Is wealth generated from stocks artificial or real? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is wealth generated from stocks artificial or real? 

A  A  A
In this issue:
» DII's stake in BSE 500 companies on a meteoric rise
» Mark Mobius' advise on the current Greece and China crisis
» An update on markets
» ...and more!

At the peak of the meltdown in Chinese stocks last week, a friend sent me the following message on one of the social messaging groups I am a part of. 'China loses 15 Greece in 15 days', it said. I found myself nodding in agreement. The wealth that was destroyed in China in a short span of 2-3 weeks was truly staggering to say the least.

However, to my surprise, another member of the group responded by saying that the wealth lost in China was notional in nature. In other words, it was sort of artificial. So while the wealth lost in Greece was quite small in comparison, it was not notional but 'real' and therefore more significant than what happened in China.

To say that I was irked by this comment would be an understatement. It was not just this gentleman - someone who I can vouch is quite articulate in other matters - has this huge misunderstanding about stocks. This myth is far more widespread. As a matter of fact, this is a misconception that plagues quite a lot of people out there. They seem to be of the view that, as compared to other asset classes, wealth generated through stocks is artificial or notional in nature. And therefore, one should stay away from stocks.

So for everyone who has ever harboured this suspicion, here's a hard fact: wealth from stocks does not come out of thin air. Just as with all the other asset classes, you invest your hard-earned savings into stocks which then go up over time, resulting into wealth accumulation.

I find it hard to fathom how this is different from any other form of wealth creation.

Yes, stock prices tend to be a lot more volatile. In other words, the real estate that you invested in or the gold that you bought, or for that matter, your fixed income bonds do not go up and down in prices as much as stocks do. Also, since gains from stocks can come and go quickly, people compare it to gambling where money can be made or lost at the drop of a hat.

Gambling is a good analogy to describe what most people tend to do with their stock investments. However, what separates gamblers from investors who truly seek safe wealth creation is that the latter invest in stocks based on their long-term values. Whether stock prices go up or down in the near-term is hardly of any consequence to them. They very well know that over the long term their wealth from stocks will only be decided by what the businesses underlying those stocks will do. And as long as they continue to grow in value year after year, the near-term volatility in their share prices is hardly a concern to them.

There's one more thing that makes people uncomfortable about stocks. And it is the fact that, unlike say investment in real estate or other physical assets such as gold and agriculture, stock ownership is only on paper. Consequently, the touch and feel aspect of it is missing which is not the case with other assets. Well, these people would do well to remember that behind every stock is a firm with a lot of tangible assets in the form of its plant and machinery, its inventories, its offices and its people. And therefore, is just as real as any other asset.

I'm sure there could be other reasons which make people feel that wealth created from stocks is notional in nature and therefore cannot be relied upon. However, there are indeed certain characteristics of stocks that give people that kind of an impression. But if you analyse in a little more detail, you will come to the conclusion that stocks can indeed be great wealth creators. As a matter of fact they rank amongst the most attractive asset classes out there.

All one needs is the right kind of approach and the mental courage to not get panicked by frequent ups and downs in stock prices. For as long as the underlying stock is of good quality, it will end up creating good wealth over the long term. Wealth of the real kind, mind you, and not notional or artificial.

As we write, the Eurozone seems to have finally hatched the third bailout plan for 'too big to fail' Greece. Look forward to our views on this in tomorrow's edition.

What do you think? What are the other reasons people think wealth creation from stocks is artificial and not real? Let us know your comments or share your views in the Equitymaster Club.

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02:45  Chart of the day
Analysis of domestic institutional (DII) ownership patterns gives interesting insight pertaining to sentiments prevailing amongst retail investors. Since DIIs typically consist of mutual funds as well as insurance companies, an increase in DII stake indirectly suggests an increase in retail participation.

Today's chart of the day shows that DII's stake in 96 of the BSE 500 companies stood at 9.36% in the June ending quarter. This is considered to be highest in the last 25 quarters indicating that local investors have been significant buyers in the June quarter. Further, a consistent increase in DII stake reveals that the trend of flows has been quite buoyant despite volatility in markets.

How much do retail investors own in BSE 500 companies?
Note:- The data pertains to 96 of the BSE 500 companies

Such a phenomenal rise is attributable to the rising money inflows in the domestic fund houses. Sentiments amongst the retail participants are so positive that the average asset under management (AUM) for the mutual fund industry is at an all time high. And this money has found its way into equities via the DII route. This is certainly a good sign for the mutual fund industry since rising AUM will yield higher fee for them. As for domestic investors, if they are willing to show some patience and stay invested for the long term, even they shall be benefitted by higher returns.

A rising domestic institutional investor (DII) stake indicated that the Greece crisis and the China debacle have not impacted the sentiments of the Indian investor that much. While such factors do have an impact on stock prices over the short term, in the long term - earnings and domestic macro drivers influence returns.

Even the legendary investor Mark Mobius is of the opinion that one should not get swayed in by the current negativity too much. Yes, the situation in Greece is troublesome. Even China is not looking that great as the bubble seems to have burst. However, when it comes to India the situation is all together different. Though there is disappointment in some pockets towards the Modi government for the lack of pace shown in reforms, at least the perception towards corruption has gone down a bit. Also, one should realize that the steps taken by the current government will take some time to fructify. Thus, any correction due to external factors like Greece and China crisis should effectively be seen as a buying opportunity. However, investors need to be stock specific in such markets. The best approach could be to route money via mutual funds if one lacks the necessary expertise.

Remember, India is an exciting opportunity and for retail investors to benefit out of this story, their faith in equities must remain intact. Just figure this out - About 80% of the market cap in China is owned by the retail investors. Thus, a rising stock market created a wealth effect for the Chinese. However, when it comes to India it is the FII's who rule the roost. Thus, if the domestic investor wants to get benefitted out of the India story he should remain patient and be invested in equities for the long term. And not get swayed by global factors too much as Mark Mobius pointed out.

The Indian stock markets were trading in the red at the time of writing. While the BSE Sensex was down by 4 points, NSE-Nifty was up by 3 points. The Asian stock markets were trading in the green at the time of writing. European stock markets also opened strong today.

04:50  Today's investing mantra
"Behind every stock is a company. Find out what it's doing." - Peter Lynch
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This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst) and Jinesh Joshi (Research Analyst).

Equitymaster requests your view! Post a comment on "Is wealth generated from stocks artificial or real?". Click here!

2 Responses to "Is wealth generated from stocks artificial or real?"

Atul Sharma

Jul 19, 2015

All asset classes provide notional profit only till booked. In stocks popular wrong beliefs are fuelled because it is only asset class where daily valuations are published and are easily accesssible to all interested.

Like (1)


Jul 14, 2015

As long as profit or loss is not booked, it's notional. It's real once it's booked & comes in our hand. Of-course dividend is always real.

Like (1)
Equitymaster requests your view! Post a comment on "Is wealth generated from stocks artificial or real?". Click here!


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