These are three questions that an investor should constantly ask himself.
Am I buying equities today with a good idea of what their terminal value will be?
Let’s start with something very basic about investing. Investment is essentially what you put in today and receive back at a particular point of time in the future. You are putting today some savings to receive more at the end of a specified period of time. What we call investment is what we put in today and then we have to think of a terminal value of what we expect over a period of time, let’s say ten years. Now first, let’s look at a bond. I buy a 7 years bond with a face value of Rs 100 paying an annual interest. I know the terminal value of this bond at the end of the seventh year is still Rs 100. It is only in very rare case that I can lose everything on it. So when I set aside a certain amount of money in the bond at a specified period I get that amount back and earn a certain amount of interest over it.
When I make an investment in equity, what is important for me is to make a good guess of what the terminal value can be, say at the end of the 10th year. Now, if I am right I will make money, if I’m wrong I’ll lose money. So there’s a risk and there’s a question of reward that is associated with equities. If I put in x amount here, how much do I get at the end of a ten year period?. What is the terminal value of an equity?. What can it be? There isn’t anything certain like the bond where I know the terminal value is. What is the value that I’m going to get at the end of a specified period of time, if I invest in equity. Now that is investing.
Am I playing the investment or momentum game?
The basic question that has arisen in the recent past is: Am I paying the terminal value of the 10th year today itself, when I buy equity? If I am doing that then am I really investing or I’m merely trying to be a momentum player? To my mind if one makes money out of momentum, you make money, you again put in back into the momentum game and one day you’ll lose. So the question that arises is that am I buying something for which I am already paying the terminal value ?. If I am doing that, then I am not going to succeed. If I am doing that at best I’m a momentum player. And the whole question is how good a momentum player I am. And momentum players can learn from the recent experiences of George Soros and Julian Robertson (these are two hedge fund managers who have wound up their funds because of extreme volatility in the markets). This is very clear that you can go on beating the averages but one bad year can wipe you out. Right? So what do we do in this kind of a new change that we are seeing?
Now the question comes about, am I paying the terminal price today?. Now what decides this? I think the best guides have come from this cosmos. Carl Sagan says, that if there are no changes; then there would be no science. But all the changes will have to be in accordance or in conformity with the laws of the nature. He says the sun rises in the east and sets in the west. This is nature. It has to conform to the laws of nature. Whenever we abuse these laws of nature, we pay for it. That is the cosmology which Carl Sagan is talking about. So let’s apply this to our market.
Am I investing as per the laws of nature?
Or do we really want to be punished? I don’t have an answer at this moment. But we do need to think seriously on this particular matter. Let’s take this question of the laws of the nature. Let’s look at it this way. I don’t know much about technology. Not much really, infact I know nothing about technology. But I do know one thing. Let’s take a benchmark company today, Infosys Technologies, whose integrity and capacity to do things cannot be questioned. So we have taken this as a benchmark company. It’s the benchmark that will decide what other valuations can be. Somewhere in March 2000, it was quoted at Rs 13,700 per share. The outstanding number of shares were slightly more than 66 million. The market valuation was around Rs 910 billion. Now the reason the stock was at that kind of a valuation ( around 100 times the fiscal 2000 sales), was that it was growing at 85%. Now if you apply this growth rate, this Rs 910 billion becomes 10.6 trillion dollars.
Now go back to Sagan, the cosmologist. He says two things. "You throw up a stick in the air it has to come down." Or as he says, "Bacteria doubles every 15 minutes". So it doubles 96 times in a day. It can become mountain in a day. It can reach the sun in two days and in three days it becomes the universe. He says don’t worry, the bacteria also dies."
So the basic question is to someone who is merely applying common sense and no knowledge: Can Infosys become worth $10.6 trillion in ten years. I give one more year and it will become 20 trillion. Give two more years and it will become a world economy which is 30 trillion. So is this going to happen? Or at Rs 910 billion am I paying a terminal price?
So I made some another kind of calculation which showed that it might grow for some time at 70, 60, 40 percent and ultimately at 30 percent for two or three years and ultimately the growth will settle down at about 10 to 15 % and the sales figures as per the spreadsheet comes to around Rs 192 billion. Now when this growth rate as we see in the book, "New Rules for the New Economy" by Kevin Kelly, in which he says, "When the growth rate of Microsoft drops you know the market will flee it". So if we guess that Infosys will be a Rs 190 billion company in 10 years and the market capitalization would come to three times like everything else then the terminal value could be Rs 576 billion. Now if I’m paying Rs 910 billion for something that is likely to be (though I cannot be sure) Rs 576 billion, am I playing the momentum or am I investing?