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‘Great’ Stocks are Bad Investments for the Long Term

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.

Confused?

See, there are two factors that you must consider before buying a stock:

  1. What is the value of the company’s business (also known as its intrinsic value)?
  2. 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.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Awanish Chandra says:

    One suggestion….while speaking about returns 32% and 34%, it would have been more apt to talk about CAGR….though its written in 10 years….but still gives confusion in the mind that it is CAGR or point to point return in 10 years….

    Also for Infy……it was mostly in the range of 1000 in 2000….then dropped to 500 range afterwards….and continued to remain there……so return should be more than 32%….or need to mention prices as on which date……

    • Vishal Khandelwal says:

      Hi Awanish. Thanks for your suggestion and feedback. Since I mentioned ‘only 32%’, I assumed it implied point to point returns. Also, the base price for Infosys is its peak adjusted price of Rs 1,726 of 8th March 2000. But I’m sure you got the ‘big idea’ of the article i.e., to not buy good businesses when they trade at expensive valuations. Regards.

      • Awanish Chandra says:

        Hi Vishal….thanks for the clarification……i did understand the returns….as infy is close to my heart…..lol…..but just wanted to point out if you mention cagr of less than 3% in 10 years ….ppl will wud be able to related more that it is even less than savings bank interest rate…..so what to talk about FD rates……

        big idea was very clear in the article……and i loved reading that……

        keep doing good works for innocent investors….

        • Vishal Khandelwal says:

          Thanks Awanish! Please see if you can spread the word about the Safal Niveshak initiative to your friends who might be interested. Regards.

          • Kamal Garg says:

            I find from the price chart that Infosys was around Rs. 800 in early 2001 (I do not have price charts earlier than this) and now adjusted for Bonus/Split, it is quoting at around Rs. 3600.00
            What is the confusion on this ptp return or CAGR return.
            I think there is some confusion on this.
            Pls. clarify.
            It is intriguing to note that ptp return is only 34% since 2000 (we are not talking about PE ratio prevailing then and now). We are just talking about the prices prevailing then, now and CAGR return.

  2. IRFAN SHAIK says:

    Good post

    Don’t we consider the bonus 1:3 BONUS (july 2004) and 1:1 BONUS (july 2006) in the overall long term returns?

    Bonus brings good amount of return just by doubling the stock quantity for say 1:1 bonus.

    Irfan

    • Vishal Khandelwal says:

      Thanks for your comment, Irfan! Bonus shares don’t add to the returns of a stock. This is simply because, for example, while a 1:1 bonus doubles the number of stocks, it also cuts the stock price into half to adjust for the bonus shares.

      For instance, if you have 100 shares worth Rs 100 each, your total investment will be Rs 10,000. If the company gives a 1:1 bonus, your number of shares will double to 200, while the stock price will adjust to Rs 50, thereby keeping your investment value at Rs 10,000.

      I hope this explanation helps. Regards, Vishal.

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