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Why Equity?

Globally it has been experienced that over time, a portfolio of well chosen shares will always out perform all asst classes including time tested fixed deposits and also inflation.

What is required is ?

A.
Logical allocation in equity out of ones total savings
B.
Proper selection based on value – price matrix
C.
Patience and appetite to withstand the volatility of the market.

Why equity beats Inflation?

Companies consume certain inputs in the form of man (salary), machine (depreciation) raw materials, money (interests) etc and then makes profits by selling the output (products or services) at a price higher than the cost of inputs. Further, the companies run by good management are supposed to grow over a period. As the cost of inputs increase due to inflation, the company has to either pass on the total expense to the customers to make the same amount of profit or has to compensate it through improves efficiencies, sales etc. And to make bigger profits such efforts become more important. So, in a good business the profits will outpace inflation. And since the price of a stock is determined in the long run by the earnings of the company, it can very well be expected that return on equity investment will outpace inflation.

Why equity beats return on fixed deposit


Historically return on investment in equity over last 31 years has been higher then fixed deposit by 17.72% (sensex 27.03% vs FD 9.31%). Such out performance following can be attributed to following few rationale.

A.
Banks are the lifeline of any economy. They have to make profits also. They take deposits and then lend a part of it to the companies at a margin of appx 3- 5%. The companies, in turn, take such loans on the hope of generating higher return than their cost. And since the price of a stock is determined in the long run by the earnings of the company, it can very well be expected that return on equity investment will outpace fixed deposits. Tax rate differential make such outperformance even more attractive.
B.
Company managements are well aware that the return earned by the equity shareholders over a period has to be higher than the risk free fixed deposits otherwise the stock price might get hammered, affecting the interests of the promoters the most.
C.
It is always in the interest of any economy that the return on employment and tax generating equity must be higher than the fixed income instruments. It also helps to curb indirectly social unrest and improve the standard of living of the mass.

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Analyst Mohalla