Book contents
- Frontmatter
- Contents
- List of Figures
- List of Tables
- List of Corporate Snippets
- List of Abbreviations
- Preface
- Acknowledgements
- 1 Corporate Finance: A Conceptual Introduction
- 2 Financial Markets
- 3 The Time Value of Money
- 4 Capital Budgeting
- 5 Risk and Return
- 6 Valuation
- 7 Capital Structure and Financing
- 8 Dividend Payout: Policy and Practices
- 9 Leverage
- 10 Financial Derivatives
- 11 International Finance
- 12 Working Capital
- 13 Ratio Analysis
- Appendix
- Bibliography
- Index
5 - Risk and Return
Published online by Cambridge University Press: 30 April 2020
- Frontmatter
- Contents
- List of Figures
- List of Tables
- List of Corporate Snippets
- List of Abbreviations
- Preface
- Acknowledgements
- 1 Corporate Finance: A Conceptual Introduction
- 2 Financial Markets
- 3 The Time Value of Money
- 4 Capital Budgeting
- 5 Risk and Return
- 6 Valuation
- 7 Capital Structure and Financing
- 8 Dividend Payout: Policy and Practices
- 9 Leverage
- 10 Financial Derivatives
- 11 International Finance
- 12 Working Capital
- 13 Ratio Analysis
- Appendix
- Bibliography
- Index
Summary
Risk is like pornography. I can't define it but I know it when I see it.
—Potter Stewart, the US Supreme Court JudgeFigure 5.1 shows annualized returns on investment in the US equities over a period of 92 years from 1926 to 2017. The return in any given year varied significantly from the average (10.20 per cent), varying from more than 50 per cent to being significantly in the red. The variability in returns can test the patience of even the most experienced investors. In 1930, the return was −44 per cent. This was on top of a negative return of over 27 per cent in the previous year. An investor who had invested US$100 in the US stocks at the end of 1928 would have been left with only US$41 after two years. Not many investors can bear such significant dilution of their investments. It is the prospect of such losses that keeps stock investors awake at night. It is significant and noteworthy that more than one in four years have experienced negative returns on equity investments.
From 1926 to 2017, the annualized average return on the US large stocks at 10.2 per cent per annum was of course much higher than returns on most other financial instruments (Figure 5.2). Investment in government securities over the same period yielded 5.5 per cent. The gap in returns leads to disproportionate impact in the amount of wealth, especially over a long period. An investment of US$1 in government securities amounts to US$131 (at 5.5 per cent per annum) after 92 years. A similar investment in equity is worth US$7,353 (at 10.2 per cent per annum).
Inflation (2.90 per cent) adjusted, the difference in wealth in real terms is even greater. Of course, riskier avenues of investment do exist if one has the heart to withstand even greater vicissitudes in return. Return on small stocks are more volatile than that of overall equity, but the return is also higher at 12.1 per cent and the wealth, at the end of a period of 92 years is far greater, at US$36,929.
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- Information
- Corporate FinanceTheory and Practice in Emerging Economies, pp. 124 - 147Publisher: Cambridge University PressPrint publication year: 2020