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Bottomline: Your odds of beating the market are slim

Bottomline: Your odds of beating the market are slim

Bottomline: Your odds of beating the market are slim
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By CNBCTV18.COMAug 8, 2022 9:41 AM IST (Updated)

Stock picking is painstaking work and the probability of beating the market is slim for most, here’s why

The recent upswing in the market has caught many a seasoned investor by surprise. And opinions are still divided on where the market is headed. At times like this, we often hear experts wax eloquent about taking a stock-specific approach. That’s easier said than done.

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For one, not many of our brightest fund managers have consistently beaten index returns over varied time periods. We dug a little deeper into data to figure out why that is. Here are some interesting findings.
We looked at the BSE-500 index set of stocks over a 10-year, 5-year and 3-year period to gauge how they have performed. As corporate action adjusted data wasn’t available for the entire set, we used a close proxy, market capitalization (of course this doesn’t factor in dilutions) for our study. Here are the big picture findings.
Over a 10-year period, 5-year period and 3-year period, the Nifty (NSE-50 Index) has returned a compounded growth (CAGR) of over 12 percent, 13 percent and 14 percent, while the BSE-500 index has delivered 15 percent, 17 percent and 21 percent. If we add a risk-premium to the Nifty index returns of about 7-7.5 percent (similar to the Nifty return over a risk-free rate) for active management, the returns should be in excess of 20 percent.
So, what are the odds of an investor being able to earn such returns (20 percent+)? It is about 33 percent over a 10-year period for BSE-500 stocks, and 42 percent over 5-year and 3-year periods. What this suggests is that your chances of outperformance are lesser than underperformance, and this is more so over a longer term. Interestingly, the chances of earning less than 5 percent (includes negative returns) are higher in the short-term than in the long-term.
10 Yr5 Yr3 Yr
10 Yr5 Yr3 Yr
CAGR (%)
Returns >20%0.340.420.42
Returns <5%
This suggests higher return and loss potential in the shorter-term compared to the longer-term, also a popular belief. But what gets interesting is the internal picture, with midcaps dominating the high return 50 percent+ CAGR list over a 10-year period, but more largecap stock participation in the 5-year period and still more in the 3-year period. For example, the 10-year toppers include names like Aarti Industries, Astral, Bajaj Finance, PI Industries, Tata Elxsi and Vinati Organics, while the three-year toppers include Reliance Industries (also due to equity expansion following the rights issue, ex-of this, the return is about 30 percent), Apollo Hospitals, Divi’s Laboratories, ICICI Bank and Tata Consumer Products.
This challenges the notion that largecaps don’t deliver high returns in the short term. But over a long term of 10 years, we note that the steady compounders of 20-25 percent have a large section of large cap names like Hindustan Unilever, HDFC Bank and Kotak Mahindra Bank.
Are there any common factors that define strong compounders of 25-50 percent over 10 years? A healthy average return on equity of 16.4 percent to 21.3 percent over the past 10 years stands out. The other factor that stands out is a health operating cash flow generation over the 10 years, barring a few aberrations (like for COVID-impacted companies for 1-2 years). So, if you are looking for compounding candidates, these could be a couple of factors to weigh.
For those who haven’t cut their teeth in the investing business, the wiser move is to invest in index funds. The Nifty and even broader indices like BSE-500 have delivered healthy returns over the risk-free rate over a 10-, 5- and 3-year period. What’s more, if you can follow a drip investing, rupee-cost averaging approach by investing a fixed amount via a systematic investment plan (SIP), your returns could be still higher.
Don’t try to be a stock-picker, unless you have the knowledge and time to invest in such decisions, as the odds of beating the market are loaded against you.
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