Dhirendra Kumar explains how equity works and why it is superior to other asset classes
21-Apr-2017 •Research Desk
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Answer transcript: Equity means part ownership of a company and hence makes one entitled to the profit of the company. Stock price is a reflection of rising/falling stock prices. If the company is performing well, that means the sales and profit of the company is rising. Rising stock prices can be a reflection of inflation and if the company has pricing power, they will be able to increase their sales and, in turn, profit. On the other hand in fixed income instruments, it is seen the returns are not substantially higher than inflation.
Secondly, company will borrow only if they can maximise its returns, and hence cost of interest on borrowings have to be lower than its earnings. Superior company can enlarge their market share and create greater efficiency to maximise their returns and that reflects in higher stock prices. However, ownership comes with many associated risks. Many companies die out or stay stagnant in the process or are not able to recover from the high investor risk. In equity, you are entrusting your money to a fund manager who is likely to invest in companies which are attractively priced and are likely to generate good returns. These are the primary reasons why equities generally give higher returns as compared to other assets over the long term.