NON LINEAR RETURNS AND TATA TEA

Investors in stocks should reconcile and understand the concept of non linear returns very clearly in order to get optimal returns from their investments. I often get queries from investors in mutual funds and stocks. Both these instruments have given no real returns in the last 4 years.

The economy of a nation goes through cycles of growth and recession. It is rarely that an economy continuously clocks a linear growth as is the case with South Korea. Indian economy peaked in 2007-08 and then decelerated. From approx 9% GDP growth we are now talking of a 5.5% growth this fiscal. A shaving off of 4%. This is gigantic. Had we been USA with a GDP growth of 2%, going back by 4% would mean a negative growth. We would have been into a recession. The argument I am building is, that the state of economy is a barometer of the stock markets. Because stock markets are a proxy for businesses and business growth leads to GDP growth. Hence, a deceleration of Indian economy has led to no growth in business and no rise in stock prices. Stocks are languishing, mutual fund NAVs are languishing. There is pessimism all around. These are the seeds for the next stock market bull run. But that is another story.

When stock markets languish, the stocks give flat returns and therefore, for 4 years a good stock may go up and down and not increase but suddenly when it gets a fillip, it may double, giving you the targeted 16-18%  compounded annual growth return(CAGR).  And that is the concept of non linear returns. Every year , one will not get a  16 % appreciation in the share price. But in a few months one may get 120% returns. No one can time that point from where returns will start. Even Buffet and Munger have never done that.

A case in point is the share of  Tata Global Beverages. About six years to the date,  I had recommended this stock to a friend on 11 Oct 2006. He bought 1000 shares at an average price of Rs 75/-.  In 2007 he asked me and said, “Yaar, kuchh action nahi ho raha”. I said, I had recommended the stock for a long term and my long term is anything beyond 5 years. By 2008, the stock had further gone down, the whole market was in the throes of a panic market post the sub prime crisis and every good stock was available at throw away prices. As I say, 2008 was the buying opportunity of the decade for Indian stock investors. Anyway, every year I would get a call from him .

So in 2010, when he rang up again, I said the price is 135/- if you want you can sell (at least your yearly calls to just check on the price would stop.) He sold off the shares at Rs 135 and got a compounded annual return of 15.8% (for four years), not bad by any standards. However, whether he could deploy the Rs 1,35,000 he received to again get a similar or higher return, I don’t know. But if he had continued to stay with the stock, he would have got a 15.5% CAGR as on 16 Nov 12 price i.e for six years instead of four years. Sometimes inaction in stock markets is much better than action. At the end of the day, our aim is to get a compounded 16-18% returns on one’s money for not one or two years but for 20 years or more.

If that be the cornerstone of my strategy, wouldn’t  it have been better to keep holding the stock for some more time, if the fundamental business was still robust and profitable. You decide. By 2013, Tata Global Beverages would have given close to 18% CAGR to my friend, if only he had the patience.

Tail Piece:   Due to the setting up Starbucks Stores across India and a Joint Venture with Pepsico, the stock is now moving and giving non linear returns. The  stock price should cross Rs 200 in a few months.