Tuesday, June 30, 2015

Equities are the real gold over long term


In last 36 years
CAGR (%)
Rs. 10,000 has become
Rs. 29.40 lacs
Rs. 3.80 lacs

The table above summarizes the returns of Gold and of S&P BSE SENSEX (‘Sensex‘) since 1979, when the Sensex commenced with a base value of 100.

Einstein said “Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it”.

This has been experienced here in India. At 17.1% CAGR, Rs 10,000 has become ~290 times in 36 years, while in gold at 10.4% CAGR, it has become ~35 times.

A difference of ~7% in returns over longer term (36 years) has resulted in 8x increase in wealth.

The average inflation over this period has been ~8% (CPI). Thus, gold has given returns that are close to inflation, thereby merely preserving the purchasing power. On the other hand, Sensex has delivered nearly 9% p.a. excess return over inflation. Over long periods this has made a big difference.

The reason for this is simple. Equities over time grow in line with the growth of underlying businesses. As businesses comprise the economy, the nominal growth of the economy (real growth plus inflation) is a good proxy for the average growth in businesses.
The Indian economy has grown at a remarkably constant nominal growth of 15% p.a. No wonder that the Sensex CAGR of 17.1% is close to 15% nominal GDP growth.

Who is Smarter: FII’s or Local?

It is interesting to note that in the last 22 years or so that FII have been allowed to invest in stocks in India, the FII’s ownership has steadily gone up from nil to 24% today i.e. at roughly 1% p.a. The sellers obviously have been domestic investors.

The dollars received by the locals from sale of their shares have been thus invested in gold. Gold as was pointed out earlier has yielded near inflation (~10%) CAGR vs 17% CAGR for the Sensex.

In effect, domestic investors have been exchanging a ~17% CAGR asset for a ~10% CAGR one. This certainly is not a smart thing to do.

The way Forward

Outlook for Indian economy and Indian equities is promising. India is one of the best placed among large economies in the world in terms of demographics, demand, growth etc., in my opinion. India is a key beneficiary of lower crude oil prices. The savings from lower oil prices are near 2% of GDP on run rate basis at current oil prices over CY13 average.

Apart from lower oil prices, a strong, growth oriented government bodes well for economic growth and for businesses. Key decisions of new government so far give confidence that lower fiscal deficit is a priority and it should continue to fall. The government has shown with its actions that it will prioritize quality of supply of essential things like electricity etc. over the price of supply as bad supply can prove to be even more expensive; put in place a transparent framework so that India can harness potential of its vast mineral resources; simplify tax structures and improve tax compliance; and follow policies that will aim to lead healthy and sustainable economic growth.

From an equity market perspective, current P/E multiples of equity markets are reasonable – still below long term averages (see chart below). Further, corporate earnings are expected to be better than estimates as corporate margins are significantly below the long term averages and should improve as capacity utilization and business conditions improve. There is thus room for multiples to expand as growth improves and as interest rates move lower besides strong earnings growth.

To summarize, the outlook for equities is promising with a 3-5 year view.

(While the blue line denotes the Rolling PE, the red line represents the Sensex, and the horizontal line is the average.)


Equities are the real gold. Equities compound near Nominal GDP growth rates whereas Gold compounds near inflation.

So far, Indians have preferred Gold over Equities, which is not a very wise thing to do as explained above. They would be better off by doing just the opposite.

(An article by Mr. Prashant Jain—ED & CIO HDFC Mutual Fund)