Looking back, thinking forward - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Looking back, thinking forward A  A  A
26 AUGUST 2008

"All I know", the philosopher Socrates said, "is that I know nothing."

And so it is true for most of us. We know nothing, but we can imagine we know a lot. How many of us "knew" that oil would rise from USD 70 to USD 150 in less than one year? Or that the price of rice or wheat or gold would rise the way it has risen - in the time horizon that it has.

Or how many of us "knew" that the Index would decline from 20,500 to 14,000 in 6 months?

I am guilty of not "knowing" but, in defence, we did worry about the markets being frothy based on speculative buying from so-called FIIs. I expected that the markets could decline maybe 10% to 15% - but not 35%. We figured that real estate stocks may correct - some really sharply, while the quality stocks would decline a little less. Everything got hammered.

We thought gold would rise - it did, but not as much as we thought it could.

One did not "know" many things - and it is unlikely we can "know" much about the future. But we can certainly try to take a view on where the future could be headed and how we can position our investments to profit from some trends.

So, I look around to see where I can get clues to what the future may bring.

CNBC has little to offer. Their definition of the future is end of the trading day. Nothing wrong with that. But it is a time horizon and an "investment" style that does not appeal to me. Gambling in the stock markets sounds like a lot less fun than flying off to Macao or Las Vegas where you can feast your eyes and your stomach while losing all that money. But given the popularity of CNBC, it obviously is what people want. Not that it makes it the correct thing to do.

The newspapers are a little generous: their definition of "long term" is between one week and one month. That is the time it takes me to start planning a meeting with a company’s management to begin our evaluation of the stock.

I look to the chartists for help. Not much there, either. They can probably tell me where things may trend on a daily or weekly basis - and the graphs and charts really look nice.

So, I turn to history. Keeping in mind the Buffett warning: if past history was all there was to the game, the richest people would be librarians.

But - to counter Buffet - what if there was a librarian out there that did actually read all that history which they collect and tabulate; and then had the ability to forecast the future based on a past trend? Surely, there is something in the history books….

I turn to history and begin with the growth rate in the Indian economy as defined by the growth rate in India’s GDP.

The data indicates that - over the 28 year period from 1980 to 2007 - the rate of growth in real GDP was 6.2% per annum. The "real" means after inflation - after the fake increase in wealth caused by an increase in prices.

I add back inflation - which averaged about 7% for the past 28 years. This allows me to get a sense of how the Indian economy grew at "nominal" prices. Combining the two, I broadly see that the Indian economy grew by more than 13% every year for the past 28 years.
Not bad.
And the BSE-30 Index increased by 18% every year since 1980.

Equitymaster is looking for you... Click here.

That is the past.
A solid growth rate in GDP: 6.2% per annum.
Inflation at 7% per annum.
Stock market returns in blue-chip companies at 18% per annum - better than any "AAA" grade bank deposit or fixed deposit.

But what does the future hold for us?
And can we come to any conclusions based on those expectations?

Looking over the gloom.
By all accounts, India’s economy is set to continue its growth. The biggest risk is that a Left government comes into power and - by some strange reasoning - does not mind the fact that their masters in China and Russia grow their economies but shut down India’s economy. So that is a risk. A real risk.

Barring this risk - and I do not think anyone should ignore it - it would be sensible to assume that India’s GDP can clip along at a 6.5% rate of growth over the next 10 years. And inflation will still be somewhere around 6% per annum. Add them up and we see a "nominal" growth of 12.5% each year.

While a growth rate of GDP is not a guarantee that stock markets will increase every year, it is safe to assume that higher economic activity should see companies making some higher level of profits - and some higher level of share prices.

Table 1: Linking economic growth to stock markets.
End of year Index at end of year Return GDP Inflation Add them
2008 14,500 15% 6.5% 6.0% 12.5%
2009 16,675 15% 6.5% 6.0% 12.5%
2010 19,176 15% 6.5% 6.0% 12.5%
2011 22,053 15% 6.5% 6.0% 12.5%
2012 25,361 15% 6.5% 6.0% 12.5%
2013 29,165 15% 6.5% 6.0% 12.5%
2014 33,539 15% 6.5% 6.0% 12.5%
2015 38,570 15% 6.5% 6.0% 12.5%
2016 44,356 15% 6.5% 6.0% 12.5%
2017 51,009 15% 6.5% 6.0% 12.5%
2018 58,661 15% 6.5% 6.0% 12.5%

Markets, as we know, never rise -or fall - in a straight line.
They zoom and zip all over the place. We had an incredible run between 2003 and 2007 when stocks increased by 5x in 5 years - not going to see those kind of returns in a hurry! But, that zoom was part of the 18% per year over the past 28 years - which means that there were years when stocks did nothing.
Or even lost value. Just as they have done since January 2008.

The key to remember on stocks is: be in it for the long term. Put your savings there. The only time you need to worry is if stocks are going down at the time when you need your money back.
Otherwise, every fall in share prices of good businesses is a chance to buy more.
Keep ploughing any excess cash you have back into the various assets you have: fixed deposits, stocks, gold. In a proportion that matches your needs and your risk-taking appetite.

If the market wallops you and the value of your holdings go down - try and add more.
People tend to do the opposite - they get scared. They withdraw.
Yes, you should be scared - if you bought the wrong business.
Or even the correct business at the wrong stock price.

And that comes to another crucial reminder: you are not buying the stock; you are buying a portion of the underlying business. The stock market puts a value on the business every day. Mostly an illogical valuation.

Another Buffett gem of simplicity: if the business does well, the stock eventually follows.

There is a lot of gloom and doom in the markets now. The key is to understand the underlying fundamentals and trends. To make assumptions and position your portfolio.
One may not "know" but one can try to decipher.
And, another quote from Socrates: "I cannot teach anybody anything, I can only make them think."

Turn off the TV, keep the newspaper aside: and think.

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

Other Views on News:

» 5 questions investors are asking now
At Personalfn, we routinely interact with investors. And ever since the equity markets turned volatile, we have (expectedly) come face to face with several hassled and confused investors. Another pattern we have noticed is that a number of investors have similar concerns. We thought it would be interesting to address the 5 most common questions that investors are faced with now. Read on...

» Oil’s fall, India’s power woes & more
Key Asian markets are trading strong this Monday morning with the gainers’ list being led by Hong Kong (up 3%), Japan (2%) and China (1%). These gains were led by crude oil’s biggest plunge (of around US$ 6.6 per barrel to US$ 114 per barrel) in four years, which was a result of increased supplies following BP Plc.’s (Europe’s second largest oil company) restarting of... Read on...

Read our Privacy Policy and Terms Of Use.
Get The Honest Truth directly
in your mail box.
Just enter your e-mail address» 

Read our Privacy Policy and Terms Of Use.

Equitymaster requests your view! Post a comment on "Looking back, thinking forward". Click here!