V K Vijayakumar | Tuesday, 11 August 2015 – 6:40am IST | Agency: dna | From the print edition
Do you know that an investment of Rs 9,500 in 100 shares of Infosys in its IPO in 1994 (everyone who applied for shares got allotment) is today worth around Rs 5.5 crore? Do you know that an investment of Rs 1,000 in 10 shares of Wipro (Rs 100 face value) in 1980 is today worth around Rs 54 crore? Those who are not familiar with the “magic of the stock market” will find it difficult to believe these spectacular investment success stories. But these are facts. Many companies like Eicher Motors, Page Industries etc in recent times have generated phenomenal returns for investors. Stock markets have the ability to create incredible wealth.
Is it possible for you to promote and build a great company like Infosys or Wipro or Eicher Motors?
Vast majority of readers will answer in the negative. Great companies are founded by visionary entrepreneurs. These visionaries, like geniuses in other walks of life, are very rare. They create jobs for the people, contribute to economic growth and create incredible wealth for investors. A great merit of the capital market is that it enables ordinary investors to participate in the sharing of this wealth. Thus, while a few extra ordinary entrepreneurs create wealth, large number of ordinary investors participates in the sharing of that wealth. This makes growth more inclusive.
The BSE Sensex was 100 in 1979. At present it is around 28000. This means, the Sensex has multiplied 280 times in the last 36 years, giving an annualised return of 16.75%. This is substantially higher than returns from other asset classes like fixed deposits, gold or PPF.
Why stocks give such phenomenal returns?
The answer lies in the dynamics of economic growth. As an economy grows, the share of agriculture in GDP declines and the share of industry and services increases. Agriculture can, at best, grow by an average of 4% a year while industry and services can grow by 8% or 10% or more on a sustained basis. Big business enterprises are organised as public limited companies allowing the public to become share holders. Thus, while great entrepreneurs create wealth, a large number of ordinary investors benefit from this wealth creation. Some industries can sustain high growth rates for a long period of time. In a competitive environment the best companies survive and grow. And the very best will expand and grow from internal cash accruals leading to explosion in profitability. When profits explode, share prices rise manifold, creating incredible wealth for shareholders.
The opposite also is true. Investment in poor quality stocks lead to wealth destruction. Investment in poor quality stocks can be enormously risky since they might cause massive wealth destruction. A major mistake committed by retail investors is that many of them invest in low priced (low quality) stocks expecting big capital appreciation. Often, this results not in wealth creation, but in wealth destruction.
Direct investment in stocks requires some expertise. For those who do not have the expertise or the time for direct investment in stocks, it would be better to entrust their money with experts who invest their money in good securities. This is the essence of mutual fund investment. Mutual funds also have given excellent returns in India. There are funds that have given annualised return of more than 20% for the last 20 years. During the last 15 years, the average annual return from equity mutual funds has been 21.09% with the best fund giving 26.62% and the worst fund giving 13.71%. Remember that these are tax-free returns. Dividend from equity/equity funds and long-term capital gains (capital gains from sale of shares/ equity funds after holding the same for a year) are exempt from tax.
In 1991 when India initiated economic reforms, the net profit of India’s corporate sector was Rs 6,400 crore. Now, India has several companies making a net profit of around Rs 10,000 crore each. The net profit of India’s corporate sector presently stands above Rs 4 lakh crore. This is likely to rise to above Rs 10 lakh crore by 2020. We are living at a time when India is emerging as the fastest growing economy in the world. This will lead to an explosion in corporate profitability and unprecedented wealth creation.
The writer is investment strategist at Geojit BNP Paribas
Source : http://goo.gl/MulfLb