You had 100 US $ to invest. You were about to leave on a journey – it was uncertain where you were going. It was an army expedition. You did not know whether you will come back. Your brother also came along with you. He too had the same amount. He too had to invest. He invested in equity. You invested in debt.
No newspaper, no phone, no communication. Rip Van Winkle hit both of you. Suddenly you woke up in 2014, today.
You realized that both you and your brother had slept for 88 years. The year that you invested was in 1926. After that slavery was still being abolished, the world went into a crippling recession, many countries got their independence, 1 world war was fought, the US dropped 2 atom bombs, many countries defaulted. World population defied Malthus. Asia emerged, Europe declined.
Americans burnt the Vietnam people, occupied all oil producing countries, tried to finish the Middle east.
You and your brother opened your portfolios. You had 2100. Not bad at all you thought. It had grown 21 times. Your brother had 531,300. This gap is Equity Risk Premium that your brother got.
Your brother actually got rewarded for investing in an economy which dominated the world for a very long time. It plundered economies, raw material suppliers, consumers, …and all the companies did well in that period. So the equity premium looks good. The question to ask (fairly) will there be an equity premium over the next 100 years? Really?
Why did I take the American example? simply because Indian equity markets do not have enough of recorded history. Even if you discount the quality of balance sheets, disclosure, honesty of promoters, the American Equity history is longer than the Indian history, and over longer periods of time the difference is more stark.
Understanding the ‘price’ of risk is the most important one if one were to go and find out what to do in the markets as a whole. However for most of the non index investors (like me) who are stock pickers, the state of the market is NEVER an issue. I am looking at buying shares with a good RoCe, RoNw, a rising market share, good management, and an increasing EPS over say 10 quarters.
So once you have your list of shares ready (and you are willing to add them steadily over a 20 year period) you will find your bargains in this market. Sure the market can remain depressed for a few more days, weeks, months or even quarters. However, if you are a long term investors some of these falls could be a good opportunity to buy. The skill is not in the buying. The skill is in the holding over the next say 2 years when the index may just grind its way from 25000 to say 23,000. Say in 2018 the market goes from 23000 to 33000 in 3 months, will you be there? Or at that stage will you say “oh when the index was 23000 I should have bought some shares”. That is vague, and regret is a useless emotion in the market. I am not a person who is very much worried about the macros, but risk premium is worth knowing / learning and trying to understand.
For the more brave ones who are comfortable with numbers, here is an article by Aswath Damodaran..worth reading
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