Risk: the time element

We all know that 'company' and 'market' risks are the hazards that any equity investor faces, right? Wrong. Risk has another dimension - that of time. ime plays a role that is often not very o!vious to us in the stock market. o e"plain this facet of risk let me give you a simple e"ample. #ow likely is it that you may trip and fall in the ne"t one second? #ow likely is it that you might trip and fall in the ne"t half an hour? #ow likely is it that you might trip and fall some time in the ne"t five years? $et the point? %ou can say with &''( certainty that you will not trip in the ne"t one second. %ou can also, perhaps with the same degree of certainty, say that you are unlikely to trip and fall in the ne"t half an hour. )ut the degree of certainty would definitely reduce over a five-year time frame. *nd further still, over a &'year period. hat in other words, ladies and gentlemen, is the time element of risk. Risk increases with time *rgua!ly, the time element of risk is very often part of company risk or market risk. )ut the reason we would like to focus on this element separately is that this is an element of risk that is not understood very well. +either is it given the place of prominence that it deserves. his is particularly true of what we call 'growth' stocks. ,tocks that you !uy !ecause you think that they will grow phenomenally over the ne"t few years. '$rowth' investing has !een the most popular and successful form of investing in recent years. ,tocks from the technology, media, telecom and !iotech sectors are prime e"amples of 'growth' stocks. hese 'growth' stocks look e"pensive !y conventional metrics - price-earning -./01, price-!ook -./)1 and economic value -021. )ut even after the recent meltdown in the past three months these stocks have handsomely rewarded investors who !ought them 3-4 years ago. 5espite, as we said, !eing overvalued !ased on conventional metrics even two years ago. 6n the words of the legendary investor and thinker )en7amin $raham8 ' he successful purchase of growth stocks requires two rather o!vious conditions - first, that their prospect of growth !e realized9 and, second, that the market has not already pretty well discounted these growth prospects.' :et us presume that the second condition -which continues to !e de!ated to death1 is not true - the market has not already discounted these growth prospects. ,o then, the only other condition that needs to !e met is that the prospects of their growth need to !e realised. his is not as simple as it seems *nd the o!vious num!ers that we look at do not tell the whole story. 'Infosys ka EPS agle saal 100 taka bad jayega' is the typical refrain that one gets to hear. +ow we are no slaves to conventional metrics and are willing to !e completely open minded. )ut is it okay to !uy 6nfosys at a ./0 of &;' only !ecause it will grow at &''( in <%3''&? he answer is a resounding +=. 6f !uying 6nfosys at this price is to !e a profita!le proposition for you, then 6nfosys must grow at a scorching pace not 7ust ne"t year !ut for many years !eyond that. he risk in owning 6nfosys comes from time. he risk is not whether it will grow at &''( ne"t year, !ut whether it can grow at a compounded annual growth return ->*$R1 of ?'-@'( over the ne"t five years. +ot an impossi!le task for a company with an impressive track record. )ut look at the size of the challenge. * ??( >*$R over the ne"t five years means a forecast of Rs3?''cr profit in <%3''?. hat is more than what !ig daddy Reliance makes !y way of profits currently. *t today's price -RsA;A'1 that would place 6nfosys at a reasona!le ./0 of 3' times its <%3''? estimates. hat is a ./0 that many companies -including Reliance1 are not getting even on their <%3''' earnings currently. )ut that is another issue altogether What is relevant to you as a !uyer of 6nfosys shares is that the company cannot afford to trip and fall anytime over the ne"t five years. +ow what degree of certainty would you place on that? )efore you 7ump to any conclusions, it's not as impossi!le as it may seem -as our analysts are at pains to point out1. *fter all, this same company reported a profit of 7ust Rs&4cr in <%&BB?. Would you have -in &BB?1 estimated that it would, in five years, grow to report a profit of Rs3;?cr? * twenty-fold 7umpC =ur o!7ective in highlighting 6nfosys is to underline the time element of risk. We are aware of the risk and have chosen to take it !ecause we have confidence in the management of this company and !elieve that its strategy and !usiness model will ena!le the company to get there. hose who took this risk in &BB? have

!een amply rewarded. Dany people would dismiss this entire concept of time element of risk on the premise that if 6nfosys is going to dou!le its profits this year, then so will its price and, hence, they can dump the share within si" months and make money. o them we suggest that they consider the second condition listed !y )en7amin $raham8 '?that the market has not already pretty well discounted these growth prospects.' Who does not know !y now that 6nfosys -profits1 will grow !y A'-;'( this year? *ny!ody with access to a decent !roker or >+)> knows that !y now. )y that count its growth prospects for this year are pretty well discounted. he reason why there is still money to !e made from !uying 6nfosys is that its growth prospects for the ne"t five years are not discounted. +ot every!ody attaches a high degree of pro!a!ility -or the same degree of pro!a!ility1 to 6nfosys reaching its destination in five years time. hat is why those who take the risk -of time1 will !e amply rewarded. *s an equity investor you must ask yourself this question every time you !uy a stock. What is the time element of risk that 6 am taking? his is particularly true of !uying 'growth' stocks. Copyright 2001 Sharekhan.com & SSKI Investor Services Pvt. Ltd. A !ights !eserved. Copyright 200" Sharekhan.com & SSKI Investor Services Pvt. Ltd. A !ights !eserved.