Right selection of stocks in investing is crucial to make money. One may follow different approaches towards stock selection but it all boils down to consistency in analysis, stock-picking and ultimately allocation – these 3 are the key ingredients of successful equity investing.
Conventional wisdom suggests two primary ways to analyse a stock. Fundamental analysis, which aims to ascertain the fair value of a business (stock). It takes into account quality of business of a company, demand and supply forces, pricing environment, and growth rates among other factors. Technical analysis, which assumes that the elements that impact movement of markets are easily predictable and all information about a stock is captured by the price of a stock at that moment in time. Technical analysts evaluate stocks on the basis of price and volume recorded on the stock exchanges. These two styles of analyzing stocks are applied in the following way: successful investors prefer fundamental analysis to ascertain the valuation of the stock and technical analysis to time the entry into and exit from a stock.
After employing these approaches, there are two main styles of investing. These are value and growth investing. Fund managers construct portfolios by following either value or growth investing philosophies. Growth investing basically means to buy stocks where the underlying business exhibits high sustainable growth rates in general. A growth investor may not mind paying up extra for such stocks in order to benefit from future potential high growth. Value investors, however, are price conscious. They prefer to buy a stock at a price less than the intrinsic value of the stock. If the current market price is less than such fair value, then they buy the stock and wait for the market to fix the anomaly, and in that process end up making money. Sometimes fund managers employ a mix of the two – value and growth – called Growth At Reasonable Price (GARP).
Value investing as an approach to pick stocks has been trampled by growth investing over the past decade in almost all key stock markets in the world, including India. This can be assuaged from this simple underlying statistic: The Nifty500 Value 50 TRI has given 2.83% whereas Nifty growth sectors 15 TRI gave 11.91% in the past ten years. Moreover, a detailed study of constituent companies of Nifty 500 makes it clear that investors have preferred growth over value in past ten years. We analysed 343 companies out of the Nifty 500 index with a 10-year track record.
We found that this entire universe of 343 companies registered ~9% CAGR in net profits between 2010-20, while the stock prices grew at a mean CAGR of 9.5% over the same period. Drilling down further, we observed that 153 companies which struggled to grow their net profits (An average of 1.9% CAGR over the past decade) were punished as they lost value at 3% Mean CAGR over this period.
However, for Companies displaying high growth, the difference could not be more stark – 159 of the 343 Companies studied displayed a mean earnings CAGR of 16.2% over 2010-20 and the stock market proceeded to reward shareholders with a mean return CAGR of 21.8% – this is almost 3x the return that Nifty 500 Index generated over the same period (7% CAGR)!
It is well beyond doubt that investing in stocks does create wealth in the long term & this asset class helps investors beat inflation comfortably as they offer superior returns to other asset classes. As seen from above, India has traditionally been a growth investing market and given the underlying macro tailwinds, there is no reason to assume that this narrative would change anytime soon.