Do you get paid for investing in stocks?
In this issue:
» AAA rating for a loss making near defunct airline
» Bernanke condemns virtues of Gold Standard
» Why China produces steel to lose money...
» Iran's political imbroglio hurting India's crude prices
» ...and more!
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It is known as stock premium in investing parlance. But the extra return that stocks must fetch over and above the fixed return on risk free debt instrument is often not a criterion for stock selection. The premium is to compensate for the extra risks that stock investors bear. That risk comes in two forms. The first is that shareholders get paid only when other claimants on a company's cash flow have received their due. This includes employees, the taxman and creditors. Hence, if a company goes bankrupt, the shareholders are the maximum losers. Profits and dividends are thus highly variable and can disappear altogether when times get tough. The second risk is that share prices are volatile, more so than bond prices. Hence there can be periods of negligible returns even if the investment is for a long tenure.
In the developed world, stock investors have fetched very little or no premium over long durations in the past few decades. Take the performance of the Japanese stock market for instance. After peaking at the end of 1989 the benchmark index is still 75% below its high. Over 30 years ending in 2010, American equities beat government bonds by less than a percentage point a year. Hence stock investments warrant the additional premium when they have a lesser possibility of beating risk free returns.
However, when it comes to stock selection investors often get blinded by the growth and profitability prospects. Whether the current valuations leave ample scope for returns to outdo bonds and fixed deposits is ignored. As a result, investors often hold on to stocks that offer mediocre returns. In the bargain they forego the opportunity to invest in more promising ones. Thus stock investing is not just about keeping your money locked for a very long term. It is also about evaluating from time to time whether you are getting paid well enough for the risk.
Do you check the premium before investing in stocks? Let us know your comments or post them on our Facebook page / Google+ page.
01:30 | Chart of the day | |
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Data source: Economic survey 2011-12 |
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Over the last few years, the voices in support of a return to the gold standard have been getting louder. Mr Bernanke is now going around giving lectures to save his own job. He argues that the gold standard wouldn't solve the problems of the economy. It would paralyse the government's ability to intervene and stabilise the economy during adverse times. Has the US government really 'stabilised' the economy? In fact, by recklessly printing money and artificially keeping interest rates low, the US Federal Reserve has done nothing but delayed the climax of the crisis. And in doing so, it has actually magnified the problem to such an extent that return to stability will be impossible without first going through a system collapse. A shift back to the gold standard, though painful in the short term, would put the US economy back on track. But the government has its own axe to grind. They would never want gold to take away from them the power and influence they have not only on the US economy but the world at large.
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True, that independent board's motto is to protect the interest of minority shareholders. But there has hardly been any instance where these independent directors have voiced their concerns against any such discriminative policies. Thus, there was a strong need to enact stricter laws like board reservation. However, SEBI should also ensure that the empowerment exercise does not result in an abuse of control by minority shareholders.
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04:56 | Today's Investing Mantra |
Today's Premium Edition.
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