22 Aug 2021

Index vs value investing

I came across this tweet yesterday, and I think this highlights an advantage of index investing.

When seen with the context of inflation, NTPC is just losing money. Losing money through such a stock is a risk an index investor systemically avoids. A value investor might hold onto NTPC hoping that the price will eventually go up. It’ll be baffling to such an investor that you’d sell off a company just because it’s stopped satisfying an arbitrary requirement. (Other than whole market indices, everything else, including Nifty 50, Sensex, and S&P 500, pick an arbitrary number of companies.)

It’s possible that a company is kicked out of the Nifty 50 index today, but joins the index again a few years later at a higher valuation. A value investor that holds onto such a company throughout the journey will be satisfied at the end. But an index investor will be selling when the company leaves the index and buying again at a higher price when the same company rejoins the index. An index investor should be comfortable with such a turn of events.

Corollary: If you are an index investor but you cannot stomach buying expensive stocks, you should reconsider your investing style. Maybe you are a value investor in your heart, but you’re investing in indices because that’s more fashionable.

PS: Investing in whole market indices does not remove this risk. I am only considering indices that pick top N companies by market cap. Vast majority of index investors in India invest in such a “top N” indices.

PPS: To be 100% clear: I don’t know anything about NTPC; I don’t even know the full name of the company. I am not claiming that NTPC is a value stock. I am only talking about a hypothetical investor who thinks NTPC is a value pick.

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