Prices | Financials | Company Info | Reports
he most commonly held belief about equity investing is that if one selects profit-making companies with established track records and holds them over the long run, one earns stupendous returns. This should rate as a gross over-simplification of the equity investing process. However, this idea is fairly well-entrenched. Many investors provide examples of such selection, except that they do not tell us that they simply got lucky.
Let's go back to the 1980s to the first set of liberalisation measures and the ensuing market boom. The BSE Sensitive Index (Sensex) was around 120 in January 1980 (this was a back calculation as the index itself was released years later). The stocks in the index, which represented the blue chips, included Hindustan Motors, Century Textiles, Bombay Burmah Trading Corporation and Premier Automobiles.
If an investor had bought these 'good' stocks, he would be bruised by the failure of these companies today. Importantly, the portfolio of this investor would not have Infosys, Bharti Airtel or HDFC Bank, since these companies were not even around at that time. The index today is at 20,000 levels. That means a compounded return of 16% over 35 years.
However, this would not have come by simply buying the 'good' stocks at some point and holding them over the long term. The performance of the Sensex over the years is due to, what is known in the academic world, as 'survivorship bias'. The index systematically drops stocks that have failed, and includes those that are succeeding, and is, therefore, biased towards stocks that survive. So, money is not made in equity by buying and holding the current winning stocks, but by actively dropping what is not working, and including the ones that are doing well.
How can investors perform this rebalancing act, particularly since the winning stocks are visible only when they have peaked? Consider the revisions to the index. The IT stocks came in when the sector was booming; banking stocks were increased after the prices rose with several IPOs; and real estate stocks came when they were moving up in a frenzy in the last boom. There is a clear hindsight bias in the index and the weight of a stock whose price is rising with high momentum can become more and more in the index.
The investors who buy winning stocks may end up buying them at higher prices, while continuing to hold the losing stocks of yesterday. That is not all. When investors select today's winning stocks, they are equally likely to buy tomorrow's losing stocks. If they are feeling smug about TCS and HDFC Bank in their portfolio, they may also be worried about Reliance and DLF.
There is no sure-fire way to only pick the winners, while side-stepping the losers consistently. If we did not know 30 years ago that Century Textiles would not be a blue chip in 2010, we also do not know if the current blue chips will be around 30 years from now. Any reasonably constructed portfolio is likely to have both winning and losing stocks, picked earnestly, but performing divergently.
Copyright © 2014 Times Internet Limited. All rights reserved.
via Business - Google News http://ift.tt/1ibb5pN
Put the internet to work for you.
0 comments:
Post a Comment