To put a number on what return to expect from equity is a challenging task. Let’s talk about companies with familiar names – like Reliance Industries, Infosys, Tata Motors to just name a few.
The names I selected are not important; it does not matter if they belong to a particular industry or if they are big, small or tiny in size. They all follow same principle and same rule, which I will talk about soon.
Pick any daily newspaper and read the stock prices. Let’s say Infosys trades at Rs. 3300 per share and yesterday it traded at Rs. 3260 per share. Just few months back it use to trade at around Rs. 2850 per share and almost a year back to as low as Rs. 2200 per share. Likewise, if we see price of Tata Motors it has oscillated between Rs. 250 at the low end and Rs. 400 at the upper end over last 1 year. This would really put a strange question in one’s mind. The companies I talked about are big proven large cap companies and their prices have oscillated so wildly over last 1 year or so. However, if one takes a longer horizon of 3 to 5 years – the price at low end and high end would give much wider range.
Each day the newspaper has a list of thousands of companies and the price at which people have been buying and selling an ownership share in each. Each company is divided into number of shares in our example of Infosys and Tata Motors – one could have purchased their respective shares at Rs. 2200 and Rs. 250. At low end of price – entire company Infosys was available at Rs.
1,08, 000 crore and Tata Motors at Rs. 65,000 crore. At high end of price the same company Infosys is valued at Rs. 1,70,000 crore and Tata Motors at Rs. 1,10,000 crore. This wide range of valuation of Infosys at Rs. 1,08,000 crore to Rs. 1,70,000 crore raises eyebrows and makes one think did the business of Infosys exhibit such wide and wild swing in its operations. Has Infosys generated over 60% growth in its business? Did the number of clients of Infosys grow by over 60%? A similar question will arise in case of Tata Motors – did the company manage to sell more vehicles to the extent of 70%? The answer is a clear no. However, the fluctuation and swing in price in case of most of the companies is a fact and can be validated.
The next logical question will be why do stocks trade at such prices and why people are willing to buy and sell shares at low price and buy them back at high price. Benjamin Graham – one of the greatest thinkers and writers on stock markets has coined a person called Mr. Market who is subject to wild mood swings. Sometimes he is in such a good mood that he names a price that is much higher than the true worth of the business. On those days, it would make sense for you to sell Mr. Market your share of the business. On other days, he is in such a poor mood that he names a very low price for the business. On those days, you might want to take advantage of Mr.
Market’s crazy offer to buy his share of the business. If the price is neither very high nor extraordinarily low relative to the value of the business, you might logically choose to do nothing.
So in our example – Mr. Market offers to sell shares of Infosys on a given day at Rs. 2200 and few months later Mr. Market offers to buy the same share of Infosys from you at Rs. 3300. It is for you to identify that Infosys is available at a huge margin of safety and should be acted upon. This will annoy you as you wouldn’t know how to determine if Infosys at Rs. 2200 is available at a bargain price.
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