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What's Happening With Stock Market Returns? What Should An Investor do?

At Scripbox we are strong believers in the value of stocks or equity investing as a way to grow wealth over the long-term. However, we cannot completely ignore the poor performance of Indian equities over the last 5 years. This has given rise to a lot of concern in the minds of even long-term investors.

At Scripbox we are strong believers in the value of stocks or equity investing as a way to grow wealth over the long-term. However, we cannot completely ignore the poor performance of Indian equities over the last 5 years. This has given rise to a lot of concern in the minds of even long-term investors.

Should you be worried? The answer to that question lies in understanding the behaviour of the markets over the last few years.

The fact most people focus on

The Nifty hit a peak of 6287 on Jan 8, 2008. Since then the Nifty is yet to breach that level, although inching closer at 6203 (as on Oct 22, 2013). This means a negative return for investors in stocks for this period and most discussion of stock market returns is influenced by Nifty not reaching its previous peak.

Does the poor Nifty performance indicate poor performance of companies?

Not really. And here are the facts most people don't talk about.

  1. The profit of the the 50 companies that constitute the Nifty has seen an increase of 53% during this period or 11.6% per annum.
  2. The revenue growth has been averaging 17.5% per annum. And please note that this is an average, so within these 50, some companies have done much better and others worse than the average. (More on this later). This is not great - but not bad either.

So why is the Nifty not reflecting this?

The performance of the Nifty is a combination of 2 factors (among others)

  1. Performance of the underlying companies - which we noted above is not bad.
  2. Market's opinion on whether that performance is sustainable. You may have noticed that profits have grown slower than revenue - indicating that margins of companies have declined. This makes market participants think that future profits may be lower.

Their opinion is reflected in the price to earnings multiple (Price of one share of a company divided by its profit per share). In the last 5 1/2 years this number has fallen from 28.5 to 18.4. This substantially explains why the Nifty is much lower today.

Incidentally the stock market's opinion undergoes a change fairly regularly. Historically the range for price earnings multiple has averaged from 14 to 23. The current value is almost exactly in the middle of this range. It was at 28.5 when the Nifty hit the last peak.

What could change the market's opinion?

The most likely trigger would be an increase in profits of companies. Please note that this has a double effect. Higher Profits + a higher multiple lead to a dramatic rise in the value of companies just as lower profits and a lower multiple lead to a decline.

What does this mean for a long-term investor?

  1. As a long-term investor, you already know about the cyclical nature of stock markets. No one can predict the start of an upward or downward movement but the end of both in inevitable.
  2. I also mentioned that some companies have done better than the average. This is another fact which often gets ignored. Careful stock selection and good investment process have delivered returns even during this gloomy phase. For example while the Nifty return over the last 5 1/2 years is negative, the mutual fund portfolio selected by Scripbox has returned a positive 1.7% return or almost 3% better than the Nifty.

So sustain your faith in stocks, continue investing, choose your stocks or equity mutual funds with care and monitor them regularly.

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