How is the impact of inflation on stocks, stock market and what should those buying shares, be looking at?
UDAYAN RAY How does a regular investor figure the impact of inflation?
MOHIT SATYANAND You know before answering that question I am going to answer another question, which is: to what extent should an investor look at inflation in terms of managing his overall net worth?
And I think that the average Indian investor or the average Indian household does not think hard enough about inflation. And the reason I am saying this is that if we actually thought enough about inflation, none of us would put money into fixed deposits. Okay?
I like to think of inflation in India at a very broad long term secular basis. And on that basis I look at inflation as being between 7-8% per annum. Now, this means that if I put money into fixed deposits, and I am paying any income tax--I of course pay 30% on the margin, but even if you’re paying 20%, you get 8% from the bank on an FD, you pay 20% of that, it is 1.5%. So, you are getting 6.5%. This is less than the historical average of inflation. This also means that between the government and the bank, you are actually paying somebody to hold your money. Historically, if we look at the long run, equities return about between 12-15% per annum.
UDAYAN RAY Depending on the state of the market.
MOHIT SATYANAND Depending on the state of the markets, (and) which two points are you looking at, are you looking at the Sensex or the Nifty or small caps. Let’s say 12% plus an average dividend yield of 1%, that’s 13%. (Now,) 13% minus even 7% inflation, you are looking at 6% return year on year over the long run. So you are not comparing 13% on stocks with 8% on FDs. Actually you are comparing in terms of real purchasing value which is all that we are concerned with— comparing 6% with minus 0.5%. This is the most important inflation number to think of.
UDAYAN RAY Sure.
MOHIT SATYANAND Now let’s talk about inflation and stocks. And lastly let’s talk about inflation and government because I think that’s another aspect of inflation which people don’t look at. India is an economy which has lived with its inflation throughout its history. And unlike a lot of economies if inflation in India is 5 or 6%, it’s no big deal. There are other countries where inflation over 2% is considered very disturbing. It is not so in India. People have grown used to 5, 6, 7 and 8%. The RBI is trying to constrict that band. I think it’s a good thing. But I think that inflation below 8 or 10% is not something that we need to worry about too much as investors. (That’s) Because our companies know how to deal with inflation.
UDAYAN RAY Sure, sure.
MOHIT SATYANAND And if a company knows how to deal with inflation, that means that it’s going to figure out a way to protect its earnings irrespective of what inflation is at a broad level. And therefore, as long as it’s within these broad parameters it doesn’t worry me hugely. Now, there’s a lot of talk about inflation in our pink press, in our financial journals and on business channels. And the normal link that is being discussed is if inflation rate doesn’t go down, interest rates won’t go down, and if interest rates don’t go down, the economy won’t grow, so on and so forth. As I said in another segment, this whole thing of interest rates being low or high, it doesn’t worry me hugely. There was a time when interest rates in our country were 14-15%. Today, we look at 7 and 8%. But between 8% and 6.5%, I don’t think it matters. If I am a company manager evaluating a new investment, and I say that the difference between 8% and 7% is going to determine the future of this investment i.e. whether I make it or not, then there is something wrong with that investment. Because the cost of capital, except as I said for infrastructure, is not the most significant cost of a project. It’s only one component. And therefore interest rate personally doesn’t worry me too hugely.
UDAYAN RAY So what you’re trying to say is the critical fact is how smart the company is.
MOHIT SATYANAND That’s right.
UDAYAN RAY Can it smartly run its business? Can it smartly adapt and generate earnings?
MOHIT SATYANAND Absolutely.
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