There are not more than 4% of Indian population invests directly or indirectly in the Indian stocks. Majority of them do not believe that stock market is the place to make money. The whole stock market runs on the decisions made through speculation and if we look at the long term returns (5 years minimum), 90% of retail investors had faced capital impairment, 6% had managed to get mediocre returns and 4% had only managed to get extraordinary returns.

There are very few success stories around you to motivate you to invest in the stock market. When I talk to the people who invest in the market, they say, “Invest only in the blue chip business as they are the only safe haven in India”. When I question them about where to find these businesses, they point towards NIFTY50 and SENSEX.

The definition of blue chip for them is, “well established business with stable earnings and no extensive liabilities”. They do mention these businesses as low risk business. After having an interaction with many investors I get the impression that there is a lack of understanding about what truly constitutes in the ‘high quality’ business.

A ‘high quality’ business for us is the business that generates higher returns on invested equity, have less or no debt, have sustainable competitive edge and also have surplus cash flow through its operations. We grade businesses on these qualities and for us A1, A2 and B1 grade businesses are the real blue chips rather than conventional blue chips which are constituted on the basis of market capitalisation.

Most of the businesses that constitute in the NIFTY50 are mature business. We follow only 20 businesses from it and rest of them are not investment grade businesses for us. This is the reason the index had given very poor returns which explains why most of the retail investors had managed to get only mediocre returns or capital impairment. NIFTY50 had given a returns of 41% in the last five years or 7.11% compounded every year. They are lesser than bank fixed term deposit returns.

NIFTY50 index is made up of businesses like Bharti Airtel, which are trading 1% below the price it was trading five years back. Also made up of Reliance Industries which had generated only 2% capital gains in the last five years. Instead, if you had picked up Bajaj Auto, Bosch and Eicher Motors from the same index your returns would have been far better. Clearly this tells us that the colour of all chips in the NIFTY50 or SENSEX is not blue. I strongly believe that indices should not be constituted on the basis of market capitalisation but on the basis of definition of ‘high quality’ that we mentioned above.

Warren Buffett once observed that time is the friend of wonderful business but enemy of the poor one. You don’t want to put shares of bad business, even if they are big one, in the bottom drawer and forget about them. Long term buy-and-holding should only apply to truly high quality businesses – like A1 and this is the reason our returns are far better than indices returns.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise you to take professional advice before going ahead with our views.