January 18, 2010

Analysing the poll

I recently conducted the following poll on the blog. The results of the poll for the 205 responses are given below

What do you expect to make from investing in stocks in a 3-5 yr time frame?
10-15% per annum – 16%
15-20% per annum – 33%
20-25% per annum – 25%
25-30% per annum – 9 %
30%+ per annum – 14%

What was the idea behind the poll?
I had the poll for two main reasons. The first reason was to gauge the return expectations of the readers from stock market investing. The second reason was to discuss what I think would be required to get these returns

Comparing against market returns
The above return expectations are for a portfolio and hence it makes sense to compare it with index returns which serves as a benchmark. Why consider index returns? Well, it’s a passive form of investing. You can invest in the index and go to sleep and still make these returns. So one can call the index returns as zero effort (not zero risk) returns.

So what can one expect from the index? One cannot predict where the index will be in 3-5 years (though there are more forecasters than we need), but one can try to make an intelligent guess. The index is currently at a PE of 23 which is fairly above average. The index EPS has grown at an average of 14% for the last 17 years with 20%+ growth in some years and negative in others.

For the sake of argument let’s assume that the EPS growth will be 14% for the next 3-5 years and lets also assume the PE will remain the same (though I will not really bet on it). If one makes these simplifying assumptions, then the index returns would be 14%. If the EPS growth is higher or PE increases further, then the returns could be higher. On the other hand if the EPS growth is slower or PE contracts, then the index returns will be less than 14%.

So in conclusion one can say that the index returns are likely to be in the first option of the poll. By the way, almost 86% of those who participated expect to beat the market by a decent amount :). High expectations indeed!!

First option: 10-15% per annum
This is an easy one to achieve as long one does not try to get too clever. One needs to create an SIP (systematic investment plan) in an index fund or ETF and put a fixed amount of money into the fund every month. The SIP should give a return of 1-2% in excess of the index (due to cost averaging). So if one were to follow this plan, these returns are quite achievable.

Second option: 15-20% per annum
This was my choice of expected returns . This choice means that index investing alone will not help. If the index were to return 14% or so (which is not destined to happen), then achieving these kind of returns would require a combination of the following
- An ability to pick high quality companies at slight undervaluation. These companies have to do well to give the 15-20% returns for the next 3-5 years
- An opportunistic pick of a few companies which are in temporary distress. If one is able to identify such companies and buy them before a turnaround, then you can add a few extra percentage point returns.
So this option looks doable, but would require more than average, but not extraordinary effort to achieve it. A reasonably diversified portfolio of 12-15 stocks should help one to achieve these kind of returns

Third option: 20-25% per annum
Now we are getting into an interesting area. A 20-25% return means one would be able to triple his or her money during this period. At the current PE levels and an optimistic expectation of 14% returns, getting 20-25% would require quite an effort. I can think of the following

- An ability to identify some out of favor stocks and being able to bet heavily in a few of these ideas. For example if you think that sugar stocks are going to do well and are able to pick some cheap stocks before the turnaround and sell after the turnaround happens, then the returns are likely to be good.
- A core portfolio (50-60%) of high quality companies which will give above average (more than 14%) returns
This option is not a low risk, low effort option. It would require a decent amount of work to research underpriced stocks and bet heavily on them. I don’t think you can make these kinds of returns unless you have a decent amount of experience in stocks and can devote ample time to investing. Almost 25% of the poll participants think they will fall in this category of real superior investors

Fourth option – 25-30%
As expected only 9% of the participants selected this option. A 25-30% return means making 3-4 times your capital. If you have not made these kind of returns in the past for a 3-5 year period, then expecting such returns would be risky. One can make these kind of returns only if
- One picks undervalued picks, holds till they hit fair value and then sells them. In addition one will have to find such ideas consistently
- One will also have to be a bit lucky to make these kind of returns. A mid size to large market crash would certainly help. If the market were to crash, an investor should be able to commit a lot of money.
- A focused portfolio (less than 10 stocks) would be required with a decent turnover in the stock holdings.
- A small amount of portfolio will have to dedicated to options or arbitrage kind of ideas where one should be able to make 30%+ returns
These kind of returns are not easy to get, especially if investing is not your full time work. A lot of guts, some amount of luck and sufficient investing experience would be required to make these returns.

Fifth option: 30%+ returns
This option was voted by 14% of the participants. I can think of some reasons behind these fairly high numbers. Some of the participants voted for the sake of it without giving much thought or are getting delusional about the returns. One can expect these returns only if one is very new to the market and has no clue of what to expect or has been around for quite some time and is a superior investor

I really don’t have specific ideas of how one can achieve these kind of returns at low to moderate risk. One can make these kind returns only by being aggressive in the market and through a decent amount of leverage via options or otherwise. A 30%+ returns for the future would mean beating the market by more than 16-20%. These kind of high returns are not achievable by buying index stocks. One can make these returns by having a highly focused portfolio (3-4 stocks at best) of great ideas or by investing in other kind of instruments such as options.

The problem with such expectations is that unless one has made these kind of returns for some time, it is likely that the investor would take on high risk and could thus get wiped out. I hope these investors know what they are doing.

By the way – if you expect to make 25% or above, please share your thoughts via email or comments as I would really be interested in knowing how you plan to achieve these kind of results.

Why no negative returns
Someone mentioned in the comments on the absence of an option for below 0% returns. I think that is quite possible, but would be an uninteresting option. If one believes below 0% returns, then it is an easy decision. Put all your funds in cash or FD and get on with other things. A 0% or less return would mean a PE drop of almost 50% in the next 3-5 years.

An optimistic bunch
I have to say the participants of the poll are a very optimistic and confident bunch. I personally think a 15-20% would be a very good return for me and more likely to be around the 15% level than the 20% mark.

Final point: If you were expecting me to provide an 8 point or 10 point plan to achieve 15%+ returns and have voted for option higher than 15%, please re-think your expectations. If you need someone else to show you how to beat the market, then you could be in for an unpleasant surprise over the next 3-5 years.

15 comments:

Mitran said...

Based on this article, kindly start advice on the portfolio building with current valuations along with stated portfolio. So that new peoples will also join the party.

Lucky said...

I was relived to see that I had selected the same option as you :-)

On second thoughts, I find scoring a 15-20% might be really challenging (especially given the time I am able to devote to this activity). I hope I still survive with a 10-15% return.

So what's your mantra for 2010?

Amit said...

Interesting results! What would probably be even more interesting would be a poll asking readers for what how much they expect a benchmark index (nifty/sensex) to rise/fall over the next 3 years from current levels.

That would truly demonstrate the level of 'irrational exuberance' among readers :)

Vic said...

Thanks Rohit. I really like the breadth of topics discussed here, you're truly a great teacher.

I hope by using ur paid service and other ideas, we're able to achieve 15-20% returns. It would be good to get closer to your strategies/timings. In the process, learn more about other aspects of investing.

Thanks,

vikas

Rohit Chauhan said...

Hi amit
thats true , there is more optimism now than last year. but you never know ..maybe others are more pessimistic

rgds
rohit

Rohit Chauhan said...

Hi vic
i cant say about the returns ...but yes i plan to publish a model portfolio as part of the paid service and this model portfolio will mimic almost 90% of my portfolio.

Saif said...

nice post sir...when are you planning to launch the paid scheme and is it open to blog readers and others alike

Madhav said...

Hi Rohit,

Thanks for sharing the poll results and comments on the same.

Personally, if I cannot make 15-20% or beat the sensex by 5% in an average year, I would think it a waste of my time and energy studying investing, spending time monitoring news, taking buy/sell calls etc. So, though it might seem odd that there may not be many intelligent investors out there (including me), if the rewards do not match the efforts then I would rather invest in real estate (residential land) or MF instead of taking the active investing route.

Like I have mentioned before if you are going to provide a paid research service with buy/sell calls, value the stocks and provide a potential upside kind of info, I will be interested.

Cheers.

Nandy said...

Hi Rohit, Interesting analysis. I voted for 20 - 25%, with realistic expectation around 20%. And I did that because, as an investing style I have a few companies in mind and wait till they are grossly undervalued and go for the kill. (And I don't fret if they go down in the short term, after I buy, et al). In fact, I made good use of the Oct 08 to Mar 09 and made great buys. If the market puts up a good sale once in a while, things are quite achievable, I think.

Rohit Chauhan said...

Hi saif
i will be launching the service towards later part of the year. it will open to everyone, but i plan to limit it to no more than 15-20 subscribers as i want see how it works, scale it and only they roll it out further

regards
rohit

Rohit Chauhan said...

hi madhav
beating market 5-10% over long term is not as easy as it looks ..yes one can do it for 2-3 years by some lucky picks...but over 5-10 years is not easy and few do it.
why are there are more people trying this than exepected ? no one wants to accept that they are ordinary as others and will be above the average ..ofcourse most of these people want to be above average but not put effort to be above it

look at the number of people chasing tips and trying to get rich quickly

Rohit Chauhan said...

hi nandy
yes it may be ..its for each one of us to decide. a focus portfolio definitely will help

rgds
rohit

Sajith said...

Interesting poll. however i have a diferrent view towards this. If you look at just stock returns a 25-30% returns is reasonable. However when you look at your total market returns i believe that this kind of returns is not worth the time you invest for it. This is because the market always moves in cycles of 4-5 years with a slight upward bias. And you should be able to get superior returns in such cycles.

Also by using some derivative techniques it is possible to get very superior returns compared to general market returns.

I have an article written on it recently on how to maximize your stock market returns using options

http://stockface.blogspot.com/2010/01/maximize-your-returns-using-options.html

Rohit Chauhan said...

Hi sajith
i really dont agree that stock specific returns are completely disconnected from the markets. only a few investors are able to beat the market by 5-10% over long term. being able to do 1-2 yrs does not mean much.you may be in a position to make 25-30% returns, but i dont think majority of the investors would ..25-30% returns p.a for 5+ years are not easy to make
on options i have no idea ..you may be right, but i have not tried to know more

Abhay Munot said...

Hello Rohit,

At the outset thank you for writing this wonderful blog. I enjoy reading your entertaining & informative posts.

I am glad that you are giving a sensible advice to Indian investors to not expect unreasonably high returns in future. I am an Indian investor based in USA and I also recently wrote a post on my blog http://thesensibleinvestor.blogspot.com/2009/12/equities-return-drivers.html about the expected return going forward and coincidently our return expectations turned out to be quite close.

Thanks,
Abhay