Infosys was a great stock in March 2000, but has returned its investors only 32% since then.
HUL was a great stock 10 years back, but has generated returns of just around 34% over these years.
The list of such ‘great’ stocks is endless – stocks that were loved so much by investors but failed to return much over the long term.
Let me clarify one thing here – ‘great’ here means stocks that investors love so much that they are willing to pay any price to own them.
This makes ‘great’ stocks really bad investments for the long term.
See, there are two factors that you must consider before buying a stock:
- What is the value of the company’s business (also known as its intrinsic value)?
- How much is the price of the stock in relation to the company’s intrinsic value?
So while a business that is doing well, has a good management at helm, and has the potential to grow strongly and profitably in the future is a great business, if its stock price is high in relation to its business value, it isn’t a great investment.
If you look at Infosys in March 2000, which was the peak of the dotcom bubble, the stock was trading at three-digit price to earnings (P/E) multiple, which made it very expensive and thus a ‘great’ stock (because every one and his grandmother wanted to buy the stock at any price) but a ‘bad’ investment.
The price has to be right
As Benjamin Graham, the father of value investing, taught, the price you pay for an investment matters a great deal.
In fact, price is the primary determinant of the return you earn on your capital. If you pay Rs 10 to buy ownership of Rs 2 in profit, your return is 20%. If you pay Rs 50 to buy Rs 2 in profit, your return is just 4%.
So never forget this: Price matters.
No matter how great the business is, if you overpay for your ownership, you are going to earn a sub-par rate on your money even if you hold the stock for the long term (like 10 years).
It’s basic math.
Anyways, here’s how some leading global stock markets performed during the week gone by. Indian stocks, represented by the BSE-Sensex (up 0.3%) were the leading gainers during the week. Stocks in the US ended weak.
Data source: Yahoo Finance
At this juncture, should you be a buyer or seller of stocks?
We’ll answer that on Monday.
Till then, take care and have a great weekend.
And tell us in the comments below or on our Facebook page whether you are a buyer or seller of stocks as of now.