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Equities: Stop looking back!

Feb 12, 2009

It is past experience that usually dictates what we anticipate for the future. If we have had a particular experience in the past, and if it has been pleasant and rewarding, we cannot help but look at it with enthusiasm and delight with regards to the future. The opposite is equally true. If we have burnt our fingers with something in the recent past, we are bound to be morose and totally unenthusiastic about any future encounters with it. That is how our mind works.

Infact, this habit is so strongly embedded in our minds that we may completely overlook the nuances of the present situation and directly extrapolate our experiences about the recent past into how we feel about the future. This is true in every sphere of life, just as it is true in the stock markets.

Enthusiasm for buying stocks is currently not anywhere close to what it was at the beginning of last year. Stocks were then being bought by all and sundry as the markets climbed higher and higher. And why not? Equities had been amazingly rewarding for most people for a couple of yaes. They were the asset class of the decade, the quickest way to make money. The expectation was - buy stocks and watch your money multiply like magic. But one extremely important thing was completely overlooked. To the point that it almost looked irrelevant. And that was the return on investment. Prices were touching the sky and most stocks were overpriced and had low dividend yields. In fact, in some cases the yields expected were even lower than that on a risk free government bond. But investors chose to ignore the risk attached to equities. They had become blind to the present, too busy looking at the recent past.

Incidentally, this was a situation that was completely opposite to the situation in 2003, when dividend yields on stocks were much higher than that of yields on government bonds. Apart from the good prospects for economic growth that India had, it was the attractiveness of equities due to their low valuations that set the stage for the kind of returns we saw over the next five years. But by the beginning of 2008 that had fundamentally changed. What investors had started buying for the right reasons in 2003, they bought for the wrong ones in 2007 and 2008. And that was not because the prospects of Indian businesses had fundamentally deteriorated (that cannot happen overnight), but because they were no longer available at prices that could ensure healthy investment returns.

Source: NSE
Now, at the beginning of 2009, investors are committing the same mistake that they did in 2008. They are relying on short memory than looking back at long history. As a result of which, opportunities of investing in sound and reputed businesses offering dividend yields that are much higher than the post tax return on 10 year government bond (currently 4.5%) are being overlooked. They continue to be wary of the landslide witnessed in stock prices over the last year. This is forcing them to neglect giving the present scenario a long hard look. Because if they would do that, they would realise just how much more attractive is what is being offered by equities right now.

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