Do you get paid for investing in stocks?

Mar 21, 2012

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!

---------------------------- Raise your voice before this turns into yet another scam! ----------------------------

When millions don't even have food to eat, our government is thinking about bailing out multi-millionaire CEOs!

Is this government really made up of our representatives or is it on the payroll of those corporate giants?

We at Equitymaster feel strongly about this cause, and thus have started an Urgent Poll where you can read all about this and cast your vote to make your voice be heard!

We strongly recommend every Indian, who wants to make a change, to take a look at this.

Click Here to read more and cast your Vote... Before it's too late!


Well, the very outcome of investing should be a reasonable return on the capital. Whether or not the investment is into stocks. But what makes stocks different from asset classes like debt and realty is the higher possibility of loss of capital. Now, the Indian government is willing to allow fiscal benefits for investing directly into equities. That would be akin to paying somebody for investing in stocks. But what we wish to discuss here is not about the recent fiscal sop on equity investments. But a return that every stock investor must ensure before putting money into it.

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.

 Chart of the day
As India braces for more expensive imported fuel, the share of the same is expected to rise over the next few years. As data from the latest Economic survey suggests, the share of overall imported fuel will rise from 36.5% in FY11 to 37.9% in FY17E. Here the share of natural gas imports is expected to see the maximum rise. This clearly underlines the necessity for India to develop indigenous resources.

Data source: Economic survey 2011-12

The airline sector in India has been down in the dumps what with first Air India and then Kingfisher Airlines teetering on the edge of bankruptcy. So dire has been their situation that both of them have turned to the government to bail them out amid much debate. It is unlikely that the government will come to the aid of Kingfisher. But it has no qualms lending a helping hand to the beleaguered national carrier. Thus, Air India is coming out with a Rs 7 bn bond issue. What is more, rating agency Fitch has given it an AAA rating. This reflects the absolute and unconditional guarantee extended by the Government of India. While government sovereignty in the world economy was unquestionable in the past, this has now changed post the global financial crisis. The sovereignty of several nations especially in Europe has come under fire as huge debt burdens have brought them close to defaulting. With the Indian government also being plagued by poor finances, whether its guarantee warrants the AAA rating to Air India's bond issue is the question. Moreover, will a bailout for the carrier really improve its prospects if it does not trim its bloated costs first? On a broader note, is the bailout justifiable in the first place? If you feel the same way as we do, then raise your voice to Ban Bailouts. Remember, every vote counts!

Who is a better monetary policy maker- gold or Ben Bernanke? In the aftermath of the financial and debt crises that have ravaged the global economy, the role of central bankers has come under a scanner. Should an economy be allowed to evolve its own course and correct through market forces? Or should central banks intervene and try to maneuver the economy on a course they believe to be the right one? Past evidence shows that central bankers, especially in the developed economies, have done more harm than good to the economy.

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.

In an attempt to empower minority shareholders, Securities and Exchange Board of India (SEBI) is planning to import the Italian model of board reservation into India. In Italy, it is mandatory for all listed companies to reserve a certain amount of board seats for electives who represent minority shareholders. The proposed move, if implemented, will reduce discrimination against small stakeholders. Discrimination typically happens during acquisitions, restructuring and related party transactions where controlling shareholders extract undue benefits.

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.

There are some companies where you are better off being an employer or a supplier rather than shareholder. Consider the case of US investment banks in the pre-financial crisis era. It certainly paid a hell of a lot more to be an investment banker than to be the shareholder of such firms. The reason? Well, the bulk of the profits went towards filling up the coffers of employees in the form of fat bonuses. And shareholders were left with nothing but pocket change. The Chinese steel industry is passing through a similar phase currently. There are reports that steel mills in China are producing steel not to make but to lose money. In other words, they are incurring a loss in their operations. Common sense would dictate shutting down the loss making entities. But China is as communist as they come and hence, laying off employees by closing plants is just not an option. The other route of diversification is also fraught with danger with only a few groups managing to diversify successfully. Thus, the only option seems to fight for survival till some concrete Government action comes their way. Employees though would be happy that they are on the payrolls of company and are not its shareholders.

After a sedate start, the indices in Indian stock markets managed to make firm inroads into the positive territory today, backed by engineering and commodity stocks. The indices were amongst the few gainers in Asia in today's trade. At the time of writing, the BSE Sensex was trading 247 points above the dotted line. Those in Europe have opened a mixed bag.

 Today's Investing Mantra
"Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols" - Warren Buffett

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