Equity shares or stocks or scrips. By whatever name you call them, these are fascinating instruments for investment and growth and are unlike any other investment option that you will get.
Equities are the only asset class where the underlying is morphing daily. What I mean by this is that while prices may go up and down based on demand and supply, the product that you are buying remains the same in all other cases. Take the example of real estate. It has been on a perpetual bull run until just a while ago. So, if you bought a 2-bedroom flat in Bandra, Mumbai 10 years ago, the price would probably be up by 5-6 times by now. However, the flat remains a 2-bedroom one and in the last 10 years it has not added another bedroom to itself.
This is not true for equities. Equities provide you a share in an actively running business. I always say, while we buy shares and make returns when the business does well, the actual value is added by all the workers and managers who go to work at that company every day. If you can identify a business that is expected to keep growing for the next many years, you have found an underlying that will ensure returns for you in the long term.
Another unique feature of equities is that when prices are heated, people come in droves to buy overpriced items. On the other hand, when you go shopping you will buy more if there is a sale going on, but when there is a discount going on in the equities markets people come and willingly sell there. For items that have static value, it is easy to determine the benefit they will provide and therefore a straightforward decision to buy them when the price is low. However, in equities, if you don’t know the value of the share, you are just going along with others-buying and selling when everyone else is.
Another difference is that while in daily life, things are clearer in the near-term than in the distant future. In equities, it is the opposite. It is impossible to know what price a stock will close at tomorrow, there may be a fair idea 6 months later and a much better handle of where it might be 5 years down the line. If you get the business model right and are able to predict with reasonable certainty the financial performance of the company, then five years from now, the underlying value would have changed so much that even a sharp temporary fall then would not bring down your overall returns.
Listed equities provide perhaps the easiest way to make money. In business, you need to first make something before you can earn a profit. In real estate, or even in private equity, you need to do a transaction and bear the risk of illiquidity. However, equity markets are open each trading day, people are continuously putting a price on each of the businesses listed there. All you need to know is which ones to buy. It is simple to say, but difficult to execute as it requires constant research and monitoring.
(Pankaj Chopra is the founder of Five Rivers Portfolio Managers and can be reached at pankaj@5riversindia.com)