Saturday, June 11, 2005

The Top 10 Tips for Successful Investing

1. Start Early - the sooner you invest, the more time your money will
have to grow. If you delay, you will almost certainly have to
invest much more to achieve a similar result.


If you started investing Rs 5,000 a month on your 40th birthday, in 20 years’ time you would have invested Rs 12 lakhs. Growing at an average of 7% a year, it would be worth Rs 25,52,994 when you reach 60. If you started investing ten years earlier, your Rs 5,000 each month would add up to Rs 18 lakhs over 30 years. Assuming the same average annual growth of 7%, you would have Rs 58,82,545 on your 60th birthday – more than double the amount you would have received if you’d started ten years later! The bottom line - your investments gain most from compounded interest when you have time on your side.

2. Keep some cash aside – it is always a good idea to have some money set aside in case
of emergencies. Enough to cover three months’ living expenses is often a rough guide to how much you need. And make sure you can withdraw it when you need to, without penalties.


• making a major purchase
• taking an unplanned holiday
• for an emergency such as sudden hospitalization

3. Ask yourself how much risk you can take – there is no point having a stock market investment if you are going to lose sleep every time share prices go through a rough patch. It’s vital that you are realistic about your appetite for risk – an Investment Adviser may be able to help you decide how much risk you can tolerate.

"In many ways, the key organ for investing is the stomach, not the brain. What is your stomach going to do when an investment your brain selected declines for a year or two?"

4. Bear in mind that inflation will eat into your savings – returns on risk-free cash investments may sound respectable, but when you subtract the current rate of inflation you may not be so impressed. For significant long-term growth you need to make your money work harder.


If you have Rs 10,000 in a savings account earning 3% interest each year, in 20 years time, your savings would be worth Rs 18,061. That’s a return of just over 80%. However, if inflation is
about 7%, Rs 18,061 would only be worth Rs 4,668 in today’s terms!

5. Think carefully about how long you will be investing for – only look at the stock market if you are prepared to put your money away for five or ten years, or perhaps even longer. If you are likely to need your money any sooner, keep it in a lower-risk investment so there is less chance of a fall in value just before you make a withdrawal.

“If you’re going to need money within the near future to put a down payment on a house — the
stock market is not the place to be. You can flip a coin over where the market is headed over the
next year. But if you’re in the market for the long haul — five, ten or twenty years — then time
is on your side and you should stick to your longterm investment plan.”

6. Spread your money across a range of investments – it’s rarely a good idea to have all your eggs in one basket. Depending on your goals and attitude to risk, you will probably want
to spread your money across different types of investment – equities, bonds and cash. You may also want to diversify within each of these categories. An equity fund, for example, will invest your money in a variety of companies but you may want to ensure you have a range of industry sectors too.


• High security and liquid
• Interest will always be paid
• Interest rates vary
• Best rates often have restrictions
• May not beat inflation
• Fixed interest paid regularly
• Bond issuer may default on interest payments
• Value of a bond may fluctuate
• Equities can increase significantly in value
• Can outperform other asset classes over the long term
• Equities can also fall significantly in value
• Difficult to predict what will happen in the short term

7. Invest regularly – investing regularly can be a great way to build up a significant lump sum. You will also benefit from what is known as rupee cost averaging. This means that, if you are investing in a mutual fund, over the years, whether the market goes up or down, you will pay the average price for units.

8. Choose your funds carefully – you should select investments based on your personal
circumstances and goals. If you are investing in a mutual fund, don’t opt for the flavour of the month, unless you are sure it will be right for you in the future. Don’t assume all funds investing in Indian equities are the same – look at what a fund invests in and check if you are comfortable with its investment style and objectives.

9. Remember that time not timing is the key to successful investing – when planning an investment, it can be tempting to wait for the market to drop. But you run the risk of missing out on the rises that often occur in the early days of an upward trend. In Fidelity’s experience, even the experts cannot “time the market” consistently well. It is better to choose an investment that you feel confident about and take a long-term view, so that you have time to ride out any ups and downs.

10. Review your investments – a portfolio that is right for you at one point in your life may
not be quite so suitable a few years later. Your investments need to adapt to changes in your circumstances, such as getting married, having children or starting a business. It’s also a good idea to check that each of the funds in your portfolio is living up to your expectations. Talking to an Investment Adviser could help you decide whether you need to switch money between funds.


For the greatest long-term growth potential you could invest all your money in equities. But this could be a high-risk strategy as the markets could dip just before you need the money. You may need to think about making changes to your portfolio over time. You could aim for strong growth in the early years, and then, lock in gains you may have made and move into lower-risk investments. As you get closer to needing your money, bonds and cash investments could be your emphasis.

Sunday, May 22, 2005

Stock Basics: What Are Stocks?

The Definition of a Stock

Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing.

Being an Owner

Holding a company's stock means that you are one of the many owners (shareholders) of a company, and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock.

A stock is represented by a stock certificate. This is a fancy piece of paper that is proof of your ownership. In today's computer age, you won't actually get to see this document because your brokerage keeps these records electronically, which is also known as holding shares "in street name." This is done to make the shares easier to trade. In the past when a person wanted to sell his or her shares, that person physically took the certificates down to the brokerage. Now, trading with a click of the mouse or a phone call makes life easier for everybody.

Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, one vote per share to elect the board of directors at annual meetings is the extent to which you have a say in the company. For instance, being a Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you think the company should be run. In the same line of thinking, being a shareholder of Anheuser Busch doesn't mean you can walk into the factory and grab a free case of Bud Light!

It isn't too big a deal that the shareholders are not the ones managing the company. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets. Profits are sometimes paid out in the form of dividends. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid. This last point is worth repeating: the importance of stock ownership is your claim on assets and earnings. Without this, the stock wouldn't be worth the paper it's printed on.

Another extremely important feature of stock is its limited liability, which means that, as an owner of a stock, you are not personally liable if the company is not able to pay its debts. Other companies such as partnerships are set up so that if the partnership goes bankrupt the creditors can come after the partners (shareholders) personally and sell off their house, car, furniture, etc. Owning stock means that, no matter what, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

Debt vs. Equity

Why does a company issue stock? Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to raise money. To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds. Both methods fit under the umbrella of "debt financing." On the other hand, issuing stock is called "equity financing." Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way. All that the shareholders get in return for their money is the hope that the shares will some day be worth more. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO). If you want to know more about how stocks are created, check out our IPO tutorial.

It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments. This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful. Just as a small business owner isn't guaranteed a return, neither is a shareholder. As an owner your claim on assets is lesser than that of creditors. This means that if a company goes bankrupt and liquidates, you, as a shareholder, don't get any money until the banks and bondholders have been paid out; we call this absolute priority. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.


It must be emphasized that there are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends even for those firms that have traditionally given them. Without dividends an investor can make money on a stock only through its appreciation in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing. Although risk might sound all negative, there is also a bright side. Taking-on greater risk demands a greater return on your investment. This is the reason why stocks have historically outperformed other investments such as bonds or savings accounts. Over the long term, an investment in stocks has historically had an average return of around 10%-12%. A great proof of the power of owning equities is General Electric.

Tuesday, May 17, 2005

P/E – What is it all about?

The most commonly used valuation metric by investors is the price to earnings ratio or commonly referred to as the P/E ratio. Though commonly used, it is also misunderstood for various reasons. Here is an attempt to simplify this valuation metric.

How is P/E calculated?

It is calculated by dividing market price of a stock by EPS (earnings per share). EPS in turn is calculated by dividing the net profit of the company by the number of shares outstanding.

Having calculated the P/E, what does it stand for?

Lets assume a stock is trading at Rs 100 and its EPS is Rs 20. The P/E multiple is 5 (100 upon 20). Assuming that the company’s EPS is likely to be Rs 20 each year, it will take 5 years for the investor to realize Rs 100. Of course, the assumption here is that the company’s EPS is not growing at all.
Now taking the example of commonly traded stocks like Infosys and Tisco. While the former trades at a P/E multiple of 25 times, the latter trades at 7 times. Why is it so? It is believed that the stock price of a company tracks its long-term earnings growth potential. In an economy, some companies (or sectors) are likely to grow at a faster (like say software or pharma) rate. So, the P/E multiple of companies from these sectors are likely to be higher and vice versa. Depending upon growth expectations, the P/E multiple could vary.
There is one crucial factor here i.e. expectations. Though Infosys may be trading at 25 times earnings, if EPS is expected to grow by 25% per annum, the investor could realize the money in four years.

P/E – Is it a discount or a multiple?

There are two ways of quoting P/E valuations:

1. Tisco is currently trading at Rs 350 discounting its earnings by 5.5 times
2. Tisco is currently trading at Rs 350 at a P/E multiple of 5.5 times

Which is right? The answer to this lies in the formula for calculating P/E itself.
P/E is Market price divided by EPS. If we were to reverse the formula,
Market price = P/E multiplied by EPS. Stock prices reflect future earnings potential and not past performance. Discounting the current price with historical EPS is not a right way to analyse companies.
Take a hypothetical case. If Tisco’s EPS for the next year is expected at Rs 50 and the growth in EPS is around 15%, the market price is calculated by multiplying Rs 50 with 15 times i.e. Rs 750. When determining the stock price, one does not discount earnings but multiply earnings.

What is the ‘right’ P/E multiple for a stock?

The answer to this question is not easy. In the previous example, we have assigned a P/E multiple of 15 times because EPS is expected to grow by 15% in the immediate year. Is this the right way? Not necessarily. Here, it is important to understand industry characteristics of the company.
For a commodity stock like Tisco, EPS tends to grow at a faster rate when steel prices are recovering or are at the peak and the EPS is likely to decline at a faster rate during downturns. To qualify this statement, if we look at EPS growth of Tisco from 1994 to 2004, the compounded growth in earnings is 17%. However, the CAGR growth in the last three years was 193% (the recovery phase). So, if one believes that steel demand is likely to trace long-term economic growth and that 15% growth is unsustainable, the P/E multiple should be ideally much lower than 15 times. Similarly, the long-term growth prospects for software companies could be much higher than commodities. So, the P/E multiple for software stocks could be at a premium.
Determining the P/E multiple for a stock/sector also depends on:

  1. Historical performance – Why does Infosys trade at a higher P/E multiple compared to Satyam? By historical performance, we mean, focus of the management (without unrelated diversifications), ability to outperform competitors in downturn/upturns and promise vs performance. This can be gauged if one looks at the last three to five year annual reports of a company.
  2. The sector characteristics – Margin profile, whether it is asset intensive and intensity of competition. Less asset intensive sectors (say, FMCG) are considered defensive and therefore, could trade a premium to the overall market.
  3. And more importantly, expectations. Take the case of textile stocks. Expectations of significant growth opportunities post the 2005 quote regime phase out has resulted in upgradation of P/E multiple of the textile sector.

When is P/E not useful?

  1. Economic cycles - In FY02, Tisco was trading at a P/E multiple of 20.5 times its FY02 earnings. Was it expensive? Based on FY05 expected earnings, Tisco is trading at a P/E multiple of 5 times its earnings (at Rs 250). Is it cheap? If one ignored Tisco in FY02 on the basis that it was ‘expensive’ on the P/E multiple in FY02, the opportunity loss is as much as 350%. Businesses operate in cycles. During downturn, EPS will be low but P/E will be inflated and vice versa. At the same time, during expansionary phase, corporates invest in capacities. In this case, high depreciation costs suppress earnings. P/E, in this context, may mislead investors.
  2. Not actively tracked – There are number of companies in the Indian stock market that are not actively tracked by investors, analyst and institutions. For example, Infosys’ average price was Rs 2 in FY94 and the P/E multiple was 17 times. At times, P/E multiple may be lower because some sectors/stocks are not in the limelight.
  3. Expectations – On the downside, some stocks may be trading at a significant premium because earnings expectations are higher. High P/E also does not mean a good stock to buy. What if the expectations are unrealistic? One needs to exercise caution to this extent.
  4. Means little as a standalone number – P/E, as a standalone number, means little. Besides P/E, it is also important to look at margins, return on net worth, cash generating ability and consistency in performance over the years to assign a value to a stock.
  5. Market sentiment – During bear phases or when interest in stocks is low, valuations could be depressed. Since equities are considered less attractive during these periods, valuations are likely to be below historical average or below earnings growth prospects.

When is P/E useful?

A powerful metric – Unlike metrics like discounted cash flow method and so on, P/E is relatively a simple and at the same time, a powerful metric from a retail investor perspective. Though the factors behind determining the ‘right’ P/E multiple are important, a historical perspective of a stock’s P/E could make this exercise less complex.
To conclude, valuation of stocks involves subjectivity. A person X may assign a higher P/E multiple to the stock as compared to a person Y depending on the risk profile and growth expectations. In the end, it all boils down to how the company is likely to perform.
It is not that stock market is always right when it comes to valuing a stock! As Mr. Benjamin Graham puts it “in the short term, the market is a 'voting' machine whereon countless individuals register choices that are product partly of reason and partly of emotion. However, in the long-term, the market is a 'weighing' machine on which the value of each issue (business) is recorded by an exact and impersonal mechanism”. Watch the earnings!

Monday, May 16, 2005

Benjamin Grahams principles to Invest

The famous investment guru, Benjamin Graham, once said, ‘Investment is most intelligent when it is most businesslike.’ Yet, if one were to take a look at the profile of an average investor in the equity markets, there emerges a very capable businessman who has gained success in his own business but has operated in the markets with complete disregard of all sound business principles of business. In this regard, let us take a look at some of these principles that have been completely violated in the markets, but if followed with discipline, would result into investors earning adequate returns.

The first of these principles, as given by Graham, is to ‘know what you are doing.’ This is similar to knowing your business. In the investing sense, this means that an investor should not try to make business profits out of his investments. More simplistically, this means that he should not try to earn returns in excess of normal interest and dividend income, unless he knows as much about his investments’ values as he would know about the value of his business. If he defies this basic principle, he is not an investor, but a speculator who is betting on his intuition without the adequate knowledge to back the same.

The second principle is ‘not letting anyone else run your business’ (stock market investment, in this sense) unless one is pretty sure of the integrity and ability (the management of a company or a mutual fund). This rule would help investors determine the conditions under which he entrusts his money for someone else to manage.

The third principle is for the investor to ‘undertake an investment only when a reliable calculation indicates that there is a fair chance for a reasonable return on the investment.’ More simply, based on this principle, an investor’s strategy for earning profits should be based on careful calculations and research rather than plain optimism. Not following this principle is equivalent to putting your principal to a considerable risk.

And finally, the most important principle is to ‘have the courage of knowledge and experience.’ This is to say that once you have arrived at a conclusion from the facts and careful calculations, you need to act on the same caring not much about what everyone else is doing (or betting on). This is discipline, the most important rule at the root of sound investing.

By following these principles and not giving in to greed/fear that rising/falling markets bring with them, you can ensure that the consequences of your mistakes would never be disastrous. And more importantly, you will not blame the stock markets for your losses. When that happens, no matter what the markets throw at you, you will always be able to say with much confidence.

Source : Equitymaster

Textile Quotas make a comeback

INDIAN textile exporters are expected to gain the most from the US administration’s decision to impose `safeguard quotas’ on three categories of clothing shipments from China, mainly because Indian suppliers have a strong presence in some of these product categories in the US.
In two of the three items that have come in for US restrictions — cotton knit shirts and cotton trousers — Indian exporters have already made significant gains in the last four months since quotas were phased out. The Indian strength in these categories is reflected in the 116 per cent jump in exports of cotton knit shirts to the US between January and April 2005. The growth in Indian cotton knit shirt supplies was next only to Chinese exports, which, however, recorded a massive 1,005.85 per cent growth during the period, according to US Customs and Border Protection (CBP) data. In the case of cotton trousers too, Indian supplies to the US were up 66.80 per cent between January and April this year.

The move to re-impose quotas on the three categories of clothing imports from China would mean that Chinese shipments in the these categories would be permitted to increase this year by just 7.5 per cent, as compared with shipments made during 2003.

“Since Chinese exports have already surged to such high levels during the first four months of the year, the 7.5 per cent annual cap would allow very insignificant quantities of Chinese exports to the US for the remaining part of the year in these product categories,” a textile sector analyst said.

According to domestic exporters, a large number of US buyers and retailers have already begun making enquiries on the capacity of Indian suppliers to ramp up production. “US retailers have been factoring in the administration’s move and have been working on developing alternatives to China as a big manufacturing base. India is the most obvious alternative,” the analyst said.
The one constricting factor in the otherwise bright scenario is the capacity limitation of Indian exporters. “While the entire provinces in China are involved in the production of one or two specialised products, resulting in a mass assembly line production model, Indian exporters have been constrained by lack of scale. It remains to be seen by what measure our suppliers can increase production to take advantage of the situation,” the analyst pointed out.

The third category on which the US has re-imposed quantitative restrictions, namely undergarments, is an area where Indian suppliers have traditionally not been very strong, unlike their Chinese counterparts. But analysts sense an opportunity in this category too. “With Chinese exports likely to be plugged for the rest of the year, there is ample opportunity for Indian hosiery players to make inroads into this product category in the US market.”

Besides the three items targeted so far, the US administration has also announced its intentions to take up four more petitions filed by the US industry last year seeking re-imposition of quotas in other clothing categories.

Even though quantitative restrictions on the global textile trade were done away with from January 1, under China’s accession agreement with the World Trade Organisation (WTO), member-countries can impose quantitative restrictions in the form of `safeguard quotas’ on Chinese imports till 2008 if they can prove that imports from the country are getting `market-disruptive’ in nature. The restrictive clause, however, applies only to China because of its late entry into the WTO.

Friday, May 13, 2005

8 investing tips

Equities: 8 investing tips

The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks. Read on

Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles. By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals. Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back.
It is apt to note here what Warren Buffet, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, “It means we miss a lot of very big winners but it also means we have very few big losers…. We’re perfectly willing to trade away a big payoff for a certain payoff”.

Avoid trading/timing the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers’ end at the end of the day. In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again. In Benjamin Graham’s (pioneer of value investing and the person who influenced Warren Buffet) words, “Basically, price fluctuations have only one significant meaning for the ‘true’ investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market”.

Avoid actions based on rumours/sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investors’ portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffet, “Be fearful when others are greedy and be greedy when others are fearful”.

Avoid emotional attachment/averaging: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price. However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company’s performance may improve for the better and the stock would provide an opportunity to exit at higher levels. Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffet’s words, “Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks”.

Avoid over-leveraging: This behaviour is typical in times of a bullrun when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards). However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements. In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

Keep Margin of Safety: In Benjamin Graham’s words, “For ordinary stocks, the margin of safety lies in an expected ‘earning power’ considerably above the interest rates on debt instruments”. However, having a stock with a high margin of safety is no guarantee that the investor would not face losses in the future. Businesses are subject to various internal and external risks, which may affect the earnings growth prospects of a company over the long-term. But if a portfolio of stocks is selected with adequate margin of safety, the chances of losses over the long term are minimised. He further points out, “while losing some money is an inevitable part of investing, to be an ‘intelligent investor,’ you must take responsibility for ensuring that you never lose most or all of your money.”

Follow research: The upswing in the stock markets attracts many retail investors into investing into equities. However, picking fundamentally strong stocks is not an easy task. In fact, it is even more difficult to identify a stock in a bullish market, when much of the positives are already factored into the stock price, making them an expensive buy. It is very important to understand here that owning a stock is in effect, owning a part of the company. Hence, a detailed and thorough research of the financial and business prospects of the company is a must. Given the fact that on most occasions, research is influenced by vested interests, the need of the hour is unbiased research. Information is power and investors need to understand that unless impartially represented (in the form of research) it could be misleading and detrimental in the long run.

Invest for the long-term: Short-term stock price movements are affected by various factors including rumours, sentiments, market perception, liquidity, etc, however, in the long-term, stock price tends to align themselves with its fundamentals. Here it must be noted what Benjamin Graham once said, “…in the short term, the market is a ‘voting’ machine (whereon countless individuals register choices that are product partly of reason and partly of emotion), however in the long-term, the market is a ‘weighing’ machine (on which the value of each issue (business) is recorded by an exact and impersonal mechanism).”
Of course, it must be noted that the above list is not exhaustive and there may be many more points that an investor needs to understand and follow in order to be a successful investor. Further, the above points are not just a read but needs to be practiced on a consistent basis. While making wealth in the stock markets was never an effortless exercise, it becomes all the more difficult when stock markets/stock prices are at newer highs.

Source :

Thursday, May 12, 2005

Stock split? What's that?

Sure does sound funky. But a stock split happens quite often.
And, what it means is rather direct. Your stock actually gets split.
To understand what a stock split is and how it impacts you, read on.

  • First understand what a share is

Any business has a lot of assets: machinery, buildings, land, furniture, stocks, cash, investments. It will also have liabilities. This is what the company owes other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities. Take away the liabilities from the total assets, and you are left with the capital. Assets - Liabilities = CapitalCapital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital. This capital is subdivided into shares.
So if a company's capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore (10 million) shares of Rs 10 each. So, if you own 100 shares of Gujarat Ambuja Cement, for example, you own a very small part -- since Gujarat Ambuja has millions of shares -- of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.
  • How is this share valued?

If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.
When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock. So the price of Company X shares will go up and down depending on the demand for Company X stock.
If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).
If the number of shares in a company is multiplied by its market value, the result is market capitalisation.

  • Now you will understand what a stock split is

The face value of a company's shares may be Rs 100.The company may want to change the face value. So it will take one share of Rs 100 and make it two. So now, the face value of each share is Rs 50. If you owned one share, you will now own two. So basically, the number of shares have increased. But, the number of shareholders have not. The number of shareholders are the same. It is just that the number of shares they own has doubled.

  • Who will get the additional shares?

The company announces the split ratio on a particular date called the record date. All shareholders whose names appear on the company's records as on the record date will be eligible for the additional shares. A few weeks later, the shares will start trading ex-split on the stock exchanges.

  • How is it different from a bonus?

Earlier I had mentioned that cash reserves form part of the company's assets. Now when these reserves get large, the company may decide to convert it into shares. These shares are then given free of cost to the investors. So when you get a bonus, the number of shares you own increases at no cost to you.
A stock split is somewhat like a bonus in the sense that, when a Rs 10 stock is split into two Rs 5 shares, the number of shares you hold doubles at no cost to you. But that is where the similarity ends. A bonus is a free additional share. A stock split is the same share split into two.In a stock split, the number of shares increases but the face value drops (the face value never changes for a bonus shares). So a stock split is just a technical change in the face value of the stock. There is no other change in the company.

  • How does this impact you?

In one way, nothing has changed. It's like cutting an 8-inch pizza into 12 slices from four slices before. But, if you want to buy the shares of a company which are frightfully expensive, you can now buy them for less.
For example, the face value of the shares of Rs 100 will now be Rs 50 (above example). So, if the share was quoting at Rs 200 (when face value was Rs 100), it will now quote at Rs 100 (since the face value is now Rs 50).So, those who could not afford to buy the shares at Rs 200, may now be able to buy it at Rs 100. But this is just in theory. Chances are that instead of the stock quoting at Rs 100, it may quote at Rs 120. Sometimes, the stock price of a company goes up after a stock split because demand for those shares increase. More investors may want that stock since they can afford it. For instance, JB Chemicals & Pharma split the face vaue of its stock from Rs 10 to Rs 2, by a four for one split April 5. So for every one stock you held, investors got four new ones. What happened to the price of the stock? It was Rs 451 before the split and adjusted to Rs 90 after the split. The stock did go up, however, from around the Rs 400 level to Rs 451 before the split. Balrampur Chini's split the face value of its stock from Rs 10 to Rs 1 on March 23, sending its stock down from Rs 681 before the split to Rs 68 after it. The stock had moved up from Rs 637 to Rs 668 in the month before the split.The Gammon India stock split on March 15 led to the face value of the stock going down from Rs 10 to Rs 2. The stock was Rs 1,235 before the split, coming down to Rs 247 afterwards. It had moved up from around the Rs 870 level to Rs 1,235 a month before the split.
So do note, if you are an investor in the company, you have reason to celebrate when you get a bonus. No reason to celebrate when your stock is split.
But, if you want to buy more shares, then it is good news because now you will be able to afford them or at least get them cheaper.

Wednesday, May 11, 2005

LIC P/e Ratio Fund Review

LIC Mutual Fund is set to launch a fund that would invest based on P/E ratios. The scheme would invest in companies whose P/E ratios is less than that of Sensex or Nifty. The scheme blends an allocation comprising 65 per cent to equities and equity related instruments, and also in derivatives. The balance 35 per cent of the assets will be invested in those companies whose P/E ratio is more than the index at the time of investment.