High returns won’t make you rich, BIG bets will

We had an interesting email exchange with one of our customers. He raised an interesting question and made us think hard. His question goes like this:

Can you suggest business/stocks growing more than 25% CAGR? I want compound my portfolio above 25% CAGR over long term.

Edited answer: There is no way to find in advance which stock may yield 25% CAGR. As stock essentially follows earnings growth, we are sceptical whether there would be many businesses growing above 25% CAGR over long periods. In past quite a few business grew at stellar rates as inflation was 10-12% and GDP growth was 8% (Market returns approx ~ GDP growth + inflation). Penetration was low and higher inflation made it easy to pass on the prices, earnings grew faster than volume growth.

Currently, inflation levels are at ~5-6% and GDP growth rate is likely to be 5-6% over 5-7 years (Market CAGR approx. 12-13% est.). In such situation, for a company to grow at 25% CAGR, almost double of market growth rate, seems quite impossible. Over 2-4 years a company may grow at higher growth rates, but we certainly doubt if it can grow beyond that, profitably. Hence, we do not wish to chase every high growth company.

We prefer sticking to quality companies which may come to a price such that we may earn 15-18% from our buy price. Since an average company in the market may grow at 13%, we may spot few companies earning 15%+ returns on equity. Some of our holdings will yield 15-18%, a few lower than that or even negative. However, we still stand a good chance to earn 15%+ returns provided we concentrate on high conviction and low downside ideas; keeping portfolio reasonably diversified in 10-15 stocks.

We cannot know in advance if a company can compound at 25% CAGR consistently. Also, no promoter or analyst or investor can be certain that a company would grow 25% CAGR. There will be few. Even if we do find one or two, can we bet our significant networth on just a few? Seems risky! Afterall, 25% CAGR is just a ‘hope’ and not a certainty! At the same time, it makes no sense in taking chances with 2-3% of portfolio on every other company which could be a multibagger. We may load up 25-30 companies and end up becoming the market, yielding average results. We instead bet heavily in a quality company even its just 13-15% CAGR with lower downside risk. Returns can be enhanced by building more stake. We think this is prudent and sound strategy.

Aiming for 25% CAGR, we may result paying up for a high growth company and thereby making our holdings susceptible to loss of capital. High growth companies react very negatively on slightest of disappointment in growth numbers as they trade at high multiples.

We advise not to aim for 20%+ portfolio returns to start with. One may earn once in a while or over short period, but over long term it’s difficult without taking high risk. Your financial goal should be to beat inflation to maintain our lifestyle and add 6-7% returns over it so as to generate wealth over long term (or retirement corpus). This means you need to earn bare minimum 11-13% returns. Any return beyond this benchmark is icing on the cake.

We have seen may of you betting just 3-5-10% of their net-worth in equity market and expect 20%+ CAGR. Let’s assume you end up earning 30%+ CAGR, it won’t help you getting wealthy or financially free as you bet just small % networth in great opportunity. It won’t significantly improve your lifestyle.

You rather earn 12-13% (conservatively) and bet entire networth in equity (Exclude residence). This will certainly make you wealthy over long term; and entire wealth being liquid it will be at your beck and call. Most Indians have illiquid Real Estate as 90% of networth (sometimes even leveraged), which earn nothing beyond 2-3% rental yield post maintenance costs. Capital appreciation can’t get much ahead of inflation rate over long term unless one is an expert distress property purchases. Since property is illiquid, you can’t think of selling it in hurry or can’t sell a part of it in case of emergency.

We think if you invest 40-60-70% of networth in equity (even index fund) at 13% CAGR, you can get UBER RICH over long term!

Happy Investing!

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4 Responses to “High returns won’t make you rich, BIG bets will”

  1. I agree with the premise of this blog. I however think the question really is a stock screener question which is could you give me a list of companies that have been growing at a CAGR of 25% over the past five years and not companies that will grow at a CAGR of 25%. Because the latter is asking to predict the future and no one can do that.

    But perhaps from a stock screening POV this may be a good starting point for that particular customer. After all the reason why we use moneyworks4me is to identify potential stocks.

    On the other hand if you can grow at 10-15% and as the author points out invest a substantial sum in equities and if you can sustain it for 8 to 10 years you will indeed do very well.

    But the author’s use of the term betting is very scary. I hope I am not betting anything when I invest but rather I am investing and not speculating. If moneyworks4me is helping me BET then I would not subscribe to the service in the future but it is helping me to select investments on some intelligent methodology and I invest for the long term then I would subscribe to the service. I am NOT BETTING!

    • Aliya Sayyed-Team MoneyWorks4me Reply 05. Dec, 2016 at 7:52 pm

      We do have a way to sort out fast growing companies in dashboard itself. Select ‘Sort’ function in Dashboard to sort stocks by Tag. This Tagging is inspired by Peter Lynch’s book “One up on the Wall Street”

      We used the word BET more like a phrase rather than implying our gambling action. We just wanted to put more emphasis on the word “commit a sum of money” hence the word BET. We are sure that you would find our process very conservative. We seldom trade and wait for great opportunities and hit the loose ball for a six. Our tagline itself says, “Stock Investing – The Safest Way”

  2. Nice write up. Do you have any write up on “Walter Schloss” screeners for Indian stocks

  3. Very Useful article, thanks for sharing.

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