Why equity investment must be for the long term?

We have all read two things about equity, long-term and diversified. Often when you are investing in equity, you must have read or advised that invest in this strategy only when you have a long-term focus. In this article, I will explore why equity must be long-term. I will cover the diversified aspect of equity in some other article.

Equity is a long term asset category

Let’s understand what do you mean by equity? When you own a business, even a small portion, you become the equity holder, owner of the business. Interestingly, the principles of the business do not change based on the scale or geography. Even if you are a salaried person, you should be able to answer this “what is required by a business to survive?”

…profits.

What you put in the business and what you get out of the business is called profit. If you invest more and get less, you will incur losses. If a business is not able to turn losses into profits, it will shut down.

But how is profit or loss linked to a long-term focus on equities?

Let me take the liberty to introduce, the fundamental aspect of investing. Any asset value is the sum of future profits or another way to say is the ‘sum of future cash flows.’ (To maintain simplicity, I am ignoring the discounting of cash flows).

Now you will appreciate why a business with only losses may also have value. Investors expect the losses to turn into profits and assign a value based on those future profits.

A quarter or even a couple of quarters may not have any meaningful implication on the value. However, you would have seen market reactions, not just every quarter but rather every millisecond.

If the value of a company is just a sum of future cash flows, why the market value fluctuates every single day?

If you have gone to a vegetable market, you would have seen so many vendors selling different or similar stuff with different pricing or different quality.

A stock market is also a market of so many people, each with its version of the value and objective. This varied group of people causes prices to fluctuate.

“In the short run, the market is like a voting machine - tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine - assessing the substance of a company.” – A popular saying by the father of value investing, Benjamin Graham

Do you want to see the stock market, flat, or fluctuate? Any person who has a reasonable mind will say fluctuate. Why?

Fluctuations allow you to transact with the market more intelligently.

“Be fearful when others are greedy, and greedy when others are fearful.” – Warren Buffet

As you can see two variables impact share price, future business performance, and stock market behavior.

Future business performance requires assessment of the future and will be filled with probabilistic scenarios. Even the best investor in the world is bound to commit errors. However, a smart investor will ensure odds favor him/her. Therefore, even a 60% success rate is good enough. However, when the probability is high and odds are in favor, an investor must build large positions. This requires massive behavioral training because this requires standing against the crowd.

Stock market behavior over the short term is beyond someone’s control. Watch it and take advantage. Interestingly, the long-term share price movement is fundamental driven, and no one knows why, sooner than later all firms achieve their fair value.

This is precisely the reason; that equity should be treated as a long-term asset class. If you are saving for a short-term goal, equities should never form part of the portfolio.

The last point, which is often missed by investors is that you can’t assess the fair value of a lot of businesses. It is beyond the comprehension of even the best investors. Knowing your circle of competence is a key to equity investment success.

A key to success in equity investing is to allocate to quality businesses that have a long-term cash flow generation potential. Out of more than 6500 companies, there are hardly 60 companies in India that qualify as quality businesses.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

Creating wealth in a volatile world

Recently, the news flow has turned quite pessimistic. A lot of investors are worried about their investment future. Markets have always surprised but the last two years have been the most surprising even to the most experienced investors. In this article, I explore the wrong notion of news flow, the reality of our economy, and the scope of wealth creation across major asset classes.

Asset Allocation & Expected Returns

My concern about the news flow

When was the last time you read a newspaper and were happy? The reality is that the news business thrives on negative news. Now imagine, if you want to allocate funds and you are looking at a news channel or reading newspaper for some idea, chances are very low that you will find anything relevant.

Any student of economics will understand that when interest rates are low, growth momentum picks up and that causes inflation. Similarly, when the inflation is high, RBI would increase the interest rates and that will cause growth to taper down. These movements create investment opportunities. If the market rates are held constant, there can’t be any investment opportunity.

News flow paints the problem of the west as India’s problem. A lot of developed countries had near-zero interest rates when the pandemic unleashed, these countries started distributing money to pump up the economy. Now the economy is pumped and so is inflation. They will increase the interest rate to restore inflation.

India has its own set of issues. The primary issue is the reliance on oil and the oil prices mounting every single day. India did not distribute money to everyone but only to a section of society. The option to withdraw money from provident fund or clearing income tax refunds does not cause inflation. The underlying of our inflation and that of the west are different.

India, a thriving democracy

India’s economy is the sixth-largest economy in the world. The country has one of the highest GDP growth rates in the world. India's GDP will likely grow over 7-8% in the next 4-5 years. Assuming inflation to be at 7%, the nominal growth rate will be 15% pa. This would mean that we will be double the size of our economy in the next five years. This is huge!!

• The unemployment rate in India was 7% as of January 2022. History indicates that this is one of the lowest unemployment rates in India.

• More than 50% of India's workforce is employed in agriculture while the sector contributes nearly 15% to the GDP. As manufacturing and service sector takes over, the share of agriculture will continue to go down.

• We have been consistently collecting GST above ₹1.3-lakh crore since October 2021. We have surpassed ₹1.6-lakh crore in April 2022.

• Oil prices are more than $120 per barrel. In April 2022, retail inflation increased to 7.8%.

The risk I see in our economic growth momentum is the oil price. As far as the oil price is maintained, we will survive, if the oil price corrects, India is sure to gain. If the oil price climbs further up, more pain is in store.

What does all this mean for your portfolio:

Equity

As far as growth momentum is high, equities will continue to do well. So far, India’s corporate profit is shining. Companies that rely on global markets, will face the headwinds. Companies that have a high return and low debt catering to the domestic market will do alright. The current correction provides opportunities in this space.

Debt

Often people look at an interest rate as a return on any debt instrument. That may be true for a fixed deposit with a safe bank, but not otherwise. A private bank offering a high return may be risky and avoidable.

A 10-year government bond is backed by the Government of India but still, it is risky. We must look at the yield to maturity and not the interest rate. Yield to maturity (YTM) is the total return that will be earned when the bond is held till maturity. So YTM considers the interest rate and the price that you pay. In the current interest rate scenario, investing in a 10-year government bond is quite risky.

So, you are pretty much left with low return liquid funds or fixed deposits. Another way to pump up return is to invest in high dividend-yielding companies along with REITs.

Gold

When fear takes over governments, they buy gold. If the current fear is so high, commodities shouldn’t be high. This means, that growth momentum is there along with demand. The fear is more supply-side and should bridge up sooner than expected. I am not very positive about gold; it should be range-bound.

Real estate

Rental yields are a hedge against inflation. The price of any asset is the discounted value of future cash flows. If your rental cash flows increase, the real estate value will increase as well. Although we don’t have a perfect real estate cycle in India, broadly speaking, we have a 12–15-year peak-to-peak cycle. If we saw 2012 as the peak, we should see 2026 as the next peak, this means the prices should start climbing now. Please note that an apartment is not an investment, land and commercial property is.

As an advisor, I prefer fear over euphoria, it creates opportunities across asset classes. This is the time to get active for the next 3–5-year cycle.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

What do we learn from the stock market movement?

In the last few days, markets have been nervous. A lot to do with inflation and central banks increasing the interest rates. When the interest rates increase, the impact is negative on the overall growth of the economy.

Stock market fall

Interestingly, it’s not the first time and I am sure it won’t be the last time either. Most of the central bank’s work is to tackle this problem.

Let’s look at the last decade and reflect on what has happened in the past and how did we fare in the journey.

NSE 500 Total Return to Shareholders

2010

The 2008 global financial crisis had a minimal impact on India due to its conservative policies. Our economy continued to do well even during 2008 and 2009. We received the highest ever inflows by FIIs to the tune of $29 billion in 2010.

2011

A lot of the previous year’s euphoria was built into the market price, and we saw a correction of 25% in 2011.

2012

Nothing unusual, the stock market bounced back by 28%. Another $25 billion we received from FIIs.

2013

A very messy year for India. We were facing high inflation along with a high fiscal deficit. We must acknowledge our reliance on Oil, whenever oil price increases, so do inflation.

Oil price 2010-22

2014

The market wanted clarity on policies and growth. The election in 2014 provided that hope. Along with that oil prices and other commodities collapsed. This reduced inflationary pressure in the economy.

2015

When the commodity prices collapse, the world does not feature growth, meaning a tepid economic growth leading to a drop in corporate profitability. So, the stock market was range bound.

2016

The market gave a window of 6 weeks to invest post demonetisation but recovered very quickly.

2017

A much-awaited GST was implemented. Markets scaled up especially smaller firms zoomed past their fair value.

2018

SEBI classification of mutual funds category along with expensive small and mid-cap companies saw a massive correction. Large caps continued to soar.

2019

The debate over GDP numbers started, and a lot of pain was hidden due to a few companies doing well within the nifty 50 index.

2020

March 2020 witnessed a heath crisis but had an unusual fear impact on the markets. All the commodity prices collapsed, central banks reduced to the lowest interest rates ever, a lot of developed countries distributed money for free, etc. Markets find comfort whenever the policies help increase corporate profitability. The market rebounded in the second half.

2021

The news of the vaccine gave another push to the markets given the interest rates were still held low. We witnessed oil prices gradually inching up echoing the growth momentum.

2022

Developed countries that distributed free money have so far seen the worst ever rise in inflation. The market was anyways sitting sideways since October 2021, waiting for such information to come in. The situation was accentuated due to Russia and Ukraine as well.

Anyone who is in the markets for the last decade or more will accept that the last two were aberrations. However, equity investors have made money over five-year plus investment period.

Equity investing is long-term and allocating for 2-3 years is a bad idea. Secondly, indices mask a lot of pain that individual investors might be facing if someone invested in a specific stock.

“Be fearful when others are greedy, and greedy when others are fearful.” – Warren Buffet

History indicates that the stock market opportunities emerge only when the fear prevails. And when there is euphoria, it is time to fold your hand.

Mid 2021, 21-year-olds were offering me stock advice. I was concerned because when everyone around is talking about the stock market, clearly the bubble is built up. A lot of cyclical and low return companies without any cash flows were touching new highs. The recent correction is a problem for these low-quality companies. Similarly, the recent correction is an opportunity for high-quality companies.

I also believe that the recent western narrative is lopsided. India’s only concern at this point is the oil price. The western world will face more problems because of free money distribution.

Investing is simple but not easy.

Investors should use this opportunity to build positions in high-quality companies. This must be done only when you have the time and skill to pick direct stocks. Alternatively, invest in mutual funds and continue with your monthly mutual fund investments (SIPs). So life goes on, the way it should be.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337