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The weighing machine

Stocks tend to follow profits in the long term

The weighing machine

"In the short run, the market is a voting machine but in the long run, it is a weighing machine," said Benjamin Graham. In order to validate these words in the Indian context, we observed the correlation between profits and returns of Sensex stocks over five years. We also studied the yearly correlation between them for the last five years (data for 2017 are given in the table). We found that there is a weak correlation between returns and profitability on a yearly basis. But over five years, compounded returns of most of the stocks have followed growth in profitability, especially operating profits. Operating profits are a better tool than the profit after tax when the latter also comprises extraordinary items. Hence, look for companies with decent earnings growth.

The weighing machine