Equities are meant only for outsized returns
Equities are more and more getting mainstream in everyone’s portfolio. However, it amazes how the meaning of equity investment has been changed over the years for an uninformed investor.
By first principles, equity investment is meant to provide capital to a business where the residual profits are shared with business owners (after all business needs have been met). The equity investors accept the trade-off of being paid the last with a potential of outsized returns. The word outsized returns is key- Equity investments are never meant to get a pre- defined rate of returns. They are, by definition, financial products where profits to shareholders will vary and oscillate a lot depending on the market environment.
Talk to any business owner, and you will be hard pressed to find one whose business doesn’t encounter slowdown, margin reduction, and any other unexpected surprises. Yet, market reacts so much differently (sometimes drawdowns of 50%+) on some of these very predictable business short term business outcomes.
This increased volatility is causing the market to invent new products to tame volatility with an intent to increase the equity capital flow (in the name of democratising the equity investment game), - including holding 200 stocks (in mutual funds), inventing balanced funds (mix of equities and debt) and buying only sure shot dividend yield stocks. These approaches tend to hide the very essence of equity capital for businesses and entrepreneurs.
For a pure investor in a business, the game of equity investing should be about extremes and not about low volatility x% returns. If equity investment is all about generating 2%-3% additional returns over the government inflation protected securities, we don’t find that worth playing and devoting one’s significant financial and mental capital.
As in life, most companies do-not matter at all and only small handful have the capability to provide outsized returns. One must be uninterested in the average company, but look only for extreme performers. For us, extreme performers could include moderately growing but deeply undervalued (doesn’t mean 50% undervalued, but deep undervaluation of 80%+) or these superstar gem businesses which have very very long runway and a dominant profitable market position . In the first case, we look for extreme market dislocation with catalysts, while the other entails entrepreneurial creative and imaginative mindset that appreciate the long term potential of compounding with ability to handle business vicissitudes.
The excitement of finding extremely dislocated businesses or being associated with great entrepreneurs with whom you will stand for a decade and compound the business many multiple times its current worth is what makes this game worth playing . The middle game should totally be avoided and is not worth your financial and mental bandwidth.
It wont be easy. Great pursuits are never meant to be easy and the outcomes may not come as expected, but one has in his power to atleast design the intent and the process to think like this and only buy businesses which have potential to generate materially outsized return potential .
Akhil D.
Disclaimer : The information is not intended to be and does not constitute financial advice or any other advice, is general in nature, and represent personal opinion. Before using this article’s information to make an investment decision, you should seek the advice of a qualified and registered securities professional and undertake your own due diligence.
None of the information in this article is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, company, or fund.