How much return should you expect from stocks? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

How much return should you expect from stocks? 

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In this issue:
» What to expect from future US Fed chief Ms Yellen?
» Can the auto industry recover this fiscal?
» The effectiveness of NREGA
» Will the new management improve asset quality at SBI?
» and more....

Equities as an asset class are risky in nature; which is why one expects higher returns - as compared to relatively safe instruments such as bonds and fixed deposits - from them. But then, what should be the ideal return that one should target? One may hear multiple responses to such a question. Some of which include capital doubling every year, every three years, every five years, etc.

At the end of the day, one needs to be realistic about the same.

Over the years, many models and tools have been derived which the investing community uses to come up with answers to the question - what returns one should expect from equities.

Given the riskiness of equities, what these tools essentially try to arrive at is the additional premium that equities need to compensate for their riskiness and volatility. All this is in comparison to a safe asset class such as a long term government bond. To calculate such premiums, many factors need to be taken into consideration depending on the model used. These include assumptions on GDP growth, target inflation, expected yield on indices, earnings growth forecast, amongst others. In short, a good number of assumptions are to be taken just to arrive at this figure of risk premium. Broad calculations on these can give results varying from 8% to 20%. More so, as one keeps tweaking such assumptions, the number could move higher.

Since there are complications behind each factor - which in itself require many assumptions, we believe one can keep things simple by calculating the compounded returns the benchmark index, BSE-Sensex. This needs to be done over a long period. For instance, the index has returned 14.2% on a compounded basis for more than two decades. As the index represents the top blue chip safe stocks in the entire stock universe, we believe this would be a good figure for expected return target.

One thing that needs to be kept in mind here is that the above calculation takes into consideration the historical data. Having said that, the same is calculated over a very long term period thereby taking into account the many cycles and volatility that the market has witnessed over the years.

What is the rate of return that one must expect from Indian equities? Let us know your comments or post them on our Facebook page / Google+ page

How much exposure should one have towards equities as an asset class in one's overall asset profile?
We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!

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01:20  Chart of the day
India's trade deficit declined to US$ 6.8 bn during the month of September 2013. This is the lowest figure since March 2011. The same was largely on account of a sharp 18.1% reduction in imports - due to lower crude prices and gold and silver imports. On the other hand, merchandise exports increased by 11.2%. But the key question here is, is this a reason for India to cheer? Well, not entirely as this may not be a sustainable trend. Crude prices - which are not in our control - were lower last month and helped the country report better numbers. Further, while the investment scenario in the country may be dull at the moment, as and when things take turn for the better, companies will look at importing more capital equipment which would change the trade deficit scenario entirely. The long term solution we believe is to boost exports, by making India more competitive on a global scale.

Trade deficit: Where to from here?
Data Source: Mint

So, Ms Janet Yellen is almost confirmed as the next US Fed Chairman barring some last minute surprises. However, don't expect any radical changes in the way the US central bank is run. For if her public statements are anything to go by, she seems to be cut from exactly the same cloth as her predecessor. And there is no doubt that she will continue with the policies Bernanke-led Fed has pursued. In other words, the best way to deal with a problem of excess money is to throw more money at it. Indeed, for people like Yellen and her ilk, the economy is nothing short of efficient machine. You pull and press some levers here and there and low and behold, the problem is solved. Nothing can be further from the truth though. For unlike machines, every economy has thinking, decision making participants. And one just can't have a one size fits all approach for these kinds of systems. Consequently, the best solution is to leave the economy alone and not continuously meddle in its affairs. However, the appointment of Ms Yellen goes to show that nothing has been learned at all.

Things have never been so bad for the Indian auto industry. For instance, as per SIAM, car sales in India have fallen 4.7% in the first six months of this fiscal. This is the sharpest decline in half-year sales since 2002-2003. Indeed, auto sales were subdued in FY13 and the trend is expected to continue for FY14 too as slowdown in the economy, higher interest costs and fuel costs take its toll. Besides cars, commercial vehicles have been particularly hit hard as the fortunes of this segment are closely linked to that of the Indian economy. The silver lining in the cloud this fiscal has been healthy monsoons. And so there are hopes that this should raise incomes which will spur some demand for cars. But a broader recovery this fiscal looks doubtful.

Meanwhile, many of the auto companies have gone in for price hikes despite such difficult conditions to pass on costs related to the steep depreciation for the rupee. Most of them are focusing on product launches as well. While the latter may not do much in terms of bolstering the fortunes of the sector in a weak environment, we believe that in the longer term product launches are essential on account of the stiff competition in the auto space.

Finally the government has received some praise for one of its populist schemes. The applause is by none other than the World Bank. The World Bank has lauded the government's NREGA (National Rural Employment Guarantee Act) Scheme. It has stated that this is a 'stellar example of rural development'. The direct cash transfer system of the scheme is what caught the World Bank's interest. Its report states that the scheme 'stands out as an employment creation and poverty alleviation scheme is the fact that work is provided as a legal right and not just a one-time scheme'.

The scheme has essentially been criticized by many as a populist measure that has led to a burden on our fiscal state. It has also been accused of destroying work ethics and jobs in general. The thing is that the scheme has made a large part of the rural population dependant on the government. The corporate world has also held the scheme responsible for leading to higher labor costs.

The thing is that the government's intention behind this scheme to eradicate poverty can and must be appreciated. But maybe it is time now for the same to undergo a serious overhaul. The question that the government needs to ask itself is how the scheme can help in contributing towards overall economic growth as well. It also needs to address the issue that the scheme has further stressed the government's finances which are already under tremendous pressure. Unless the scheme is overhauled to a more meaningful avatar; continuing to allocate vast sums of money without contributing much to the overall economic growth would only hurt the country in the long run.

A new management now seems to be the only hope for the troubled economy and troubled companies. Readers would recall the kind of euphoria markets witnessed when the RBI got a new governor. Not that Dr Subbarao's stint as the RBI governor was in any way disappointing. But the appointment of Dr Raghuram Rajan rekindled hopes that the RBI would yield a magic wand to wish away India's economic troubles. Similar seems to be the case with India's largest public sector bank. State Bank of India's (SBI) troubles with rising non-performing assets (NPAs) have been no secret over the past few quarters. Again the ex-charman Mr Pardeep Chaudhary had made several attempts to curtail the bank's rising slippages. However, markets are hopeful that the new chairperson, Arundhati Bhattacharya, will do wonders in SBI's NPA control. The chairperson herself has outlined some measures to bring NPAs under control. She has also insisted on change of management for defaulting companies. However, there is no denying that getting rid of the NPA burden will be a time consuming process.

In the meanwhile, the Indian stock markets hovered around the dotted line during the post noon trading session. At the time of writing, the benchmark BSE Sensex was down by 35 points (0.2%). Banking and oil and gas stocks were the top underperformers. Most of the Asian stock markets were trading higher led by Japan and Singapore. The European markets opened on a positive note.

04:50  Today's investing mantra
"Investors should be very wary of purchasing today's hot issue. Most initial public offerings underperform the stock market as a whole. The managers of the companies themselves try to time their sales to coincide with a peak in the prosperity of their companies." - Burton Malkiel
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6 Responses to "How much return should you expect from stocks?"


Oct 23, 2013

Gdp+ inflation should be the banch mark..


parimal shah

Oct 11, 2013

I have been noticing the following text since last few weeks. When will you really start telling?
'it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!'


vinod kumar tandon

Oct 10, 2013

On an average good company's share should double in 3 years that means compounded average return should be 24 percent per annum.


tarun maheshwari

Oct 10, 2013

If one take a horijon of 10 years a return of 15% approx. Can be safely assumed

Like (1)

Umesh Sharma

Oct 10, 2013

A lot is being written about the growing NPAs in banks.It is not that the banks are not sensitive to the issue.They have the necessary competence to identify the merits of each borrowing account at the outset itself.But despite this, if the banks are burdened with ever increasing NPAs the reason for this lies elsewhere.Just as our society is burdened with compulsory reservations so is the banks with priority sector advances which have a high potential for becoming a NPA.The government owns the banks and the banks have to comply with government guidelines.In such cases the loans will have better chance of recovery if the government makes suitable legislation for making the recovery efforts of banks stronger.But with the Political parties offering all kinds of promises including the loan waivers the task before the banks becomes really onerous.As the CEO is appointed by Government he has to be amenable to and recommendations of ministers,MPs etc.and at ground level branches have to listen to the MPs,MLAs etc.This results in addition of NPA accounts whether banks like it or not.The only way out is to make banks independent of Government influence as it was before 1969

Like (1)

Sony Gholap

Oct 10, 2013

Dear sir , My view regarding the return from the stock market is as follows,
The return from equity market is GDP PLUS INFLATION,
IN INDIA IT IS GDP(5%)+ Inflation(9%)=14%.
Actually you can add Corporate Earning 2% above this so more optimistic Return is 16%, but practically 14%.

Like (1)
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