Why Are We Gung-ho On Equity?

Earlier in this module, we learned that the equity asset class has the potential to consistently deliver returns more than inflation.

Here on, we have established that equity returns in the past twenty years have been way ahead of any other asset class.  But this is certainly not the complete picture.

The Sensex & the Nifty 50 index highlight the performance of the largest, most active & liquid companies listed on the Indian Stock Exchanges. These companies are considered to be fundamentally strong & dependable with a proven track record, also known as large caps or blue chips.

As per SEBI (Securities Exchange Board of India), the Top 100 companies in terms of market capitalization (valuation of the company based on the total no of shares * current market price of each share), are reckoned as largecaps. 

Now, What about the performance of companies further down the list aka Midcaps (101st-250th) & Smallcaps (251st onwards)?

Let us see:

You will be appalled to know that the Nifty Midcap & Nifty Smallcap Indices have outperformed their large-cap peers by a stellar margin- delivering CAGR returns of 24.35% and 16.15% in the past twenty & seventeen years respectively. 

The returns on the Nifty Midcap index are almost 8x that of savings accounts, 4x of fixed deposits and 2x that of Gold. 

Mind-boggling. Isn’t it?

Now let us shift focus to the charts, observe carefully all three of them- Nifty, Midcap Index & The Smallcap Index. 

What do you observe?

1)Stocks are upward trending- This is our first natural instinct as soon as we observe any of the charts. Stocks are in a long-term uptrend and this trend is unlikely to reverse any time soon. There is a strong correlation between economic growth and stock market performance. In essence, as long as the growth levers of the Indian economy are in place, stock markets shall continue to be buoyant.

2)Stocks are volatile - compared to other financial instruments that provide fixed returns every year. Neither do they move linearly in one direction. Stock prices fluctuate every second based on demand-supply dynamics. Although it may sound like a negative feature about equities, smart investors know how to make volatility work in their favour. Buying on market declines is an excellent strategy and works well for long-term investors.   

You must have noticed a striking similarity between all the three charts. I have pointed out the same in the chart of Nifty 50 below and you can compare this feature in the other two as well:

Notice how stocks corrected drastically three times in a twenty year history- 2001, 2008 & 2020. The Nifty 50 Index fell between 40%-60% from its peak on these three occasions. To give you an idea of how scary things were, Imagine a ₹1,00,000 portfolio being reduced to ₹50,000 in a matter of months. 

Panicking investors sold off their stocks at rock-bottom prices whereas the smart ones were busy accumulating their favorite companies. You will notice that eventually, the market punished the panic mongers by scaling another peak. By buying at such throwaway prices, investors benefited hugely. 

Prudent investors know that volatility is actually a boon if you are committed to long-term investing. They usually buy more when people are selling in large hoards. And that is precisely how they stay ahead of the curve.

Present-day, countless Midcap & Smallcap stocks are up more than 5X to 10X from their lows of the 2020 crash. Yes you heard it right, 500%-1000% returns in just a little over one year. 

The list goes on and on. But what about the blue chips?

To give you a perspective, they aren’t lagging behind in terms of returns. 

The key-takeaways from this section are:

• Stocks are in a long-term uptrend.
• Volatility is a boon and we can make it work to our favour.
• Large cap companies have an established track record and are best suited for investors with low risk-appetite.
• Midcap & Smallcap stocks have delivered better returns than their largecap peers but carry higher risk.
• Patience is a gifted virtue and more so for long-term investors. 
• Investors must not panic when the market falls but instead add to their positions if they are confident about the prospects of the company.
• Returns are quadrupled when stocks are bought on market declines.