This investing process is unlikely to disappoint

Tue, 18 Mar Pre-Open

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Five years ago, the BSE-Sensex was trading at a value of about 8,940 points. Today, it trades at levels of close to 21,934 points. As such, over the past five year, the index has compounded at the rate of about 20%. Not bad at all.

But, if we shift the base year to the previous year, i.e. to 2008, then the CAGR comes to 5.7%, which is very disappointing. The return would be even less, if we further shift this date back by two months, close to the peak levels seen in the early 2008 period.

That stocks haven't been the preferred asset class is something that we have been writing about for a while now. But we have also been writing about why it is imperative for all individuals to have some allocation of their overall investable net worth in equities, purely on the basis of their long term returns, which could be way above the high inflation levels of the country.

A recent article by the Mint discussed some of the key mistakes that people make while investing in equities, and those that need to be avoided. This is especially at a time when the markets are seemingly in rally mode, thereby appealing to people sitting on the fence about equity investments. The three key mistakes highlighted by the business daily include having no exposure to equities, having a herd mentality and having a notion that all stocks can rise.

The business daily also compared market returns over different periods, and different time frames - from 1984 till date. During three ten-year periods, 1984 - 1994, 1994 -2004, 2004-2014 the Sensex returns stood at 31.36%, 4.28% and 14.38% respectively. However, it is the learning from the middle period that we would like to highlight. As per data available on ACE Equity, the market valuations in March 1994 stood at levels of 45-50 levels (P/E ratio), which eventually tapered down to long term average level of 17-18 times by 2004. While data of the previous period is not available, in March 2004, market valuations stood at levels of 17-18 times. Currently, the valuations are at similar levels. Over this period (2004-2014), the Sensex return - of about 14% on a CAGR basis - has been largely driven by earnings which grew at the pace of 15% on a compounded basis.

This we believe is something very important to understand. Over time, fundamentals do drive the stock prices, while sentiments play their part in the shorter period. If investors practice the simple process of low P/E investing, they are likely to see strong returns over long periods, and thereby avoid burning their fingers and having bad experiences while investing in markets.