Every new investor in the stock market has these questions, else similar questions in their mind. Either they ask for a tip with existing investors or they try to buy stock on their gut feeling. And the interesting thing is sometimes they are right when they follow their gut. But most of the time they end up losing their money and when asked, they say “I am holding it for a long time and let my investment grow”. But is it really the case?
With the stock market expanding every day and lots of ticker symbols to choose from, new investors get puzzled and end up choosing a stock without any research/analysis of their own. And as said by Oracle of Omaha, “don’t put all your eggs in one basket”. So, if there are so many stocks in the market which stock should new investors choose?
To answer that question, Sharesansar carried out research on 5-year horizon historical returns of the top 2 highest market cap companies of every sector and studied the correlation between those stocks and compared the total return with the market return. Now, there are lots of other ways to evaluate the returns an investor can achieve in the long-time horizon. However, this is just one way a new investor with higher capital can pick stocks to build a well-balanced portfolio.
Before we get started with the comparison of returns let’s look at what higher market capitalization means to the investors and the company itself. Mathematically, the market cap is calculated by multiplying the total number of outstanding shares by the latest market price of the company.
- The company with a higher market capitalization is considered a safer investment because in most the cases the company has a long and proven track record.
- Companies with a longer track record and higher market cap tend to have steady dividend payments.
- Higher market cap stocks have lower growth potential which makes them less volatile.
So, let’s dive into investment in every sector and find out the historical returns on a 5-year time horizon.
To understand the importance of diversification, let’s take a look at the portfolio that constitutes the top 2 high market caps companies of every sector in NEPSE. Investors might confuse this strategy with index fund but this is not an index fund investment rather it is one of the strategies to diversify the investment over a long haul for passive and defensive investors.
Let’s look at the returns that these investments have provided over a 5-year period. Now, some of the investment has given a negative return but what this strategy signifies is if one investment has a negative return then another investment with low correlation to that investment will even out the odds of losing the portfolio value.
When we look at the total returns till August 28, 2020, from Jan 1, 2015, the portfolio value has increased to Rs. 86.89 lakhs i.e. the compounded annual return of 29.43% over a 5-year period which has overperformed the market rate of return of 10.03%. Though the stocks have underperformed compared to market return some stocks have done very well. Salt Trading Corporation Limited (STC) has the highest compounded annual return of 86.37%, outperforming the market by 76.34%. On the flip side, Chilime Hydropower Company Limited (CHCL) underperformed relative to the total market return with a negative return of (10.54%). Having the highest Market Capitalization of Rs. 1 kharba, Nepal Doorsanchar Company Limited (NTC) has the compounded annual return of just 8.76%; underperforming by just 1.27%. However, when we observe the overall portfolio, only 2 companies have negative returns and only a few companies have underperformed other than that 9 companies have outperformed relative to the market return which has enabled the portfolio to even out the losses taking the net worth to Rs. 86.89 lakhs.
It is interesting to observe that Salt Trading Corporation Limited (STC) provided the highest return to shareholders with a total of 95% bonus shares in 5 years which has increased the number of shares and the price appreciation that contributed to value increment. At the beginning of 2015, the price of STC was just Rs. 224, which clarifies investors that the price you pay has an inverse relation to the return you get; meaning that if paid a higher price, the return will simultaneously decrease, decreasing the possible upside.
To conclude, diversifying investments in higher market capitalization might be one strategy for a new investor because of the potential upside and less downside risk. Companies having a long track record is likely to thrive in the market which is a plus point for an investor because in the long haul, investment is likely to grow and one main reason for diversifying your investments is that the nature of investments which can even out the loss of other investment and stabilize the total returns. But as Warren Buffet says “Whether it’s socks or stocks, I like buying quality merchandise when it's marked down” which signifies that just buying and holding doesn’t guarantee the return, the fundamentals, and the price you pay for a stock matters when it comes to returns.