Equity markets continued to inch forward, up 0.43% for the month. Though markets closed up 27.7% for the the calender year 2012, this was on the back of a steep fall of 24.6% for the Nifty in 2011. Nifty was trading at 6135 as on Dec 31, 2010 and 6139 as on Dec 31, 2007. The current levels of the Nifty, at 5905, trails these high levels seen 5 years back. We are into the 5th year of the bear market consolidation phase and one would find it difficult to add the word ‘celebration’ to this anniversary.
Though the Nifty and Sensex have seen such a corrective phase, one should remember that this is just an index and it is composed of individual stocks. A brief look at the performance of individual stocks over the past 5 years gives a dramatically different picture. Of the 50 companies that are currently in the Nifty, 9 companies have seen a fall of over 30% in their stock price. 16 companies have seen their stock price increase by more than 75%. 16 companies which were in the Nifty as on Dec 31, 2007 are currently not in the Nifty and the performance of these stocks over the past 5 years as been worse than the averages. Of these 16 companies, which were removed from the Nifty, 11 companies witnessed a fall of more than 50% in their stock prices. If one had held onto the original basket of Nifty stocks from 2007, the fall in portfolio values would have been significantly worse than the Nifty’s performance. Many of these stocks did see a sharp fall and looked tempting at times, but are yet to show signs of recovery.
It is important to note the divergence in behaviour of individual stocks, despite a market that has delivered nearly nil returns over the same period. An analysis of the financials of the companies that have done well, even during the past 5 years, a few characteristics stand out. Firstly, these companies have been growing revenues consistently over this period. Secondly, they are all very profitable. The average Return on Equity of the stocks that did well is about 20% better than the poor performers. Thirdly, the good performing stocks were trading at reasonable valuations at the beginning of the period. We believe, as long as the investor is willing to be patient, it is possible to make a reasonable rate of return above inflation by sticking with the simple hypothesis of buying into high quality companies, which grow in line with the economy and are very profitable, at prices that are fair.
This experience is best described in a statement by Warren Buffett in Berkshire’s 1989 annual report – ‘It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price’. With the prospects for the Indian economy looking good, led by highly favourable demographics, and a relatively flat market over the past 5 years, we are finding a few wonderful companies at fair prices. We look forward to buying into these companies.