We, equity investors, by our very nature, are optimists. We are cautious optimists, but we understand very well that the future will be better than the past. Even in the worst of times, the economy grows and businesses make more money than they had in the past. The process has its hiccups. There are ups and downs. However, we investors are extremely confident that 2018, say, will be a lot better than 2008 and 2028 will be a lot better than 2018. Shorn of all the theory and the maths, this belief lies at the heart of long-term investing.
For months now, sceptics have been asking why the markets are rising, despite poor corporate performance. I guess now they have their answer. In times like these, the basic contradiction between actual investors, who have skin in the game, and the tribe of sceptics, on the other hand, becomes clear.
The patron saint of this belief is, of course, Warren Buffett. Back in September last year, he predicted that in a 100 years, the Dow Jones index would hit a million points (it was at 22,400 at the time). Obviously, this was just a round number extrapolation. In fact, it's quite a modest number since it implies a growth of 3.9 per cent per year. If the BSE Sensex grows at 10 per cent a year (which is a modest number in India), it would hit 49,60,00,000 (49.6 crore) in a 100 years. These are not numeric projections, although they can be taken as such. Instead, they are a declaration of faith in the continuity of the country's economic environment, and the success of human beings' urge to improve their lot.
Once an investor believes in this, the problem devolves to choosing the right stocks to invest in. There too, instead of starting with companies and sectors, it is helpful to understand the basis on which such selections are made. You can look at the valuation (price to earnings) of a stock; you can look at its dividend yield; you can compare its price to its book value; you can look for stable earnings; you can look for high growth; you can look for turnarounds; you can look for businesses that are opening up new technologies and markets; you can look simply for companies that have some kind of investor momentum behind them; and you can look for companies that have some combination of these factors. Finally, on top of all this, companies whose managements have a track record of competent execution are another layer of selection.
Therefore, it is obvious that what we equity investors do has two steps. We believe, as optimists, that there will be growth and there will be more prosperity. On the basis of that, we have to choose for ourselves the best investments that can benefit from that. It is definitely not necessary to be able to foretell what will happen. Sometimes, when I discuss long-term investing with some investors, they come up with objections like what the predicted EPS of so-and-so company at the time is, what the GDP growth will be, what oil prices will be, etc., etc.
Investors who feel that investing is about predicting EPS and GDP have a different set of problems. People like us, all we need is faith that the world will grow, and a rough sense of which companies are well run. That's enough.