We often find people saying investing in equity in long term can bring better results than traditional investment methods like FD etc.
What is the reason that equity outperform fixed interest rate instrument in long term ?
For that we need to understand that what is the source of growth of capital for investment in equity and FD’s
It is known fact that money invested in equity goes to the operating of the business though it may be partially at times because not all the time money collected by promoter share sellers of company is used for growth of the company operations.
Assuming ideal situation, If suppose all the money invested in equity goes for expansion and operation of the business. The business in turn on performing gives return in terms of earnings or profit of the company. So one rupee invested in any company before one year now turned into suppose 1.5 rupee with 50% earnings growth. For understanding sake I am considering positive growth case.
In the long term of company share performance, the earnings growth of a company is suppose to reflect into share price of the company in natural scenario. Thus growth in the company performance in turn the money invested in capital reflects in long term growth of company share.
On the other side if we consider that a company has raised money from selling of debt bond. Then it is bound to give not more than prefixed interest rate at the end of year that is around 8-9 percent prevailing in India. Same money is being used in above mentioned company example but as compare to FD’s there is no obligation of giving out extra earned 50% returns on capital.
Also if we consider the fact that money taken by bank through FD instrument can be used for giving loan. There is no obligation to the bank to return the excess earned loan income by higher interest rate loan.
There is one another dark side to equity investing that company can fail to perform thus giving lesser return than FD, as that is the case with many companies.
Thank you very much for reading me, kindly correct me for my errors in understanding the topic.
You have taken great pains in typing all this.
But you got much wrong.
Only money spent in buying at IPO goes in business (expansion, loan repayment etc etc)
After that its all speculations!
Though @maddy_Des already explained, I will tell little more. The company gets funds via ipo and allots shares to the applicants. Later the shares alloted were sold and bought in the secondary market based on the performance of that company. No doubt, equity is the best investment option for long term. Start invest in equity. U will retire wealthy.
Thanks. @goldb
What you typed is mere theory. And as you know theory has practically no relevance.
Consider this. If I gave you 100 Rs and asked you to start a business, what will you do? you will go and buy some goods to resale. In100 Rs you can easily start chana or moongfalli business.
In 100 rs you can get 1 kg of moongfalli (expenses to roast them, your wage etc included)
What you expect in return.
Ideally in INdia we consider 40% margin for any business from manufacturer to retailer each.
So you will sell your goods and earn Rs 140 total 40 being your profit.
That means after spending 100 you expect 40 profit.
What’s PE ratio here? 0.4.
What’s PE of NIfty ? 27+
I agree with your point maddy_Des,
But I think we need to look at bigger at more deeper picture of the economy…
when money gets invested in, by IPO into business, its value doesn’t remain fix. I am talking about value of money invested in business and not about its current price.
Every time business shows earnings change the value of money supposed to be get readjusted with it.
As for readjustment of current value of money, equity is the forerunner instrument later comes the conditioned instruments like FD etc.
So what I am trying to say is that, whenever you buy a share you are investing into the business itself with new adjusted value of money compare, to that invested at the time of IPO.
You can say that may not directly going into the business like IPO but if you see the total value of business you are buying the business only.
and the PE ratio is subject to individual consideration, it may be less for someone at its peak or naturally costlier for somebody. The more mature investor participation increases that will bring out the better PE’s.
I personally think that even Fundamental Analysis FA is just a ruse used by smart money to drive the market their ways.
There is no way you can explain the market behaved in PSU Banks few days back