How Much to Expect From Stocks?
MAS Team | 30 December 2016
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Had you invested Rs1 lakh a decade ago in the current market leader in the air-cooling segment, Symphony, your money would have grown to a mammoth Rs8.37 crore. But what were your chances of being able to identify this stock and then holding it so long? Negligible.

 

These are one-off cases, or outliers, for the statistically-minded. You need to be really lucky to be able to get on such stocks and hold them through their volatile journey upwards.

 

So, what kind of returns can we expect from stocks? We need to arrive at the average return, not the eye-popping exceptional return. This will give us an idea about what is called the base rate of stock returns.

 

Such base returns can be arrived at by collecting a database of ALL stocks and then calculating their returns over a long period. This is what we have done. For our yearly Wealth Creators study, we have worked with a database of more than a 1000 stocks. The table below represents average compounded annual total shareholder return (CATSR) by the entire database for the decade ending 31st October:
 

 
The mean and median returns of all stocks for the three 10-year periods are given in the chart. The best average return is 8.41% and the worst return was 6.81%. These are the returns you would get if you blindly buy stocks, without any prior knowledge. Most return expectations take into account some prior knowledge and therefore make us fall for what is called hindsight bias. This average is a good representation of investors’ expected returns as it is adjusted for outliers and considers performance by laggards too. After looking at this data, our comfort levels with fixed income products would increase dramatically and we will be dissuaded to invest in stocks directly. It also explains why a large number of people lose money in stocks: they have unrealistic expectation from stocks and are overconfident about their abilities to choose the correct stocks.
 
The table below represents average compounded annual total shareholder return (CATSR) by top-500 companies for the decade ending 31st October:
 
 
Over each of the three decades, the top-500 stocks delivered an average return of 17.31% to 24.17%, which is around 2.5 time to 3 times the average return. This is what investors should be aiming for, the top-500, not the glory stocks. The top 500 is skewed by the outliers. So, what happens when we disaggregate the average data? For this we need to look at distribution of returns. We compared the number of stocks that delivered returns in a particular range for all the three decadal periods:
 
 
The table above represents the number of stocks that were present in a particular range of returns for each of the given decade. For example, 134 of the top 500 stocks for the decade ending 31 October 2016 delivered returns in the range of 9%-15%. You realise that 1/3rd of the top 500 companies did not create huge wealth, only reasonable wealth. For the decade ending 2014 there were five companies delivering compounded annual returns in the range of 55%-60% that pushed up the average. We once again understand the importance of stock selection. 
 
Then comes the crucial issue of timing. You would notice that three decades have different distribution of returns. Companies did far better in the 2004-2014 period than in the 2005-2015 and 2006-2016 periods; the green bars show this. In fact, most of the companies delivered high returns in this period and very few, only 12%, or 59, out of top-500 companies, delivered returns in the range of 9%-15% for the decade ending 2014. Conversely as many as 134, or 27%, and 178, or 36%, companies delivered returns in the range of 9%-15% for the decade ending 2016 and 2015 respectively. This underlines the importance of buying stocks when the market is low, which it was in 2004 compared to 2005 and 2006. 
 
In short, be aware that a large number of stocks will deliver very poor returns. Some robust, well-proven method to select stocks is a must. Be aware also that what you get is determined by when you start. You need some sense of market valuation to time your purchases. Increase your asset allocation when the market valuation is down.