly super competent Government but you fail to foresee these opportunities. You decide to play safe and invest your hard-earned money in fixed deposits. Would it be the right decision?
Gaining Conviction Isn’t That Hard
Walking your path of conviction is not difficult. The tough part is finding your path in the first place — In investing, this means understanding the factors that influence stock markets.
I started this article with ‘As long as the economy is growing and we have a stable government, past data suggests our equity investments will be fine.’
How do we find out if the economy is growing? Well there are various economic indicators that tell us about a country’s health and progress. Examples are GDP growth, Inflation, Interest rates, Current Account Deficit (CAD), growth in the forex reserves, PMI, IIP etc. I will not get into the specifics here but maybe in some other article. Instead I will try to present a simplified view.
At a high level, a country is said to progress when the businesses thrive, income levels rise, unemployment falls, consumption increases, infrastructure improves, foreign investments increase and demand for skilled workforce increases. The economic indicators, listed above, help us gauge these parameters. A stable, business friendly, government with a majority mandate has a big role to play in the overall progress of a country.
So does that require investors to be economics experts?
Not at all. Investing based on macroeconomic forecast is a difficult task. Macroeconomics is the study of economic indicators. Even the most trained economists don’t get their forecasts right always. Moreover, the stock market may not necessarily move inline with the forecast. So sitting on the sidelines while the economic news continues to be negative often results in missing a significant upturn in the market.
Investment requires conviction and that comes from within. No matter how sound a forecast might be, it is hard to pull the trigger unless we believe that it is the right thing to do. And that means we need a logical story for our own self on why Indian economy and hence the equities will do well.
Where Do I Get My Conviction From?
Stock Market indices, Nifty50 & Sensex, composition includes large cap companies that represent majority of sectors, as they are the leaders in the respective sectors. Production output of these companies adds up to a big percentage of our country’s GDP. Growth of these companies signifies GDP growth aka economic growth. As stock markets are forward looking, the positive growth outlook from these companies is vital for the stock market performance.
Even though Nifty50 includes only 50 of the 1600 companies traded on NSE, it accounts for up to 66% of the NSE market cap. Hence, index movements have a huge impact on the psyche of an average investor and thus a ripple effect on almost all the stocks.
So the growth of these large caps is vital. But how do we know whether these companies will grow or not. Well, there is no guarantee. It is normal for companies to underperform sometimes, maybe due to the factors outside their control e.g inflationary factors like rise in crude prices impacts the input cost for many and hence narrows down their margins. While short term under performance of one or multiple companies is normal, the likelihood that none will perform for a prolonged period is zero and there is a strong explanation that supports this. (FYI, indices composition goes through a change periodically wherein the consistent performers stay while the consistent losers get replaced.)
Index constituents are leaders from the respective major sectors of the Indian economy. For example, Banking sector is represented by SBI, HDFC Bank, ICICI Bank etc., Oil and Gas by Reliance, Adani Gas, IGL etc., FMCG by HUL, Nestle, ITC, Britannia, Marico etc., telecom by Bharti Airtel, Reliance etc., automobile by Maruti, M&M, Tata Motors, Bajaj Auto etc., IT by TCS, Infosys, HCL etc., healthcare by Sun Pharma, Apollo Hospital etc. and the list goes on. Like that, every sector gets represented. These are all popular household names that touch the life of every Indian on a daily basis. Can you imagine a life without them? Sounds impossible, right. As India’s population grows and earnings increase, one can only expect consumption to go up. Higher consumption will add to the top line and bottom line of these companies.
Next strong factor is the Indian demographics. India is a young country; nearly 65% of its population is younger than 35 [See chart below]. It has an opportunity to drive economic growth on the back of its rising working-age population. As other growing economies confront a rapidly graying population, India’s rising young population has the potential to fulfill the demand for skilled workers worldwide.
The growth of a young population that’s enjoying rising incomes is creating a large emerging middle class in India. This boosts consumption and also opens up new opportunities for businesses as the segment increasingly procures services like education, healthcare insurance etc. from private players. No wonder, foreign investors want to tap the Indian consumer market due to its high volume and high spending capacity. Take the case of Netflix: Given the low penetration in India, it makes a huge case for the company to focus here where the growth lies compared to a developed economy where it is close to saturation. So it is an incentive for both the domestic and overseas investors to incur capital expenditures and expand their footprint.
Then comes the government reforms. Development of the labor-intensive manufacturing sector is crucial for the country to capitalize on its rapidly growing population and the current regime is cognizant of that. Several schemes have been rolled out to boost manufacturing capabilities, encourage exports [e.g PLI schemes for pharma companies] and improve investment climate, including lifting caps on foreign direct investment (FDI). As FDI increases, other than the access to foreign capital, advanced technology and efficient models, new and large foreign markets open up for Indian businesses.
Additionally, government has been spending heavily on infrastructure developments. Infrastructure investments stimulate an economy due to the multiplier effect. Every rupee that government spends creates an additional amount of private sector spending. For example, the government hires a person to build a road, that person goes out and spends money at a store. As the store does good business, store owner hires more workers with the money and so on, thus the multiplier effect.
Government expenditure gets funded by the collected taxes and borrowings from the banks or capital markets. Now in order to keep the borrowings (aka fiscal deficit) in tight control, government has taken effective measures to widen the tax base [See chart below]. As a result, nowadays it is very hard to escape the tax net. Also lower government borrowings frees up more for the private sector to borrow, debt to GDP ratio improves and has a positive impact on the country’s ratings.
Forex reserves have been growing at a healthy pace [See chart below]. Significant reserves cover is necessary as it establishes a good image for the country at the international level. Trading countries can be sure about their payments, thus helping in attracting foreign trade. As an example, Sri Lanka troubles got escalated after the forex cover dropped heavily thereby impacting the ability to provide food, fuel and other essential goods to citizens, and repay massive foreign debts.
Commercial banking sector, which at one point in time was in a stressed state, is healthy again. Inspite of the pandemic jolt, NPA’s are at a six year low, as per the RBI’s official statement in June 2022. Banks are eager to lend to corporates/individuals and far more cautious than ever before. Bank lending too has a multiplier effect on the economy growth.
These are just few factors that explain why India is expected to be the fastest growing economy. The consistent increase in the forex reserves [see chart below] is a testimony of how India is being perceived by the foreign investors.
Chart shows that the forex flows have been broadly inline with the desirable direction. Direct investments (FDI flows) have outstripped portfolio investments (FPI flows) and equity flows (FDI plus FPI equity) have outstripped debt flows (FPI Debt plus ECB).
Foreign investment inflows (FII + FDI) work as catalysts for price movement in the Indian markets, as they invest in large amounts thereby influencing the market trends. As long as the country performs at an acceptable level, it will continue to attract fresh money and stock markets will do well.
Your Biggest Fear…
What if the market never recovers and the capital loss becomes permanent?
We saw how markets are linked to the performance of companies. With all the above explanation, do you still see a possibility of markets never recovering? Not really, right? Because for that to happen, consumption by private sector and government has to drop significantly to the extent that these companies run into losses. If it at all happens, it will be limited to a very short period.
Permanent loss of capital is possible, but only in a situation where you are invested in a company with governance issues or poor fundamentals. However, if you are invested through mutual funds of top AMCs, this risk also gets eliminated. Mutual funds protect your investment from company specific issues as the investment is diversified across companies and your money is managed by professionals whose whole objective is to protect and grow your money. You just need to choose a fund with good past track record. Websites like valueresearch.com or moneycontrol.com help you do that. Trust and performance are vital for the growth of this industry and hence no worries.
Conclusion
Equity investments require conviction and true conviction can only come from within by trusting your own research. It is up to us how we connect the dots to recognize that something good is emerging around us.
India is well placed to grow for the next few decades. A pro-business environment paired with investor’s belief, works in favour of the country. Thereby, reinstating the faith that equity-linked products will grow over the long term at about 12% [GDP growth+inflation+equity risk premium] on a conservative basis.
This is my way of connecting the dots. You may have your own. Whatever it is, it better be strong as that is the only thing that will help ride the market falls.
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Note: All posts are opinion of the author. I am not a SEBI registered advisor.
