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CONTENTS

Introduction
1 Investing - The What’s and Why’s
2 About Financial Planning
3 Managing Investment Risk
4 Investing in Equity - A must
5 Equity Investing: Know before you go
6 1-2-3 of Equity Investing
7 Invest -in Multiple Ways
8 The Process of Investing in IPOS/OFS
9 Secondary Market - The Nuances
10 The Investing Process
11 Studying Investment Opportunities
12 Selecting Equity
13 Sound Investment Strategies
14 Investing in Equity - Is it Expensive?
15 Invest Online
16 Keeping Track of Announcements
17 Don’t Ignore your Investments!
18 Calculating your Profits!
19 Tax on your Equity Investments
20 Get your Complaints Resolved
Conclusion
Introduction

There are many who will caution you that investing in stocks is not
everybody’s cup of tea. However, that’s not true. Over the long run, stocks
are known to deliver the highest returns compared to other conventional
financial investment products. What’s more, with an adequately diversified
portfolio of stocks, the longer you stay invested, the lower will be the
volatility that your portfolio experiences. Further, it is widely held that
India is slated for strong economic growth due to its demographic dividend
and current level of progress; the only way to participate in and benefit
from this growth is to invest in well-chosen stocks. In a nutshell, a well-
selected, adequately diversified portfolio of Indian stocks, if held over the
long run, is the surest and best way to ensure that your wealth grows. And
why should increasing one’s wealth not be everybody’s cup of tea?!

There is a simple caveat to this proposition for wealth increase. And it is

usually this caveat that leads people to believe that investing in the stock
market is best avoided. Here it is: Investing without adequate knowledge is
dangerous. You must realise that investing in stocks is no less a decision
than investing in a business. Now, would you put your money into a
business without much thought? Certainly not. Similarly,

investing in stocks must be preceded by an understanding of the stock and

the industry to which it belongs. This leads you to the next question: Can
anyone who makes an effort master knowledge of stocks and industries?
Well, adequate study gives you enough knowledge to follow the
recommendations of experts and gauge for yourself whether you would like
to invest or not. It also gives you enough confidence to hire a fund manager
or invest in a mutual fund and oversee this investment successfully.

So now that you are convinced that with a little effort, it is possible for you
to be a successful stock investor, where do you begin? Right here. With this
book! It literally tells you ‘Everything you wanted to know about stock
market investing’. Starting at level zero, the book gradually takes you
through concepts and strategies that are directly and indirectly related to
investing in stocks. Finally, it leaves you with classic investing rules that
prepare you for your journey into the world of stock investing. So sit back
with that cup of tea, or whatever other beverage suits your fancy, and take
your first step into the world of stock investing by turning to Chapter 1…
 Chapter 1

INVESTING THE WHAT’S AND WHY’S

Chapter 1
INVESTING THE WHAT’S AND WHY’S

Build Today a World for TOMORROW…

We live in uncertain times where jobs disappear, constant reskilling is the

order of the day, currency fluctuations are a given, and saving is no longer
enough. In such a scenario, the significance of investment cannot be
overstated. At one point of time, you will realize that things cost more over
time and doing nothing with the money when you have it, will definitely
cause it to lose the buying power. When you stay amidst uncertainties, it is
important to make investments to let your money grow rather than
diminish. As a matter of fact, it is the key to build a better tomorrow.

The Need to Plan and Invest

No social security

Until a few years ago, it was common for people to stay in the same job all
their working lives. But today, every sector has an ocean of job
opportunities to offer. Unlike in a cushy government job, where one gets the
benefit of a pension that has a dearness allowance built in (which grows
with inflation), most people work in the private sector, without any
guaranteed job security. Thus, the only way to secure old age is to invest
now, when one is young and capable of earning.

Nuclear family
Investment addresses the acute concern of the ‘sandwich’ generation who
looks after their aged parents and takes care of their children’s needs today,
but can’t depend upon their children to look after them in their old age. It’s
quintessential that they make the most of their earning years and invest for
their future needs. If that sounds intimidating, take heart. All you need to
get started is a primer on investing. That’s precisely what this book is
about!

Inflation

Wherever there’s talk of money, there is always talk of inflation. You have
heard of it too, but do you really know what it means? Inflation is the rate at
which the cost of goods and services rises. Simply put, as inflation goes up,
your purchasing power decreases. Due to inflation, over time, the value of
your money reduces. The following table demonstrates how the value of Rs
10,000 decreases at different levels of inflation, over a period of time.
[Note: In case you want to know how these figures have been arrived at, the
formula for calculating the amount is Rs 10,000/ (1+inflation rate) Number
of years]. You can see that with higher inflation and over longer time
periods, the value of your Rs 10,000 is continuously going down!
Inflation percent per annum
Years 2 3 4 4.5 5 6
5 9,057 8,626 8,219 8,024 7,835 7,472
10 8,203 7,440 6,755 6,439 6,139 5,583
15 7,430 6,418 5,552 5,167 4,810 4,172
20 6,729 5,536 4,563 4,146 3,768 3,118
25 6,095 4,776 3,751 3,327 2,953 2,330
30 5,520 4,119 3,083 2,670 2,313 1,741

The table above clearly indicates that over the years, you have to spend
more in order to maintain your standard of living. What about other
expenses like retirement and planning for your children’s higher education?
Well, obviously, those will cost much more too. A management course that
costs Rs 15 lakh today will cost around Rs 41 lakh (at 7 per cent inflation),
15 years later when your child is ready for it!

In order to meet that expense after 15 years, you will have to block more
than Rs 11 lakh today in a fixed deposit @ 9 per cent. If you take into
account taxation, this figure will be even higher. (This is because you will
have to pay off the tax every year on your fixed deposit interest income and
re-invest only the balance). This is clearly not enough in the long run,
especially for salaried individuals. The following table shows the
comparative cost of certain life goals now, and the expected cost after 15
and 20 years, assuming an inflation rate of 7 per cent.
Expenditure Heads @ Current Price 15 years hence 20 years hence
House Rs 30 lakh Rs 82.77 lakh Rs 1.16 crore
Children’seducation Rs 15 lakh Rs 41.38 lakh Rs 58.04 lakh
Children’s marriage Rs 2 lakh Rs 5.51 lakh Rs 7.73 lakh
Post retirement needs Rs 20 lakh Rs 55.18 lakh Rs 77.39 lakh

Can you beat inflation? Certainly, but putting your money in a fixed deposit
is not the way to go about it. To fight inflation, the key is to invest in an
investment option which gives you a higher rate of return than inflation, and
ultimately leaves you with a surplus to meet your goals. If not, you will find
that the value of your investment has actually reduced! Shocked? Let’s see
why this happens. An investment that offers a return of 10 per cent per
annum sounds quite good. But are you really going to earn so much? The
answer is ‘No’. You have to factor in inflation to find out your actual
earnings. This is called the “real return”.

Real return = Stated return — Rate of inflation

Inflation percent per annum

Stated
Return in 2 3 4 4.5 5 6
percent
5 3% 2% 1% 0% -1% -2%
 10 8% 7% 6% 5% 4% 3%
15 13% 12% 12% 10% 9% 8%
20 18% 17% 17% 15% 14% 13%

In addition, if you take into account the tax implications, the real return
might be even lower. Hence, assuming that the stated return is 10 per cent at
an inflation rate of 7 per cent, translating into a real rate of 3 per cent, a 30
per cent tax on 10 per cent interest income would knock off 3 per cent,
which is the real return.

Real return = Stated return — inflation — tax rate

That doesn’t sound as good, does it? So the next time you have money to
invest-
- Invest smartly. Choose only those investments which deliver a ‘real
return’.
- You might consider investments such as equities, real estate, and
commodities which historically have given real returns.

Make your money work for you

The chief principle here is that investment is all about making your hard
earned money earn more money for you! Simply put, it is the practice of
making your money work for you, while you work for more money.

How your money moves (Cashflow)

· Inflows
One look at your bank statements will show you that the credits into your
account come from one or more of the following sources:

1. Salary
2. Business and
3. Investment
income (interest, dividends, etc.)
· Outflows Now let’s look at where your hard earned money vanishes
each month:

1. Expenses
a) Essentials (house rent, electricity, telephone, gas payments, food,
and clothing)
b) Non-essentials (the new flat screen television, the designer bag or
perfume, the latest mobile or other forms of consumption
expenditure)
c) Taxes, over which most salaried people have little control; and
2. Investments (money spent in obtaining insurance, stocks, bonds,
mutual funds, fixed deposits, etc.), which, if at all, unfortunately comes
last in the order of priority for most people. After this little exercise,
you hopefully know where your earnings come from and where they
go.
Example of a Cash Flow Statement
Transaction In (Credit) Out (Debit)
Regular Income    
Salary for June Rs. 40,000.00 (+)  
Income from Investments    
Dividend from Mutual Fund Rs. 20,000.00 (+)  
Essential Expenditure    
Children’s Fees   Rs. 2,500.00 (-)
Fuel for car   Rs. 3,000.00 (-)
Insurance Premium   Rs. 5,500.00 (-)
Non-essentials and taxes    
Entertainment   Rs. 4,500.00 (-)
Car Loan Repayment   Rs.12,000 (-)
Taxes   Rs. 4,500.00 (-)
Total Savings   Rs.10,000 (+)

Invest FIRST!
Now, examine your outflows in order of priority. Do you invest first or do
you wait until all your expenses are met and then, if only there is some
money left, you invest it? If you invest first, you are playing SMART! If
you spend first and then invest the left over money (if any), you are playing
UNSMART!
Your Inflow Your Outflows
Earnings Investments
Investment income Expenses
Profits from investments Losses from investments
Rent income  

The “Smart Cash flow” above illustrates that your investments must come
first in the order of priority, barring any financial emergency. That way,
you’re sure of saving a particular amount each month; in addition, it may
also encourage you to limit your spends within your means.

Using compounding to grow more wealth

It’s rather simple to make your money work for you. Here is a question. Do
you spend the income you earn on your investments or do you reinvest it? If
you reinvest, you are smart! Let’s understand the benefits of reinvesting
your investment income with an example. Let’s say you have Rs 1 lakh to
invest. You decide to invest this in a 5-year bank fixed deposit which offers
you 8.5% interest per annum (compounded quarterly). Now you have two
options - 1. Opt for a fixed deposit where the interest is paid out (every 6
months) or 2. Opt for a cumulative option (where the interest is reinvested).
Let’s see what happens with each option.
  Non- Cumlative Fixed deposit Cumlative Fixed deposit
Amount invested Rs 1 lakh Rs 1 lakh
Interest rate 8.5% 8.5%
Interest received for 5 years 42,500 50,366

If you opt for the cumulative option, you will receive additional interest of
Rs 7,866 which is 5.5% higher than interest on non-cumulative option!
Investment avenues such as equities and mutual funds often have a much
higher rate of return than fixed deposits. For example, equity markets
(represented by the Sensex, which is explained later in this book) have
given a return of 16.75% per annum over the last 38 years. Re-investing at
these attractive rates helps you build up your wealth and reach your
financial goals much faster. The following example demonstrates how
reinvestment over a longer time period can boost your income. Anita and
Sunita are 25 years old. Anita invests Rs 10,000 @ 7 per cent today and
goes on re-investing her investment income at the same rate. Ten years
later, Sunita decided she would like to do the same. When they turn 60, they
decide to see how much money they have earned. Anita’s Rs 10,000 grows
to Rs 1,06,765.81, while Sunita’s Rs 10,000 grows to only Rs 54,274.32!
How can the difference be so vast considering that both invested the same
amount of money at the same rate of return? The answer is - time. Anita
begins 10 years earlier and thus earns more investment income, which is
reinvested, and consequently helps her investment grow exponentially.

Hence, your investment needs time and reinvestment of the investment

income and other profits that you get from your original investment.
Time Value of Rs 10,000 for Anita Value of Rs 10,000 for Sunita
After 5 years Rs 14,025.51  
After 10 years Rs 19,671.51  
After 15 years Rs 27,590.31 Rs 14,025.51
After 20 years Rs 38,696.84 Rs 19,671.51
After 25 years Rs 54,274.32 Rs 27,590.31
After 30 years Rs 76,122.55 Rs 38,696.84
After 35 years Rs 1,06,765.81 Rs 54,274.32

Further, the longer you reinvest your investment income, the higher your
original investment grows, and the faster you reach your financial goals.

That means, if you plan to save for your retirement, the earlier you begin
the lesser you will have to invest to build a bigger nest egg.
What exactly is the power of compounding and how can a regular person
use it to his or her advantage? Well, to begin with, it goes hand in hand with
the concept of reinvestment. Every time you reinvest your income from
interest/dividends on investments, your capital or principal that is invested
goes up. The next time you earn interest/dividends, it is on this enhanced
capital, and is therefore higher than what you would have received if you
chose not to reinvest. Over a period of time, these small extra amounts can
add up to a tidy sum. Albert Einstein once called compounding the greatest
mathematical discovery ever!

Use 2 magic wands to grow your wealth —

1. Compounding and
2. Nigh frequency of compounding.

Apart from time, another factor that influences compounding is the

frequency of compounding. You’ve probably heard of investments that
offer monthly, quarterly and annual compounding. What this simply means
is that interest is calculated at different frequencies (every month for
monthly, every quarter for quarterly, etc.) and reinvested. The shorter the
compounding frequency, the earlier your interest is

The following table demonstrates the effect of compounding across

different frequencies, for a sum of Rs 10,000 @ 9 per cent per annum for 10
years.

Thus, after 10 years, the investment which was compounded monthly grew
by almost Rs1,000 more, than the investment which was compounded
annually.

If the above figures are converted into percentage gains per annum with
respect to annual compounding, you will see that as the frequency of
compounding increases, the interest rate correspondingly increases.
Compoinding Monthly Quarterly Semi-Annually Annunally
(In Rs.) (In Rs.) (In Rs.)
1 years 10,938 10,930 10,920 10,900
5 years 15,656 15,605 15,529 15,386
10 years 24,513 24,351 24,117 23,673

Compounding is such a powerful financial tool that if you invest and

reinvest your savings and profits regularly, your investment portfolio will
steadily outgrow your earnings!
Compounding Monthly Quarterly Semi- Annually
frequency Annually
1 years 9.3807% 9.3083% 9.2025% 9.0000%
5 years 11.3138% 11.2102% 11.0594% 10.7725%
10 years 14.5136% 14.3519% 14.1171% 13.6736%
SUMMARY
• Investing is all about making your hard-earned money earn you some
more.

• A cash flow statement is essential to understand how much you can and
how much you should invest.

• Make regular investing the top priority, barring any financial

emergency.

• Inflation reduces your purchasing power. As inflation rises, you get less
out of your money. Hence, to maintain your standard your living, you
have to spend more and more every year.

• Saving smart for a home or for children’s education becomes imperative

in times of rising inflation.

• Fixed deposit returns, although safe, often cannot keep up with

inflation; hence, they cannot be your only option for creating long-term
wealth.

• Always calculate your real returns to understand if your investment is

working for you. Real return is the stated return minus the rate of
inflation minus the tax rate.

• Little drops do make an ocean. To save for your retirement, the earlier
you start, even with investing little amounts of money frequently, you
can build a sizeable nest egg and buy that snug retirement home.

• Investment avenues such as equities and mutual funds often have a

much higher rate of return than fixed deposits.

• Today, there are many attractive options for investment, including

reinvesting the income earned on traditional investment avenues.
• In the reinvestment mode, all subsequent earnings are on enhanced
capital.

• Compounding frequently earns you a little more every time, which adds
up in the long run. The shorter the compounding frequency, the earlier
your income is re-invested.

• The triad of investing early, reinvesting and the compounding effect can
beat inflation.

Your action points

1. I will save at least 10% of my income before I start spending.

2. I will create a monthly expense budget and stick to it.

3. I will create and regularly update my asset and liability statement.

4. I will opt for the cumulative fixed deposit option for my bank deposits
(and not the simple interest option); thereby I will use the power of
compounding.

5. I will opt for the ‘growth’ or ‘dividend reinvestment’ options in my

mutual fund investments instead of the ‘dividend payout’ option.

Axioms
1. Rule of 72: If you want to know how many years it will take to double
your money, you can use the Rule of 72. Let’s say you can invest your
money at 8% return on investment. Now simply divide 72 by 8. The
result is 9. In other words, it will take you 9 years to double your
money at 8% return on investment.

2. There is nothing such as “short term investing:” Believe it or not,

the term “short term investment” is an oxymoron. As a matter of fact,
such a thing is more of a speculation rather than investing. Investment
 is a commitment of expanding capital in pursuit of long term goals in
your life.

3. It’s all about RISK and RETURN: The higher the risk, the higher
the return. This is true for investments. If you are not willing to take a
risk with your money, chances of earning good returns are negligible.
However, that doesn’t mean you take rash risks; you need to assess the
risk and decide how you can deal with it before making the investment.

4. Mere information won’t work for you: For investments, it is

important to understand that knowing the facts is not knowledge. The
ability to use the information or facts to your advantage (by building
your wealth) is true knowledge.

5. Have a well-balanced investment portfolio: You never know what

disappoints you or what gets you great returns. Therefore, the secret
lies in having a well balanced portfolio that features diversified asset
classes such as cash, fixed deposits, equities, shares, etc.
 Chapter 2

ABOUNT FINANCIAL PLANNING

Chapter 2
ABOUNT FINANCIAL PLANNING

Now that we know the basics of investing, let’s take a look at financial
planning. Financial planning is the step-by-step process of developing a
personal roadmap for your financial well being. The inputs to the process of
financial planning are:

a) Your finances - your income, assets and liabilities;

b) Your goals - your current and future financial needs; and

c) Your appetite for risk

The output of the financial planning process is a personal financial plan that
tells you how to invest your money to achieve your goals, keeping in mind
your risk appetite, inflation, real returns and taxes. In short, financial
planning is the process of systematically planning your finances towards
achieving your financial life goals.

Financial planning is the process of systematically

planning your finances towards achieving your
financial life goals.

Requirements to Financial Planning

Your dreams and aspirations

Who doesn’t nurture dreams of owning a bigger house or car, exploring the
world, giving their children the best possible education, a blissful
retirement, and so on? Basically, these dreams are life goals. And one surely
needs money to achieve them. Consider this example.

Dream of owning a cars A house? Going abroad?

These are your life goals.

Mr. and Mrs. Bhanot, aged 35 and 32 respectively, have a three year old
daughter. Both work in private sector companies. Mr Bhanot plans to retire
when he’s 50. From their current one-bedroom rented suburban Mumbai
apartment, the Bhanots hope to move to their own two-bedroom apartment
costing around Rs 1 crore within the next five years. They own a small car,
for which they have availed of a loan. Mr Bhanot reckons that he will need
Rs 45 lakh for his daughter’s higher education 15 years later. He also wants
to build a corpus of Rs 75 lakh for his retirement.

The goals are charted out, alright. But what’s important is to distinguish the
short-term goals from the long-term goals.
As a general rule, any life goal that needs to be met within five years can be
considered as short-term. Beyond that, any other goal can be classified as
long-term. By this classification, the Bhanots’ goals can be classified as
follows:

Using a similar yardstick, you may classify your own life goals. Each of
your goals, whether short-term or long-term, needs financing. Carefully
planning your finances in order to have the right amount at your disposal at
the right time is what financial planning is about.

The need to plan

You may wonder why you need to undertake financial planning. You may
believe that you will do just fine without financial planning. But this results
in a strong possibility of being unable to fulfil life goals. For example,
people today realize the importance of living life to the fullest.
Consequently, many opt for early retirement from full time jobs, as
compared to a few decades ago, when most people worked until the
maximum retirement age of 58-60 years.

Financial planning helps you fulfil your life goals and

retire comfortably.

The average person can, today, expect to live a healthy life well into his or
her seventies or eighties, which means that retirement life is almost as long
as working life. Financially, it implies that savings (after taking into account
inflation) should be enough, not just to maintain the same lifestyle for
almost 25-30 years, with no new income, but also to take care of medical
expenses, which are usually higher the older a person gets. Planning for all
this is a tall order for anyone. That’s why it’s critical for everyone to plan
their finances from an early age.

How financial planning helps

Here’s a list of the benefits that a well chalked out financial plan offers:
· Helps manage cash flows and reduces unnecessary expenditure.
· Enables maintenance of an optimum balance between income and
expenses.
· Helps boost savings and creation of wealth.
· Helps reduce tax liability.
· Maximizes returns from investments.
· Ensures better wealth management to achieve life goals.
· Financially secures retirement life.
· Reviews insurance needs and therefore also ensures that dependants are
financially secure in the unfortunate event of death or disability.
· Lastly, it also ensures that a will is made.

Financial planning can help you achieve peace of

mind.

Steps to financial planning

Now that you are convinced about the importance and use of financial
planning, clearly you may wonder where to begin. You could either appoint
a financial planner to develop a financial plan for you or do it yourself.
When you actually get down to it, financial planning consists of a series of
steps.

• Step 1: Identify your current financial 6 Steps to Financial Planning

situation

Sit down with all the earning members of your family and gather all
financial information (about your sources of income, debts, assets,
liabilities, etc.). Now make a financial statement with appropriate heads
-Income, Expenses, Assets and Liabilities. You will now get a clear
picture of your current financial situation.
• Step 2: Identify your goals

Ask each member to list what they think are current and future family
goals. Prioritize each goal and put a time period against each, i.e. when
you will need the finances to achieve that goal. Quantify each goal by
putting a financial value to each one. This exercise allows you to clearly
distinguish between your short-term and long-term goals, and how
much money you need for each.

• Step 3: Identify financial gaps

Once you know where you stand financially, i.e. your present assets and
liabilities and your potential to save, and where you want to be in terms
of the financial goals that you want to achieve, a simple calculation
gives you an idea of the shortfall. You begin to see clearly the sum of
funds you need for specific goals with respect to the time factor.

This is important because it paves the way for you to identify the right
investments that will generate the necessary income within the time
required to cover the shortfall so that you can achieve your goals.
Financial Statement
Sources of Assets Liabilities Sources of expenditure
Income
Salary Residential Deposit for house Interest payable on depositfor house let
house let out out
Rent from house Furniture & Car Loan Monthly instalment on Car Loan
let out articles
Share of profit House let out Loan taken for Interest on loan taken for investment
from firm investment in Mf
Dividend from Investment   House repairs and maintenance
mutual fund made in firm
Interest on Fd Car   Recurring expenditure (food, clothes,
electricity, entertainment, etc.)
  Mutual fund   Education expenditure
investment
  Fixed Deposit   Insurance premium
      Taxes

• Step 4: Prepare your personal financial plan

Once you have a bird’s eye view of your financial gaps, you need to
review various investment options such as stocks, equity mutual funds,
debt instruments such as PPF, bonds, fixed deposits, debt funds, etc. and
identify which instrument or a combination thereof best suits your
needs. The time frame for your investment must correspond with the
time period of your goals.

Financial planning will help you place a monetary value to all your
goals and identify the investment plan that you can follow to achieve
the goals.

Financial planning will help you place a monetary

value to all your goals and identify the investment
plan that you can follow to achieve the goals.
• Step 5: Implement your financial plan

It’s now time to put things into action. Gather necessary documents,
open necessary bank, demat, trading accounts, liaise with brokers and
get started! Most importantly, start investing and stick to your plan.

• Step 6: Periodically review your plan

You may have created your financial plan and implemented it. However,
financial planning is not a one-time activity. A successful plan needs
serious commitment and periodic review (once in six months, or at a
major event such as birth, death, inheritance). You should be prepared to
make minor or major revisions to your current financial situation, goals
and investment time frame, based on a review of the performance of
your investments.

If you are not inclined or not comfortable developing your own plan,
you can always consult professional financial planners, who will take
you through the whole process. As financial planning is supposed to see
you through your life, the process is continuously reviewed and fine
tuned to account for changes in your life and in the financial
environment.

Tips for making the most of the financial planning process:

1. Start now. Even if you are in your mid thirties or forties, it’s better to
start now than dawdle for another five years. Every day counts.

2. Be honest with yourself. Seek help when needed.

3. Set sensible, measurable goals for yourself. Be realistic in your

expectations of the results of financial planning.

4. Review your plan and financial situation periodically and make

adjustments as and when needed.
Tips to Financial Planning
• Start now
• Be honest
• Be realistic
• Review your plan
• Review performance of investments
• Be hands on

5. Always review the performance of your investments; pull out if need

be and reinvest the money elsewhere.

6. Be hands-on. It’s your money and no one else will do your work for
you.

What makes a good financial plan

How do you evaluate the quality and effectiveness of your financial plan?
Well, here’s a checklist you can use.

· Does it indicate your current financial situation?

· Does it list out all your goals in measurable terms?

· Does it lay out an investment strategy?

If you noticed, changes need to be made with time, in your financial plan.
These are often a result of the dynamics of the financial environment.

A professional financial planner helps you identify potential risks

associated with various investments and explains how those risks are
managed. What risks can you expect on your journey to financial freedom?
Stay tuned.
SUMMARY

• A personal financial plan helps you achieve your goals, keeping in mind
your risk appetite, inflation, real returns and taxes.

• Divide your goals into long-term and short-term goals, where short-
term goals fall within the next 5 years.

• Understand the monetary value of your goals and always prioritize

them.

• Financial planning is essential to ensure that your saving meets your

current lifestyle, maintain a retirement corpus, and take care of any
unforeseen medical expenditure.

• A financial plan ensures peace of mind since you are prepared for most
eventualities.

• A financial plan creates long-term wealth, maximizes the returns on

your investments and ensures that you always budget for little
extravagances.

• You can create a financial plan through a series of simple steps or take
the help of a certified financial planner.

• The first step is to understand your cash flows, both inflows and
outflows.

• The most essential step of any financial plan is seeing it through, i.e.
commitment to the plan.

• A financial planner will continuously review your plan to consider any

life-changing events, such as a birth or death.
• You must be closely involved with the planning process since you must
always monitor how your hard-earned money is working for you.
• It’s never too late to make a financial plan.

Your action points

1. I will start working on my financial plan right away!

2. I will track my monthly expenditure and follow a budget.

3. I will buy life and health insurance to secure my dependants and my

wealth.

4. I will assess our financial goals after a family discussion and plan to
fulfil them.

5. I will regularly track and update my financial plan.

Axioms

Risk & Return Tradeoff: The higher the risk involved the greater the
return, and vice versa. This axiom holds true for all investment classes. So,
if you were to trade in the stock market for the short term, the risk is
definitely higher as against investing in bank deposits for a year.
Commensurately, while you earn a fixed interest rate for being invested
with a bank deposit, there is a likelihood of making a significantly higher
profit in the share market.

Diversification is the key: Diversify your portfolio across different asset

classes such as real estate, stocks, bonds, bank deposits, etc. and maturity
periods for a wholesome long, mid and short term financial plan to alleviate
risk. Your portfolio mix must be altered in tandem with the stage of the
financial life cycle you are in.
Time Value of Money: Simply put, time value of money implies that
money that we have today is worth more than the same amount of money in
future due to its earning potential. For instance, if you were to invest Rs
1,000 today on a fixed deposit at 9% interest rate, then at the end of the year
your Rs 1,000 will be worth Rs 1,090 whereas, getting the same Rs 1,000 a
year from now, it would be only worth Rs 910. The Rs 90 you’ve lost is
known as the opportunity cost.

Knowledge for Financial Empowerment: Keep yourself updated on the

latest financial trends and the various investment avenues besides reviewing
your portfolio. Let your children also understand the importance of being
moneywise and inculcate the savings habit in your lifestyle.

In investing, it pays to start early: Earlier you begin investing, your

personal financial situation will be give you better results. If you chose to
invest later in life, over time you can afford things that others cannot. In
addition, if your finances become unstable at any point of time, by investing
early you will be prepared to face it.
 Chapter 3

MANAGING INVESTMENT RISK

Chapter 3
MANAGING INVESTMENT RISK

Now that you are aware about financial planning and its importance, let’s
understand the concept of risk in investing.

About risk in investing

Investment risk is the possibility of either not getting the expected returns
on your investment or losing the money invested. Like life, all investments
carry some amount of risk, some more others less. Therefore, the key to
successful investing is to identify the probable risks that an investment
carries and match it with your risk bearing capacity and return expectation.
Risk and return are inextricably linked.
The visual shows some of the most likely avenues of investment, the return
possibility of each as well as the associated level of risk. This is known as
the risk-return trade-off. While building a portfolio of investments to meet
your financial plan, the investments have to be matched with your risk
personality. Investor risk can be further classified into two facets: risk-
taking capacity and risk tolerance.

Your risk personality is a combination of your risk-

taking capacity and risk tolerance.

Risk-taking capacity:

Your risk-taking capacity depends upon several factors such as your

investment objectives, the investment time frame, your age, income,
number of dependants, how much wealth you have already accumulated,
and so on. Let’s look at how each of these determines your risk-taking
capacity.

Investment objectives:
Defining your primary objective behind investing is most important. It
could be creating wealth to meet financial goals or protecting savings from
eroding due to inflation. Objectives determine expectations. Expectations
are determined largely by age. For instance, older people most often invest
with the objective of protecting their life savings from eroding due to
inflation. Given this limited expectation, they have a low risk-taking
capacity.

Age:

Creating wealth requires both, time and money. The longer you stay
invested, the higher are the chances of earning good returns, and lower the
risk of losing your money. Young people have time on their side and
therefore, generally, a higher risk-taking capacity. Of course, other than
choice, risk appetite also depends on circumstances and upbringing.

For example, a newly married couple planning to buy their own house
cannot afford to lose their savings and hence may be averse to investing in
high risk investments.

Investment horizon:

The longer you can afford to wait for your investment to yield you desired
returns, the more open you will be to taking risk. On the other hand, if
money is needed in the near future, a low-risk investment will be preferred.
In fact, experts recommend that as financial goals become due for
fulfilment, switch your money to lower-risk investments, even if it means
earning lower returns for a short while. Practically, this makes perfect
sense; you don’t want to risk your money just when you need it!

Income and accumulated wealth:

It is generally observed that risk-taking capacity is directly proportional to

your income and accumulated wealth. The more you earn, or have managed
to save, the more capital you have at hand for investing; consequently, the
more risk you can take.
Number of dependants:

Risk taking capacity is inversely proportional to the number of dependants

you have. For example, a young and unmarried person can afford to take a
greater risk and rough it out for a while. However, if you are supporting
your aged parents, and have to pay for your children’s education, you are
much more likely to play it safe.

All of these factors exert some influence on your risk-taking capacity.

Review your own situation and try to understand where you stand.

Risk tolerance:

Risk tolerance is the psychological element in your risk personality. It refers

to the degree of uncertainty you can handle when there is a negative change
in the value of your portfolio. In other words, it reflects how you react when
your investments make a loss.

Your Investment Personality

· Investment objectives · Your mindset towards risk

· Age
· Investment horizon
· Income and accumulated wealth
· Number of dependants

There is a subtle but important difference between risk tolerance and risk-
taking capacity. Risk tolerance lies in your mind as an investor and tells you
how much risk you WANT to take whereas risk-taking capacity is the
amount of risk you SHOULD take keeping in mind the factors discussed
above.

Generally, a panic reaction on every stock market dip reveals a low risk
tolerance. On the other hand, if you stay as cool as a cucumber and make
the best of every crash, then your risk tolerance is high. You need to know
your risk tolerance before investing because risk-taking capacity and risk
tolerance determine your investment strategy, which requires some self
discovery and general financial planning.

For example, an older person may be wealthy and therefore may have a
higher risk-taking capacity; however, due to a previous bad experience in
the stock market, he may be less tolerant towards equities.

In order to clearly gauge your risk personality you can avail of

questionnaires available with financial advisors or several tools available on
the Internet. One easy step is to visit
http://www.moneycontrol.com/planning_desk/riskanalyser_plan.php

Risk in different investments

Now that we have discussed risk from the perspective of the investor, let us
look at investment risk. This is necessary because different investments
themselves carry different levels of risk.

• Equities and Mutual Funds

Equities and related investments, such as equity mutual funds (explained in

the glossary), carry a high level of risk. This risk emerges from either
wrong selection of stocks or investing for a short time period. At the same
time, as the graph shows, returns from equities outclass all other
investments in the long run. More importantly, they help you beat inflation
and create wealth.
The risk in equities is significantly higher in the short-term, when the value
of your portfolio changes upon the whims of the capital market.

The only way you can mitigate (reduce) this risk is by selecting the right
stocks and staying invested for longer periods of time.

• Debt instruments

This class of investments includes relatively low risk instruments such as

government bonds, money market funds, bank fixed deposits, liquid or gilt
funds, and so on.

These investments are mainly lending in nature and returns are more in the
nature of “fixed” earnings, which often fail to outrun inflation. Hence, these
investments have never led to wealth creation but, are more towards wealth
preservation.

Asset Allocation - creating a suitable mix of investments

Simply put, asset allocation is all about creating an optimal investment mix,
bearing in mind two important factors: your risk profile and return
objectives. The rule of thumb is that the debt component Equity Debt of
your portfolio should be equivalent to your age, balance being equity. In
effect, as you grow older the debt component in Cash your investment
portfolio will keep rising. However, to arrive at an asset allocation
specifically for you, which would be in sync with your risk profile and
return objectives, is most likely to differ from the generic rule of thumb
mentioned above.

Your debt investment should be equivalent to your

age.

When done properly, asset allocation ensures that a portfolio diversifies or

spreads the overall risk across investments. A balanced portfolio should
include a mix of equities, debt investments, commodities (such as gold),
and real estate. How much capital you invest in each investment class
depends upon your risk profile.

Financial advisors generally classify investors into the following categories

based on investor risk:
Selecting suitable investments

As explained earlier, your risk-taking capacity is determined by your

investment horizon. Hence how long you plan to stay invested also
determines the right investment for you. This is mainly because equities are
fairly volatile, and you don’t want to chance your investment value dipping
just when you need it the most.

However, regardless of your investment horizon, make sure your portfolio

has an equity component to create wealth while the debt component
protects your capital. Depending on your age, risk profile and return
objectives it is the proportion of debt and equity that would vary. For
example, as per the generic rule of thumb we discussed above, your optimal
portfolio mix when you’re 20 should be approximately 20 per cent into debt
and 80 per cent into equity.

Assessing your asset allocation

Having identified the optimal investment mix and horizon (that will help
you meet your return objectives considering your risk profile), you now
need to compute the expected average returns on your asset allocation to
judge if the selected allocation will help you bridge the gap identified
during the financial planning process.

If not, you may need to do a combination of three things:

 Move up the return (and risk) levels to earn more, i.e., have a larger
equity component,

Reduce your life goals, e.g. aspire for a smaller house,

Save more, i.e., spend less today and invest more to help you bridge
the gap.

If your objective is to create wealth, you cannot afford to invest in low-risk

low-return investments.

How have different investments fared?

Cumulative Annualized Returns (1979 to 2018)

  CAGR growth during 1979-2018

Sensex 16.75%
Gold 9.52%
Bank FD 8.33%
Inflation # 7.11%

# Inflation is the Average inflation during 1979-2017

This table uses the concept of Cumulative Annualised Returns or

Compounded Annual Growth Rate (CAGR) to evaluate various investment
avenues and inflation.

What the graph above simply conveys is that if you had invested Rs. 100 in
equities in April 1979, 38 years later in January 2018, this Rs 100 would be
worth Rs. 35,965.02. Your Rs. 100 has grown at an annual compounded rate
of 16.75 per cent during this period.

Compare that with the next best performer (gold), in which Rs.100 invested
in April 1979 would have grown to only Rs 3,167.75 in January 2018.

Hence, in the long run, returns from equities far outperform all other
investment classes. Allocation towards high return generating investments
such as equities and equity mutual funds is thus imperative.

Your risk personality and asset allocation changes with time

Life has its ups and downs, circumstances change, and so does your risk
profile. Perhaps you were young and single when you began investing, and
had a high tolerance for risk. Two years later, you may be married, and the
parent of a baby. Suddenly, you may not be able to stomach that high a level
of risk. On the other hand, you may have come into an inheritance, and
suddenly find yourself endowed with funds, and therefore more willing to
take risks.

Thus, it is important to review your risk profile, and consequently your

asset allocation, every once in a while. Experts recommend that you review
your situation every six months to a year.

By now, you are hopefully prepared to enter the exciting world of investing;
of making your money work for you, and not the other way round.

Happy investing!

Review your situation every six months to a year.

SUMMARY
• To manage money efficiently, one must select the right investments,
each of which carries risk.

• Investment risk is the possibility of either not getting the expected

returns or losing the money invested.

• The trick is to understand what risk your investment entails and match it
to your risk-bearing capacity.

• Always remember that risks and returns enjoy a direct relationship; the
higher the risk, the higher the returns.

• Your risk-return appetite hinges on numerous factors, including

investment objectives, age, current assets, number of dependants and
risk tolerance.

• Time plays an important factor in creating money. If you start early, you
can expect good returns.

• Young people have a higher risk taking ability; hence, in combination

with an early start, they can expect high returns.

• If you can afford to wait for your investments to mature, you can afford
to take higher risks.

• If you have a considerable corpus, you have more capital for investing,
which also affects your risk taking perspective.
• Understanding your risk tolerance is core to your investment
philosophy. If, during a short, sudden downturn, you panic and sell out,
it indicates a low risk tolerance.

• Invariably, those with a higher risk tolerance tend to wait out any
downturn, and emerge successful.
• Equity and related instruments have higher risks, and hence offer higher
returns.

• Debt-related and gilt instruments enjoy lower risks. They are typically
used to preserve wealth.

• A financial advisor has a scale to classify investors ranging from

conservative to very aggressive.

• A smart portfolio must comprise both debt and equity; equity creates
wealth, while debt preserves it.

• Equity outperforms all other investment classes, in the long-term.

How much risk I want to take? Let me check a readymade financial planner
to find out. I can visit
http://www.moneycontrol.com/planning_desk/riskanalyser_plan.php

Your action points

1. I shall start investing at an early stage.

2. I will understand my risk profile before investing.

3. I will remember that risk and rewards have a direct relationship.

4. I will diversify my portfolio well in various assets classes.

5. I will remain patient while taking investment decisions.

Axioms

1. Knowing your risk appetite is a must: Investors should know their

risk appetite and accordingly invest in the stock market. The greater
the risk appetite, the better are the chances of gaining more returns and
 vice versa. However, you also should be prepared for higher losses in
this situation.

2. It pays if you start early while investing: If you are young, financial
dependence is least on you. You are capable of taking more risks and
can invest for a longer duration which can reap good benefits in the
long run.

3. Diversify and fructify: It is very risky to invest all your money into
any one sector. Say for example, you are very confident about the
pharma sector going forward; however, you should not park all your
money into the pharma sector. You can have higher a weightage of
your portfolio invested in the pharma sector and diversify the rest.

4. Track your portfolio: It is not advisable to invest and forget about it.
You need to periodically check the status of your portfolio; shuffle it if
required. If you have given your portfolio to an expert to manage it
then you should also check the statements, documents in a scheduled
manner.

5. Returns and risks go hand in hand: In other words, higher your risks
more are the chances for you gaining better returns. However, check
your liabilities and also do not borrow to invest in the stock market.
1CAGR is the year over year growth rate of an investment over a specified
period of time, assuming that interest earned on the investment in the
interim is reinvested at the same rate.
 Chapter 4

INVESTINGIN EQUITY A MUST

Chapter 4
INVESTINGIN EQUITY A MUST

As explained previously, your financial plan designs your asset allocation

with the objective of achieving your financial goal(s). Your asset allocation
can comprise a bunch of different investments, individually capable of
generating returns and carrying risk in line with the nature of the product.

A dilemma you are most likely to face in the process of choosing the right
bunch of investment products is how much to invest in specific
investments. There is a plethora of investment products that you can choose
from. The most common ones are:
1. Bank Fixed Deposits (Fds)

2. Company Deposits

3. Insurance Policies (Unit Linked, Money Back, Endowment)

4. Debt Mutual Funds

5. Post Office Small Savings Schemes

6. Pension and Public Provident Funds (PPF)

7. Equities - Shares and Equity Mutual Funds

8. Gold and Silver

9. Real Estate

How much return?

At a fundamental level, investing can either don the characteristics of

lending (where the business or market risk is not carried by you) and your
returns are set by the borrower, or there is the option of pure investing
wherein you participate in the profits/upside of the business or asset.

When you invest in Bank or Company FDs, Insurance policies, Post Office
Schemes, PPF, etc. you are in effect lending your money to the Bank or
Company or Insurer or Post Office. You will be compensated in the form of
interest, which is determined by the borrower. Other than the interest due to
you, you do not participate in the profits of any of these borrowers. Thus, if
you have invested your money in a company FD and the said company
makes huge profits, you still only receive the interest fixed at the time of
investment, and do not reap the benefits of the company’s exponential
profits.

However, when you invest in Equities or Gold/Silver/Real Estate, you now

step into the shoes of the owner (to however small an extent) of the
company the shares of which you are buying or the asset (gold/silver/real
estate), as the case may be. This now allows you to participate in the profits
of the company and any upside the asset gives in the future.

When you invest in bank FOs, company FOs, post

office schemes, etc., you are a lender. When you invest
in equity, gold, real estate, etc. you are an owner.

Resultantly, these differing relationships between the investor (you) and the
investment, either as a lender or pure investor, will carry different levels of
risks. Your risk as a lender would be restricted to preservation of your
original investment and getting the agreed to (fixed) return on the same,
irrespective of the ups and downs of the borrower. Your risk as a pure
investor is dependent on the growth and profits of the company you have
invested in or the rise in the prices of the asset (gold/silver etc.).

As an investor, it is critical that you understand this elemental difference

between investments and the resulting difference in the nature of returns
and risk from these two categories of investments. Once you have
understood the nature of your relationship with the investment, it will help
you understand what to expect out of that investment, in terms of returns
and risk.

Understanding stock markets

Equities and financial markets have been generically discussed so far, but
what really constitutes these concepts and what are the other building
blocks of the eco-system they belong to? Let’s briefly discuss this and how
do they all connect to each other.

Equity:

Equity shares refer to what a company issues to its owners which denote
their ownership of the company (business). These can be purchased either
via an Initial Public Offer, i.e., when the company raises money and offers
to the public at large a share of ownership in the company or via secondary
markets, i.e., when you buy shares from a previous holder in a marketplace.

Stock Market:
This is an electronic platform where investors come together to buy and sell
their equity shares. Like any other market, this is where the price of an
equity share gets decided upon on an on-going basis, depending on the
demand and supply and prevailing emotions of all the buyers and sellers.
The two largest markets for equities in India are the National Stock
Exchange (NSE) and the Bombay Stock Exchange (BSE).

About stock market indices:

A stock index represents the change in the weighted value of a set of stocks
which constitute the index. For example, if an index is assigned an arbitrary
base value of 100 on a given date based on the weighted value of a certain
number of stocks assigned to it, from this date onwards changes in the
individual values of these stocks will have a collective impact on the index
value. Some of the prominent indices in India are: SENSEX (30 stocks),
NIFTY (50 stocks), BSE 200 (200 stocks), etc. The stocks that comprise the
index represent leading companies from a cross-section of industries that
are large contributors to India’s economic growth.

The two leading indices that need special mention are the Nifty 50 and the
BSE Sensex.

NIFTY 50: Nifty is the stock market index of the National Stock Exchange.
It comprises the stocks of 50 of the largest Indian companies with well
dispersed shareholding from about 13 sectors in India. It was introduced in
1995 keeping in mind that it would be used for modern applications such as
index funds and index derivatives, besides reflecting the stock market
behaviour.
COMPANIES FORMING THE CNX NIFTY INDEX AND THEIR WEIGHTAGES (AS ON
31-1-2018)
Sr. No Security Name Weightage %
1 HDFC Bank 9.48
2 RIL 7.61
3 HDFC 7.13
4 ITC 5.75
5 Infosys 5.57
6 ICICI Bank 5.28
7 L&T 4.07
8 TCS 3.67
9 Kotak Mahindra Bank 3.43
10 Maruti Suzuki 2.93
11 State Bank of India 2.68
12 Axis Bank 2.38
13 Hindustan Unilever 2.32
14 IndusInd Bank 2.09
15 Mahindra & Mahindra 1.72
16 Tata Motors 1.7
17 Sun Pharma 1.53
18 YES Bank 1.52
19 Bharti Airtel 1.4
20 Vedanta 1.4
21 HCL Tech 1.3
22 ONGC 1.3
23 Asian Paints 1.22
24 NTPC 1.22
25 Hero MotoCorp 1.14
26 Tata Steel 1.08
27 Bajaj Auto 1.05
28 Ibulls Housing 1.04
29 Ultratech Cement 1.04
30 Power Grid 1.04
31 Bajaj Finance 0.96
32 Indian Oil 0.96
33 Coal India 0.95
34 Tech Mahindra 0.94
35 BPCL 0.93
36 Eicher Motors 0.92
37 Wipro 0.91
38 Hindalco 0.87
39 Zee 0.79
40 Adani Ports 0.76
41 Cipla 0.75
42 HPCL 0.74
43 GAIL 0.73
44 Bharti Infratel 0.66
45 Dr Reddys Labs 0.64
46 UPL 0.63
47 Lupin 0.47
48 Ambuja Cements 0.45
49 Bosch 0.44
50 Aurobindo 0.42

S&P BSE SENSEX: The Bombay Stock Exchange is the oldest stock
market of India. “SENSEX” stands for sensitive index. It was created in
1978-79 with a base value of 100. It comprises thirty stocks of leading
Indian companies and is well diversified with representation from almost all
the sectors of the economy like banking, information technology, cement,
autos, manufacturing, capital goods, etc. The SENSEX is revised from time
to time to incorporate companies belonging to emerging sectors of the
economy. The movement in the SENSEX values on working days is
computed on a real time basis.
COMPANIES FORMING THE S&P BSE SENSEX AND THEIR WEIGHTAGES (AS ON
31-1-2018)
Sr. No. Company Weight in Index (%)
1 HDFC Bank 11.41
2 RIL 8.85
3 HDFC 8.61
4 ITC 6.96
5 Infosys 6.74
6 ICICI Bank 6.38
7 Larsen & Toubro 4.93
8 Tata Consultancy Services 4.43
9 Kotak Mahindra Bank Ltd. 4.15
10 Maruti Suzuki 3.55
11 SBI 3.24
12 Axis Bank 2.87
13 Hindustan Unilever 2.82
14 IndusInd Bank 2.53
15 Tata Motors 2.09
16 Sun Pharma 1.84
17 YES Bank 1.83
18 Bharti Airtel 1.68
19 ONGC 1.58
20 NTPC 1.48
21 Asian Paints 1.48
22 Hero MotoCorp 1.38
23 Tata Steel 1.3
24 Bajaj Auto 1.28
25 Power Grid 1.25
26 Coal India 1.16
27 Wipro 1.1
28 Mahindra & Mahindra 1.04
29 Adani Ports 0.95
30 Dr Reddys Labs 0.78
31 Tata Motors DVR 0.32

Other than broad based indices like the BSE SENSEX and NIFTY, there are
several sectoral indices which represent a specific industry sector. All
stocks in a sectoral index belong to that sector only. For example, an index
like the NSE Bank Nifty comprises of banking stocks, NSE CNX IT is
made up of IT stocks, etc. Sectoral indices are very useful in tracking the
movement and performance of a particular sector.

Optimistic and Pessimistic Investors:

As explained earlier, in the short-term, markets fluctuate based on the

sentiment of the investors which drive the demand and supply of stocks.
Investors with an optimistic view of the future of the stocks are buyers and
are commonly referred to as bulls. Similarly, investors who hold a
pessimistic view and are sellers of stocks are considered bears.

Indices fluctuate and some of the factors that affect them are:

Changes in the economy:

Economic indicators are one of the most important drivers of an index.

GDP growth, interest rates, inflation, etc. are some of them. These have a
direct bearing on the movement of indices. Hence, news related to strong
trends in GDP growth would normally lead to an upward movement in an
index primarily because any news related to growth of the economy is
likely to positively impact almost all industries.

Changes in the industry:

Sometimes, an index like the CNX NIFTY 50 may go up, but a sectoral
index may show an opposite trend. This is primarily because of news
related to that sector. For instance, post budget in the year 2007, the cement
sector went in for a sharp correction because pricing restrictions were
imposed on cement companies in the budget.

Quantum of trading:

The size and volume of the stock traded (captured by the market
capitalization of a stock) also impacts its performance. The market
capitalization or market cap of a stock is simply equal to the share price on
a particular day into the number of shares outstanding (i.e., shares that have
been authorized, issued and purchased by investors) of a publicly traded
company.

  CNX MIDCAP CNX Nifty

02-Apr-01 834.4 1,138.1
01-Apr-02 990.7 1,139.0
01-Apr-03 903.7 984.3
01-Apr-04 2,235.7 1,819.7
01-Apr-05 2,992.8 2,067.7
03-Apr-06 4,896.8 3,473.3
02-Apr-07 4,686.2 3,633.6
01-Apr-08 6,207.5 4,739.6
01-Apr-09 3,431.8 3,060.4
01-Apr-10 7,774.1 5,290.5
01-Apr-11 8,129.1 5,826.1
02-Apr-12 7,767.2 5,317.9
01-Apr-13 7,486.9 5,704.4
01-Apr-14 8,587.3 6,721.1
01-Apr-15 13,153.7 8,586.3
01-Apr-16 12,792.0 7,713.1
03-Apr-17 17,332.9 9,237.9
31-Jan-18 20,785.2 11,027.7

Over a longer time frame, midcaps outperform large caps by a considerable

margin. If we see the graph above, Rs 100 invested in the Nifty for a period
of seventeen years starting April 2001 would have become Rs 968.96 but
Rs 100 invested in the CNX Midcap for the same period of time would
have become Rs 2,491 But you should remember that these midcaps carry
comparatively more risk than large caps. This can be seen in the graph
above. During the period 2008-2009, when the markets corrected
substantially, midcaps lost much more than large caps. Also, midcaps
gained more than large caps when the markets recovered. In a nutshell,
midcaps are more volatile.
Inflation:

Inflation is perceived to be a villain in the stock market. With a rise in the

inflation rate, the government takes measures to control money supply.
Taking liquidity out of the economy means hiking interest rates. This drags
the indices down as on the one hand, increase in interest rates makes fixed
income instruments attractive for the investors and on the other hand,
reduced liquidity means lesser trading in the stock market. This double-
edged sword curbs the growth in the rate of return, which an investor would
expect from the stock market.

Market sentiment:

Sentiment is a critical factor in the stock market. While it cannot be

quantified like GDP growth, it has a big impact on the index movement.
Sentiment is nothing but the perception of an economy, industry or maybe
even a company. There are several categories of investors including foreign
institutions, Indian institutions and retail investors, and each of them
perceive the market to move in a particular way. Therefore, even though
economic indicators may be positive, the index may trend downwards due
to prevailing sentiment. Sentiment is purely psychological and in the short-
term, a positive sentiment helps the market to move upwards.

And more…

There are several other factors, apart from those mentioned above, which
have an impact on an index. Government policies, currency movements,
global factors, etc. can all cause a serious impact. Due to larger foreign
participation, Indian markets are no longer insulated from global risks. Any
change in the international environment can affect the movement in the
stock market.
   CNX NIFTY
02-Apr-01 1,138.1
01-Apr-02 1,139.0
01-Apr-03 984.3
01-Apr-04 1,819.7
01-Apr-05 2,067.7
03-Apr-06 3,473.3
02-Apr-07 3,633.6
01-Apr-08 4,739.6
01-Apr-09 3,060.4
01-Apr-10 5,290.5
01-Apr-11 5,826.1
02-Apr-12 5,317.9
01-Apr-13 5,704.4
01-Apr-14 6,721.1
01-Apr-15 8,586.3
01-Apr-16 7,713.1
03-Apr-17 9,237.9
31-Jan-18 11,027.7
  BSE SENSEX
31-Mar-80 129.0
31-Mar-81 173.0
31-Mar-82 218.0
31-Mar-83 212.0
31-Mar-84 245.0
31-Mar-85 354.0
31-Mar-86 574.0
31-Mar-87 510.0
31-Mar-88 398.0
31-Mar-89 714.0
31-Mar-90 781.0
31-Mar-91 1,168.0
31-Mar-92 4,285.0
31-Mar-93 2,281.0
31-Mar-94 3,779.0
31-Mar-95 3,261.0
31-Mar-96 3,367.0
31-Mar-97 3,361.0
31-Mar-98 3,893.0
31-Mar-99 3,740.0
31-Mar-00 5,001.0
31-Mar-01 3,604.0
31-Mar-02 3,469.0
31-Mar-03 3,049.0
31-Mar-04 5,528.0
31-Mar-05 6,492.0
31-Mar-06 11,279.0
31-Mar-07 13,072.0
31-Mar-08 15,644.0
31-Mar-09 9,700.0
31-Mar-10 17,528.0
31-Mar-11 19,445.0
31-Mar-12 17,404.0
31-Mar-13 18,835.0
31-Mar-14 22,386.3
31-Mar-15 27,957.5
31-Mar-16 25,341.9
31-Mar-17 29,620.5
31-Jan-18 35,965.0

Equity investing for wealth creation

Equity markets have given a return of 16.75% over the last 38 years (Rs
100 invested on 1st April, 1979 would have become Rs 35,965 by the 31st
of January, 2018). Mind you, this 16.75% is compounded returns (i.e. your
yearly returns are reinvested at the same rate) for 38 years. Similarly, Rs
100 invested in the Nifty on 31st March, 2001 would have become Rs
987.34 (13.69% return) in a period of just 17 years. This is serious wealth
creation over a long time period!

This merely goes to show that it is rewarding to stay invested in equities for
the longer term. The stock market simply reflects the long-term growth of
Indian and international businesses and that when you buy into it, you’re
purchasing a piece of that future growth. The following factors justify this:

1. Industries and businesses, to which companies belong, mature over a

period of time. As industries grow, so do the profits of companies
belonging to them. An example is the explosive growth of the Indian
wireless (mobile) industry. Hence, investors start reaping the benefit of
their investment over a period of time.
2. In the short term, markets reflect the combined emotions of all
investors and hence gyrate to the tune of the currently dominant
emotion. We get caught up in short-term thinking and find ourselves
worrying about how our investments are doing right now, this week,
lately. It’s human nature to continuously wonder and worry whether the
markets are overpriced, whether they will fall, where the market is
headed NEXT. However, in the long-term, markets will reflect the
growth of industries, companies and profits. So, although you may
incur some notional losses in the short-term, if you are looking to
invest in equities you must always think long-term.

3. Equities are the only investment assets that are exempt from any taxes
(if held for over one year), which means that you get to keep all the
returns generated. All other investments, excluding PPF and life
insurance, are taxed for the gains made. This reduces the net return
from investment in assets like NSC, bank deposits, etc.

4. Equities deliver the best inflation adjusted return. As we now know,

inflation eats into the value of investments. So, in order to have a
realistic view of how your wealth has grown, you must subtract that
amount which will go towards merely compensating you for the rise in
prices.

Why you should invest for the long time

· Industries grow and profit over the long term
· Markets are based on sentiment in the short term
· Equities delivers the best inflation - adjusted returns over the long
term

  CAGR Real Growth

(1979-80 to 2017-18)
Inflation 7.11%  
Gold 9.52% 2.41%
Fixed Deposits 8.33 1.22%
Sensex 16.75% 9.64%

Inflation is average from 1979 to 2017

A comparison between the returns delivered by a physical investment like
gold and equity reveals that while equity has delivered a real return (growth
in value minus increase in inflation) of 9.64 per cent over the past 38 years,
gold has delivered 2.41 per cent.

Will the markets keep on rising?

Good question. Though over shorter periods, the market may move for a
hundred different ultimately less consequential reasons, over the long-term,
the market reflects the growth of business. So the first question is, over a
prolonged period - say, as long as a human lifetime - will business always
grow?

For that you first need to understand what grows business? A large number
of factors, primarily things like population growth, addressing human needs
and desires, advances in science and technology, environmental conditions,
governmental stability, etc. So the question changes to, do we foresee any
reason(s) that would lead to half a century of stagnation or decline?

Sure you can create possibilities in which that would happen, but most of
these possibilities involve acts of God or catastrophic events (nuclear war,
lethal airborne viruses, alien invasion, etc.). What then? In each of those
situations, you’ll have a lot more to worry about than the returns of your
investment portfolio. Each of these could bring about the effective end of
our civilization as we know it.

Thus, you can safely assume that so long as our civilization is still around,
you’ll continue to see long-term growth in business and consequently rise in
the markets.

The most important lesson that you as an investor in equities need to learn
is that equity investment is very rewarding provided a prudent approach is
adopted. This includes investment with a long-term horizon in a selection of
good companies which have a past record of performance.

Now that it is clear why equities are a must, let us move to understand the
basics of equity.
SUMMARY

• Equity markets have given a return of 16.75% over the past 38 years.

• Investing in equity is akin to becoming a part owner of the company.

• A stock market is simply a platform for like-minded people to trade

equity shares.

• The two largest markets for equities in India are the National Stock
Exchange (NSE) and the Bombay Stock Exchange (BSE).

• A stock index represents the change in the weighted value of a set of

stocks, which constitute the index.

• The two leading stock market indices are the S&P BSE Sensex and
CNX Nifty 50.

• Bulls have an optimistic view of the market and buy into the market,
while bears look at the downside and sell out.

• Indices fluctuate due to numerous reasons including economic

indicators, industry specific factors and inflation.

• Sentiment cannot be quantified and is a perception of either the

economy, the industry or the company.

• Equity markets give fantastic long-term returns because when you buy
equity, you have direct participation in its profits.

• As an industry matures, the company matures with it, stabilizes, grows

and gives you stupendous returns on your investment.

• Market fluctuations don’t last very long.

Your action points

1. I know that investing in equities would be like owing a share of the

company.

2. I know that equity market returns in the long run have outperformed
other asset class investments.

3. I will shuffle my portfolio along with the changes in the economic

indicators.

4. I will keep myself abreast of the stock market fluctuations.

5. I will restrain myself from ‘Fear and Greed’ while investing in the
stock markets.

Axioms

1. Be a Long term investor: There are various market rumours and

gossips or tips which keep floating around all the time. It is best to stay
away from such rumours and invest for a long term by doing self
research or using research done by experts.

2. Accumulate stocks over a period of time: Instead of getting into

stocks at one go, it is better to accumulate in a SIP manner. This way
you can avoid volatility in the markets.

3. Book Profits/ Losses: It is widely said that don’t marry your stocks.
Yes, book profits or losses whenever possible and rework on your
portfolio again with latest updation /situation in the market.

4. Shuffle portfolio if required: Stock markets are very risky and

volatile. Your timing for entry and exit are very important. If you
realize you are caught in the wrong side, then it is better to take timely
decision and shuffle your portfolio.
5. Read and be abreast of the macro environment: If you are a prudent
investor, it is better you have a good habit of reading newspapers and
business magazines. This will keep you aware of the macro
environment and can enhance your investment skills.
 Chapter 5

EQUITY INVESTING:KNOW BEFORE YOU GO

Chapter 5
EQUITY INVESTING:KNOW BEFORE YOU GO

When entering into the equity markets as an investor, it would really help to
know the basics of the same at the tips of your fingers. Here’s a snapshot of
what benefits equity investments offer, and the risks that unfortunately
come along with it.

An equity share is a unit of ownership in a company. Every company issues

a certain number of shares to its promoters, i.e., those who participate in its
formation. The company issues additional shares to the public, when it
raises money by way of an Initial Public Offer (IPO). Hence, in addition to
the promoters, the public too become shareholders of the company. So, if
you hold 100 shares of a company which has issued 10,000 shares, you own
1 per cent of the company.

Advantage Equity Investing

Why should you purchase shares of a company? What are the benefits that
accrue to you as a shareholder? Apart from the right to vote and decide the
future course of action that a company takes, the real benefit that you, as a
shareholder have is in the form of participation that you get in the profits
made by the company. At the same time, your liability is limited only to the
face value of the shares held by you. The benefits distributed by the
company to its shareholders can be:1) Monetary Benefits and 2) Non
Monetary Benefits.
• Monetary Benefits:

a) Dividend: You as an equity shareholder have a right to the profits

generated by the company. Profits are distributed in part or in full in
the form of dividends. Dividend is your earning on the investment
made in shares, just like interest in case of bonds or debentures.

A company can issue dividend in two forms: 1) Interim Dividend and

2) Final Dividend. While final dividend is distributed only after the
closing of the financial year; companies, at times, declare an interim
dividend during a financial year. Hence if X Ltd. earns a profit of Rs
40 crore and decides to distribute Rs 2 to each shareholder and if you
are a holder of 200 shares of X Ltd. it would entitle you to Rs 400 as
dividend. This is a return that you shall earn as a result of the
investment made by you in X Ltd. Dividends are declared as a per
cent, viz., 20 per cent of face value of shares. If the face value of
shares of X Ltd. is Rs 10, the dividend would be Rs 2 per share (20 per
cent of Rs 10). Now if you had purchased the shares of X Ltd. from the
stock markets at Rs 20, your return will be 10 per cent (Rs 2 on Rs 20).

b) Capital Appreciation: You also benefit from capital appreciation.

Simply put, this means an increase in the value of the company usually
reflected in its share price. Companies generally do not distribute all
their profits as dividend. As the companies grow, profits are re-
invested in the business. This means an increase in net worth (capital
of the company plus accumulated profits that have not been
distributed), which results in appreciation in the value of shares.
Hence, let’s say you purchase 200 shares of X Ltd. at Rs 20 per share
and hold the same for two years, after which the value of each share is
Rs 35. This means that your investment has appreciated by Rs 3000.

• Non-Monetary Benefits:

Apart from dividends and capital appreciation, investments in shares

 also fetch some type of non-monetary benefits to you. Bonuses and
rights issues are two such noticeable benefits.

a) Bonus: Instead of distributing accumulated profits as dividends,

companies have the option of issuing bonus shares, i.e., they will give
more shares to you free of cost. Prima facie, it does not affect your
wealth as a shareholder; however, in practice, bonuses carry certain
latent advantages such as tax benefits, better future growth potential,
an increase in the floating stock of the company, etc. Hence, if for
instance, Company X decides to issue bonus shares in a ratio of 1:1,
and you are currently holding 200 shares, you will receive an
equivalent number of shares (200) free of cost. Normally the price of
this company will then fall in the stock market to keep your overall
wealth at the same level. This reduced price is known as the ex-bonus
price. For example, if the price of Company X in the stock market was
Rs 40 before declaring this bonus issue, it would fall to Rs 20 after the
issue. Hence, your investment value which was Rs 8000 (200 shares x
Rs 40 per share) would remain the same (400 shares x Rs 20 per
share).

In case the bonus ratio was 1:2, i.e., for every 2 shares held the
company issues 1 bonus share, you would have received 100 (200/2 =
100) bonus shares. The ex-bonus price would then be Rs 26.67 (Rs 40
x 2 = Rs 80/3 = Rs 26.67).

b) Rights Issue: A company may need more money to expand and for
that it may need to issue more equity shares. A rights issue involves
issuing of additional shares to the existing shareholders of the
company. A company wishing to issue additional shares should first
offer them to its existing shareholders so that it allows the existing
shareholders to maintain the same degree of control of the company.
Thus you can maintain your participation in the company’s profits.
Equity investing - the risks

Although equity investment is most rewarding in terms of returns

generated, certain risks are essential to understand before venturing into the
world of equity. These can be described as follows:

a) Market/Economy Risk: The performance of any company to an

extent depends on the growth of the economy. A country’s economy,
which continues to prosper, ensures that companies operating in it
benefit from its growth. However, an equity shareholder also runs the
risk of any downturn in the economy affecting the performance of his
company. Economy related risks are usually reflected in the factors
such as GDP growth, inflation, interest rates, etc. A slowdown in the
economy pinches almost all sectors in varying degrees.

b) Industry Risk: All industries undergo some kind of cyclical growth.

Shareholders get rewarded most during the expansion stage. However,
once the industry reaches a maturity stage, the rewards from
investment are limited. Further, companies belonging to industries
where growth has retarded, incur losses or declining gains. Industry
specific government regulations too impact returns from investments
made therein.

c) Management Risk: The management is the face of an enterprise. It is

the team which gives direction to the future course of action that a
company will take. Quality of management is hence paramount.
Management changes often have a serious impact on policy matters of
 companies, thereby impacting the share price. A management which is
unable to meet the challenges posed by competition is likely to suffer
in performance.

d) Business Risk: Business risk is a function of the operating conditions

faced by a company and the variability that these conditions inject into
the company’s profits and hence into the expected dividends by the
shareholders. Business risk can be classified into two broad categories:
external and internal. Internal business risk is largely associated with
the efficiency with which a company conducts its operations within the
broader environment. External risk is the result of operating conditions
imposed upon the company by circumstances beyond its control.

e) Financial Risk: Financial risk is associated with the way in which a

company finances its activities. A company, borrowing money for
business, takes over a recurring liability of payment of interest that it
must continue paying until repayment of the loan. Beyond a specified
limit, the residual income left for shareholders gets reduced, thereby
affecting the returns on shares. More importantly, it increases default
risk, i.e., a heavily borrowed company, is at a greater risk of not being
able to meet its liabilities and hence going bankrupt.
f) Exchange Rate Risk: Some companies today earn sizeable revenues
from exports. Hence, any appreciation in the rupee vis-a-vis the
currency in which exports are billed, will lead to reduced earnings in
rupees affecting share prices.
g) Inflation Risk: Rising prices or inflation reduces purchasing power
for the common man resulting in a slowdown in the demand in the
economy. This has implications for all the sectors in the economy.
Hence, in an inflationary environment, share prices of most companies
face a downturn as the expected fall in demand reduces their future
expected income.

h) Interest Rate Risk: Rising interest rates increase the cost of

borrowing, which results in an increase in the prices of products and a
 corresponding slowdown in demand. Hence, an interest rate hike
affects share price of companies across the board.

Dealing with risk in equity investing:

Most risks associated with investments in shares can be reduced by using

the tool of diversification. Purchasing shares of different companies spread
across different industries and creating a diversified portfolio has proven to
be one of the most reliable tools of risk reduction.

Diversification

This can be best understood by the age old saying, “Don’t put all your eggs
in one basket!” When you hold shares in a single company, you run the risk
of a large magnitude. As your portfolio expands to include shares of more
companies, the company specific risk reduces. The benefits of creating a
well diversified portfolio can be gauged from the fact that as you add more
shares to your portfolio, the importance (weightage) of each company’s
share gets reduced.

Hence, any adverse event related to any one company would not expose
your whole portfolio to that risk. The same logic can be extended to a sector
or an industry. In fact, diversifying across sectors and industries reaps the
real benefits of diversification. Sector specific risks get minimised when
shares of other sectors are added to the portfolio. This is because a
recession or a downtrend is not usually seen in all sectors together at the
same time.

Risks have to be faced

Though it is possible to reduce risk, the process of equity investing itself

comes with certain inherent risks, which cannot be reduced by strategies
such as diversification. These risks are called systematic risks as they arise
from the system, such as interest rate risk and inflation risk. As these risks
cannot be diversified, theoretically, investors are rewarded for taking
systematic risks for equity investment.

Getting started

Having analysed all aspects of risk and return associated with equity
investment, you are now ready to take the plunge! This requires certain
formalities, which are explained in the next chapter.
SUMMARY

• If you hold 100 shares of a company, which has issued 10,000 shares,
you own 1% of the company.

• A company disburses benefits in monetary and non-monetary forms.

• Monetary benefits include dividends and capital appreciation.

• Dividends are of two types: interim and final.

• Non-monetary benefits include bonus shares and rights issues.

• In a rights issue, additional shares are issued first to the company’s

existing shareholders.

• Equity carries eight different types of risks: market, industry,

management, business, financial, exchange rate, inflation and interest
rate.

• One of the methods of mitigating risks is having a well-diversified

portfolio.

• Interest rate and inflation risks are systemic risks and cannot be
mitigated. However, because equity market investors accept these risks
when investing, they are rewarded far beyond other investment vehicles.

Your action points

1. I will invest in a SIP pattern in equities.

2. I shall keep proper track of dividends and other monetary benefits

given by the company.
3. I will do some research on my part before investing in a particular
stock or industry.

4. I will diversify my portfolio well amongst various industries.

5. I will monitor my earnings in a scheduled manner like monthly or

quarterly and shift portfolio if required.

Axioms:

1. Do your own research before investing your hard earned money:

Irrespective whether you are taking expert advice or not, you should do
your own research of the company you want to invest. This would
include company prospects and its management’s course of plan for the
company’s growth in the long period.

2. SIP way of investing would shield you against volatility in the

markets: Stock markets are very risky and volatile as well. It purely
depends on the timing of your investment and nobody can be 100
percent sure about it. Systematic investment is a safe and stable way to
get good returns.

3. Read and understand before diving in: It is advisable for the

investors to read some minute clauses which may not be highlighted in
the application form. A common example would be that of yield on
investments which generally is a pre-tax yield i.e. what you earn before
paying taxes. However, what is important is the post-tax yield i.e. what
you are left with after paying taxes.

4. Don’t put all your eggs in one nest: It is suicidal to have all your
investments made in one particular sector. Say for example if you
invest heavily in stocks in the IT sector which is primarily export
oriented and the rupee appreciates drastically, all the IT stocks would
plunge sharply giving your portfolio major losses.
5. It is your money; take time to review your portfolio: Although you
have hired good experts, you yourself should review your investments
periodically; say in a monthly, quarterly or yearly basis.
 Chapter 6

1-2-3 OF EQUITY INVESTING

Chapter 6
1-2-3 OF EQUITY INVESTING

Now that you are all geared up to start investing in equity, you have two
options - you can start by investing in equities either by buying (subscribing
to) shares sold by the company (Initial Public Offer) or by buying them from
another investor on the stock exchange. This chapter talks about the
formalities that you must complete before you begin investing in equity.

To buy shares on the stock market, you start by first opening an account with a
stock broker. Only a stock broker is allowed to buy or sell on your behalf on
the stock exchange. Brokers have to be registered with the Securities and
Exchange Board of India (SEBI), which is a regulatory body policing all
brokers in India.

Selecting your broker

There are a plethora of SEBI-registered brokers and sub-brokers (sub-brokers

represent the main broker to you), providing the service of buying and selling
securities. Given this large number, it would be very difficult for you to find
the right broker. You must, hence, consider the following factors while
selecting a broker:
• Reputation:
An individual/corporate/institution can acquire membership as a broker of
a stock exchange provided it has a minimum stipulated net worth. With so
many brokers out there, it is important to deal with a broker who has a
good reputation.

This is broadly reflected in the past record and the credibility that he
enjoys in the market. Several broking outfits are also promoted by reputed
institutions.

• Research:

With maturing markets and increasing competition, most brokers now

provide industry/company research helping you decide what shares to buy,
at what price and when to sell them. Inquire about whether the broker has a
strong research unit and the quality of research calls he has given in the
past.

• Broking rates:

As per SEBI guidelines, a broker can charge a maximum of 2.5% of the

consideration as brokerage. The rate charged by the broker depends on the
value of broking business you provide him. For example, if you purchase
 200 shares of X Ltd. at a price of Rs 20 per share through your broker and
the rate charged by your broker is 0.50%, your brokerage charge will be Rs
20 (0.50% of Rs 4000). Brokerage is added to the purchase price and
reduces the realisation from the sale of securities. Sometimes, a minimum
transaction charge is attached, irrespective of the value.
What to keep in mind while selecting a broker
• Reputation
• Research
• Broking rates
• Transaction modes
• Service Quality

• Different modes of transactions:

You can buy or sell shares, either by phone, placing your order through the
broker’s website or mobile site, or by making personal visits.

In case you personally intimate the broker about a trade that you would
like to undertake, over the phone or during a personal visit, the broker will
execute it with the help of your alpha numeric trading code.

Web based transactions are conducted by using a user id and a password on

the broker’s website. This is usually a unique identification for each client
and also a security mechanism.

In the case of mobile trading, a mobile share trading software, exclusively

designed to give you instant access to the stock market, is loaded on your
mobile phone. Through this route, you can catch every little market
movement, track your portfolio, check the available margin, view your
day’s position, stock quotes, etc.

• Service Quality:

Service quality of the broker is another important determinant. For

instance, how fast a broker can transact for his clients reflects his service
standards. Since markets operate on a real time basis, at times, small delays
could end up resulting in a huge notional or real financial loss. Another
 aspect of quality is prompt transfer of your shares by the broker to your
demat account (explained later), prompt payment to you in case of sales,
timely dispatch of contract notes to you, regularly providing your
transaction ledger, etc.

What you need to open a broking account

The following documents are essential to open a broking account:

a) Proof of residence (A list of acceptable documents provided)

b) Proof of identity (Since PAN is a must, it is used for this purpose)

c) Bank account details (cancelled cheque for direct debits and credits)

d) Photographs

How to select a suitable depository participant

Before the depository system was introduced in India, securities were held by
investors in the form of physical certificates. Buying or selling them entailed
receiving them or handing them to the broker as the case may be. Securities
can now be held in electronic form, which has been made possible by the
process of dematerialisation (demat) after the introduction of the depository
system in India.

A depository can be compared to a bank.

It holds securities (like shares, debentures, bonds,
Government Securities, units, etc] of investors in
electronic form.

A depository can be compared to a bank. It holds securities (like shares,

debentures, bonds, Government Securities, units, etc.) of investors in
electronic form. Besides holding securities, a depository also provides services
related to transactions in securities. A depository interfaces with the investors
through its agents called Depository Participants (DPs). If you want to avail
the services offered by the depository, you have to open an account with a DP.
This is similar to opening an account with any branch of a bank in order to
utilise the bank’s services.

Dematerialisation is the process by which physical

certificates of an investor are converted to an equivalent
number of securities in electronic form.

After opening a demat account, you can dematerialize your physical

certificates. Dematerialisation is the process by which physical certificates of
an investor are converted to an equivalent number of securities in electronic
form. In order to dematerialise certificates, an investor will have to request his
DP for the dematerialisation of certificates by filling up a dematerialization
request form (DRF), which is available with the DP, and submit the same
along with the physical certificates. The investor has to ensure that before the
certificates are handed over to the DP for demat, they are defaced by marking
“Surrendered for Dematerialisation” on the face of the certificates.

You can use this demat account for the purpose of holding and transferring
securities in electronic form. In case you are buying or selling shares, a buy
transaction results in a credit entry while a sell transaction leads to a debit
entry.

A large number of DPs spread across the country are registered with two
depositories in India, which are NSDL (National Securities Depository
Limited) and CDSL (Central Depository Services (India) Limited). You must
decide on the right choice before you open a demat account.
There are several types of DPs operating in the market. They can be broadly
classified as follows:

a) Banks such as PSU Banks, Private sector Banks, Foreign Banks, etc.

b) Custodians

c) Brokers

Select a suitable DP:

You need to keep the following in mind while selecting a DP:

a) Services: Some DPs provide some value added services. You need to
check your requirements and then select a DP who is in a position to offer
you the specific service you may need.

b) Cost: With effect from 1st April 2007, SEBI has made it mandatory for
DPs to display the charges that they levy on investors on the websites of
their respective depositories. This can help you to make a comparative
analysis of the charges of different DPs vis-a-vis the services rendered by
them. Some standard charges are as follows:

1) Annual
Maintenance Charges
2) Charges for debit from demat account
3) Demat and remat charges
4) Charges for pledge of securities

DPs are now not allowed to levy charges (other than documentation and
statutory charges) for opening accounts, crediting demat accounts and custody
charges. Further, some broker DPs don’t charge separately for demat accounts.
However, they club these charges along with brokerage. You must therefore
clarify with broker DPs regarding the charges.

c) Accessibility: Since you get only two working days after trade (T+2) to
transfer shares from your account to the broker’s account in case of a
sale, you must check whether the DP is easily accessible or not. You can
also avail of the internet-based facility for transfer of shares, provided
your DP has subscribed for such a facility. This means that you need not
visit the DP’s office personally to submit the delivery instruction slip for
transferring shares from your account to the broker’s account. You may
keep this factor in mind while selecting the DP.

Linking a bank account:

Transactions involving shares entail the movement of money in terms of

inflow and outflow from your bank account. Hence, bank accounts are
essential along with broking and demat accounts. You may use your savings
account for purchase and sale of shares by mentioning the bank account details
in your demat and broking account.

Demat account->Broking account->Bank account:

Some brokers and banks offer a ‘Three-In-One’ demat account, where you
open demat, broking and bank accounts with the same entity, in case of a bank
DP. Elsewhere, if the DP is a broker, an existing bank account can be used for
the purpose of a ‘Three-In-One’ account. This ensures easy transfer of funds.
However, in some cases the brokers insist on opening a bank account with a
particular bank as they often have tie-ups with that bank. E-trading platforms
are also available in most cases where ‘Three-in-One account’ facilities are
available.

What you need to open a demat account:

You can approach any DP of your choice and fill up an account opening form.
At the time of opening an account, you have to sign an agreement with the DP,
which details your rights and duties and those of your DP as well.
You have to submit the following along with the prescribed account opening
form. In case you want to open an account jointly with other person(s), the
following should be submitted for all the account holders:

I. Proof of Identity (P0I) (copy of any one proof):

• Passport

• Voter ID Card

• Driving license

• PAN card with photograph

• Identity card/document with applicant’s Photo, issued by

a) Central/State Government and its Departments,

b) Statutory/Regulatory Authorities,

c) Public Sector Undertakings,

d) Scheduled Commercial Banks,

e) Public Financial Institutions,

f) Colleges affiliated to Universities, (this can be treated as valid

only till the time the applicant is a student)

g) Professional bodies such as ICAI, ICWAI, ICSI, Bar Council,

etc., to their members;

h) Credit cards/Debit cards issued by Banks.

II. Proof of Address (POA) (copy of any one proof):

• Ration card

• Passport

• Voter ID Card

• Driving license

• Bank passbook

• Verified copies of Electricity bills (not more than 3 months old)

• Residence Telephone bills (not more than 3 months old)

• Leave and License agreement/Agreement for sale.

• Self-declaration by High Court & Supreme court judges, giving the

new address in respect of their own accounts.

• Identity card/document address, issued by

a) Central/State Government and its Departments,

b) Statutory/Regulatory Authorities,

c) Public Sector Undertakings,

d) Scheduled Commercial Banks,

e) Public Financial Institutions,

f) Colleges affiliated to Universities, this can be treated as valid

only till the time the applicant is a student); and
 g) Professional bodies such as ICAI, ICWAI, Bar Council, etc., to
their members;

Note: It’s now mandatory to link Aadhaar number with your demat account.

III. Bank account details

You can submit a cancelled cheque which captures your MICR number and the
details of your bank account. Proper bank account details must be provided in
a demat account as benefits like dividend and interest may directly get credited
to the bank account. Also, when you make an application for an IPO, you may
receive a direct credit of the refund amount in your bank account to the extent
of shares not allotted.

IV. Passport-sized photograph

V. Copy of PAN Card

You must remember to take all original documents to the DP for verification.
Your DP will carry out an “in-person verification” of account holder(s) at the
time of opening your account. You should remember to obtain a copy of the
agreement and schedule of charges for your future reference.

Making a nomination in your account

Nomination can be made only by individuals holding beneficiary accounts

either singly or jointly. Non-individuals including society, trust, body
corporate, partnership firm, karta of Hindu Undivided Family, holder of power
of attorney cannot nominate. Further, only an individual can be a nominee. A
nominee cannot be a society, trust, body corporate, partnership firm, karta of
Hindu Undivided Family or a power of attorney holder.

You can nominate one person for your demat account. While a minor can be a
nominee, the guardian will sign on behalf of the nominee and in addition to the
name and photograph of the nominee, the name, address and the photograph of
the guardian must be submitted to the DP.
In order to appoint a nominee, the nomination form duly filled-in should be
submitted to the DP either at the time of account opening or later. The account
holder, nominee and two witnesses must sign this form and the name, address
and photograph of the nominee must be submitted. If nomination was not
made at the time of account opening, it can be made subsequently by
submitting the nomination form. What’s more, you can change the nomination
anytime by simply filling up the nomination form once again and submitting it
to the DP.

It’s time to start investing!

Once you are through with this paper work, you are now ready to start
investing!

Stock markets are open from 9:15 a.m. to 3:30 p.m. on all working days.
Before the markets open, there is a pre-open session of trading activity. This
session is typically conducted between 9.0 am to 9:15 am. Stock exchanges
don’t work on Saturdays, Sundays and notified holidays.
SUMMARY

• The first step to buying shares is to open an account with a SEBI-

registered broker or brokerage house.

• With a plethora of SEBI registered brokers and sub-brokers, it is essential

to check their reputation, research capabilities, brokerage rates, service
quality and modes of transaction before you choose one.

• A strong research unit and quality of earlier market predictions are a good
indicator of choosing a broking house.

• In share markets, time is money. How soon a broking house transacts your
requests can decide whether you make or lose money on the market.

• A depository is similar to a bank in that it holds your securities in

electronic form. It communicates with investors through its agents called
Depository Participants (DPs).

• Dematerialisation is the process by which physical certificates are

converted to an equivalent number of securities in electronic form. A
demat account is used for holding and transferring securities in electronic
form.

• DPs are registered with two depositories in India: NSDL (National

Securities Depository Limited) and CDSL (Central Depository Services
(India) Limited).

• To select a DP, check its services, cost and accessibility.

• SEBI has mandated that DPs display the charges that they levy on
investors on their websites.

• DPs are not allowed to levy charges (other than documentation and
statutory charges) for opening accounts, crediting demat accounts and
 custody charges.

• Some brokers and banks offer a ‘Three In One’ demat account, where you
open demat, broking and bank accounts with the same entity, especially in
case of a bank DR E-trading platforms are also available in most cases
where ‘Three in One account’ facilities are available.

• You must provide proper bank account details for a demat account, as
benefits like dividend and interest may directly be credited into the bank
account.

• You can nominate one person for your demat account.

Your action points

1. I will open a demat account with a good broker.

2. I will do cost and service analysis of the DPs.

3. I will research stocks before investing.

4. I know DPs cannot levy any charges for opening accounts, crediting
demat accounts, etc

5. I will make a nomination for my demat account.

Axioms

1. Go for a registered broker only - Once you decide to invest in equities,

it is required for you to open an account with a broker. It is extremely
necessary that you choose a registered broker or a sub broker as this
would help you to file your grievances (if any) in future. Market
regulators will be able to help you only when you are enrolled with a
registered one.

2. Experts can enhance your investment decisions - There are many

experts in the stock market who track the stock moments very well. It
 would be beneficial to you, especially if you do not track markets
consistently.

3. Check whether your broker can give you good research as well - It is
not about the brokerage fees always. You also should be able to get good
advice on various stocks. So go for a broker who not only offers you
competitive prices but also provides you good researched stocks.

4. Ask for documents in electronic format - It would help the environment

-surely, by now you must be used to accepting your bank statements also
in a soft copy format. Then why not for your stock format transactions!
Have a demat account and go for electronic statements sent to your email
account rather than physical copies.

5. Listen to the world, but take your own decisions - You will get advice
on stock market investing from various sources and at times, you can get
confused as well. Take advice but the final decision should be yours.
 Chapter 7

INVEST IN MULTIPLE WAYS

Chapter 7
INVEST IN MULTIPLE WAYS

Now that we have understood buying/selling shares on the stock market, let’s
understand investing in shares through various other channels/forms. They can
be through Initial Public Offering (commonly known as IPO), divestment by
public sector divestment (known as PSU divestment), applying for rights issue,
bonus or in Merger and Acquisitions. Let’s understand them one by one:

The IPO route

As the name suggests, initial public offer (IPO) is a company which is a first
time entrant into the stock markets offering shares to the public.

Most listed companies are usually started privately by their promoter(s).

However, the promoters’ capital and the borrowings from banks and financial
institutions may not be sufficient for setting up or running the business over a
long term. So, companies invite the public to contribute towards the equity and
issue shares to individual investors.

As opposed to the Secondary Market, where you buy/sell shares on the stock
market, the Primary Market is where you buy (sales will happen in the
Secondary Market on the stock exchange) the shares which are issued by the
company the first (Initial) time. Hence, when you buy shares in the Primary
Market (IP0), the money which you pay goes to the company for its business
growth while, when you buy shares in the Secondary Market (on stock
exchange), the money which you pay goes to someone who currently owns
those shares.
Buying at Face Value:

The nominal value of the share is called the Face Value or Par Value. It is the
original cost shown on the share certificate and the extent to which the
shareholder is liable to the company. In the case of equity shares, the value is
generally quite small; for instance Rs 2, Rs 5, Rs 10, etc.

Buying at a premium:

When shares are offered at more than the Face Value, then it is said that the
issue is at a premium. The premium is the amount charged over the Face
Value. For example, if X Ltd. issues shares having a face value of Rs 10 at a
total price of Rs 20 per share, the difference between the issue price (Rs 20)
and the face value (Rs 10) is the share premium that the company is charging
you. Normally a company charges a premium if it has already accumulated
some past profits.

Entities in a Public Issue:

When a company launches an IPO inviting the public to apply for its shares, it
has to appoint various parties (intermediaries) that will enable it to
successfully complete the issue process. The various intermediaries involved
are:

• Book Running Lead Managers (BRLMs): These managers are

responsible to include compliance as per SEBI, completion of formalities
and managing the whole pre-issue and post issue activities.

• Bankers to the Issue: Bankers to the issue carry out all the activities of
ensuring that the funds are collected and transferred to the escrow
accounts.

• Underwriters: Underwriters are institutions/individuals who agree to buy

the shares of the company in case the company is unable to sell its shares
to the public. For providing this safety net underwriters charge a
commission to the issuing company for this service.
• Registrars to the Issue: The Registrar finalizes from the total list of all
applicants the list of eligible allottees after deleting invalid applications,
and ensures that shares are credited to the allottees’ demat accounts and the
refund orders are sent to unsuccessful applicants.
Entities in a public
• Book running lead managers
• Bankers of the issue
• Underwriters
• Registers to the issue

Understanding the issue:

• The issue price:

Issue price is the price at which shares are issued by the company. This
includes the face value plus share premium, if any. Shares issued via an IPO
can be priced by two methods.

Firstly, the issuing company, in consultation with the Lead Merchant Banker,
arrives at a fixed price at which it offers the shares to the public. For example,
X Ltd. could decide to issue its shares at a price of Rs 20 per share.

Otherwise, the company and the Lead Merchant Banker could fix a minimum
(floor) and maximum (cap) price for the issue. This range is called the price
band. Investors are free to bid at any price within this range. The final price at
which all shares are issued to the applicants is determined by market forces
according to the demand for the issuing company’s shares. This is called the
Book Building Process.

For example, X Ltd. could decide to issue 3000 shares in a price band of Rs 20
(floor) and Rs 24 (cap) and invite investors to bid for the shares within this
band. Five bidders bid within this price band as per details below:
Bid Qty Bod Price(Rs.) Cumulative Qty Subscription
500 24 500 16.67%
1000 23 1500 50.00%
1500 22 3000 100.00%
2000 21 5000 166.67%
2500 20 7500 250.00%

The price discovery [cut off price at which the company

decides the issue price] is a function of demand at
various prices.

The price discovery (cut off price at which the company decides the issue
price) is a function of demand at various prices. The highest price at which the
company is able to issue the desired number of shares is the price at which the
book cuts off (price at which 100% of the issue can be safely subscribed), i.e.,
Rs 22 in the above example. The company along with its BRLM will finalize
the issue price at Rs 22 or below. All bids at or above this price are valid bids
and considered for allotment.

In the case of a book building IPO, the offer must be open for a minimum of
three days and a maximum of seven days, i.e., applicants are allowed three to
seven days within which they should show their interest by applying for the
shares within this price band.

Sometimes, the company may retain the right to issue additional shares, over
and above the originally proposed issue. This over-allotment option, which
cannot exceed 15% of the originally proposed issue, is popularly known as the
“greenshoe” option. This is normally done if the demand for shares proves
much higher than expected. Continuing from the above example, X Ltd. can
decide to have a greenshoe option of 15% on its 3000 shares issue. In this
case, it can allot 3450 shares (15% over 3000 shares). A greenshoe option can
provide additional price stability to a share issue, since the company has the
ability to increase the supply of shares and smoothen out price fluctuations if
the demand surges too high.

The company also has the option to either call for the full amount of the issue
price or part of the amount at the time of inviting applications. In case it calls
for the full amount, no further amount is required from successful applicants,
and in case lesser shares are allotted to successful applicants, the excess
amount received is refunded. For example, if you had bid for 500 shares of X
Ltd. at Rs 22 per share, you would have paid Rs 11,000 to the company.
Assume that the final issue price was Rs 22 and you were allotted 100 shares
(since the issue was oversubscribed). The company will then refund you Rs
8,800 (Rs 11,000 less Rs 2,200).

Similarly, if the company calls only for a partial amount, say 50% of the issue
price, at the time of seeking applications. In this case, you would have made a
payment for Rs 5,500 (500 x Rs 11) while applying. You would then be
refunded Rs 3,300 (Rs 5,500 less Rs 2,200).

Investing in the primary market has its own benefits and drawbacks.
Some of the key benefits are:

• Shares are priced in a relatively attractive manner allowing ample scope

for the IPO investors to gain from their investment, while at the same time,
the company successfully raises funds.

• It is safer to invest in the primary markets than in the secondary markets as

the scope for manipulation of price is smaller.

• The investor does not have to pay any kind of brokerage or transaction fees
or any tax such as goods and service tax, stamp duty and STT (Securities
Transaction Tax).
• There is no need to time the market as all investors will get the shares at
the same price.

ASBA has made investors’ life easy:

With recent changes made by SEBI to the ASBA (Application Supported by

Blocked Amount) facility, investors have several benefits accruing to them.
ASBA is an alternative process of subscribing to IPOs, which ensures that the
applicants’ money remains in their bank account till shares are allotted. Main
advantages accruing to investors in light of the 2016 modifications are:

i) Money required for allotment of shares is taken from the bank account
only when the applicant’s application is selected for allotment.
ii) Since the money remains in the applicants’ accounts till share allotment,
they don’t have to worry about forgoing interest for that period.
iii) There is no need to worry about loss or delay of funds since the money is
directly credited by the bank into the applicants’ accounts.

Some of the major drawbacks are as follows:

• In case of over subscription, the shares are allotted on a proportionate

basis. Thus, in such cases small investors hardly get any allotment.

Conclusion:

IPOs in recent times have lost shine due to dis-appropriate pricing and
promoters shying away due to very volatile markets. SEBI, however, has made
many amendments to safeguard the retail investors’ interest. They not only get
discount on the IPO price band,

Public Sector Unit (PSU) Divestment/Offer for Sale

Today, PSU Divestments or Offer for Sale have become the flavour for
investors. SEBI has directed private companies to have a public holding of
25% and PSUs to have a 10% public holding.

History: PSU divestment started with the new economic policy initiated in
1991. The need for private participation was urgently felt to improve the
falling return on investment ratio, quality of management, under-utilization of
capacities, problems related to poor planning and execution skills and above
all, to create autonomy in taking much needed business decisions. Many of the
PSUs then were becoming a drag on the overall economy and thus, to increase
the resources of the government and reduce fiscal deficit, PSU divestments
began.

Initially, divestment happened through sale of minority stakes of the PSUs

through domestic or international issue of shares. The maximum number of
divestments happened during the period of 2001 and 2004 through strategic
sale to private entities or offer for sale to the public. Since 2009, with more
stable government and improving stock market conditions, divestments have
once again become popular among investors.

Simplifying Divestment: Selling shares of PSUs (Public Sector Undertakings

-Government companies) through IPO (Initial Public Offering) and FPO
(Follow on Public Offer) is called disinvestment.

IPO (Initial Public Offering) will be listed for unlisted companies. FPO
(Follow on Public Offer) will be for already listed companies.
In the current fiscal, the government has embarked on garnering Rs 40,000
crore through FPOs in PSUs like Coal India, Indian Oil, Bhel amongst others.

Divestment Process
• You need to compulsorily have a demat/trading account and permanent
account number (PAN) to participate in a divestment/Offer for Sale (OFS).

• The sellers are required to deposit the offered shares with the exchange
before 11.00 a.m. on the day.

• Once the OFS starts, you can participate in the process yourself using your
online trading account by placing your bids under the OFS section of your
broking website.

• Investors, who do not have an online trading account, can place their bids
by directing the dealer of their broking company to do it on their behalf.
You can modify or cancel your bids during the offer timings except in the
last 60 minutes i.e. till 2:30 p.m.

• The exchange will announce the indicative price only during the last 60
minutes of the OFS. Indicative price is the volume weighted average price
of all the valid/confirmed bids. For example, let’s say there are a total of
1,000 shares in an offer for sale with Rs 200 as the floor price. If the
investors bid for 200 shares at Rs 210 and 800 shares at Rs 200, the
indicative price for the offer would be [(200*210)+(800*200)]/1000 = Rs
202.

• Once the bidding gets over, the allotment price is fixed and allocation is
done. The successful bidders will be allotted shares directly into their
demat account on T+1 basis the very next day.

• In case of partial allotment or no allotment, the refunds will be made on

the same day itself. This makes the OFS process really fast, just like
 buying shares of the company from the open market.

• Unlike 1P0s/FPOs, no physical application forms are issued to apply for

shares in the OFS process. OFS process is completely platform based.

• While IP0s/FPOs remain open for 3-4 days, OFS gets over in a single
trading day as the markets gets closed for trading at 3:30 p.m.

• Though it is not mandatory to disclose the floor price before the issue
opens, the promoters usually disclose it prior to the share sale in almost all
of the issues. Alternatively, the promoters can submit the floor price in a
sealed envelope to the exchange which will be disclosed post closure of the
offer. In case the floor price is not disclosed to the public, the investors can
place their bids at any price they want.

Advantages of investing in PSU divestments:

Indicated below are the advantages for an investor for investing in a PSU
divestment:

1. Most PSUs are cash rich companies and pay rich dividends.
2. PSUs generally have good assets and almost have monopoly in the
businesses they operate in.

3. To attract retail investors, these divestments come with good discounts

and one can use this opportunity to make good profits.

However, investors should be cautious and check the pricing of the offer since
some of these PSUs are trading at high valuations. Discounts do help attract
retail investors, but pricing is one of the foremost aspects that would help
attract retail investors.

A number of the issues recently have been offered at 5-10% discount to the
offer price. Hindustan Copper OFS in November 2012 gave a steep discount of
42% to the prevailing market price. Even then, the issue had to be bailed out
by the likes of Life Insurance Corporation (LIC) and public sector banks, led
by State Bank of India (SBI). The company was trading over 40 times its one-
year forward price-earnings (P/E), which was significantly high compared to
other companies in the metal and mining space.

Disadvantages:

While there are advantages of investing in PSUs, there are some disadvantages
too:

1. Many of the PSUs are still held by the government and complete
autonomy in terms of its operations is still not given. For instance, HPCL,
BPCL carry huge subsidy burden offered by the government on fuel.

2. Some of the PSUs are trading at high valuations and retail investors
should be aware of their future prospects before investing.

3. PSUs like MTNL, BSNL face intense competition in their respective area
of operations because of lack of efficiency and aggressiveness.

Conclusion:

PSU Divestment is a very good resource generating tool for the government to
curtail fiscal deficit and give autonomy to the companies. The government can
divest its stake either through fresh issue or follow on issue. Retail investors
can participate in the divestment program by subscribing to the issue and in
most cases they are given a discount in order to save their interests. However,
pricing remains the key factor and one should always check with experts the
prospects of the company before investing.
Advantages
• Rich dividends
• Monopolies in business they operate in
• Shares offered at good discounts to market pric

Disadvantages of Investing in PSUs

• Lack of automony
• Trading at high valuations
• Facing competition
Investor Categories:

Category of investors who can invest in an IPOs or OFS:

As far as the IPO is concerned, the total share issue is normally divided into
three parts for three categories of investors. These are:

1. Qualified Institutional Bidders.

2. Non-Institutional Investors.

3. Retail Investors.

Qualified Institutional Investors (GIB):

Under this quota, financial institutions such as banks, mutual funds, insurance
companies, Foreign Institutional Investors, etc. are permitted to bid for the
shares. A maximum of 50 per cent of the issue can be reserved for investors
falling under the QIB category. Out of this 50 per cent, 5 per cent can be
reserved for mutual funds.

Non-Institutional Investors:

Under this quota, resident Indian individuals, HUFs, companies, NRIs,

societies and trusts whose share application size is more than Rs 1 lakh are
allowed to bid. At least 15 per cent of the total issue can be reserved for Non-
Institutional Bidders. Incidentally, this quota is also popularly known as the
High Networth Individual (HNI) quota.

Retail Investors:

Under this quota, only individuals, both residents and NRIs, along with HUFs
are allowed to bid.

The application size, however, should be less than Rs 2 lakh. A minimum of

35 per cent of the issue has to be reserved for such investors.
Other ways of investing

Apart from these two routes of investing, there are also some other ways of
investing directly in the companies:

1. Rights issue:

A company can come out with a rights issue in order to reward its
investors and give them a chance to subscribe to more shares in the
company. The capital of the company increases. For example, 1:4 rights
issue means an existing investor can buy one extra share for every four
shares already held by him/her. Usually the price at which the new shares
are issued by way of rights issue is less than the prevailing market price of
the stock, i.e. the shares are offered at a discount. Ideally, such an issue
occurs when a company needs funds for corporate expansion or a large
takeover.

If a shareholder does not want to exercise the right to buy additional

shares then he/she can sell the right as the rights are usually tradable.
Alternatively, investors can just let the rights issue lapse.

An investor should be able to look beyond the discount offered. The

investor should subscribe to it only if he/she is completely sure of the
company’s performance. Also, one must not take up the rights if the share
price has fallen below the subscription price as it may be cheaper to buy
the shares in the open market.

2. Bonus Issue

Who doesn’t like a bonus? Bonus shares are always welcome and are
generally given by companies with strong fundamentals.

Bonus shares are shares given to existing stockholders in proportion to the

number of shares they hold. A 1:1 bonus means that a shareholder will get
one share for each share held by him. For example, if an investor is
holding 10 shares, he will get 10 more. The shareholders do not pay
anything for these shares.
 Usually, after the bonus issue, the share price of the company gets
adjusted according to the bonus ratio. For example, if the price before
bonus is Rs 200 and a company issues bonus shares in the ratio of 1:1, the
post-bonus share price will be around Rs 100, which means that the total
market value (2 x Rs 100=Rs 200) remains the same.

3. Mergers and Acquisitions (M&A)

This is another interesting way of investing for retailers. Let’s take an

example of the latest merger of Satyam Computer with Tech Mahindra.
The stock prices of both these companies moved up nearly 15-20% in a
short period of time just before the record date of the merger. Here,
investors got 2 shares of Tech Mahindra for every 17 shares of Satyam
held as on the record date.

Investors should be aware of the fundamentals of both the companies.

Apart from the short term gains, one has to take a long term view of the
company as well as the sector in which it operates.

Conclusion:

In today’s markets, there are lots of opportunities available for investors to

invest in good and quality companies. These can be through IPOs, PSU
Divestments, Bonus and Rights issue and through Merger and Acquisition
activities. However, those who are not market savvy should take expert view
and do some self-study regarding the company’s business model and the
pricing of the issue before investing.
SUMMARY

• Companies invite the public to invest in them through IPOs.

• Government generates funds through divestments to fund the fiscal deficit

and fulfil other funding requirements. Private companies have also offered
shares for sale to comply with the SEBI guideline to maintain promoter
shareholding at 75%.

• A public issue is a mode to invite the public to subscribe to the share

capital of the company.

• In the primary market, you buy the shares that are issued by the company
the first time.

• In the secondary market, you sell the shares on the stock exchange.

• When you buy shares in the primary market through an IPO, the company
uses the money for its business growth.

• The value that the company assigns to the share is called the face value or
par value. When shares are offered at more than the face value, the issue is
at a premium.

• The intermediaries in a public issue include book running lead managers,

bankers to the issue, underwriters and registrars to the issue.

• Underwriters are institutions/individuals who agree to buy the shares of the

company in case the company is unable to sell its shares to the public.

• Primary market issues are of four types: Initial Public Offer, Offer for Sale,
Follow on Offer, Rights Issue and Preferential Issue.

• Rights shares are normally offered in a particular ratio to the number of

shares held prior to the issue and used by companies who want to raise
 capital without diluting the stake of existing shareholders.

• The company issues shares at the issue price. However, the final price is
arrived at through the book building process, which is determined by
market forces according to the demand for the issuing company’s shares.

• For a book building IPO, the offer must be open for at least three days and
a maximum of seven days and can be extendable by another 3 days.

• Investors should know the valuations of the company they would be

investing in.

• In case demand for shares is higher than expected, the company can issue
additional shares, called the greenshoe option. This over-allotment option
cannot exceed 15% of the originally proposed issue.

• One of the key benefits of investing in the primary markets is that the
scope for price manipulation is smaller.

Your action points

1. I will do my research while applying in IPOs or OFS.

2. I will find out if there is any discount to the retail investors; if yes, then I
will go ahead and invest in a good company.

3. I will find out the reason as in why the company is giving out its shares.

4. Even while applying for a rights issue or a bonus issue, I will check the
valuations of the company.

5. I know I can invest maximum Rs 2 lakh as a retail investor in an IPO.

Axioms
1. Research the stock: The rule remains the same while investing in an IPO
or an OFS or a rights issue as well. Know the company, its management
and the growth prospects of the company. Here, you also should be aware
of the reason why the company is raising money.

2. Know the price you are paying for the stock: Generally, these issues
are highly priced. So check whether the price is high; if yes, the reason for
the same needs to be known as in whether the company has any
monopoly in its area of business. If no, then you can buy the stock at
lower levels when it gets listed on the bourses.

3. Retail discount in IPOs - a boon: SEBI has directed companies to give

retail investors a discount to the offer price. The discount varies from 5-
10%. In some cases, some companies even offer a clause wherein after 6
months of being on bourses, if the share price is below the offer price,
then the retail investor can give back their shares to the company at the
offer price.

4. ASBA application for IPOs a better option - Applying for IPOs

through ASBA could be a preferred option for the investors since your
money though blocked for the shares remains in the account and earns
interest for you.

5. Exit on listing if you are not a long term investor - If you do not want
to stay invested for a longer period and just want to gain on listing, then it
is better to exit on the listing day of the stock. Do not worry; market
volatility would give you many opportunities to enter the same stock
again!
 Chapter 8

THE PROCESS OF INVESTING IN IPOS/OFS

Chapter 8
THE PROCESS OF INVESTING IN IPOS/OFS

Now that you know the pros and cons of investing in IPOs and OFS, here’s
how you can actually go about the process of investing in the same.

To profit from equity investing (through an IPO or via secondary markets)

it’s essential for you to study the company you plan to invest in, and also
check whether you are investing at a reasonable price. Some of the
essentials in terms of homework that you need to do on this front before
you apply for an IPO are briefly explained below. Incidentally, all of this
information would be available in the Draft Red Herring Prospectus (the
document that any company that wishes to do an IPO has to file with SEBI
and make available to all prospective investors).

Do a check on the promoters and the company

The background of the promoters and the company is the first aspect that
you need to study. Check the professional background of the promoters,
their qualifications and experience in managing the company you propose
to invest in, their track record in managing any other companies, if any, etc.
A company promoted by experienced promoters would lend a higher level
of comfort when you are investing in it.

Checking the promoters’ background is extremely important; a lot of people

in the past have raised money from the primary markets only to disappear
later. The names of such ‘fly-by-night’ companies can be found on
(www.watchoutinvestors.com), which has a record of companies whose
promoters have cheated investors in the past. You must, hence, study the
offer document carefully to know more and make sure about the credibility
of the promoters.

The names of ‘fly-by-night’ companies which have

cheated investors in the past can be found on
www.watchoutinvestors.com.

In case the company is newly promoted, i.e., there is no past track record,
there would not be any past performance of the company to evaluate. Then
you will have to limit your company evaluation to the prospects of the
industry it falls within, the competitive advantage (USP) that the company
would have vis-à-vis other players and the size of the opportunity the
company has before it.

In case the company is already in business, a study of the past track record
of the company as regards growth in sales and profits would help you in
understanding the company better.

Why the IPO

You may think that it’s not your concern to dig into the ‘whys’ and `what
for’ of an IPO you are investing in. But the following explanation will tell
you that it is just as important as the background check. You need to
understand why the company is raising money via an IPO. Money could be
raised for several purposes including setting up or expansion of a project,
business growth, acquisition of a competitor or complementing business,
repayment of debt, etc.

It’s important to find out why the company is raising

money through the IPO.

Though you may not be fully conversant with the ins and outs of the
business the company is in, or will be engaging in, you need to understand
how, after raising the funds, the company will be able to enhance its value.
This is best measured in terms of increasing its sales, profits or profitability
(profits as a per cent of sales).

Studying promoters’ capabilities and the company’s past background

combined with the purpose of the issue should give you a fairly good idea
on whether the investment is worthwhile.

Promoters’ stake

The promoters’ stake in the company should be closely watched too. A low
promoter stake indicates a lesser commitment by the promoters. A higher
promoter stake indicates that the promoters are committing/ risking more as
they believe more in the business and the company.

Share price

Carried away by the euphoria of booming stock markets, companies

sometimes tend to issue shares at expensive valuations, leaving investors
with reduced potential profits and sometimes losses. Though valuation of
shares is an on-going study, understanding the fair value of the company’s
shares is critical to make money from investing into equity shares. A high
priced issue may end up eroding value, even if the company’s business is
good.

Companies operating in different industries are valued by somewhat

different methods. For instance, real estate companies are valued on the
basis of their land bank (the value of the land they already own). Most
manufacturing companies are valued on the basis of their profits, whereas
companies in the hospitality sector (hotels) are valued on the basis of their
replacement cost of assets.

Thus, to value the share price correctly, you must understand the method
which best suits a particular company and then apply that valuation method
to judge the fair value. If the issue price exceeds the fair value, then you
should avoid the issue.
Let us take a look at a couple of methods for valuing a company’s shares.

Price Earnings (PIE) Ratio: This is the most popular method for valuing
shares and most companies in the manufacturing and services sector tend to
be valued so. This valuation method is based on the concept that a share
price is some number of times a company’s profit per share.

The P/E ratio is calculated by dividing the proposed

price of the issue by the earnings per share (EPS] of
the company to arrive at a multiple. Market leaders
enjoy higher P/E multiples.

The PIE ratio is calculated by dividing the proposed price of the issue by
the earnings per share (EPS) of the company to arrive at a multiple. The
EPS is calculated by dividing the profits (earnings) of the company by the
total number of shares that the company has issued. The higher the
multiple, the more expensive the company (or its share) is valued at. The
company’s P/E ratio should be compared with that of other companies in
the same industry, to gauge its standing. Market leaders enjoy higher PIE
ratios than their peer group.

Suppose X Ltd. already has a share capital of 3000 shares (face value Rs 10
each) and proposes to issue 3000 new shares via an IPO at Rs 20 (face
value Rs 10 and share premium Rs 10). Money raised from this IPO would
be towards expansion of its business and post-expansion, X Ltd.’s total
profits are estimated at Rs 20,000. Its EPS (Earnings Per Share) will then be
Rs 3.33 per share (Rs 20,000 divided by 6000 shares). Hence, its P/E ratio
will be 6 (Rs 20 divided by Rs 3.33). Now, if other companies in the same
industry are quoted in the stock market in the band of 7x to 10x profits, the
issue by X Ltd. at 6x can be considered reasonably priced.

Issue Price to Book Value (P/BV): This valuation method is used mostly in
valuing real estate and banking companies and is based on the concept that
a share price is closer to the company’s book value (BV). Book Value is the
number arrived at when you divide the company’s net assets (all assets less
liabilities) by the total number of shares that the company has issued. You
then divide the company’s issue price by this number (BV per share). The
lower this number, the more reasonable the price of the share. The
company’s Price to Book ratio should be compared with that of other
companies in the same industry, to see its standing.

Divide the company’s issue price by the book value

per share. The lower this number, the more
reasonable the price of the share.

Suppose X Ltd.’s total assets are Rs 210,000 and liabilities are Rs 30,000,
i.e., net assets are Rs 180,000 (Rs 210,000 less Rs 30,000). It has issued
(including the current IPO of 3000 shares at Rs 20 per share) 6000 shares
having a face value of Rs 10 each. Its book value will be Rs 30 (Rs 180,000
divided by 6000 shares). Its price to book value will be 0.50 (Rs 20 divided
by Rs 30).

Undertaking financial analysis

Analysing a company’s financial statements (Balance Sheet, Profit and Loss

and Cash Flows) also proves to be a very helpful tool in evaluating a public
issue. By concentrating on a few key figures, you can get a decent idea of
the company’s financial health. We will understand these by way of an
example. Assume X Ltd. has the following financials for the last three
years:
  Year 1 Year 2 Year 3
Turnover 10000 115000 138000
Costs 75000 885000 107970
Operating Profig 25000 265000 30030
Copering Margins Interest 25.0% 23.0% 21.8%
Interest 2000 2000 2000
Profit Before Taxes 23000 245000 28030
Taxs 6900 7350 8409
Net Proft 16100 17150 19621
Net Profit Margin 16.1% 14.9% 14.2%
Share Captial 30000 30000 30000
Reserves 16100 33250 52871
Net worth 46100 63250 82871
Book Value (Rs) 15.4 21.1 27.6
Loans 20000 20000 20000

Sales/Turnover

A year-on-year comparison of the turnover establishes a growth rate over

three to five years.

A consistent growth rate is a good sign. This again needs to be compared

with industry growth to check whether the company is lagging behind its
peers. On the other hand, an out-performance means an increasing market
share, which is a very good sign. X Ltd.’s turnover has grown by 15% in
Year 2 over

Year 1 (Rs 115,000 less Rs 100,000 divided by Rs 100,000) and by 20% in

Year 3 over Year 2. Now, if the industry in which X Ltd. is operating in is
growing at approximately 10% a year, X Ltd. is growing at a faster rate and
hence outperforming the industry and gaining market share.

Operating Margins

Operating profit margin is the ratio of the operating profit to the total sales
of the company. Operating profit is the difference between operating costs
and turnover. Better the operating margin, healthier is the company. X Ltd.
had an operating margin of 25% in Year 1 (Rs 25,000 divided by Rs
100,000) but the margin is steadily decreasing (23% in Year 2 and 21.8% in
Year 3) with increasing turnover. This means that to grow faster than the
industry (see Turnover above), X Ltd. is partly sacrificing its operating
margins, i.e., possibly selling goods at a lower price to sell more than its
competitors.
Net Profit Margin

Total Net Profit divided by Turnover gives you the Net Profit Margin. Net
Profit margin normally moves in tandem with Operating margins except
when the company’s interest and depreciation costs changes significantly
either ways. These are the two main expense heads (and taxes) that are
reduced from operating profits to arrive at Net Profit. A company with
increasing turnover, increasing operating margins and increasing net profit
margins means that the company is becoming operationally stronger and
also paying less interest cost to support growth.

Earnings Per Share (EPS)

A company may achieve growth in turnover and profits consistently, by

resorting to equity dilution, i.e., further issue of equity shares to fund
growth. This affects the EPS adversely. As explained above, when most
shares are valued at a multiple of EPS (P/E Ratio), lowering of EPS will
lead to lower share price.

Cost of debt

Cost of debt gives a fair idea of the company’s operation. Good companies
often get cheaper funding than others. They have the negotiating power, as
their credit rating is often good due to a track record of consistent and
timely payments. Credit rating, hence, throws light on the financial health
of the company. X Ltd. has borrowed Rs 20,000 throughout Years 1-3 and
is paying an interest cost of 10%, i.e., Rs 2,000 every year on its borrowing.

IPO Rating
The Process of Assessing IPOs
• Check the promoters’ reputation and company’s background
• Find out why the ocmpany is having the IPO
• Find out the promoters’ stake
• Assess the share offer prive
• Do financial analysis
• Find out IPO rating
Studying each and every public issue may not be possible. Hence, financial
experts such as brokers, consultants, etc. usually rate the IPOs and take
decisions on behalf of their clients - the investors. However, such
individuals may have vested interests in recommending the issue. Hence, a
neutral agency having expertise in judging IPOs could grade issues in order
to provide a fair view to potential investors.

Though IPO grading is still optional, SEBI is currently considering a

proposal to make it mandatory. This will help small investors in arriving at
a decision for investing in public issues.

Once you are convinced that an IPO is worth investing into, the next step is
applying for the issue by following these simple steps:

Application form

Application forms are available with any share broker, bank, depository
participant, etc. You need to have a demat account, since physical shares are
no longer allotted. Information asked in the form must be duly filled or else
the application is liable to get rejected. The following information must be
filled:

• Name, age and address of the applicant

• Name of the depository participant and demat account number

• Number of shares applied and in case of a book built issue, the bid price

• Bank details

• Category of the applicant, i.e., retail, non institutional, etc.

• PAN (Permanent Account Number allotted by the Income Tax

Department) if the value of the shares applied is more than fifty
 thousand rupees.

• Signature of the applicant

You must then submit the form either from where you got it or with any of
the collecting bankers mentioned in the application form. It’s as simple as
that. You must now wait for the allotment or the refund order.

Steps to Allotment

The allotment process depends on the response to the issue. A good

response to the issue (i.e., bids received at the issue price decided by the
BRLM is more than the total number of shares available for issue) results in
proportionate allotment. The proportion depends on the over-subscription
(excess applications over issue size) under each category, viz. retail, non-
institutional and qualified institutional buyers (QIB). Thus, the allotment is
equal to the proportion in which the investors have applied to the issue.
For example, in case of X Ltd.’s issue of 3000 shares, if the total number of
shares applied for were 30,000, you would normally be allotted one tenth
(3000 divided by 30,000) of what you had applied for. However, in case the
over-subscription is very high and it is not possible for the company to allot
the minimum number of shares it would want a shareholder to have, the
company would resort to a “lottery” system to determine who would be
allotted the minimum number of shares.

The bidders who bid at a lower price than the issue price fixed by the
BRLM are not eligible for allotment. Therefore, only those who apply at or
above the issue price have chances of getting allotment.

On closure of the issue, bids received are aggregated under different

categories, viz. firm allotment, QIBs, Non-Institutional Buyers (NIBs),
retail, etc. The over-subscription ratios are then calculated for each category
as against the shares reserved for each category in the offer document.
Within each, the bids are then segregated into different buckets based on the
number of shares applied for. By applying the over-subscription ratio, the
number of shares to be allotted in each bucket is determined. Then, the
number of successful allottees is determined.

It is a transparent and clear process as the basis of allotment is publicly

declared and you can cross check your allotment. Once the allotment
procedure is over, you must check your demat account, in the event that
your application has been successful. In case of any discrepancy, you need
to approach the registrars to the issue.

Listing the share

Presently we follow the T+6 day system for the listing of shares, meaning
from the closing day of an issue, the shares must get listed within 6 business
days.

Now that you have understood the investing process through the primary
market, let’s venture into investing through the secondary market!
To invest in the secondary market, you need to procure the services of a
broker.
SUMMARY

• It is essential to understand the company you are investing in and the

price you are investing at, to profit from equity investing.

• The draft red herring prospectus is an invaluable document to help you

understand the risks involved in IPO investing.

• Check the background of the promoters, their qualification and

experience and their track record in managing any other companies.
This is important to separate the serious market participants from those
looking to swindle you.

• Understand why the company is raising money. If the money is used to

grow its business, you know that you have high potential to earn returns
on your investment.

• If the promoter’s stake in the company is low, it could be a red flag, as

this indicates lesser commitment.

• Use valuation techniques like PE ratio and Issue price to Book Value
ratio to gauge if the issue price exceeds the fair value, in which case you
should avoid the issue.

• The PE valuation method is based on the concept that a share price is a

number of times a company’s profit per share.

• The Issue price to Book Value method is used mostly in valuing real
estate and banking companies. Book Value is the value when you divide
the company’s net assets (all assets less liabilities) by the total number
of shares that the company has issued.

• Do a yearly comparison of the turnover to establish a growth rate of

three to five years. A consistent growth rate is a good sign.
• The net profit margin normally moves in tandem with operating
margins.

• In case over-subscription is very high and the company cannot allot the
minimum number of shares to a shareholder, the company can resort to
a “lottery” system to decide allotment.

• The allotment process is a transparent and clear process, as the basis of

allotment is publicly declared and you can crosscheck your allotment.

• The shares must be listed on the stock exchange within 6 working days
from the closure of an issue.

Your action points

1. I would research the company offering IPO before investing in it.

2. I would read the risks involved in the business of the company and also
do due diligence of the promoters’ background.

3. I would take expert opinion, if required, to assess the fair price of the
company using valuation methods.

4. Depending upon the listing price and its movement on the listing day, I
would decide whether to hold the shares or sell them on that day itself.

Axioms:

1. Fundamental research a must before investing: Be it investment in

a secondary market or primary market, the investor should do the basic
study about the company. You should know the prospect of the
business the company is in, various risks involved, promoter
background and others.
2. Check IPO grading by the credit agencies: You can check the credit
rating a company has received before subscribing to the IPO. Agencies
like Crisil and Care rate companies based on their debt and risk profile.

3. Know the basic valuations and ratios: As an investor, learn some

basic valuations and ratios like Debt/Equity, Price to earnings, Price/
sales, Return on Equity, Return on Networth. This would give you a
broader idea of the stocks you are investing in.

4. Be a informed investor in IPOs: As an investor in IPOs, you should

be aware about the whole allotment process, refund procedure, whom
to reach in case of a problem, etc.

5. Take expert advice when to exit the stock: On the listing date, if the
stock price moves up continuously or if it falls to below the floor price,
you should be prepared for your next move. Take expert advice
whether you should book profits or stay invested.
 Chapter 9

SECONDARY MARKET THE NUANCES

Chapter 9
SECONDARY MARKET THE NUANCES

Now that you know about what to look out for in companies when
investing, the nature of stock exchanges, choosing a broker and choosing a
depository participant, let’s take a look at the process of investing in
equities and debt instruments in the secondary market. Parties to
transactions:

In the secondary market, there are basically three parties to a transaction.

These are buyers, sellers and intermediaries that facilitate a transaction
between them.

Buyers and Sellers mainly consist of retail investors, high networth

individuals (HNIs), mutual fund houses, companies, institutional investors
(banks, insurance companies, etc.), Foreign Institutional Investors (Flls),
etc.

Retail investors are individual investors with limited access to funds. These
are small value investors who park their surplus funds in equities to earn
returns.

The term ‘High Networth Individual’ or HNI is used to refer to individuals

and families that are affluent in their wealth holding and consequently are
higher value investors as compared to retail investors.

Mutual funds pool in money of several investors and invest in various asset
classes including equities. These funds are managed by professional fund
managers who for a fee manage your investments along with those of
others. Returns generated by them are distributed among the investors in
proportion to the investments made by individual investors. As businesses
are becoming increasingly complex to value and markets are becoming
increasingly volatile, this investment mode has gained a lot of popularity
across the world. It is ideal for investors who lack the skill and acumen to
pick up good stocks. Not only that, it also offers investors a variety of
schemes to choose from.

Foreign Institutional Investors (Flls) are large institutional investors such as

venture capital funds, pension funds, hedge funds, mutual funds and other
institutions registered outside India and investing in India.

Mutual funds and FlIs have gained a lot of importance as market

participants as they manage huge sums of money and are often instrumental
in giving direction to the stock markets in the short-term. Heavy buying or
selling on their part plays a substantial part in the market movement.

Intermediaries such as stockbrokers, depositories, depository participants

and banks facilitate movement of securities and money in secondary market
transactions. Explained in depth earlier, their roles are recapitulated below:

• Stock brokers are entities registered as members with the concerned

stock exchange. In turn you, the investor, would be required to open an
account with the broker. Brokers charge commission-based fees for the
services they offer. Sub-brokers appointed by main brokers offer similar
services.
• Depositories, through Depository Participants (DPs) appointed by them,
facilitate holding and transfer of shares belonging to investors in the
electronic form. Previously, shares were held in physical form, that is,
there were paper share certificates for shares held. This system of
holding shares through depositories reduces paper work and time and
also does away with risks such as bad delivery, fake securities, etc.
associated with physical certificates. There are two depositories in
India, the National Securities Depository Limited (NSDL) and the
Central Depository Services (India) Limited (CDSL). These two
depositories provide service to investors through their DPs. As per SEBI
regulations, entities such as Banks, Financial Institutions, SEBI
registered clearing members - (stock brokers), etc. can become DPs.

The Investing Process

You can now see at one glance the process of investing - that is purchasing
and selling shares - in the secondary market.

In case you choose to purchase shares on the stock market, the process will
be:

• Open a trading account with a stock broker.

• Open a demat account with the Depository Participant.

• Open a bank account if you don’t already have one.

• Place an order with the Broker to buy shares on your behalf.

• The Broker buys the shares by executing orders on the electronic

terminal provided by the stock exchanges.

• The Broker issues you a contract note detailing the value of shares
purchased, plus his brokerage cost plus incidental charges.
• Make payment to the Broker.

• The Broker collects your shares via a settlement process and makes
payment on your behalf.

• The Broker credits the shares collected to your depository account. In

case you choose to sell shares on the stock exchange, the process will
be:

• Place an order with the Broker to sell shares on your behalf.

• The Broker sells the shares by executing orders on the electronic

terminal provided by the stock exchange.

• The Broker issues you a contract note detailing the value of shares sold,
his brokerage cost plus incidental charges.
• Transfer shares from your depository account to your broker’s pool
account.

• The Broker delivers your shares via a settlement process and collects
payment on your behalf.

• The Broker makes the payment to you

Some important terms/concepts prevalent in the secondary market are:

Price:

The price of a share is determined by the market forces of demand and

supply. The share prices of liquid stocks with wide participation keep
changing during the trading hours. They can be tracked continuously on
trading screens.

Circuit Filters:

Share prices can swing in a volatile manner on the back of news or

rumours. It is important to protect the interest of investors and guard them
against volatility in price movements. So shares are subjected to an upper
and a lower circuit. The price of the share can move within this range only
on a particular trading day. There are various limits like 2 per cent, 5 per
cent, 10 per cent, 20 per cent circuit, etc. that different shares are subjected
to.

Volume:

The term volume refers to the total number of shares traded during the day.
Volumes can be calculated for particular scrip or even for all the scrips
traded on the stock exchange.

Debt instruments:
In secondary markets, like equity shares, certain debt instruments (bonds)
are also quoted. The stock exchanges, viz. BSE and NSE, have a separate
segment called the Debt Segment where these debt instruments are traded.

Bonds:

A bond is a form of loan borrowed by the government or a company from

the investors. Like any fixed income investment, bonds carry an interest
rate and are redeemable after a specified period. Bonds (also known as
debentures when issued by a company) are normally secured by a specific
security which can be enforced in case of default. For example, X Ltd. had
issued a debenture (bond) a year back having a face value of Rs 100,
carrying a coupon (interest) rate of 12 per cent payable half yearly and
redeemable five years after issue and is available in the secondary market.
In case you buy these bonds from the secondary market, this bond will pay
interest of Rs 6 every six months and will be redeemed four years from
now.

Some other popular types of bonds that are traded are:

Zero Coupon Bond:

These are issued at a discount to the face value and at the time of
redemption the bond holder is reimbursed with the face value of the bond.
The difference between the issue price and redemption value is the
investor’s gain (return). For example, X Ltd. could issue bonds having a
face value and redemption value (value at which the company will pay back
the investor) of Rs 100. If these bonds are issued for Rs 80 and are
redeemed after three years, the difference between the redemption value
and face value of Rs 20 will be the investor’s return. As these bonds don’t
pay any periodic coupon (interest) rate, they are known as zero coupon
bonds.

Convertible Bond:
These bonds offer the investor the option to convert bonds into equity
shares at a fixed conversion price. For example, X Ltd. could issue
convertible bonds of face value Rs 100 giving the option to the investor for
converting it into five equity shares at a price of Rs 20 per share three years
from allotment of the bonds.

Treasury Bills (T-bills):

T-bills are short-term securities issued by the Government. They mature in

one year or less from their issue date. Like regular bonds, they carry an
interest rate which is periodically paid.
SUMMARY

• Buyers, sellers and intermediaries are the triad in a secondary market

transaction.

• Mutual funds pool together the money of several investors and invest in
various asset classes including equities. Professional fund managers
manage them.

• Foreign Institutional Investors (FIIs) are large institutional investors

including venture capital funds, pension funds, hedge funds and mutual
funds.

• The forces of demand and supply govern the price of a share. You can
constantly monitor share prices on a trading screen.

• To protect the interest of investors and guard them against major losses
due to volatile price movements, shares are subjected to an upper and a
lower circuit. There are various slabs like 5%,10% and 20% circuits.

• Certain debt investments (bonds) are also quoted on the secondary

markets; NSE and BSE have separate debt segments for these
instruments.

• Bonds are like any fixed income investment; they carry an interest rate
and are redeemable after a specified period.

• T-bills or Treasury bills are short-term (less than one year) securities
issued by the Government.

Your action points

1. Since I do not have ample time for tracking investments, I would put
some money into mutual funds.
2. Apart from equities, I would also explore the options for bonds,
government securities and other debt instruments.

3. I will choose sensibly from the variety of schemes offered by mutual

funds.

Axioms

1. Risk and rewards go hand in hand: Unless you take risk, there is no
lucrative opportunity for returns. However, if you don’t see risk in an
investment, don’t buy it.

2. No time for equities - Go for mutual funds - Mutual funds pool in

several investors’ money and employ experts to manage the corpus.
Here again, the better way is the SIP route wherein you can take
advantage of the volatility of the markets.

3. Flls drive the market - It is widely known fact that Hs who have huge
corpus drive the market direction. It would be useful to also be aware
of their market participation and seek this opportunity to shuffle your
portfolio.

4. Circuit filters are not a major help: Upper and lower circuit limits work
for a particular trading day. If the outlook for a particular stock has
suddenly turned negative, it would start getting selling pressure and
might face lower circuit limits almost everyday. Retail investors may
not get an opportunity to transact within these.
 Chapter 10

THE INVESTING PROCESS

Chapter 10
THE INVESTING PROCESS

Now that you know what secondary markets are, let’s see how you can go
about investing in them.

The Accounts:

To invest in Secondary Markets you need to have three accounts:

• Broking Account

• Demat Account

• Bank Account

You need to open a broking account with a stockbroker. Refer to Chapter 6

for this. A stockbroker is associated with one or more stock exchanges. The
NSE and BSE are stock exchanges where shares of most of the listed
companies are traded. Of these, the NSE has higher volume and value of
shares traded than the BSE. Further, NSE has a far larger and more vibrant
traded market for derivatives. Most brokers in metro cities and towns are
members of either of these two exchanges.

You will need to have a demat account so that shares purchased/sold by you
can be credited/debited to this account. Refer to Chapter 6 for this. Many
brokers also act as depository participants (DPs) with NSDL and/or CDSL.
It means that you can maintain your demat account with your broker. You
may give your broker a specific power of attorney to operate your demat
account on your behalf, if you so desire. The broker will then automatically
debit your demat account to the extent of shares sold and effect delivery of
shares from there. In the absence of such power of attorney, you will have
to fill up, sign and submit the share delivery instruction slip each time
shares are sold. Alternatively, in case you do not want to maintain your
demat account with the broker, you can opt for Banks and SEBI approved
financial institutions or any of the DPs registered with a depository to
maintain a demat account. You would incur some nominal charges for
maintaining a demat account.

You will also need a bank account for making payments towards purchase
of securities and receiving payments pursuant to sale of securities. Certain
brokers link these three accounts (broking/ demat/bank) enabling you to
conveniently buy and sell shares on their trading website, removing the
need to physically write or receive cheques or delivery instruction slips.

The broker earns his income out of commission that he charges every time
you buy or sell shares. Over the years, brokerage rates have come down
gradually. Most brokers charge a commission on the transaction value in
delivery based transactions, i.e., where you will take or give delivery of
shares and not buy/sell and square up within the same day. In case you
buy/sell and square up on the same day (popularly known as intra-day
trading) then brokerage charges are generally lower. Brokers charge
different brokerage rate to different customers based on the volume of
business they generate from customers.

Once you have opened these accounts you are ready for trading.
Money for the margin:

You must maintain some margin money with the broker depending on the
volume and the size of transactions you are likely to execute. The broker
gives you an exposure on the basis of such margin money. Say for instance
you maintain Rs 25,000 as margin money with the broker and he offers an
exposure of four times the margin money. This would mean that you can
place an order for purchasing shares worth Rs 100,000. Once the order gets
executed you would have to pay the full amount of Rs 100,000 plus
brokerage and other taxes so as to maintain the margin of Rs 25,000 with
your broker.

The broker might in good faith accommodate your order if it marginally

exceeds the limit provided to you. However, he may not execute the
transaction if the difference between the margin money and the amount of
the proposed transaction is large. In our example, Rs 25,000 is maintained
by you as margin money and if you want to buy shares worth say Rs
300,000 then the broker would ask for additional money before executing
this trade. Here again, the level of exposure varies from broker to broker
and customer to customer. There are brokers who offer an exposure of upto
10 times of the margin money in frontline liquid stocks. The broker, in
order to safeguard his interest, would deliver the shares to your demat
account only after he has received the entire payment for the transaction. It
is important to note that you do not earn any interest on the margin money
held with the broker.

We will now take you through the investment process to make you
conversant with it.
Buy/Sell instruction:

• Decide which company you want to invest into, the number of shares
you want to buy and the price at which you want to buy these shares.

• Place the order for the same by instructing the broker to purchase the
shares on the above terms.

• The broker will feed your order in his trading terminal through which
he can access the automated system which will match the orders
between a buyer and a seller.

• Alternatively, if you have access to an online trading account, you can

log in to the online trading platform through the internet and place an
order.
• The system matches opposite orders and executes them. For example, if
you had placed an order to buy 100 shares of a company at Rs 1705 per
share and there is someone else who has placed an order via the same or
another broker to sell 100 shares of the company at the price of Rs 1705
per share, the system will match these two orders and execute the buy
for you and sell for the other party.

This is an example of “Limit Order” indicating that the transaction is

carried out at a predetermined price, which is Rs 1705. The trading system
operates on a strict price time priority. Suppose if there are five different
buyers wanting to purchase shares of a company at the same rate of Rs
1705 per share, then the buyer who punched the order first in the system
would get priority. Similarly, if there is more than one seller at the rate of
1705 then the seller having punched the order first would get precedence.

NEAT (NSE) and BOLT (BSE) are widely used operating systems for
trading of shares.

The above illustration will give you some idea of what the trading screen
looks like. The headings in the illustration are indicative and not exhaustive.

There are also “Market Orders” where shares are purchased or sold at the
currently prevailing market price. If you instruct the broker to buy 100
shares of a company at “market price” then as per the table ‘Matching
orders’, you would get the shares at Rs 1699 which is the best sell offer.

Matching Orders
Scrip Pre Last Last traded Best buy Best by Bes sell Sell Volume
Name Close traded quantity quantity bid offer quantity Traded
price
Company 1,688.05 1695.00 175 100 1697.25 1699.00 125 4,87,565
A
Company 901.00 905.00 35 50 903.00 904.50 150 3,98,252
N
Company 1101.45 1090.00 400 200 1089.50 1090.00 45 2,45,846
C

But had you wanted to buy at Rs 1694 then the order would have stayed
pending until it found a buyer at that price. Similarly, if there’s a seller who
wants to sell the company’s shares at Rs 1701 then his order too would stay
pending until it found a buyer at that price. Apart from what is displayed in
the table, there is also other information like open price, day’s high price,
day’s low price, etc. An investor can see the 5 best buy offers and 5 best sell
offers on the trading terminal. This screen is known as the Order Book.

Order Book Company A

Buy quantity Best bid Best offer Sell quantity

100 1697.25 1699.00 125
45 1697.15 1700.00 5
Company A
80 1696.35 1701.00 40
350 1696.00 1701.75 100
100 1695.00 1702.50 400

As seen in the table ‘Order Book’, the best buy bid is of Rs 1697.25 per
share. Once the buyers at that price get their shares, the next best price that
is Rs 1697.15 per share would appear on the trading screen as the best bid
for Company A. This price would find place in the table ‘Matching Orders’
in the best buy bid column against Company A. The case would be vice
versa for selling shares.
An order fed in the computer holds validity for the entire trading day. In
limit orders you can modify the price and quantity for your order as long as
it’s not executed. Alternatively, you can altogether cancel your order.

Evidence of order execution:

For all executed transactions, the broker will issue a contract note to you.
The contract note is a confirmation of trade done on your behalf by the
broker. It contains details of the trade, viz. order number, trade number,
trade time, share name, quantity, trade price, brokerage, settlement number
and details of other charges. It also bears the name and address of the
broker and the SEBI registration number of the broker.

Delivery:

Once the order for buying shares is executed, you are obligated to take
delivery of the shares and pay for the same. Similarly, the seller who has
sold the shares is obligated to deliver the shares and collect payment for the
same. This process is known as the “clearing and settlement” process and is
handled by the respective brokers via the Clearing Corporation/Clearing
House (CC/CH) of stock exchanges (National Securities Clearing
Corporation Ltd. (NSCCL) in case of NSE and BOl Shareholding Ltd.
(BOISL) in case of BSE). These are taken care of in pay-in and pay-out of
funds and securities.

Making payment:
When you purchase shares, the buying broker collects the money from you
and transfers it to a separate bank account (along with money from his other
clients who have done purchases). The CC/ CH matches the respective
buying brokers’ accounts and sends electronic instructions to the clearing
banks to debit the buying brokers’ accounts to the extent of their payment
obligations. The banks process these instructions and debit bank accounts of
the buying brokers and credit accounts of the CC/CH. Simultaneously, the
CC/CH will carry out a similar exercise for the shares to be credited to the
buying broker’s account, i.e., shares purchased by the buying broker on
your and other clients’ behalf.

Receiving payment:

This is the reverse of Pay-in. When you sell your shares, you are entitled to
the sale proceeds and obligated to deliver your shares. The broker in this
case will collect the shares sold for you and transfer these to his “delivery
pool” account (along with shares of other clients who have sold shares
through him). The CC/CH matches the respective selling brokers’ accounts
and sends electronic instructions to the clearing banks to credit selling
brokers’ bank accounts to the extent of their receipt entitlements. The banks
process these instructions and credit accounts of the selling brokers and
debit accounts of the CC/CH. Simultaneously, the CC/CH will carry out a
similar exercise for the shares to be debited to the selling broker’s pool
account, i.e., shares sold by the broker on your and other clients’ behalf.

Instruct to sell:

Every time you sell shares you need to fill up the delivery instruction slip
and hand it over to the DP. A delivery instruction slip would contain the
following details:
• International Securities Identification Number (ISIN): - It is a unique
code assigned to a security of a company. No two securities would have
the same ISIN number.

• Name of the company whose shares need to be transferred.

• Quantity of shares: - These need to be filled in figures and words

• Settlement Number: - Each trading day is assigned a settlement number.

All transactions carried out on a particular day and particular stock
exchange will fall under the same settlement number. For ascertaining
the settlement number on the day you have sold shares you can either
ask your broker or the information is also available in daily business
newspapers.

• Clearing Member (CM) Name: - This will bear your broker’s name
since he acts as a clearing member for you.
• CM-BP ID: - This is the id assigned by NSDL to the clearing member.
You need to put in your broker’s CM-BP id in the assigned column.

• Signature of the Account holder(s): - If the account stands in a single

name, i.e., your name alone, naturally, you will have to sign. However,
if there are joint holders, all the holders must sign the instruction slip in
the order in which their names appear in the account.

• Execution date: - Execution date is the date on which securities will be

actually debited from your account. The execution date written on the
delivery instruction has to be entered by you. You may issue the
instruction well in advance of the date on which you want the securities
to be debited from your account but your account will be debited only
on the execution date. This facility is called future dated instruction
facility.

You have the option of giving your broker a specific Power of Attorney
(POA) to automatically debit your demat account to the extent of shares
sold by you. In this case, your broker will fill the required slips for
transferring the shares from your demat account. It is advisable to give POA
only to a person in whom you have full faith and trust. Once you have given
the delivery instruction slip to your DP, your DP executes the instruction
and on the execution date prescribed by you, the shares move to the
broker’s pool account. Indian markets follow a T+2 settlement cycle, i.e.,
the pay-in and pay-out of funds and shares are completed on the second
working day from the date of trading. So if you buy shares on Monday, you
need to pay the broker latest by Tuesday morning (so that his account can
be debited by CC/CH on Wednesday morning) and you should receive the
shares in your demat account within one working day after the pay-out.

Similarly, if you sell shares on Monday, you need to submit the delivery slip
of such shares latest by 4 p.m. on Tuesday and you should receive a cheque
from the broker within one working day after the pay-out, i.e., by Thursday
in our example.
Once this process is completed, the settlement is fully completed, i.e., you
have made payment of the shares you purchased and have got the shares
credited to your demat account or conversely in case of a sale delivered the
shares and got the money credited to your bank account.

Selling first:

Normally as an investor, you would only sell what you have already
invested in. Our stock markets allow you to also short sell, i.e., sell shares
even though you don’t own them. You would do this if you expect the price
of a share to fall and want to profit from it without owning the shares.

As this would imply that you would not be able to give delivery of the
shares that you’ve sold, as you don’t own them, you will have to buy them
back (on the same day) at a lower price. When you buy back the shares, the
transaction gets squared up with a “sell” followed by a “buy” and you are
not required to give delivery of shares. You would gain out of such a
transaction if you have been able to square up at a profit (buy at a lower
price). If you are unable to buy at a lower price (the share instead of falling
as expected, rises instead) you will make a loss from this transaction. For
example, you expect prices of X Ltd. to drop and short sell 100 shares of X
Ltd. at Rs 30 per share on Tuesday at 11 a.m. You will have to buy back
100 shares of X Ltd. before market closes at 3:30 p.m. on Tuesday. In case
you are able to buy the same below Rs 30, you profit from the transaction,
otherwise you are exposed to a loss to the extent of difference between your
buy price and Rs 30.

If you have short sold the shares in the cash segment, then as explained
above, you have to square up the sale by purchasing them the very same
day. However, in the Futures segment, it is possible to carry forward your
short positions over the next day or in that case, till the date of expiry of the
futures contracts (refer to the section on Derivatives Investing in Chapter
9).

A clear understanding of the steps involved in investing in the secondary

market and actually implementing the same is critical.
SUMMARY

• The NSE and BSE are the major stock exchanges. Of these, NSE has
higher volume and value of shares traded than the BSE. The NSE is also
a better market for derivatives.

• Margin money, deposited with the broker, is a function of the volume

and the size of transactions you are likely to execute.

• Brokers use NEAT (NSE) and BOLT (BSE) operating systems for
trading shares.

• Market orders are when shares are purchased or sold at the currently
prevailing market price.

• An order fed in the computer is valid for the entire trading day. For
Limit orders, you can modify the price and quantity for your order until
it is executed.

• The contract note is a confirmation of trade done on your behalf by the

broker. It contains details of the trade viz. order number, trade number,
trade time, share name, quantity, trade price, brokerage, settlement
number and details of other charges.

• The respective brokers handle the clearing and settlement process via
the Clearing Corporation/Clearing House (CC/CH) of stock exchanges.
For NSE the clearing house is National Securities Clearing Corporation
Ltd (NSCCL) and in case of BSE, it is BOI Shareholding Ltd. (BOISL).

• Pay-in and Pay-out are handled by the broker and the CC/CH.

• You can give your broker a specific Power of Attorney (POA) to

automatically debit your demat account to the extent of shares sold by
 you. In this case, your broker will fill the delivery instruction slips for
transferring the shares from your demat account.

• Indian Markets follow a T+2 settlement cycle i.e. the pay in and pay out
of funds and shares are completed on the second working day from the
date of trading.

• Short selling is when you sell shares even though you don’t own them,
and is permitted in Indian stock markets. This is done when you expect
the price of a share to fall and want to profit from it without owning the
shares. You have to square off your positions by the end of the day.
Short selling can be tricky and only seasoned investors should attempt
this.

Your action points

1. To invest in the secondary market, I will open a Demat, Trading and a

Bank Account.

2. I know that margin money is required for stock market transactions.

3. I will keep proper record of the contract notes so as to know my broker

is doing everything right.

4. I will keep stop loss for my orders so as to avoid major losses.

5. I know that in India, T+2 settlement cycle is followed.

Axioms

1. Invest in ethically managed and fundamentally strong companies:

You should identify and invest in those companies which are
fundamentally strong, which are, however facing a sectoral downturn.
These stocks can be down presently but can give higher returns once
the sector turns for the better.
2. Short Selling - An option for seasoned investors: Short selling can
adversely affect you if you do no keep stop losses or cut your position
on time. Retail investors who have low risk appetite can stay away or
keep proper stop losses to reduce risk.

3. Don’t borrow margins to trade: Almost all broking houses provide

margin amount to the investors to increase their business. However, as
an investor, please remain restricted. Do not forget that you will have
to square off your position in a day or 2 and pay your broker if you
incur losses.

4. Smart broker would execute orders swiftly: Stock prices can have a
free fall or quick jump in certain situations and only a smart broker can
maximize your gains and minimize your losses. Be sure you have your
account with a smart broker!

5. Don’t get emotional about a stock: If you have made heavy losses in
a particular stock, don’t swear to yourself that you’ll make profits in
the same stock. Just chill out! Similarly, you should know to book your
profits and losses.
 Chapter 11

STUDYING INVESTMENT OPPORTUNITIES

Chapter 11
STUDYING INVESTMENT OPPORTUNITIES

Now that you are conversant with the investing process, we will look into
how to select companies that would prove to be good investment avenues.
The two most used tools to select companies and prices at which you should
buy them are Fundamental analysis and Technical Analysis.

Assessing the robustness of the company:

Fundamental analysis is the study of underlying forces that affect the

functioning and well being of a company. Fundamental analysis can also be
applied to the economy and industries. But for our purposes we will limit
this to evaluate companies.

We have discussed some of the aspects of evaluating companies in the

chapter on IPOs and as explained there, the aspects of studying the
promoters’ and company’s background, interest of the promoters, etc.,
remain the same whether you are evaluating IPOs or companies to be
invested in through the secondary market. In this chapter, we will discuss
the evaluation process and valuation of shares in greater detail.

Broadly, you can go about selecting the company either by a “top down”
approach or a “bottom up” approach.
“Top Down” means that you first study the state of the economy, the
industries that will benefit the most from the current state of the economy,
and then the companies that provide the best value within these industries.

“Bottom Up” focuses more at the company level while the industry and
economy are given less importance.

For example, India is currently falling short of the required infrastructure to

grow at an attractive rate and hence, the government is laying an added
thrust to infrastructure development. Against this economic backdrop,
industries that are expected to do well over the next few years will be
targeted towards infrastructure development like engineering, construction,
cement, etc. Locating companies within these industries means that you
have used a top down approach to identify companies.

Similarly, if you come across a company on a stand-alone basis which has

say, developed a technology that will dramatically reduce its production
cost and consequently increase its profits, or has on offer a unique service,
and the same is available at an attractive value, this identification method is
known as the bottom up approach.

Whichever approach you use, what do you look out for in a company? After
you have evaluated the promoters’ and company’s background, the
industry’s prospects and the company’s capability to capitalize on the
opportunities, what is important is to understand and interpret financial
statements of companies. It involves analysis of revenues, expenses, assets,
liabilities, cash flows, etc. of previous years and then trying to estimate the
future performance of a company. There also is comparative analysis of
companies belonging to the same sector.

All this analysis helps to determine what price is fair for the company’s
share. The share price of a company would be overvalued or undervalued if
it is not trading around the fair price level. An undervalued share is one
whose current trading price is below its fair value and such a share provides
an opportunity to buy. An overvalued share trades above the fair value and
hence there is a bright chance that it might correct down to come close to its
fair value. Fair value, however, is relative and ambiguous. Different
analysts might arrive at different fair values for the same company as their
assessment about the company and estimations about the future prospects
vary.

Companies operating in different industries are valued by somewhat

different methods. For instance, real estate companies are valued on the
basis of their land bank (the value of the land they already own). Most
manufacturing companies are valued on the basis of their profits, whereas
companies in the hospitality sector (hotels) are valued on the basis of their
replacement cost of assets.

Thus, to value the share price correctly, you must understand the method
which best suits a particular company and then apply that valuation method
to judge the fair value. If the market price (or issue price in case of an !PO)
exceeds the fair value, then you should avoid the share.

Let us take a look at a couple of methods for valuing a company’s share.

Using the PIE ratio:

This is the most popular method of valuing shares and most companies in
the manufacturing and services sector tend to be valued accordingly. This
valuation method is based on the concept that a share price is some number
of times a company’s profit per share.
The PIE Ratio is calculated by dividing the proposed price of the issue by
the earnings per share (EPS) of the company to arrive at a multiple. The
EPS is calculated by dividing the profits (earnings) of the company by the
total number of shares that the company has issued. The higher the
multiple, the more expensive the company (or its share) is valued at. The
company’s P/E Ratio should be compared with that of other companies in
the same industry, to see its standing. Market leaders enjoy higher P/E
ratios than their peer group.

For example, assume Company X Ltd. is trading at a market price of Rs

100 per share. It had earned Rs 20 per share and hence its P/E Ratio will be
5 (100 divided by 20). This implies that at the current rate of earnings, it
would take 5 years to recover the market price of Rs 100 that you would
pay to buy shares.

But this is assuming that the earnings stay constant at Rs 20 per share. In
case of a growing company, earnings tend to grow over the previous year’s
earnings. Assume X Ltd.’s earnings are expected to grow at a rate of 25 per
cent over the next few years. (Year 1= 20, Year 2 = 201.25 = 25, Year 3 =
25x1.25 = 31.25, Year 4 = 31.25x1.25 = 39). In such a case, you will be
able to recover the Rs 100 you paid for the share much earlier, say in
approximately three and a half years and hence the “forward” P/E multiple
will drop from 5 to approximately 3.5

Long-term earnings are factored in the current share prices of companies.

Investors are willing to pay higher multiples for companies where strong
earnings growth is anticipated. That is why a frontline software company
like Infosys would trade at a PIE multiple of 35 to 40 times. Whereas
commodity based companies like Steel Authority of India (SAIL) would
command a lower P/E of say 10 to 15 times only because its earnings would
not grow at the same rate as IT companies.

Using the P/BV ratio:

This valuation method is used mostly in valuing real estate and banking
companies and is based on the concept that a share price is closer to the
company’s book value (BV). Book Value is the number arrived at when you
divide the company’s net assets (all assets less liabilities) by the total
number of shares that the company has issued. You then divide the
company’s issue price by this number (BV per share). The lower this
number is, the more reasonable the price of the share would be. The
company’s Price to Book Ratio should be compared with that of other
companies in the same industry, to see its standing.

Suppose X Ltd.’s total assets are Rs 210,000 and liabilities are Rs 30,000,
i.e., net assets are Rs 180,000 (Rs 210,000 less Rs 30,000). It has issued
6000 shares having face value of Rs 10 each. Its book value will be Rs 30
(Rs 180,000 divided by 6000 shares).

Its price to book value will be 0.50 (Rs 20 divided by Rs 30).

Whether you have adopted the PIE or the P/BV approach to arrive at a
share valuation, you would then have to compare it to other companies
within the same industry to gauge whether the company you are evaluating
is expensive or undervalued compared to its peers.

Assessing the financials:

Financial analysis is the core of Fundamental Analysis. This means

studying the company’s Balance Sheet, Profit and Loss and Cash Flows to
understand the company’s strengths and weaknesses. By concentrating on a
few key figures, you can get a clear picture of the company’s financial
health. We will understand these by way of an example.

Assume X Ltd. has the following financials for the last three years:
  Year 1 Year 2 Year 3
Tuner Over 1000000 115000 138000
Costs 750000 88500 07970
Operating Profit 25000 26500 30030
Opeating Margins 25.0% 23.0% 21.8%
Interest 2000 2000 2000
Profit Before Taxes 23000 245000 28030
Taxes 6900 7350 8409
Net Profit 16100 17150 19621
Net Profit Margins 16.1% 14.9% 14.2%
Share Capital 30000 30000 30000
Reserves 16100 33250 52871
Net Worth 46100 63250 82871
Book Value (Rs.) 15.4 21.1 27.6
Loans 20000 20000 20000
Return on Net Worth 34.9% 27.1% 23.7%
Debt Equity ratio 0.43 0.32 0.24

Sales:

A year-on-year comparison of the turnover establishes a growth rate over

three to five years. A consistent growth rate is a good sign. This again needs
to be compared with the industry growth to check whether the company is
lagging behind its peers. On the other hand, an out-performance means an
increasing market share, which is a very good sign. X Ltd.’s turnover has
grown by 15% in Year 2 over Year 1 (Rs 115,000 less Rs 100,000 divided
by Rs 100,000) and by 20% in Year 3 over Year 2. Now if the industry in
which X Ltd. is operating in is growing at approximately 10% a year, X
Ltd. is growing at a faster rate and hence outperforming the industry and
gaining market share.

Operating Profit Margin:

Operating profit margin is the ratio of the operating profit to the total sales
of the company. Operating profit is the difference between operating costs
and turnover. The operating margin reflects the operational efficiency of a
company. It reflects how efficiently a company is utilizing its resources like
labour, raw materials, etc. Better the operating margin, healthier is the
company. X Ltd. had an operating margin of 25% in Year 1 (Rs 25,000
divided by Rs 100,000) but the margin is steadily decreasing (23% in Year
2 and 21.8% in Year 3) with increasing turnover. This means that to grow
faster than the industry (see Turnover above), X Ltd. is partly sacrificing its
operating margins, i.e., possibly selling goods at a lower price to sell more
than its competitors.

Net Profit Margin:

Total Net Profit divided by Turnover gives you the Net Profit Margin. Net
Profit Margin normally moves in tandem with Operating Margins except
when the company’s interest and depreciation costs change significantly
either ways. These are the two main expense heads (and taxes) that are
reduced from operating profits to arrive at Net Profit. A company with
increasing turnover, increasing operating margins and increasing net profit
margins indicates that the company is becoming operationally stronger and
also paying less interest cost to support growth.

Earnings Per Share (EPS):

A company may achieve growth in turnover and profits consistently, by

resorting to equity dilution, i.e., further issue of equity shares to fund
growth. This affects the EPS adversely. As explained above, when most
shares are valued at a multiple of the EPS (PIE Ratio), lowering of EPS will
lead to lower share price.

Debt - how expensive:

Cost of debt gives a fair idea of the company’s operation. Good companies
often get cheaper funding than others. They have the negotiating power, as
their credit rating is often good due to a track record of consistent and
timely payments. Credit rating, hence, throws light on the financial health
of the company. X Ltd. has borrowed Rs 20,000 throughout Years 1-3 and
is paying an interest cost of 10%, i.e., Rs 2,000 every year on its borrowing.

RONW:
This is arrived at by dividing the company’s Net Profit by the company’s
total Net Worth. This shows how well the company is utilizing its
shareholders funds. The higher the ratio, the more efficiently the company
is using its shareholders funds.

Debt Equity Ratio:

This is arrived at by dividing the company’s debt by its net worth. The ratio
reflects how much of the total capital of the company is funded by
borrowed funds (debt) and how much by owned funds (equity). The lower
the ratio, the healthier the company and this would mean that it will be able
to face business downturns better as it would not be obligated to service
(pay interest and repay principal) much debt.

There are several other ratios that enable investors to make out various
aspects about the company. You can always check for quarter-on-quarter
and year-on-year earnings growth of companies to see how fast it is
growing.

The following are some of the other criteria that you can look into while
evaluating a company on the fundamentals:

• Does the company have a healthy dividend paying track record?

Companies that regularly pay dividends are considered healthier as they
are able to throw out surplus money which are paid back to its
shareholders and not needed within the company.

• Checkout the products and services a company is dealing in. What is the
future outlook? Is the market for its products/ services growing? Is the
 company positioned to service higher demand?

• Does the company have a sustainable competitive edge over other

companies? How difficult is it for other companies in the industry to
duplicate the competitive edge? How difficult is it for other companies
to enter this industry?

• Does the company hold remunerative patents and copyrights? For what
period are they valid? This holds a lot of relevance for pharma
companies

• Does the company have an international presence? In case there is a

recession in one country then revenues from another country can shore
up the deficit if the company has international presence.

Analyzing the technicals:

Technical analysis is a method of evaluating future share price movement

based on statistical analysis of trading volumes, historical price charts, price
trends, pattern formation, etc.

Technical analysis is useful in determining short term movement of share

prices. Though, sometimes it is used as a supplement to fundamental
analysis, it can be considered as an alternative method to determine future
price movements. When used together, while, fundamental analysis helps
you to decide on what scrips (stocks) to buy and what would be a good
price range to enter such stocks, technical analysis helps you to decide at
what point within the price range you should enter the stock. However,
there are people, who use only technical analysis to trade in various stocks/
other assets without looking at the fundamentals.
The basic assumption in technical analysis is that the prices repeat a historic
pattern. Technical analysis is all about tracking those historic patterns and
trends and on that basis, trying to figure out where the prices are heading.
Various kinds of graphs and charts like bar charts, line charts, candlesticks
(a theory), etc. are used to determine the behaviour of price movement and
future price trends. When share prices break out of such trends, it holds a
lot of significance, as it helps in making decisions to buy or sell.

All about trends

It is often said that in stock market you go with the trend. So what is trend?
A trend is nothing but the direction of price movement. However, you need
to keep in mind that prices never move in a straight line, rather they always
move in a zigzag way making highs and lows in a particular time span.
Now when you follow those high and low points they represent a trend. A
trend can be up ward, downward or side ways. This is one of the important
aspects of technical analysis, as the trend can guide you to buy, sell a stock
or just stay on the sideline. In terms of time frame, a trend can be long term,
intermediate and short term. Also, a long term would consist of many short
and intermediate term trends. Now when you join the top points of the
highs or the bottom points of the lows you have a trend line.

About Supports and Resistances:

An important concept in the use of trend lines is that of support and
resistance. In the short-term, share prices tend to oscillate in a range. The
range has a bottom and a top. The lower bottom of the price range is said to
be a support while the upper top is said to be a resistance for the share.

Every time the share price comes around the support level, buyers would
come in to buy the stock. As a result of increased buyer interest and strong
demand for the share at the support level, the price will start moving
upward. If there is any bad news about the company or any internal or
external development that would affect the company adversely then the
support is broken and the price might fall sharply. In the case of resistance,
the opposite holds true.

Every time the share price reaches the upper end of the price range, i.e., the
resistance level, investors start selling the stock. The resistance would be
broken if there is increased demand for the stock. The demand might come
on the back of positive news, impressive earnings or any other factor like
the company getting a new business contract. When a support level is
broken, it would become the resistance level of the new price range and
when a resistance is broken it becomes the support level of the new price
range. Let’s take the example of the Company X. It is trading at a price of
Rs 205.00. It has a support at Rs 195.50 and a resistance at Rs 209.00. If the
209.00 mark is crossed convincingly then 209.00 would become the new
support level of the share. If the share price goes below 195 then the level
would become the new resistance level for the stock. Every time a support
or a resistance is broken with high volumes of shares traded then it’s a
strong confirmation that the share has moved in a new price range.

How to analyse a trend - Continuation pattern:

When the prices move in a particular trend and after pausing for some time,
continue to move in the same earlier direction, it’s known as continuation
trend. There are some particular patterns, which are known as continuation
patterns. Triangles and flags are two major formations of continuation
patterns.
Triangles: The price moves in such a way that the trend lines form a shape
of a triangle. There can be three types of triangles:

a) Symmetric- In this pattern, two trend lines converge as the upper one
moves down and the lower one goes up.

b) Ascending- Here, the lower trend line moves up and crosses the flat or
horizontal upper line.

c) Descending- This is just the opposite of the ascending line, as here, the
upper line moves down and crosses the flat or horizontal lower line.

If it’s an uptrend or down trend, then there is a high chance that after
breaking out of this triangular pattern, prices would continue to move in the
earlier direction. In case of an uptrend, the upper trend line provides
resistance and lower trend line provides support. In case of a downtrend,
this becomes just the opposite.

Flags: This is another type of continuation pattern. This happens normally

after a consistent and steeper movement in prices, when they pause for few
moments/days etc. Normally prices consolidate within a parallel channel.
Reversal patterns:

The patterns that indicate the end of the current trend and starting of a new
trend are known reversal patterns. There can be top reversal, which signifies
end of an up-move and a bottom reversal, which indicates end of a
downtrend. Needless to say that for any reversal pattern to take place, there
has to be a prior trend. Volume plays an important role in reversal patterns.
Normally reversal patterns happen after breaking out of a trend line on
either side. Normally, the volatility remains higher when a top is made in an
uptrend than during a bottom formation in a downward trend.

Head-and-shoulder pattern: One of the most important reversal patterns

is the head- and- shoulder formation. This is so called due to the type of
formation of the chart. This type of formation happens towards the end of a
trend, when prices try to continue the earlier trend but eventually falter.

When the price crosses the ‘neckline’, it normally signifies that a reversal is
already on the way and the opposite movement normally equals to the
distance between the tip of the ‘head’ and the ‘neckline’ of the ‘head- and-
shoulder’. When this pattern is formed in case of a downward trend, it is
called inverse head-and-shoulder.
Double and triple bottoms and tops: When in an uptrend, prices make the
same highs or when in a downtrend, prices hit the lowest points a couple of
times, they are known as double top or double bottom respectively. When
such high or low points are hit three times, they are termed as triple top or
bottom. These patterns essentially indicate that despite market forces, the
prices are not able to cross those respective support or resistances and thus,
there is a high possibility of a trend reversal.

Gap analysis:

Sometimes, in a continuous bar/ candle stick chart, for a particular period of

time, no trading takes place. That area in a bar chart/ candle stick chart is
termed as a gap. In case of an uptrend, at a certain point of time, if the price
opens higher than the highest point of the previous bar/ candle stick or in
case of a downtrend, at a certain point of time, if price opens lower than the
lowest point of the previous bar/ candle stick then these gaps are created.

Gaps are considered to be one of the major indicators of trend reversals.

Gaps can also be of three types:
a) Breakaway gap - This occurs after completion of an important and
consistent trend. In this case, there is a break out of a continuing trend
and is supported by a gap formation.
b) Runaway gap - These gaps occur during the mid- way of a trend and
show the strength of that trend, be it upward or downward.

c) Exhaustion gap - This can happen after the other two gaps already
had been there and instead of going up or coming in a new trend,
prices falter. This can cause significant move in the opposite direction
and can trap traders.

Using Moving Averages:

Moving average involves taking an average of share prices of a company

over a specific period of time. The time period can be of 20 days, 50 days,
100 days, 200 days or any other time period found suitable by the analyst to
carry out his research. A line is drawn connecting the moving average for
each of the days. When the share price comprehensively breaks out above
the moving average line, it is considered a positive sign. Conversely, if the
share price on a day pronouncedly moves down below such a line then it’s
considered a negative sign for the future price movement.

There are a huge number of techniques followed in technical analysis.

Analysts use a combination of these to arrive at a decision. Like
fundamental analysis, technical analysis is an on-going study, but Supports
and Resistances and Moving Averages which we have discussed are among
the most basic and widely followed techniques of technical analysis of
stocks.

Candlestick technique:

‘Candle sticks’ are basically a type of charting pattern that is used in

technical analysis. This technique was originated in Japan during the 17th
century. The name is so due to the formation pattern.
A candle stick has three parts-upper shadow, real body and lower shadow.
The upper shadow indicates the high, the lower shadow signifies the low
and the real body constitutes open and close. Normally, an unfilled candle
indicates lower opening prices and higher closing. If prices open higher and
close lower, that pattern is represented by a filled candle. They are also
known as bullish and bearish candles respectively.

Candle stick patterns are easier to understand visually and can be used
extensively in technical analysis.

Some of the important candlestick formations are:

Candle Stick Patterns

Spinning tops: These have long upper and lower shadows and small real
body. These normally indicate indecision. The next candle formation
becomes important to get an idea of the trend.

Doji: When there is extremely choppy price movement with prices closing
very near to the opening positions, these types of candle sticks are formed.
They also represents indecision but normally used as an indication of a
reversal.

Bullish engulfing pattern: An unfilled or a bullish candlestick is formed

just after a filled or bearish candle stick in such a way that the price opens
lower than the previous open and closes above the previous session’s
opening price. This is a bullish signal and you can expect the next move to
be positive.

Bearish engulfing pattern: This is just the opposite of the bullish pattern.
Here, the price opens higher than the previous closing and closes below the
previous open. It’s definitely a bearish signal.

Morning star: This is a bullish pattern. After a bearish candle, a smaller

candle stick is formed followed by a bullish candle. This pattern is called as
morning star.

Evening star: This is just the opposite of the morning star and signals a
bearish trend to start.
Hammer: These are candlesticks with long lower shadows with smaller
real body at the top. This type of formation at the bottom of a downward
trend is called hammer. A pattern with long upper shadow and smaller real
body at the bottom is known as inverted hammer and they are normally
formed at the top of an upward trend. You can understand that these give
you reversal signals.

There are other patterns also and they are helpful in understanding the price
direction and future trend of a stock. However, all these patterns and
indicators need to be supported by good liquidity, which implies large
participation. Thus, trading volume plays an important role in technical
analysis.

Fundamental Analysis versus Technical Analysis:

At the base level, technical analysis starts with analysis of share price charts
whereas fundamental analysis revolves around study of company’s financial
statements.

Fundamental analysis takes a long-term approach in analyzing a stock.

Fundamentals of a company do not change on a daily basis unless there is
some major development. On the other hand, technical analysis is useful for
short-term evaluation of the share price. It proves handy in taking decisions
as regards short-term movement of share prices.

A company may not be fundamentally sound but it may yet make for a
good trading buy if its price is hovering around the support level. So it can
be said that technical analysis is used for a trade and fundamental analysis
is used to make an investment decision. To conclude, the approaches do not
substitute each other but if judiciously used can complement each other.

A smart way of making an investment would be to first evaluate the share

on its fundamentals and then use technical analysis to buy the share at the
optimum price.
If you want to learn technical analysis in detail, you may refer to a book on
technical analysis published by Bestsellers 18—Technical Analysis Trading
—Making Money With Charts.

This dedicated book on technical analysis enlightens readers on techniques

of identifying patterns and producing consistent results with them.
SUMMARY

• Fundamental analysis and Technical Analysis are the two popular tools
used for picking stocks.

• The two methods used to start off on cherry-picking a company are the
‘top-down’ approach or the ‘bottom-up’ approach.

• You must hunt out undervalued shares, where its current trading price is
below its fair value, since these appreciate considerably over the long
term.

• You must apply different parameters for valuing companies in different

industries.

• The two common valuation ratios are the Price Earnings (P/E) ratio and
Issue price to Book Value (P/BV) ratio.

• You can ascertain a company’s financial health by studying the

company’s balance sheet, profit and loss statement, and cash flow
statements.

• The operating margin reflects the operational efficiency of a company.

The higher the operating margin, the more it is efficiently it is run vis-a-
vis its peers.

• Another indicator of financial health and market reputation is the

company’s credit rating. A higher credit rating indicates that the
company has a lesser possibility of defaulting on its debt obligations,
which shows sound fundamentals.

• Technical analysis is typically used for gauging the short-term

movement of the share’s price and involves statistical analysis.
• Fundamental and technical analysis are used in tandem. Use
fundamental analysis to fix the price range at which you should buy the
stock and technical analysis to fix the actual price within that range.

• Technical analysts use a combination of methods to conclude the buying

or selling price of a stock.

• Technical analysis is used for a trade and fundamental analysis is used

to make an investment decision.

• With regard to which is the better method of analysis, you cannot use
one or the other. They have to be used together.

Your action points

1. I will utilize both fundamental and technical tools to pick the right
stock.

2. While following technical calls, I would also strictly follow the support
and resistance levels.

3. Good undervalued stocks can become a multi-bagger if invested on

time.

4. I would first do a fundamental research to pick up a stock and then

take technical view to know the appropriate price of investment.

5. I would also look at the credit rating given to the company by the
rating agencies.

Axioms

1. Macro environment knowledge would be useful - Just by regularly

reading financial papers and watching financial channels, you can
know the various global movements and can try to analyse how it
 might affect the Indian economy and various industries. Then you can
pick up a couple of stocks within that sector for investment. At the
same time, remember to take an expert opinion as well.

2. Know the financial health of the company before investing - As an

investor, you should know how much turnover the company makes and
also what are its EBIDTA and Profit margins. Know for yourself where
you are parking your hard earned money.

3. Know the basic valuations and ratios - As an investor, learn some

basic valuations and ratios like Debt/Equity, Price to earnings, Price/
sales, Return on Equity, Return on Networth. That would give you a
broader idea of the stocks you are investing on.

4. Don’t forget peer analysis - Make sure you do some competitor

analysis for a company. You should know what the other companies in
the industry are doing and what Price/ Earnings (PE) ratio they are
trading at. Depending upon their product/ service strength in the
market, some companies claim better P/E.

5. Technical Analysis for short term trading - While fundamental

research is good for long term investment, technical tools which are
statistical in nature can be used for short term trading. It is advisable
for investors to follow the support and resistance levels given.
 Chapter 12

SELECTING EQUITY
Chapter 12
SELECTING EQUITY

We have briefly discussed about fundamental analysis and the process of

identifying investment prospects either by following a top down or a bottom
up approach in the previous chapter. We will explore these approaches more
in depth in this chapter.

Macro & sector based selection

Going by this approach, companies are always first identified with respect
to the dynamics of the economy and by tracking economic trends to
forecast the future. There are two types of factors which impact a share’s
price. While certain factors are common to all companies, there are a few
that are specific to an industry or a company. For example, when interest
rates change, it affects all sectors of an economy; however when the
government brings in price measures related to the cement industry, only
the cement industry gets affected. Hence, there are factors working at the
macro (economy/industry) level and micro (company) level.

Economy based parameters

This approach begins with the ‘big picture’ — of studying the

macro¬economic environment within which the economy is performing. In
evaluating these factors, investors/fund managers look at variables such as
the growth rate of the economy, the prevailing interest rate scenario, the
political conditions and the regulatory environment, among others. It is
important to note that today, more than ever, global factors have become
very critical. It is not uncommon to hear that due to some changes in the
policies followed by the government in the United States, the Indian
economy has been adversely affected. Similarly, a manic fall in the Chinese
stock market sends shockwaves through India as well. It is therefore critical
that global issues are borne in mind while evaluating the macro-economic
scenario.

Apart from pure economic factors, there are certain other factors which
have gained ground in recent years. For example, an eye on geo-political
developments also holds significance today, as terrorism and war do impact
world economies. For example, the 9/11 attacks on the World Trade Centre
in US had repercussions across the world’s stock markets and it took a
fairly long period of time for markets to bounce back.

Assessing Sectors

The next step is to decide on industries that hold long-term promise. In

growing economies like India, certain sectors will outshine in the years to
come. Hence, if industries connected with infrastructure, power and
telecommunications are likely to do well, they are attractive investment
opportunities. There are certain filtration methods which can be applied to
all industries. For example, due to economic growth if you expect the per
person disposable income to rise sharply and, accordingly, the spending
pattern to switch in favour of lifestyle products, you should take exposure to
sectors such as organized retail, travel, multiplexes and branded apparel.
Fund managers generally bet on certain sectors, which they expect to
perform better than the whole economy over a three/five-year period.
Selecting Companies
  X Y
EPS (Rs.) 10 10
Share Price 100 130
P/E 10 13
EPS Goth 10% 50%
Year 1    
EPS 11.0 15.0
P/E 9.1 8.47

The last step involves selecting individual stocks based on fundamentals.

The idea is to identify companies that are undervalued vis-a-vis their fair
value. Hence, it is important to arrive first at a fair value. We have
discussed the basics of fundamental analysis and usage of a couple of
commonly used tools like PIE and P/BV ratios and comparing them to the
company’s peers to arrive at fair value in earlier chapters.

The PIE ratio is the most widely used measure of valuing shares. A high
P/E ratio per se does not mean that a share is expensive. The company
could be growing at a much faster rate than its peers and hence deserves a
higher P/E. Let’s understand this via an example for Companies X and Y.

As per the table above, both companies have the same EPS of Rs 10 but
Company Y is traded at Rs 130 as against Rs 100 for Company X. On the
face of it, Y looks more expensive than X. However, when you account for
the growth in their respective earnings, Y at 50% as against X at 10%, the
outcome dramatically changes. Company X’s one year forward (next year)
WE moves down from 10 to 9.1 while Company Y’s one year forward WE
drops from 13 to 8.7, i.e.; lower than X.

Incidentally, a ratio that captures this growth in earnings to value shares is

the PEG ratio. PEG stands for Price to Earnings Growth. This is arrived at
by dividing the company’s WE Ratio by the expected growth in the
company’s earnings.
Continuing with the above example: X Y
  X Y
EPS (Rs.) 10 10
Share Price 100 130
P/E 10 13
EPS Groth 10% 50%
peg 1.00 0.26

For Company X, PEG is 1 (10 divided by 10) and for Company Y it is 0.26
(13 divided by 50). Lower the PEG, less expensive the share. Hence, don’t
look at a WE Ratio on a stand-alone basis. Consider this in terms of growth
in the company’s earnings and in relation to its peers. This analysis will
help in determining whether the company’s share is undervalued or
overvalued.

Starting with company selection

As opposed to the macro approach, company selection begins with micro-

analysis at the company level. In the process of evaluating the company,
industry and economic factors are also evaluated. Instead of first forming a
view as to which industries are liable to perform well in the future and then
locate companies within these industries, this approach strongly believes
that the fundamental strength of a company drives its share price and future
return potential. External factors can, at best, have an impact for a limited
period of time. Even in a depressed phase of the economy or the stock
market, a company with strong fundamentals would perform. It can be seen
that even in the worst stock market fall, all stocks don’t generate negative
returns. This approach attempts to identify such stocks which have high
intrinsic value and hidden inherent strength s.
Here, the aspects studied are management quality, promoters’ track record,
business outlook, market competitiveness and relative valuation, as all these
are considered to be inherent strengths. Since promoters and managements
guide the future course of action for a company, the role played by them is
critical. In the Indian context, Reliance Industries has done well across all
kinds of economic environments. Hence, every time the promoters
approach the capital markets, the issues are met with a tremendous
response. This goes to show the importance of the promoters’ role in
driving future growth.

This approach further looks at the financial fundamentals of the company

which is at the core of its valuation. Past performance measured by growth
of top line and bottom-line over a period of time is evaluated. Profit margin
and future profit potential is compared with the margin generated in the
past. Healthy margin patterns driven by good sales growth would ensure
that the company continues to grow in future.

Stock selection is followed by a forecast of industry prospects and general

economic conditions by looking at factors such as GDP growth, Index of
Industrial Production, prevailing rate of interest in the economy and the rate
of inflation. Though these factors are considered secondary to valuation,
they have a limited role to play. No company can remain insulated from the
macro-economic environment in which it operates and hence these factors
cannot be overlooked. However, in this approach, macro-economic factors
are secondary to the performance of a company.

Investors using this approach are typically value investors hunting for a
good bargain. They look at under-researched companies that have the
potential to unlock long-term value and concentrate on the hidden value.
The maxim is that if a stock has strong fundamentals, then it would perform
well in all circumstances. If the situation turns out to be positive, then it can
perform well beyond expectations. However, it should not be forgotten that
stocks are selected to generate returns in all kinds of situations and not only
in the most optimistic situation.

Conclusion

There is no single style that works for everyone or at all times. In practice, a
blend of the top down and bottom up approach would work to your
advantage.

Further, while every style has its advantages, there are also limitations to
each. In the top down approach, by emphasizing too much on economic
conditions and market movement, changes not as per your expectations may
have a larger impact on your portfolio. Likewise, in the bottom up
approach, in the process of focusing on individual companies, industries
and sectors with a promising outlook may be left out. Hence, you must
avoid such pitfalls by taking a balanced view of the micro and macro
variables that influence the investing process.
SUMMARY

• The macro approach starts with macroeconomic factors like the state of
the economy. It then moves to the state of the industry and then to the
company.

• In evaluating the economy’s state, analysts start with looking at

variables such as the growth rate of the economy, the prevailing interest
rate scenario, the political conditions and the regulatory environment,
among others.

• In today’s globalized world, global factors also play a large part in

determining market trends.

• In times of political instability globally, geo-political factors have

assumed significance.

• Try to look for sectors that have immense potential down the line. For
instance, in a growing economy, the infrastructure sector holds promise.

• Although the WE ratio is the most widely used measure of valuing

shares, you cannot use it in isolation for analysis. A high P/E, by itself,
does not mean that a share is expensive.

• The company-based approach is the exact opposite of the macro

approach. It starts with the company i.e. microeconomic factors.

• Sound fundamentals distinguish a company from amongst its peers. A

strong company will perform even in the worst stock market crashes.

• The company-based approach tries to identify companies with latent

inherent strengths and high intrinsic value.
• Investors using this approach are typically value investors hunting for a
good bargain.

Your action points

1. I will keep myself abreast of the global economy.

2. I will read financial news papers and business magazines regularly.

3. Beware; typically retail investors enter the markets when Flls or HNIs
are ready to exit the markets.

4. I will do my own basic research using the macro and company-based

approach.

5. I will ensure that the price I pay to buy the stock is lesser than the
stock’s intrinsic value.

Axioms:

1. Fundamental Research - Gateway to stable investments: You do not

have to do hard core financial research to understand the prospects of a
company or a sector. Just by regularly reading financial papers and
watching financial channels, you can gauge which industries would be
better bets to invest. Then you can pick up a couple of stocks within
that sector for investment. At the same time, remember to seek expert
opinion as well.

2. Diversification remains the key: However confident you might be on

a particular sector, do not put all your hard earned money into any one
sector. Always diversify into various industries. Say for example, the
US economy is expected to do well in future, which is good for the
Indian IT industry; still do not invest only in IT stocks.

3. Peer analysis helps: Always study competing companies. You

should know what the other companies in the industry are doing and
 what Price/ Earnings (PE) ratio they are trading at. Depending upon
their product/ service strength in the market, some companies claim
better P/E.

4. Political situations have a higher say: Be aware of the political

situation in the state or the country. This could impact economic
policies, which in turn will impact the company’s performance and
profitability.

5. Economic indicators can swing the market: The government from

time to time releases certain economy related data like export import
data, inflation, RBI declares CRR and Repo rates. Market experts track
this data closely and take their positions accordingly. Be aware of these
indicators and their implications on the companies; invest accordingly.
 Chapter 13

SOUND INVESTMENT STRATEGIES

Chapter 13
SOUND INVESTMENT STRATEGIES

The stock market in India has seen several ups and downs in the last few
years. How does one manage investment within this kind of volatility? How
do you build wealth in spite of these large, and sometimes scary, market
movements? There are several approaches (strategies) you can adopt while
investing. Some of these are discussed below:

Investment strategy: Value Investing

Value investing simply means investing into shares that are available at a
price below their true value. True value is value emerging from one or a
combination of assets, earnings, dividends, definite prospects and factors of
management. Fundamentals of value investing: Value investing is based on
the following premises:

1) A share of a company represents ownership.

A share is not simply a piece of paper that can be sold at a higher price
on some future date. Shares represent more than just the right to
receive future dividends from the business. Economically, each share is
an undivided interest in all corporate assets and ought to be valued as
such.

2) A share has an intrinsic (true) value.

 A share’s intrinsic value is derived from the economic value of the
underlying business. It is at this inherent value that a share should be
priced. If the share value is less than the intrinsic value, the share
should be purchased and when the share attains its intrinsic value, the
investor would benefit.

3) Who said stock markets were efficient?

The truth is - stock markets are inefficient. This means that there is
always the possibility of making a profit in the market. If the markets
were efficient, the shares would be already priced at their intrinsic
value and hence, there would be no deviation between the intrinsic and
market price. This concept of efficient market believes that a stock is
always properly priced and an investor will not be able to generate
returns from investing in the market.

4) Being committed to the investment.

One of the basics of value investing says that investors need to be

committed to the investments they make. As per the basic principle of
value investing, investors ought to treat investing with seriousness and
studiousness. An investor should treat the shares he buys and sells as a
shopkeeper would treat the merchandise he deals in.

5) Margin of safety

Margin of safety is the difference between the share price and its
intrinsic value. This difference (buffer) absorbs any mistake any
investor might make in his calculations. This margin of safety may be
provided by a firm’s working capital position, past earnings
performance, land assets, economic goodwill, and a combination of
some or all of the above.

Thus the concept of value investing is centred on the fact that you as an
investor can benefit from any deviation in the value of a stock from its
intrinsic value. You need to understand the intrinsic value first before
making your investment. Implementation of value investing in real life
requires that you should look at the financial performance of the company.
Refer to earlier chapters on Fundamental Analysis to analyze financial
performance. Comparison of the company with its peers is also necessary in
case of value investing to understand its relative valuation vis-à-vis its
peers.

For example, assume X Ltd. which is in the business of profitably

manufacturing scooters and is traded at a price of Rs 50 per share. X Ltd.
has a capital of Rs 10 crore (face value Rs 10) and earns a profit of Rs 5
crore every year. The EPS of X Ltd. is Rs 5 (Rs 5 crore divided by 1 crore
shares). The P/E of X Ltd. is 10 (Rs 50 divided by Rs 5). Company Y from
the same industry is trading at a P/E of 8 times. On the face of it, X Ltd. is
reasonably valued, maybe slightly overvalued, compared to Y Ltd. (PIE of
X being 10, vis-à-vis 8 of Y).

However, X Ltd. has investments in other companies whose market value is

Rs 30 crore. That means that against 1 crore shares of X Ltd, it has an
investment portfolio of Rs 30 crore, i.e. Rs 30 per share. This means that
from the current market price of Rs 50 per share of X Ltd. Rs 30 can be
directly attributed to these investments and the market is giving only the
balance Rs 20 to its scooter manufacturing business. With an EPS of Rs 5
and effective price of Rs 20 per share (50 less 30), the WE drops to a very
attractive 4x as against the previously calculated 10x. Company X Ltd. now
becomes an attractive value investment.

Investment strategy: Growth Investing

The growth investing approach believes in investing in those shares, which

have high growth potential. Those who follow this style, known as growth
investors, invest in companies that exhibit signs of above-average growth,
even if the share price appears expensive in terms of metrics such as price
to earnings or price to book ratio.

One of the basic premise on which the growth investing strategy is based is
that companies which have high growth potential can fetch better returns in
future. To identify the high growth potential of a company, some parameters
which are used are as follows:

1) Price Earning Ratio (PIE):

This ratio shows the relationship between the earnings of a share,

reflected by EPS, and the price that the investors are willing to pay for
it. A company with a high WE Ratio is considered to have a high
growth potential. High PIE Ratio means that investors are willing to
pay more for each rupee of profit generated by the company. This is
primarily because the company has a potential to generate profit in the
future at a fast rate which will cover the price paid by the investors.
Another similar kind of ratio used to identify the growth potential of a
company is the Price of Book Value (P/BV). A company selling at a
higher price to book value also reflects the high growth potential. The
premise behind this is the same as above. That is to say that the market
is valuing the company at more than what the book value of the share
is.

2) Future Growth:

The concept of growth investing is based on the fact of future growth

potential of a company. As a result of this all those sectors or
companies which promise future growth potential are treated as growth
sectors or companies. Currently, in India the construction sector as a
whole is being considered as a sector which has high growth potential.
As a result of this, shares belonging to the construction sector are being
picked up as the future growth shares. The reason behind this is that
the construction companies have a big order book which will ensure
revenues and profits in future and in a way they are assured about the
cash flow.

3) Long term growth:

Growth investing is an approach that strongly believes in the long-term

story. This effectively means that there are no short cuts for an investor
 to make profits from growth oriented stocks in the short-term. It takes
some minimum time frame for companies with growth potential to
deliver. In the initial stages, there may be limited profit potential for
these companies, but over a period of time growth companies may start
to bring better-than-expected results for investors. All the investors
desirous of investing in growth shares should be patient over 3 to 5
years to get attractive returns.

Growth investing in brief is like betting on a small company, with ambitious

growth targets, becoming a large company over time. This transformation
will take time and an investor has to be patient while this unfolds and reap
attractive returns. One of the basic tenets of growth investing is to select an
upcoming sector in the economy and then benefit from the growth of that
sector. Some examples of such growth companies which started as small
companies in emerging sectors are Infosys in software, Bharti in telecom,
Unitech in real estate, etc.

Investment strategy: Contrarian Investing

Contrarian investing is taking a contrarian view on the markets. This

normally manifests into investing into sectors and companies that are not
currently in favour by investors. At any given point of time, there are
certain sectors (and stocks within these sectors) that are favoured by
investors. There is a herd mentality which drives investors to fancy these
sectors.

Contrarian investing means taking an opposite view to the currently

prevailing trend. It believes in identifying those stocks which have strong
fundamentals and good growth prospects but, have been ignored by the
market over a period of time. At such times, they are normally available at a
price lower than their intrinsic price allowing a patient investor to benefit
from it.

Contrarian investing is based on the following tenets:

1) Invest in ‘value’ stocks which are overlooked by the market:

Contrarian investing believes in intrinsic value like value investing. It

emphasizes on the fact that one should look at those stocks which have
been overlooked by the market. At any given point of time, there are
companies which are fundamentally sound but, possibly facing
temporary problems, which are ignored by investors and hence
available at attractive values. For successful identification of these
stocks, it is important to understand the company’s fundamentals, their
future potential, and reasons for being ignored by investors and also
validate that such reasons are temporary and will be overcome by the
company. There are several contra mutual funds in the market which
invest on this idea.

2) Stay objective:

Contrarian investing also believes in the fact that an investor should

not chase the market, but should try to invest in the shares with
potential that are currently ignored by investors having good potential.
The basic premise is to avoid herd mentality and think independently.

Contrarian investing is very much like value investing except, that the
focus is specifically towards sectors and shares that are not currently
fancied by markets. Often this form of investing is made when a sector
or share has been beaten down in the markets due to some reason.

Investment strategy: Value Averaging

The problem with volatile equity markets is that you are never sure whether
you are buying at the bottom and selling at the top. Buying low and selling
high, i.e., timing the markets has rarely been successful for most investors.
Emotions often play a significant part in deciding buy and sell levels,
sometimes with disastrous results on returns and capital.

Value Averaging is based on the premise of removing the human decision of

“timing the market” from equity investing and instead the entry and exit
decisions are left to the market. In case of value averaging, an investor
always tries to maintain the value of his holdings at a particular level. In
case there is excess investment, the same is withdrawn and in case there is a
shortfall, the same is replenished. Market volatility is then used for one’s
own benefit. An example will help understanding this.

You decide that you would like to invest Rs 1 lakh in the stock markets
every year and would like to increase your exposure in the market every
year by Rs 1 lakh. The important word here is ‘exposure’ and not
investment. Now if by the end of Year 1 your investment value increases by
50%, i.e., your exposure to equity markets is now worth Rs 1.5 lakh. As
your investment by start of Year 2 already stands at Rs 1.5 lakh, you invest
only Rs 50,000 in the market in Year 2 to take your total market exposure to
Rs 2 lakh, while investing the balance in debt. By Year 3, assume the
market crashes and your investment value comes down by 50%, i.e.,
becomes Rs 1 lakh. As per your Value Averaging strategy, the value of your
investment should have been be Rs 3 lakh, i.e., you are short by Rs 2 lakh,
which is what should be invested (from your new savings and pulling
money out of debt). By Year 4, the market has zoomed up and has doubled,
i.e. your investment value of Rs 3 lakh now stands at Rs 6 lakh! What is
needed as per your plan is only Rs 4 lakh, i.e. instead of investing further in
the market at this point, sell off Rs 2 lakh and invest this in debt. And so on
and so forth.

In effect, instead of you deciding as to when to enter or exit the markets, the
market depending on its prevailing level is making this decision for you. If
the market is high (overheated), it triggers off a divestment out of the
market and similarly if its low (undervalued), it triggers off an investment
in the market.

This wraps up the various investment strategies that can be deployed in the
markets. A combination of these strategies would prove most beneficial as
you would then be able to develop a portfolio of shares that have been
identified from different strategies. Such a portfolio of shares is expected to
generate out performance returns with diversified risk.
Investing Strategies
Value Investing Growth Investing Contrarin Investing Value Averaging
• A share • Using the P/E • Inves inn value • Any time the maker
represents ratio to assess stock ignored by
ownershop grwoth stocks the market
• A share has • Assessing the • Stay objective • Take advantage of market
interisic future growth volatility
value
• Stock • Assess long   • Control the value of your
markets are growth holding to eh level you are
not efficient confortable with
• Be      
committed to
your
investment
• Have a      
margin of
safety
SUMMARY

• Although the Sensex has grown phenomenally, it has not been a smooth
journey. Numerous corrections have shaken investor confidence.

• Picking an investment strategy suited to you will ensure that you sit
through market volatility and wait for your stocks to deliver value.

• These strategies include value investing, growth investing, contrarian

investing and value averaging.

• Value investing believes that the stock market is inefficient. If the

markets were efficient, the shares would have been already priced at
their intrinsic value. There would be no opportunity for trading and
consequently no scope for profits.

• There is no place for sentiment in value investing. One must look at the
stock market with a clear, unprejudiced eye.

• Growth investors invest in companies with above-average growth, even

if the share price appears expensive when measured in conventional
valuation metrics.

• Growth investors don’t look for short-term profits. The very premise of
growth investing is to invest in stocks that have high growth potential,
which could fructify in the long-term.

• Contrarian investors go one way while the rest of the market takes the
exact opposite way.

• The contrarian investing philosophy believes in going against the herd

mentality. This means picking up shares of companies that are in
temporary trouble, hence currently ignored by the market.
• Contrarian investing is similar to value investing, where both sets of
investors place importance on the value of the company and its future
potential.

• Few can time the market i.e. buying at the lowest dip and selling at the
highest peak.

• Value averaging aims to do away with the human element of timing the
market.

• Using a combination of investing strategies leads to a well-diversified

portfolio.

Your action points

1. I won’t panic when the markets are volatile and there are negative
returns in my portfolio.

2. I will take a contrarian view after consulting experts or will do

research well.

3. Timing the market is very difficult; I will try to average my investment

by buying the same stock at lower levels.

4. Instead of buying all the shares at one price, I will slowly and
gradually accumulate them.

5. I will have a well diversified portfolio of stocks and spread the risk
across.

Axioms:

1. Volatile markets - Swings your portfolio into gains and losses:

Though Sensex has moved up over the past years, it also has been
subjected to huge volatility. This volatility gives you entry and exit
 points. If you are sitting on healthy profits, it is advisable to book
partial profits.

2. Long term investment remains the key: To avoid short term

volatility, it is advisable to be a long term investor in the markets. Do
research, identify good growth company and invest in it for 2-3 years
time frame.

3. Don’t be emotional with your investments: If you have lost money

in a particular stock, don’t get emotional and aim at making money in
the very same stock.

4. Buy on dips and sell at peaks - Not possible for experts also: It is
very difficult to time the market even for the experts. To take care you
do not get caught at the wrong side, average the stock at different
levels.

5. Contrarian view for informed investors: Taking a contrarian view in

the markets can prove fatal sometimes. It requires patience and
temporary loss bearing capability. One cannot take a contrarian view
just for the heck of taking it. This has to be taken with the help of an
expert view and with your own conviction in the markets.
 Chapter 14

INVESTING IN EQUITY IS IT EXPENSIVE?

Chapter 14
INVESTING IN EQUITY IS IT EXPENSIVE?

Having understood the many facets of equity investments, we now come to

the important question: How are these on the wallet?

Transaction charges in equity investments vary from broker to broker.

Brokers offer various schemes for different types of investors/ traders.
Frequent and high value investors/traders may be offered lower rates.

Further, it must be borne in mind that these are transaction charges and are
levied when you buy or sell; they don’t include taxes which you have to pay
when you earn a profit. Hence, even in the event of losses, you will have to
pay these charges which effectively increase your losses.

Brokerage:

Your broker charges a commission based fee for all transactions of purchase
as well as sale of shares. Increased competition has drastically reduced
brokerage fees over the years. Typically, retail customers incur a brokerage
of 0.25 per cent to 0.50 per cent of the transaction value. Hence, if you ask
your broker to purchase 100 shares of a company @ Rs 1700/share and
your brokerage charge is 0.50 per cent, then the brokerage cost will be Rs
8.50 per share (0.50 per cent of Rs 1700) and your cost of shares would
increase from Rs 1700 to Rs 1708.5 per share (other charges explained
below are not considered).
Brokerage rates could be lower if you do not buy and sell for delivery and
square off the transaction on the same day (intra-day). For instance, if you
buy 100 shares of a company and sell them on the same day itself, then you
may incur a brokerage of 0.03 per cent to 0.05 per cent. Continuing the
above example of 100 shares of the company bought at Rs 1700 per share
and assuming intra-day brokerage of 0.05 per cent, the brokerage at the
time of purchase could be Rs 0.85 per share (0.05 per cent of Rs 1700).
Similarly, 0.05% could be payable on the sale price when you sell the
shares on the same day.

Goods and Service Tax:

Brokerage commission is now subject to Goods and Service Tax (GST)

which a broker will charge you and pay to the government. The current
GST rate is 18 per cent which is charged on the brokerage (not on the
transaction amount)
Securities Transaction Tax (STT):

Buying and selling of shares is also subjected to Securities Transaction Tax

(STT). STT would be applicable whenever a buy or sell transaction is
executed on a recognized stock exchange like NSE or BSE. It is levied on
the transaction value. Hence, off market transactions such as “Open Offers”,
“Buy back of shares”, etc. are exempt from STT.

Individuals, whose income from share transactions is treated as business

income (i.e., traders, as opposed to investors) can claim a rebate for the STT
paid by them on such share transactions. The condition is that the total STT
amount refundable should not exceed the tax payable amount on earnings
out of share transactions.

The rate at which STT is presently levied on different transactions is

depicted in the table below:
STT RATES
Product Transaction STT rate Charged on
Equity – delivery   0.10% Turnover
  Sell 0.10% Turnover
Equity – intra day   NIL -
  Sell 0.025% Turnover
Futures   NIL -
  Sell 0.010% Turnover
Options   0.125% Settlement
  Sell 0.05% Price, on exercise premium

STT of 0.001% is charged by the AMC at redemption of units to the seller

of the units only on equity schemes.

Demat Account:

Like different brokers have different brokerage structures, different

Depository Participants (DPs) charge different fees for rendering depository
services. You should thoroughly understand the charge structure and
confirm the same with your DP before signing the agreement for opening a
demat account. There are no account opening charges (except statutory
charges). No demat charges are levied for purchase (credit) of shares. The
demat charges generally charged by the DPs to the investors are for yearly
account maintenance, demat of physical share certificates and transaction
charges for sale (debit).

Turnover Tax:

At present, the turnover tax on cash market transactions is 0.0037 per cent
of the transaction value.

It is levied on purchase and sale transactions. On futures and options

transactions the rate is 0.0014 per cent.

Stamp Duty:

Stamp duty on broker contract notes is levied at 0.01 per cent of the
transaction value. It is levied on purchase as well as sale transactions.

Capital Gains:

Gains from shares held for more than one year and on which STT is paid on
sale are considered long-term capital gains and subject to 10 per cent tax
rate. Gains from shares held for less than one year and on which STT is
paid on sale are considered short-term capital gains and taxed @ 15 per cent
(plus surcharge and education cess)
SUMMARY

• The transaction rate of investing in equities varies from one brokerage

house to another.

• High-volume traders and high networth individuals may get lower rates.

• Transaction charges are irrespective of the taxes paid on making a

profit. They are charged even in case of a loss.

• Retail customers incur a brokerage of 0.25% to 0.50% of the transaction

value.

• Brokerage, commission is subject to 18 per cent GST which is charged

on the brokerage amount.

• Securities Transaction Tax is applicable on every transaction made on

the stock exchange.

• Different Depository Participants charge different fees for opening and

operating demat accounts. The demat charges are for yearly account
maintenance, demat of physical share certificates and transaction
charges for sale (debit).

• The turnover tax on cash market transactions is 0.0037% of the

transaction value.

• Stamp duty on broker contract notes is levied at 0.01% of the

transaction value.

• If gains accrue from shares held for less than a year and you pay STT
on the sale, the gains are considered short-term capital gains and taxed
at a 15% rate (plus surcharge and education cess).
Your action points

1. I will select a broker not only because of lower brokerage, but a broker
who can also provide me good research.

2. I will calculate my investment returns after deducting brokerage and

taxes.

3. I know I can buy and sell without taking delivery and square off the
position on the same day as well.

4. I will save on STT by being a long term investor.

5. If I start trading as a business, then I will claim rebate on SIT.

Axioms

1. Know the cost and your returns: While investing in the stock
market, understand the costs involved. You should know that you have
to pay brokerage and taxes on your investments. What is left is your
return!

2. More trading means lower charges: High-volume traders and high

networth individuals can get lower rates. If you are going to regularly
trade, then you can also ask your broker to give you some concession
on the brokerage fees.

3. Long term investment pays: It is known that long term investment

gives better returns. You should also know that you pay lower taxes as
well. Gains from shares held for more than one year and on which STT
is paid on sale are considered long-term capital gains and taxed at 10
per cent.
 Chapter 15

INVEST ONLINE
Chapter 15
INVEST ONLINE

Investing online enables you to operate your share trading account through
the internet from anywhere in the world. It does away with the hassles of
contacting your broker on the phone to place orders, as you could punch in
the order yourself. This is the single biggest convenience that is making
online option popular in India, like other countries.

Many brokers prefer clients opting for online investing and are promoting it
over the conventional method as it saves costs, which they would otherwise
incur on running a conventional outlet, like rent for space, salaries,
electricity charges, etc. Among investors too, particularly the young tech
savvy lot, online investing is gaining popularity, as it offers flexibility.

How do I invest online?

You would primarily be required to open a broking account. Needless to

mention, an internet connection is a pre-requisite for accessing the online
facility. You would then need to link a savings bank account and a demat
account with the broking account. Brokers usually have a panel of banks for
this purpose. If you already have an account with a bank on the panel, then
you may link this account to the broking account instead of opening a fresh
one. On having finished the formalities and enrolling for the facility, you
would be assigned a username, a password and a pin number. These are
important for security and identification. Functions in an online broking
account are quite similar to conventional broking accounts. While placing
an order, you are required to feed in the company code, name of the
exchange, number of shares you wish to buy or sell and the type of order
(limit/market, etc. Refer to Chapter 10 - The Investing Process). The
broker’s system will then process the order provided your bank account
holds sufficient money for the transaction. If you qualify on these
parameters, then the broker’s system will forward the order to the exchange
and the order would get executed.

Understanding different kinds of orders

You need to feed in the type of order, i.e., whether it’s a limit order or a
market order. A market order gets executed immediately at the prevailing
market price. Other orders follow the exchange’s rule of price time priority.
Price time priority means that the highest bid (buy) price and the lowest
offer (sell) price for a stock gets priority. If there is more than one order at
the same price level, then the one punched in earlier would get priority.
From the time you feed in the order till its execution, each process is carried
out electronically.
After the order is executed

If your purchase order for shares has got executed, then the broker will
debit your bank account with the required funds for the transaction. As per
SEBI directions, your broker is required to transfer the shares from its pool
account to your demat account within one working day after the pay-out
day.

In case of selling of shares, if your order for selling shares gets executed,
your broker will debit your demat account with the required shares. Your
broker is required to transfer funds to your bank account within one
working day after the pay-out day. The lag is because of the T+2 settlement
cycle that is followed in Indian capital markets.

If you’ve bought and sold shares the same day, then the differential amount
would be adjusted in your account.

Like in the case of conventional trading, all transactions carried out will be
supported with contract notes from the broker.

Brokerage expenses for online trading and offline trading should be

confirmed from the broker at the time of opening a trading account. In case
of online trading, you will need an internet connection.

Online security:

In the light of growing cyber crime and internet fraud, you may be a little
hesitant to adopt online trading. To address such anxiety, technology has
come to our aid to make the internet transactions secured and provide
necessary confidence to you about the system. The major concern that you
may have is “Am I doing the transaction on the authentic website?” and the
second major concern could be “Will someone be able to trap my
transaction and make changes in it?” These concerns are addressed by
having Secured Socket Layer (SSL) implementation. Reputed and trusted
third party agencies, after doing due-diligence, issue an electronic
certificate providing the reference to the URL (website). You can verify this
on your browser and if it confirms, you can safely assume that you are
transacting on an authentic site. Further, this also facilitates strong
encryption of data being transmitted between your browser and website.
This ensures that no one can trap and modify the transaction. However, you
must be vigilant of your computer system at all times. If the same is weak it
may so happen that certain programs are installed on your system without
your knowledge and with malicious intentions. These could pose a threat to
your data. You also need to ensure that the credentials such as Password and
PIN are complex enough so as to make it difficult for anyone to guess or
crack them, but at the same time logical so as to ensure that you remember
them. Please do not write such details on paper because this could be easily
lost and someone can get hold of your credentials making it easy for them
to access and transact on behalf of you.

However, it remains your prerogative to ensure that no one apart from you
gets to know your password and PIN. It is advisable to keep changing the
password and PIN at regular intervals to ensure safety. Some software
automatically logs you off from the site if there is no activity for 30
minutes. Further, if you suspect a leakage of any information, you must
immediately inform the broker. The broker can issue a fresh password and
PIN.

Investing online - the benefits:

Reduced Paper work:

If you are a regular trader and tired of the cumbersome paper work of
regularly issuing cheques, filling up demat account delivery slips every time
you sell shares, then online trading is a much more convenient alternative.

Overcoming communication related errors:

In conventional offline share trading, there are instances of

miscommunication between the broker and the client, leading to errors in
order feeding. Online trading does away with this problem as the client
feeds in the order himself.
Access to information:

You can feed in all the shares of your interest in a single window on the
trading screen and track the movement on a real time basis, without having
to call up your broker from time to time to inquire rates of several shares.
Most software applications have news tickers which enable you to react
briskly and timely to news developments.

Overcoming location limitations:

You can access your trading account from anywhere in the world with a
computer and an internet connection, which otherwise would be a quite
cumbersome by the conventional offline method.

Lower settlement risk:

Every time shares are sold, the system initiates delivery. It does away with
the chance of delivery not being met due to negligence or lack of
communication between the broker and client.

There are pros and cons to everything and online trading too is not spared
of some minor problems. However, the reason why these are
“impediments” and not “disadvantages” is that these are not fundamental
problems, but are issues which arise in operation and can be overcome.

Infrastructure! glitches:
Good speed broadband services in India are quite expensive. Connectivity
is often disturbed by interruptions and disconnection. For running online
trading software optimally, you need to have reliable broadband
connectivity, at a decent speed, as the software flashes share prices on real
time basis. An inefficient service would result in delayed rates. This defeats
the very purpose of the system, as your trades are then based on incorrect
information.

Adapting to technology:

A certain section of non tech savvy investors might resist the online trading
platform or would not be comfortable with the system. If you are one of
those, then you would require adequate training before using such a system
as it may lead to mistakes in entering orders, which could prove costly if
amounts involved are huge.

As aforesaid, these are only minor issues and it is evident that the pros far
outweigh the cons and online trading seems to be the way forward for
transacting in stocks.
SUMMARY

• Investing online is popular because it gives you the convenience of

conducting transactions at the click of the mouse.

• Brokers and banks work together to offer this facility.

• It is easy to start investing online. Your security is also assured with

your account protected by a username, a password and a pin number.

• A market order is executed immediately at the prevailing market price.

• As in conventional trading, all completed transactions are supported

with contract notes from the broker.

• Security is not an issue with online investing as most brokerage systems

install the most advanced security systems in the world. Some of these
systems include using 128-bit encryption systems and electronic tokens.

• Even with the most advanced security measures, it is essential that you
follow basic guidelines like not disclosing your password and PIN to
anyone.

• The advantages of investing online include less paperwork, fewer

communication-related errors and better access to information. In
addition, you can transact from the comfort of your own home or office.

• The only hitches to investing online could be the non-availability of

broadband internet to all and older investors who are uncomfortable
with new technology.

Your action points

1. Having an online investing account would allow me to transact at my
own convenience.

2. By using the online investing facility, I will not need to depend on any
broker to transact on my behalf.

3. I will take all precautions to avoid my transactions getting tampered.

4. My orders would get immediately executed at the click of the button.

5. I know how important it is to keep my password and PIN safe and

would change them frequently.

Axioms

1. Execute your orders at the click of a button with online investing -

Broking houses are now promoting investors to go online in order to
avoid fixed costs like office space, people etc. For an investor, it is
trading at your own convenience.

2. Online investing enables going green - Using the online facility

would reduce ample amount of paper work and also would save you
from signing delivery slips and cheques frequently.

3. Take all safety measures while using the online medium - You can
transact online safely by taking security certificate for the URL from
third party agencies. In addition, there are cyber cells that can come to
your rescue. However, remember, prevention of fraud is better then
follow up!

4. If you are young and tech savvy - Go the internet way: Online
investing is very convenient for the young generation who also have
constant access to internet. These young people can start investing
early and also make use of the latest technological forays rather than
investing in a traditional manner.
5. Good broadband connection a must for online investing - Share
prices are updated dynamically when you are transacting online. If any
delays in the updation of these prices due to bad connection, then the
very purpose of transacting online would get defeated.
 Chapter 16

KEEPING TRACK OF ANNOUNCEMENTS

Chapter 16
KEEPING TRACK OF ANNOUNCEMENTS

Now that you are certain about how to go about investing in equity, here’s
an insight to the background of these investments and other shares related
transactions, between you, the investor and the company.

About corporate actions

Corporate actions are events initiated by corporates, which impact

shareholders. They could be cash corporate actions like dividends, interest
payments, etc. or non-cash corporate actions like issue of bonus shares,
splitting the face value, consolidation, merger, etc. that result in change in
the number of securities held by the shareholder or allotment of other
securities to the shareholder.

The depositories facilitate the issuer to distribute securities arising out of

non-cash corporate actions in dematerialized form directly to the account of
the investor.

At the request of the issuer, the depository electronically provides details of

beneficial owners to the Issuer/R&T Agent as on the date of book
closure/record date. The Issuers’ request for the beneficial owners’ details
as on one day prior to the book closure start date or as on the record date
(e.g. If book closure is from September 6, 2017 to September 10, 2017, the
Issuer will request for beneficial owner details as on September 5, 2017. If
record date is on September 5, 2017, the Issuer will request for beneficial
owner details as on September 5, 2017. The details provided by the
depository include particulars such as name, address, bank account details
etc. of the beneficial owners.

Cash-based corporate actions

The issuer/R&T agent distributes dividend, interest and other monetary

benefits directly to the beneficial owners on the basis of information
provided by the depository in respect of securities held by the beneficial
owner in dematerialized form in the depository system. If the bank details
including MICR number are valid, the Issuer may use Electronic Clearing
System (ECS) to credit dividend/ interest directly into the bank account of
the beneficial owner. Bank account details as furnished by the beneficial
owners to Depository Participants (DPs) are printed by the Issuer on the
dividend/interest warrant. It is important for beneficial owners to verify that
the bank account details mentioned in their DP account are accurate. This
will avoid delays in receiving dividend etc.

Non-cash-based corporate actions

The Issuer collates the entitlements of the beneficial owners who are to be
given securities in dematerialized form. Based on the entitlement details
uploaded by the Issuer, credits are effected to the accounts of the beneficial
owners on the execution date mentioned by the Issuer. If the account
number of the beneficial owner to which the Issuer intends to give credit
does not match with those maintained at the depository, the Issuer obtains
the correct account number from the beneficial owner in order to give credit
of securities in electronic form or the Issuer may have to distribute the
securities in physical form.

Automation

Credit of securities corresponding to a non-cash corporate action, which is

based on a pre-determined ratio (e.g. bonus shares, split of shares,
consolidation of shares, securities issued as a part of merger/de-
merger/amalgamation scheme etc.) is automated in the depository system.

In an automatic corporate action, the issuer/R&T agent sets up the ratio of

entitlements in the depository system, based on which the system
automatically credits entitlements into the beneficial owner’s demat account
on the ‘execution date’.

The ‘why’ of corporate actions

Companies initiate corporate actions for a number of reasons. One of the

prime reasons is increasing shareholder wealth. Other reasons vary
depending on the type of corporate action. Stock splits and reverse stock
splits are undertaken with the idea of improving the marketability of the
securities. Issue of rights and warrants aid the company in raising additional
funds for expansion programs, acquiring other companies and meeting
additional working capital requirements.

Dates to remember:
• Announcement date

This is the date on which a decision is taken by the board of directors

for any type of corporate action. For example, if the Board of Directors
held a meeting on 1st September to declare dividend, this date is the
Announcement Date.

• Ex-Date

This is the date from which securities are traded on the stock exchange
without right to the buyer for the corporate benefits.

• Record date

This is the cut-off date for determining the list of the shareholders who
are entitled for the corporate action.

All about dividends

Dividends are the most common corporate action undertaken by any

company. The most common form of dividend is cash dividend; however, a
company can also pay stock dividends.
A company rewards its stockholders by sharing its profits by issuing cash
dividends. For example, if Company X announces 30 per cent dividend, the
shareholder is entitled to receive Rs 3 per share on every share of Rs 10
face value held by him. The dividend is sent across to the shareholder in the
form of a cheque or transferred to his bank account.

Regular dividend paying companies also increase shareholder value. Let us

understand this by way of an example:

If X Ltd. had not declared any dividends in the last four years your profit
would be Rs 25 (Rs 75 less Rs 50) i.e. 50%.

Further, regular dividends also indicate stabilization of company’s profits

and its capacity to generate sufficient earnings for distribution as well as
retention.

About bonus shares

Bonus shares are issued as a way of celebrating growth with the

shareholders of the company. Reserves (i.e. past retained profits) are
distributed to the shareholders in the form of bonus shares. These free
shares are issued to the existing shareholders on a fixed proportion. A bonus
issue will increase the company’s outstanding shares and hence dilute the
existing earnings per share. The shares become more attractive due to a fall
in prices.

Assume X Ltd. has an equity capital of Rs 40 crore (4 crore shares of Rs 10

each) and reserves of Rs 200 crore and the market price of X Ltd.’s share is
Rs 100. X Ltd. declared a bonus of 1:2, i.e. for every 2 shares held,
shareholders will be rewarded with 1 share.

On declaration of bonus, X Ltd.’s capital will increase by Rs 20 crore and

reserves will go down by the same amount.

Market price of X Ltd.’s share will theoretically drop from Rs 100 to Rs

66.7 (Rs 200 divided by 3 shares) to reflect adjustments in a manner where
the post bonus market capitalization remains the same.

Split!

A stock split, as the name suggests, means splitting the existing stock
(share) into smaller units of the stock. The smaller units have a lower face
value as compared to the existing stock. Unlike a bonus, the stock split does
not change or affect the equity of the company but reduces the price of the
share by the same proportion. Theoretically, the market capitalization would
also remain the same. The main reason a company would split its stock is to
increase the number of shares in the market and create more liquidity.

Market Capitalization of X Ltd Market Capitalization of X

(pre bonus): Rs. _ 400 crores (4 Ltd (post bonus): Rs. 400
=
crore - shares x Rs.1001 crores (6 crores shares x Rs.
66.7)

For example:

Suppose you hold 20 shares of X Ltd., which declares a stock split in 5:1
ratio.
Theoretically, the share price should fall in proportion to the increase in the
number of shares. However, the reduced share price and increased number
of shares in the market will attract more interest, as more investors, who
were otherwise not in a position to purchase a higher priced stock, will be
attracted to buy.

Face Value Rs. 10 per Share

Market price Rs. 800 per share
Number of shares before stock split 20
Number of share after stock split 100 (20 share x 5, since
ratio is 5:1)
Theoretically, the market price of the share the Rs. 160 per share (Rs.
stcok split should fall to 800/5)

Reverse Split!

Consolidating stocks with lesser face value to a higher face value is known
as reverse stock split.

The strategy of reverse stock split is undertaken with the motive of making
the stock look worthy an investment in comparison to other stocks in the
peer group. This may work for newer companies having lesser investment
interest over the initial years of their listing, owing to lacklustre business
performance, but with a turnaround business plan in place. The stock may
gain momentum and become an attractive investment post reverse stock
split. Buy it back!

A share buyback is exactly the opposite of issuance of shares. The company

offers to buy back the shares from its shareholders. Buy back price is
usually higher than the prevailing market price to persuade shareholders to
offer their shares.
If the management thinks that the stock is relatively undervalued and/or it
does not have an attractive opportunity to deploy its cash reserves, it could
offer to buyback the shares which would consequently increase the
company’s EPS and reward its shareholders.

Once a company buybacks its shares, it reduces its outstanding capital (as a
company cannot hold its own shares under the Companies Act. Bought
back shares must be immediately cancelled by the company), reducing the
number of shares and making the stock less liquid (reduced supply). As the
company’s earnings will now be distributed over a lesser number of shares,
it will result in an increase in EPS and improve the overall financial health
of the company, i.e., ratios like return on assets (ROA) and return on equity
(ROE) improve as the company’s equity has shrunk.

Blue chip companies like Bajaj Auto and Reliance Industries had
announced massive buybacks in the past. But, for a fast growing economy
like India, a company will have enough avenues to invest in the form of
investments in R&D, acquisitions, expansion of business to name a few of
them.

Promoters may choose not to participate in the buyback and on a reduced

capital base their holdings will increase. This could also be one of the
reasons for a buyback. For example, X Ltd. has a capital of Rs 40 crore and
promoters hold 50 per cent of these shares. X Ltd. announces a buyback of
20 per cent of its capital, i.e., 80 lakh shares of face value of Rs 10 each (20
per cent of 4 crore shares of face value Rs 10). If promoters don’t
participate in this buy back, once the share capital of the company has
shrunk from 4 crore shares to 3.20 crore share (4 crore less 0.80 crore),
promoters holding will increase from 50 per cent to 62.5 percent (2/3.20 x
100).

However, you must take a call keeping the following in mind:

Holding on to the shares or selling it off in the buyback offer - in case you
expect the stock price to increase even beyond the buyback price in the near
future then it is best that you do not tender your shares.
Selling in the buyback offer or selling in the secondary market – this is
relevant because on buyback of shares you would not enjoy the lower
capital gains taxes (15 per cent for short term gains and 10% long term only
if above Rs 1 lakh) which you can avail of if you sell your shares on the
stock exchange. Your capital gains taxes could be higher nullifying the
benefit of any higher price the company may offer vis-à-vis the market
price.

Restrictions on Buybacks

• Buyback needs to be approved by passing a special resolution in the

general meeting.

• The company needs to file a solvency declaration with the Registrar of

Companies and Securities and Exchange Board of India (SEBI).

• The shares bought back should cease to exist.

• Buyback is restricted to 25 per cent of the total paid-up capital and free
reserves.

• No further stocks should be issued over the next six months, except
bonus stocks and conversion of warrants.

Exercise your rights!

Rights issues arise when a company offers to its existing shareholders the
right to buy new shares normally at a discount to the existing market price.
Rights are granted to existing shareholders in proportion to their existing
holdings. For example, X Ltd. having a capital of Rs 40 crore and traded at
Rs 50 per share announces a rights issue of 3:4 at a price of Rs 40 per share.
This means for every 400 shares of X Ltd. that you hold you now have the
right to subscribe (buy) 300 shares at a price of Rs 40 per share.
Rights are exercisable for a limited period of time, known as the
subscription period. Rights may also be renounced in favour of someone
else for a price. The post rights issue price is accordingly adjusted.

Continuing with the above example:

Current value of your holdings = 50 x 400 = 20,000 (A) Value added if

rights exercised =
40 x 300 =12,000 (B)

Total post rights value = A + B = 32,000 (C) Total post rights number of
shares = 400 +300 = 700 (D)

Theoretical post rights price = C/ D = 45.7

In effect, in case you choose not to subscribe to the Rights Issue, you can
instead choose to renounce it and the theoretical price for the same would
be Rs 45.7 per share, i.e., a premium of Rs 5.7 to the Rights Issue price of
Rs 40 per share.

After delisting, if you still hold the securities, you can return them to the
promoter, within a period of six months from the date of delisting and, the
promoter will buy them at the same final price that is paid to the other
shareholders.

Mergers & Acquisitions (M&A)

A merger or an amalgamation refers to a combination of two companies

where shareholders of merging company are offered shares of the merged
company. There is a mutual decision between two companies to merge into
one entity. The merger should be approved by a vote of shareholders of
each company and the High Court(s) of the State(s) in which the registered
offices of the companies are located. Mergers are planned with the objective
of achieving operational synergies, cost advantages and significant
expansion in the market share of the business.
An acquisition on the other hand is a company acquiring a large stake or the
entire stake in another company. The difference in this case is that the
acquired company does not cease to exist. Consequently, there is no share
exchange involved. However, as the acquirer company controls the acquired
company, the shareholders of the acquirer indirectly have a stake in the
acquired company.
SUMMARY

• Be a conscientious investor. Keep yourself updated on various company

happenings as they could be to your benefit.

• When a company interacts with its shareholders through AGMs,

announcing dividends, buyback of securities etc. it is a corporate action.

• Corporate actions are voluntary and involuntary. Voluntary actions

include issuance of rights and involuntary actions include issue of bonus
shares etc.

• Cash dividends are a form of reward for stockholders.

• Cash and stock dividends both come from distributable equity.

• Past, retained profits are distributed to the shareholders in the form of

bonus shares, which are free.

• A stock split does not change or affect the equity of the company;
however, it reduces the price of the share by the same proportion.

• A reverse stock split makes the stock look like a good investment
compared to other stocks in the peer group; reverse stock splits rarely
take place in India.

• In a share buy back, the price is usually higher than the prevailing
market price; buyback is restricted to 25% of the total paid-up capital
and free reserves.

• In a rights issue, rights are granted to existing shareholders in

proportion to their existing holdings.
• Mergers achieve operational synergies, cost advantages and significant
expansion in market share.

• There are three types of M&As: horizontal, vertical and conglomerate.

• A promoter or an acquirer cannot purchase more than 55% of the shares

of a company, except by way of an open offer to the public.

• An open offer is shareholder-friendly, democratic and a transparent

mechanism.

• De-mergers happen if the business unit is unprofitable or if the

management proposes to move out of that business and hive it off.

Your action points

1. I will keep myself abreast of the corporate actions of the company.

2. Dividends are my profits which are in addition to the rise in stock price
(over my purchase cost).

3. Before exercising my option to subscribe to the rights issue, I will do

research about the growth aspects of the company.

4. I will make myself aware about a merger or de-merger of the

company’s business unit to assess whether it’s beneficial or otherwise.

5. I will keep track of announcements of buyback of shares by the

company. It’s a positive step because this shows the management’s
confidence in the growth prospects of the company.

Axioms

1. Low risk appetite - Invest in high dividend paying companies: If you

do not have much time to do research in stock markets, but still want to
 be a part of it, then you have a safe option of investing in high dividend
yield companies. However, make sure your entry point into the stock is
at reasonable levels.

2. Corporate action - A good opportunity for an Investor: Any corporate

action like buyback, bonus shares, stock split, etc would give you a
good opportunity to enter or exit from the stock with positive returns.
However, remember your actions should be swift or else you would
lose a good opportunity.

3. Stock split creates better liquidity in the market: Stock split

basically splits the face value of the stock but does not change the
equity. We can see change in the share price but market cap of the
company remains intact. More market participants can own the stock in
this case.

4. Issue of Bonus shares reduces the earnings per share: Bonus shares
increases the equity and thus dilutes earnings per share (EPS). EPS is
calculated by PAT / number of equity shares. Though investors get free
shares as bonus from the company, share price can fall since EPS
would fall.

5. Merger/Demerger - An action towards better future: When a

company merges two of its business units, it would be able to utilize
the combined resources in a better way and thus increase shareholder
value. In the case of de-merger of business unit, by hiving off its loss
making entity, the management can now focus on the core business of
the company in a better way.
 Chapter 17

DON’T IGNORE YOUR INVESTMENTS!

Chapter 17
DON’T IGNORE YOUR INVESTMENTS!

Investing in equity is not just a one-time affair. It should not stop at tracking
the stock market, selecting stocks and investing in them. It must go beyond
that. Investing in shares is probably only half the job. Once you have
carefully chosen your stocks, you must monitor your investment portfolio
rigorously. In fact, not only does it involve tracking developments related to
the stocks that you have purchased, but also tracking the industries to which
they belong, their competitors, events that impact the capital markets and
the economy at large and overall global developments too.

Once you have carefully chosen your stocks, you must monitor your
investment portfolio rigorously.

Moreover, managing equity investments requires periodic churning, that is,

buying of fresh stocks and selling of overpriced stocks. The whole process
also demands expert knowledge and experience.

Therefore, equity does not allow you the luxury of sleeping over your
investment just as would be possible in case of fixed income securities.
Besides, as Indian markets no longer work in isolation, you also need to be
well aware of global issues which affect the future prosperity of your
investment. For instance, the phenomena of mergers and acquisitions in
global telecom, steel and non-ferrous metal industries are also impacting
Indian companies. In the same vein, if there is a credit crisis that has struck
the US market, Indian equity is likely to feel tremors and that will also
impact the value of the stocks that you hold.

Maintaining an investment portfolio

Reviewing valuations of your equity investment on a periodic basis is a

necessity. It will help you to gauge which stocks are undervalued, which
may be approaching their fair value and determine which ones are trading
above their fair value. Thus, you can churn your portfolio accordingly.

You can maintain an excel sheet in which you could key in your
investments and update it on a periodic basis, say monthly or weekly.

Portfolio trackers

Wealth or portfolio trackers are also provided by various brokers and

websites. They help you to keep a track of your investments, cash flows and
give you a real time view of your net worth through regular price updates.
With ready access to intra-day movements in the value of the stocks that
you hold, it could become easier to decide what to sell and what to hold.

Portfolio trackers provided by brokers and websites help you keep

track of your investments, cash flows and give you a real time view of
your net worth through regular price updates.

Portfolio assessment - long-term and short-term

Further, you can also divide your portfolio into long-term and short-term
holdings. The long-term portfolio would require lesser micro management.
Short-term stocks however, would require more rigorous and regular
monitoring of share prices and developments related to the company and
industry.

Portfolio assessment - sector wise

You should also segregate your stocks under various sectors which would
help you to analyze your exposure to various sectors. Portfolio balancing
can be achieved by managing or limiting overexposure to a particular
industry.

Assessing financial performance

The annual report of a company is a good source of information and a must

read for investors. These will generally be available on the websites of the
companies whose stocks you possess. Some websites like
kotaksecurities.com even display reports which analyze the fundamentals of
various companies. You should focus on the key components of the report,
viz. balance sheet, profit and loss account and the cash flow statement for
your analysis. You must also not forget to peruse the Notes to the Accounts
as, often, some significant items are explained for better understanding that
you may not notice in the financial statements. Moreover, with a rise in the
level of transparency like addition of management discussion and analysis
to annual report, you are in a better position to understand the company’s
future prospects.

Newspapers are full of advertisements about the financial results of

companies at the end of every quarter, i.e., June, September, December and
March. Company results are also discussed extensively on television news
channels like CN BC Awaaz and others that track the equity markets. All
these media channels help you to remain abreast with the company’s
performance through the year. This enables you to churn your portfolio
based on latest information if you feel the fundamentals have improved or
deteriorated.

Reading accounts
Here’s a look at a prototype of company accounts and the numbers and
ratios that you should pay attention to while tracking the financial
performance of a company.
Profit & loss Account for the year ended
31 March 2017
  Rs.
in Crores
Sales 5,852
Sales return -1,365
Net sales 4,487
Cost of sales 4,121
Gross profit 366
Net operating expenses  
- amortisation of intangible assets -1
- Depreciation -304
Group operating profit 61
Share of results of joint ventures and associates 63
Profit from operations 124
Investment income 26
Finance costs -25
Profit before taxation 125
Taxation -34
Net Profit (profit for year attributable to equity shareholders) 91

Balance sheet as on 31 March 2017 Rs in Crores

Liabilities Amount Amount Asset Amount Amount

Equity     Non-current asset    
Called-up share capital 215   Intangible assets 427  
-goowill
Share premium account 43   -other 9  
Equity component of 16   Property, plant and 183  
preference shares equipment
Special reserve 169   Investments in joint 458  
ventures and associates
Share of joint ventures and 243   Investments 46  
associates reserves
Other reserves 5   PFI/PPP financial assets 22  
Accumulated (losses)/profits -304   Deferred tax assets 102  
    387 Derivative financial 2  
instruments
Non-current liabilities     Trade and other 50 1,299
receivables
Trade and other payables 77   Current assests    
Derivative financial     Inventories 75  
instruments
Borrowings - PFI/PPP non- 21   Due from customers for 252  
recourse term loans contract work
-other 1   Derivative financial 3  
instruments
Deferred tax liabilities 5   Trade and other 626  
receivables
Liability component of 90   Cash and cash 323 1,279
preference shares equivalents
Retirement benefit obligations 288        
Provisions 109 591      
Current Liabilities          
Trade and other payables 1,289        
Due to customers for contract 265        
work
Derivative financial 1        
instruments
Current tax liabilities 28        
Borrowings 17 1,600      
    2,578     2,578

Sales and sales growth

Growth in turnover is one of key criteria that can help you to gauge a
company’s health as it can be compared with that of its peers and the
industry to find out where the company stands. Sometimes, a company is
diversified and has a presence in more than one segment of business. A
segmental revenue break up, in the case of such multidivisional companies
will give you an insight into which segment is driving the growth for the
company. Segmental revenues also help you to track the appropriate
industries in which the company has a presence. For instance, in a
diversified company, if cement constitutes a major portion of the revenue,
its fortunes can be ascertained by tracking the cement industry.

Considering net sales (gross sales minus returns, damaged goods, excise)
for analysis gives a more accurate picture. In the above illustration, the
sales figure is Rs 5,852 crore. The figure of sales returned is Rs 1,365 crore.
Once the returned sales are deducted from the overall sales, you have a net
sales figure of Rs 4,487 crore. When you calculate the growth of this figure
over the corresponding figure for the previous year, it gives you an idea
about how the company’s revenue is increasing.

Net Profit

Also known as the bottom-line, net profit growth is the real growth driver
as ultimately what matters is profit. A company may display growth in
turnover and yet not show net profit growth due to various reasons
including a corresponding increase in costs. Profit depends on various
factors like market share enjoyed by the company, pricing power, cost
efficiency, competitive landscape, industry dynamics and so on and hence,
reflects the overall efficiency and market standing of a company. The net
profit in the illustration is Rs 91 crore and can be found in the profit and
loss account.

Operating profit

The operating profit depicts the true strength of the company’s business
model as it shows how much money is earned from core business
operations. It excludes profits made from investments, etc. It is also known
as EBIT (Earnings before Interest and Taxes). The operating profit can be
found in the profit and loss account (Rs 61 crore).

Operating profit margins and net profit margin

The operating profit margin (OPM) indicates how the company is fairing
within the overall industry in terms of pricing power. It also reveals whether
a company is efficiently managing its operations. Companies with a very
low OPM or a negative OPM perform poorly due to various internal and
external factors.

Changes in OPM over a period of time are a good indicator of its future
prospects. While expansion in OPM is good sign, a decline reflects
deterioration in business fundamentals requiring immediate attention.

The operating profit margin can be calculated from the above example as
operating profit (Rs 61 crore) divided by the total revenue (Rs 4,487 crore)
and then multiplying it by 100 which is 1.36% (i.e. 61/4487 *100 =
1.359%).

Net profit margin (NPM) is a key pointer towards the overall profitability of
the business. It excludes any extraordinary items such as loss or profit on
the sale of assets, etc. which are non-recurring in nature. In short, net profit
before extra ordinary items should be considered while calculating NPM.

The NPM can be calculated from the above example by dividing the net
profit (Rs 91 crore) by the total revenue (Rs 4,487 crore) and then
multiplying it by 100 which is 2.03% (i.e., 91/4487 *100 = 2.03%).

ROCE (Return On Capital Employed)

ROCE indicates how efficiently the company utilizes its capital. Capital
employed refers to fixed assets plus current assets minus current liabilities.
ROCE is calculated as follows:

EBIT

––––––––––––––-

Total Assets - Current Liabilities

From our above illustration, the ROCE = (125+25)/(2578-1600)*100

=15.34%
Importantly, ROCE should always be higher than the rate at which the
company borrows funds. This is especially important for you as a
shareholder because any rise in the borrowing rate for the company eats
into the shareholders’ earnings.

An improved version of ROCE is return on average capital employed

(ROACE). In case of ROACE, the average of opening and closing capital
employed is taken into consideration. For instance, in a financial year
ending of March 31, capital employed on March 31 and April 1 of the
preceding year would be considered.

ROE (Return on Equity)

ROE is also known as Return On Net Worth (RONW). This ratio reveals
the returns generated by the core equity capital provided by the
shareholders. A comparison of ROE with competitors reveals which is the
better managed company.

Among the various versions of ROE, the one excluding preference share
capital is the popular one. The formula is as follows:

Net profit minus dividend on preference shares

––––––––––––––––––––––-

Shareholders’ funds excluding preference share capital

Shareholders’ funds include share capital plus reserves.

Going back to our example, it is ROE = (91-0) / 691 * 100 = 13.17% Just
like ROACE, ROE can also be calculated by taking the average of equity
capital at the beginning and end of the financial year.

ROE analysis shows the changing profitability scenario for the

shareholders. Earnings Per Share (EPS)
EPS is a key profitability indicator and is calculated as follows: Net Profit -
preference share dividend

Average number of outstanding equity shares From our example above, the
EPS = (91-0)/10 = 9.1

EPS indicates profit allocated to each common share. For accurate

calculation you should consider the weighted-average outstanding number
of shares over the reporting period as number of shares can change over a
period due to the issue of rights or bonus shares.

In fact a diluted EPS reveals the true picture as it takes into account
convertible instruments while calculating outstanding shares. EPS is the key
component of the PIE Ratio. Thus, the way in which the EPS is calculated
can change valuations drastically.

Price Earning Ratio (P/E Ratio)

The P/E Ratio is a valuation tool, which is popularly used to compare how
expensive a stock is in terms of its earnings. It shows how much the market
is willing to pay for every rupee of earning since it is calculated as:

Current Market Price

–––––––––

EPS

Alternatively, the P/E Ratio can be calculated as:

Market Capitalization of the stock

––––––––––––––––––-

Profit After Tax (PAT)

For instance, if in the above illustration, the stock is trading at a CM P of Rs
110, at the above EPS of Rs 9.1, the P/E works out as follows:

P/E = 110/9.1= 12.08

The EPS variable used in the calculation of the P/E Ratio will determine
what you can read from this ratio. There are basically two broad types of
EPS that can be used - historic or projected. In the case of historic EPS, the
past earnings are considered and in the case of projected EPS, the estimated
future earnings are used.

In the case of a historic EPS, the P/E Ratio which is based on the trailing 12
months or last four quarters provides a more accurate picture than the P/E
Ratios based on year end EPS. Naturally, this will give you a more accurate
picture of how the earnings have faired throughout the year.

Where the projected EPS is used to arrive at the P/E Ratio, make sure that
the estimated EPS has been calculated using reliable data and methodology.

Companies with high P/Es are perceived as riskier because shareholders

have high performance expectations. For instance, if the P/E Ratio of a
software company is high because the market expects it to do extremely
well in future, any setbacks from the company could disappoint the market
and the P/E could plummet.

Being abreast of the various macro-economic developments will help you

gauge its impact on the industry/company you have invested in and thereby
decide whether you should buy, hold or liquidate.

The biggest drawback of using the P/E Ratio as a means of valuing a

company is that in isolation, it does not reveal much. You can only gain
insights when the P/E for a company is used in comparison to that of the
industry to which it belongs or in comparison to its own historic P/E. The
former will tell you whether the value of the stock is higher or lower than
that of the industry, on an average and the latter will reveal whether the
company’s stock has gained or lost value over time.
Debt to equity ratio (DIE)

The D/E Ratio simply shows how a company is financing its activities.

The formula is as follows:

Long term debt

––––––––––-

Total shareholders’ equity

The DIE Ratio in the above example is Debt of Rs 591 crore, divided by
equity of Rs 387 crore = 591/387 =1.52

A D/E Ratio of more than 1:1 means that a company is using a larger
proportion of borrowed funds to run its business. As a rule of thumb, it is
risky to invest in companies with high D/Es. This is because during
business slowdowns, when interest rates are high, the company’s
profitability margins are likely to be hit hard by interest costs. So, naturally,
in a rising interest rate scenario, high D/E companies would witness decline
in profitability. Further, a high D/E Ratio could mean that one year you as a
shareholder could make sizeable profits and the next year you may receive
a pittance by way of dividend. It will all depend upon the extent to which
the returns generated are higher than the cost of borrowing.

However, here again, this ratio is meaningless if seen in isolation. It must be

seen in comparison to the optimal ratio of the industry in which the
company operates. For instance cement and steel companies are more
capital intensive and hence could have a higher D/E of around 3:1 whereas
a software company, should have a DIE Ratio of much less than 1:1. It is
also company specific, and a new company in a capital intensive industry
can be excused for having a higher D/E Ratio than an older company from
the same industry. This is because it is assumed that as a company grows, it
may try to pay off its debt, especially the portion which attracts high interest
rates.
Price to Sales ratio (PSR)

It is calculated as follows:

Current market price

–––––––––

Revenue per share

Again, assuming that the company we are using as an illustration has a

CMP of Rs 110 and a Revenue Per Share of 448.7, the PSR will be
=110/448.7= 0.24

You can also calculate the PSR by dividing total market capitalization by
net sales.

PSR is used to value a stock compared to its peers or its own historic
performance. You should use ‘trailing’ 12 months’ net sales for calculating
this ratio. PSR varies substantially across industries and hence, should be
used to compare companies within the industry to draw meaningful
conclusions. However sales may not reveal the whole picture as even with
large sales the company could be in the red.

Beta

Beta is a financial tool used to measure the volatility of a stock (how much
its price moves) in comparison to a benchmark index (say Sensex or Nifty).
This ratio is difficult to calculate as it is rather statistical. However, it is
usually available on market related websites, equity database packages and
research reports. What you do need to know is that if the beta for a stock is
less than 1, it indicates that the price of the stock is less volatile than the
overall market. On the other hand, if it is more than 1, this stock is more
volatile than the market. So, for instance, if the beta of the stock is 1.25, this
indicates that the stock is 25 per cent more volatile than the index, which in
turn means that it carries a 25 per cent higher risk than the market. And, if
the beta value of a stock is 0.75, it indicates that the stock is 25 per cent less
volatile or carries a risk that is 25 per cent lower than that of the index.
Beneath all this, you must also be aware that the benchmark index, which is
used to represent the market, is assigned a beta value of 1. This is because
its volatility is benchmarked to itself.

There is no ideal level of beta. Knowing the beta value of a stock simply
helps you to gauge whether it is suitable for you or not.

If you are risk averse and are looking out for a steady investment, you may
prefer stocks with a beta of around 1 or less. On the other hand, if you have
a healthy appetite for risk, you may be ready to invest in a stock with a
higher beta value.

However, simply knowing the beta value of a stock does help you to decide
whether you are being adequately compensated for the risk that you are
taking. The risk quotient of a stock is directly related to its returns and the
higher the beta, the higher should be the return on the stock and vice versa.

The expected risk premium on any stock can be termed as “beta times the
market risk”, which is the reward for taking on a higher degree of risk. For
example, if the stock market provides a return of 12 per cent and the beta of
the stock is 1.25, then the risk premium of the stock is 15 per cent
(i.e.,12*1.25). More simply, for the additional risk (1.25 times the index
risk) that you are exposed to, you must be rewarded with a return of 1.25
times the market return.

You must keep in mind that the beta value of a stock is highly dependent
upon the time period during which it is measured. So, for instance, if you
choose to measure the beta of a stock when it is undergoing a transition, its
past risk profile may not accurately reflect its future risk structure. Any
change in business strategy of the company, foray into new lines of business
and a change in industry dynamics do not get captured in the beta of the
stock. So, ensure that you read the beta of a stock along with other
parameters as well.
Making estimates

By gradually developing the habit of studying annual reports and analyzing

quarterly results, you can check the future plans of the company. Further
checking the company website say once in a quarter would also keep you
updated.

Analyzing the company’s financial performance in isolation is not of much

help as it does not provide answers to questions like whether profit is high
or low and growth is satisfactory or not. A comparison of quarterly or
annual numbers with competitors, overall industry and past performance is
hence required.

More importantly, while going through results, the extraordinary items and
other income should be excluded as they are not recurring. A strict focus on
operational performance of the core business gives a fair idea about the
share and its prospects.

Assessing growth - company and sector level

Stock markets discount the future. The past is immaterial for the market and
what really matters is future growth which is dependent on certain factors
that drive business growth. You need to keep yourself abreast with recent
developments related to the company and industry.

This has two components. The first is development or news and second is
its impact on the company’s fundamentals. Research reports on the
company and industry would be great facilitators in forming opinions about
any development.

Several brokerage houses like Kotak Securities publish research reports on

a regular basis. You can procure these reports either from your broker or
from various financial websites and portals of other brokerage firms. These
reports are generally based on interaction with company managements and
hence, also provide revenue forecasts. You can also access these on
financial websites such as kotaksecurities.com. Many financial newspapers
carry regular snapshots of recently released research reports which keep
you posted about the recent ratings given by research firms.

Ideally, you should also track news related to companies through

newspapers and television channels like CNBC Awaaz and TV18. You can
also refer to the regular company announcements posted on the stock
exchanges - Bombay Stock Exchange (BSE) and National Stock Exchange
(NSE).

Assessing market and economic trends

The price of a stock is certainly dependent upon the performance of the

issuing company. However, there are various other factors that affect the
stock. The fortunes of a stock are tied to the fortunes of the industry to
which it belongs. For instance, a company may have excellent management
and efficient production technology but if the overall industry faces slack
demand or is going through a recessionary phase, the company is bound to
be impacted and so will its stock.

At a different level, the performance of the economy at large, its policies

and regulation, etc. will also impact industries and companies that they are
comprised of. The government’s budgetary allocations and policies could
have a positive or constraining impact on companies in specific sectors.
Similarly, the monetary and credit policy, the increase and decrease in
interest rates and the fluctuations in the rupee exchange rate, could have an
impact on the performance of a company.

The impact of some broader economic factors is likely to have a greater

impact on some stocks and a milder impact on others. For instance, a strong
rupee could have a negative impact on the software sector but a positive
impact on a company that is importing commodities. At the same time,
while interest rates impact all segments of industry, their movement
upwards or downwards may be most strongly felt by the banking sector.
Therefore, broad directional trends of macroeconomic and global indicators
must also be studied before deciding on a stock.
Further, certain industries such as metals (steel, aluminum, etc.) and cement
are cyclical in nature and follow macro trends in the economy like GDP
growth, manufacturing growth and so on. Moreover, metal prices are
determined more by global factors and less by domestic factors. Thus,
looking at global developments, like the spate of M&As leading to industry
consolidation, would be of great significance.

Lastly, the governments planned and budgeted spending on select segments

of the economy could provide the growth trigger to various industries.
Likewise the thrust on infrastructure, particularly on roads, irrigation, etc.
would provide greater business opportunities to companies operating in
these segments. In short, tracking the planning and prioritization of
government expenditure; for instance, thrust on power reforms, generates
additional opportunities for industries and therefore investors.

Round up

Monitoring of equity investment involves not just calculation of profit or

loss on the portfolio but also analyzing company and industry performance.
It also includes keeping oneself abreast with developments related to the
company and its competitors, industry and economy as well. Besides, you
also need to follow global markets and events. More importantly, you need
to identify various implications of these developments on the industry and
stock. Therefore, apart from money you also need to invest time and efforts
to ensure growth in your equity investment.

Factors outside the company that must be monitored

Trends in capital market

• Index movements
- Broader indices like the Sensex and Nifty
- Sector indices
- Indices specific to market cap like mid and small cap indices

• Trends in institutional investments

 - Foreign institutional investors (FI Is)
- Mutual fund investments

• Performance of global equity markets

- You can segregate this into developed market and emerging
markets

Economic trends
• GDP growth forecasts provided by various authorities or agencies like
RBI,

• Economic growth of various countries developed emerging markets

• Movement in index of industrial production (I IP)

• Inflation

• Interest rates

• Exchange rate of the rupee with other major currencies

SUMMARY

• It is essential to monitor your equity instruments and churn your

portfolio, as the markets are dynamic.

• Portfolio churn involves periodically reviewing valuations.

• Use wealth or portfolio trackers to maintain your portfolio.

• Peruse the company’s annual report’s key components - balance sheet,

profit and loss account and the cash flow statement - for your analysis.

• Be aware of what is happening in the financial markets by reading

newspapers or watching financial news TV channels.

• If you analyze the segmental revenue break up, in the case of

multidivisional companies, it will give you insights into which segments
are driving the growth for the company.

• Operating profit growth is the real indicator of growth.

• The operating profit, or EBIT (Earnings Before Interest and Taxes),

depicts the true strength of the company’s business model.

• ROCE indicates how efficiently the company utilizes its capital.

• Companies with high P/Es are perceived as riskier because shareholders

have high performance expectations. However, this ratio cannot be
viewed in isolation.

• The debt-equity (DIE) ratio shows how a company is financing its

activities. If higher than 1:1, then the company is using a larger
proportion of borrowed funds to run its business, which could be risky.
• Price to Sales ratio is used to value a stock compared to its peers or its
own historic performance. You should use trailing 12 months’ net sales
for calculating this ratio.

• Beta is a financial, statistical tool used to measure the volatility of a

stock in comparison to a benchmark index (say the Nifty or Sensex).
There is no ideal level of beta, since it depends on your risk appetite.

Your action points

1. Knowing basic financial indicators of the stock like Debt/ Equity,

ROCE, RONW, P/E, sales and operating income growth of a company
would enable me to take better investment decisions.

2. Further, I will assess the balance sheet strength by checking the net
debt position, inventory, receivable and payables of the company.

3. In addition, I will also check whether the company is generating cash

out of its operations by accessing its cash flow statement.

4. I will compare the company’s sales growth with its peers in the
industry for knowing its position in the industry.

5. I will also check the macro environment indicators like inflation, GDP
growth, interest rates in the country.

Axioms

1. Earnings before Interest, Depreciation and tax (EBIDTA) margins

- a true picture of a company’s performance - After reducing the costs
like raw material, sales and admin, wages, we arrive at the EBIDTA
which actually tells us the correct picture of the state of the company.
For example, in a situation wherein the company is not able to grow its
sales because of overall macro economic recession, but is able to
 improve its EBIDTA margins shows the ability and operational skills
of the management.

2. Higher Debt/ Equity - Business being run by debt - Nowadays, debt is

easily available since the banks get guarantee of the assets of the
company. However, a good management would always balance its
expansion plans through proper proportion of debt and internal
accruals.

3. Price to Earnings (P/E) Ratio - Should not be the only criteria to

invest in a company: The common way to value a company is the well
know PIE ratio. However, a low P/E does not always indicate a cheap
stock. Many a time a stock gets lower P/E because investors do not
believe in the growth story of the company or because of poor
corporate governance policies of the company. Probe more about the
company in such a situation.

4. Sales growth may slow down with higher base - For large
corporations, only looking at the sales growth or the CAGR
(compounded growth) may not be correct because they have a large
base of sales. For example, comparing the sales growth of Infosys (a
large cap stock) with some a mid cap IT company would not be
correct. You need to compare companies of similar sizes.

5. Investing in blue chip companies is safer - Blue chip companies are

those which have higher market cap and are also called the bell
weather stocks in their respective sectors. If you have a lower risk
appetite and do not want to spend too much time on assessing
companies, put your money into these well researched companies
during their downturn and wait for your investments to reap good
benefits in the long run.
 Chapter 18

CALCULATING YOUR PROFITS!

Chapter 18
CALCULATING YOUR PROFITS!

The basic purpose of investing your hard earned money is to earn a

handsome return on it in order to grow your finances. Keeping a track of
this return may be simple in the case of fixed income instruments, whereas
a number of factors need to be taken into account when you consider the
return on investments in shares. For instance, when you invest in a fixed
deposit, you receive a predetermined rate of interest, which comprises your
return. You may go a step further and calculate your post tax return, if it is,
in fact, subject to tax. In the case of equity, there are a number of ways in
which you receive a return. To begin with, you may receive a dividend
every year, you may be entitled to bonus shares from time to time, in the
case of a stock split, you may benefit from a marginal appreciation in the
total value of your shares, etc. There are a number of other corporate
actions (as described in Chapter 16) which may enhance the value of your
shares or actually reduce it. Last but not the least, when you actually sell off
your shares, you may receive a good price for them simply because the
market is in the midst of a bull run and the prices of all stocks have been
inflated. Alternatively, you could receive a lower than expected return, if
the market is in a bear grip and your shares have lost value.

There are a number of ways in which you receive

return from equities.

As far as equity is concerned, you must go a step further and calculate the
effective post tax return that you receive. This is the post tax return on your
investment after you have accounted for all the expenses that you have had
to incur in order to invest, maintain your position, and disinvest in the
shares.

Calculating your returns in a systematic manner can give you a true picture
of your returns. Here’s a step-by-step approach to calculating the effective
returns on your equity*.

Step 1- The cost of purchase

When you purchase your shares, you must make a note of the cost of the
shares and the number of shares that you have purchased. You must add to
this amount the Securities Transaction Tax (STT) that is paid on these
shares. If you have taken delivery of the shares, you will have to pay STT
of 0.10 per cent on the overall value of your transaction. So, for instance, if
you purchase 10 shares worth Rs 10,000 and you have to pay Rs 10 on the
transaction. Over and above that, you will have to add the brokerage (along
with the GST thereon) that you pay on the transaction. Suppose you have
paid brokerage of Rs 50 inclusive of GST, your total acquisition cost would
be Rs 10,060 (i.e., 10,000 as the cost of the shares + 10 as STT + 50 as
brokerage). This brings the purchase cost per share to Rs 1,006.
YOUR PURCHASE COST
Name of Numer of Price per Total STT Brokerage on Total
the scrip Shares share (Rs.) Investment applicable transaction (Rs.) oulog
purchsed (Rs.) (Rs.) (Rs.
XYZ 10 1,000 10,000 10 50 10,060
Limited

(GST must be paid as applicable.” Please reduce the font size as

applicable.)

Step 2- Cost of holding

Once you purchase the shares, they will be transferred to your depository
account by your broker. No charges are applicable while receiving credit of
shares to a depository account. However, you may have to pay periodical
maintenance charges, for holding a depository account. The periodical
maintenance charges may be levied by your DP on a yearly basis or any
other frequency as agreed by you while opening the demat account.

Alongside the costs, while holding on to shares, you may receive dividend
when you are a shareholder in the books of the company. Dividends are tax
free in the hands of the investor and accordingly, you must consider the
whole amount as part of your returns. So, assuming company XYZ declares
a 20 per cent dividend, you will receive Rs 2 per share that you own. This
will amount to a total of Rs 20 on the 10 shares that you hold.

Step 3 - the sale value

When you finally sell your shares, you must keep a track of the price which
you receive for your shares and the number of shares that you have finally
sold. If the price that you receive is higher than your purchase price, you
have made a capital gain (profit), if it is less, then you have made a capital
loss.

Now, if you have kept your shares for over a year, they are considered as
long-term capital assets and you are required to pay tax at the rate of 10%
on the capital gains made (excluding applicable surcharge and cess). If you
have kept the shares for a period of less than one year, these are considered
as short-term capital assets and a short-term capital gains tax of 15% (plus
10% or 15% surcharge as applicable and 4% health and education cess.) is
to be paid on the gains that you have made from the sale transaction.

Over and above this, you must take into account the STT that you have to
pay on the transaction, i.e., 0.10 per cent of the value of the transaction.

So, if you decide to sell off the shares that you purchased in ‘Step 1’ within
one year from the date of purchase, at the rate of Rs 1,500 per share, your
overall sale transaction would fetch you Rs 15,000. On this transaction, you
will have to pay STT of Rs 15.00 (i.e. 0.10 per cent of Rs 15,000). Over and
above that, you will have to pay short term capital gains tax at the rate of
17.16 per cent on Rs 5,000, assuming 10% surcharge and 4% cess, (Sale
price of Rs 15,000 - cost price of Rs 10,000). This will amount to Rs 858.

Add to that your brokerage amount. If your sale transaction is worth Rs

15,000, you may have to pay Rs 75 as brokerage.

So overall, although you have received Rs 15,000 for the sale of your
shares, the net amount that you receive is Rs 14,052 (15,000 - 15 - 858 -
75).

In case you have held your shares for over a year before selling them,
assuming the same selling price, the net amount that you receive is Rs
14,338 (15,000 – 15 – 75 – 572), with tax being calculated as 11.44% (10
per cent long term capital gains tax + 10 surcharge, if applicable + 4% per
cent education cess) of Rs. 5,000.
Sales Number Value of STT Short term capital gains tax Brokerage Net amount
Price of share sale (Rs.) (Assuming you have kept the on received afte
per sold transaction shares for less than one year transaction taxes and
share (Rs) (Rs.) (Rs.) brokerage (Rs.
(Rs.)
1,500 10 15,000 15 858 75 14,052

(GST must be paid, as applicable.)

Now, to actually find out how much return you have received on the capital
that you have invested in the shares, you must add any dividends to the net
amount that you receive, after taxes and brokerage is paid, and deduct from
it the total outgo, including your investment, STT and brokerage.

In case of the above example, it will be Rs 14,052+ Rs 20 – Rs 10,060=

4,012

This amount must be calculated as a percentage of your total outgo, not just
your investment in the shares. Getting back to the example, it works out to a
return of 39.9 per cent [(4,012/10,060)*100].
Accounting for corporate actions

Corporate actions such as stock-splits and bonus issues increase the number
of shares in the overall market and make the stock more affordable, which
in turn improves liquidity. The market soon discounts these actions and the
value of your overall holdings is likely to remain more or less the same.

Now, if you have shares of company XYZ which has declared a 1:1 bonus,
the number of shares in your holding statement will double once the stock
goes ex-bonus. Hence, if you hold 100 shares, your revised number of
shares will be 200. Then take the latest ex-bonus price and calculate the
revised value of your holdings. In all likelihood, the price of the shares will
come down to nearly half the pre bonus price.

In the case of rights issues too, you need to update the number of shares that
you hold post the rights issue.

It is only when you sell your holdings that you will actually be able to
consider the returns that you have received from these actions, in terms of
capital gains, if any.

Annualized returns

Returns on equity investments should be annualized to arrive at the true rate

of return, so that they become comparable with the return offered on other
investment products such as fixed deposits, mutual funds, etc. or for a
historic comparison on the same stock.

Sometimes, you may arrive at the overall returns that you have received
from your investment in equity over a period of a couple of years. For
example, if you receive an overall return of 100 per cent for having invested
in company ABC Ltd. for the last three years, it is prudent to calculate the
annualized return which would be 100 /3 = 33.33 per cent in this example.

You can also apply this principle in cases where the holding period is less
than one year.
For instance, if you earn a 1.25 per cent return in one month’s time, your
annualized return would be 1.25 x 12 = 15 per cent. However, the catch
here is that there is no certainty that you would earn a 15 per cent return for
the whole year. In this scenario the annualized return is just an estimate and
the result could vary drastically. Generally, the annualized returns do not
take the effect of compounding into consideration.

Other aspects

Don’t ignore cash

Ideally, you should also add the cash component of your portfolio, i.e. the
idle cash which has not been invested, to your overall base of funds to
arrive at an accurate return on your investments. For instance, if you have
an overall portfolio of Rs 10 lakh, out of which Rs 1 lakh is lying idle in
cash. Now, suppose the returns are Rs 2 lakh, your returns in terms of
percentage would not be 22.22 per cent (i.e., Rs 2 lakh/ Rs 9 lakh), but 20
per cent (Rs 2 lakh/ Rs 10 lakh) as your portfolio consists of Rs 1 lakh in
cash as well.

FIFO

Building your position gradually by purchasing shares in small lots is

always recommended. This is also known as a steady accumulation. At the
time of your sales, you can use the ‘First In First Out’ (FIFO) method to
determine the cost of shares sold to accurately determine the profit or loss
on the transaction. What this basically means is that if you first purchased
10 shares of company XYZ Ltd. at Rs 150 each and later another 10 shares
at Rs 200 each and the third batch of share at Rs 250 each, if you sell 15
shares you must consider the price of the first 15 that you purchased. In
effect, the cost price of your first 15 share is 166.67 each since you will
consider 10 shares at Rs 150 each and 5 shares at Rs 200 each. Thus, if you
maintain purchase records lot-wise it would help when you offload your
position in smaller lots. This facilitates easier calculation of cumulative
returns and annualized returns on your holdings.
The records could be kept using following fields:
1. Purchase date
2. Number of share purchased
3. Purchase cost per share including brokerage, taxes applicable, etc
4. Total purchase cost
5. Dividend per share, if any
6. Maintenance costs, if any
7. Sale date
8. Number of shares sold
9. Tax payable on the shares sold
10. Value of sale
11. Profit or loss per share
12. Profit or loss on sale of shares
13. Period for which shares are kept
14. Sector/ industry to which the stocks belong and
15. Whether the stock is also being traded in the F&O segment.
SUMMARY

• Calculating the return on equity investments is not as simple as that of

fixed-income instruments.

• The returns can come from dividends, sale proceeds post tax (different
if held for less than a year or more than a year) or even stock splits.

• After purchasing shares, add Securities Transaction Tax of 0.10% on the

overall value of your transaction.

• If you sell your shares after holding them for less than a year, these are
short-term capital assets and you pay short-term capital gains tax of
15% plus 10% surcharge plus 3% education cess on the proceeds.

• Equity rewards those who play for the long term. Your returns will be
more if you sell after a year or more.

• Annualize the returns on equity investments to arrive at the true rate of

return, and then compare with other investments.

• Consider the cash component and account for sale and purchase when
tabulating returns.

Your action points

1. I will calculate the actual returns - post taxes and brokerage.

2. I understand that dividends earned are additional profits made over and
above my returns.

3. I know that I have to pay brokerage and STT when I transact in equity.

4. I am aware of tax benefits on returns, if I invest for the long term.

5. In case of short term investment, I know that I would have to pay short
term capital gains tax plus surcharge and educational cess which will
add up to approximately 16.995 percent.

Axioms

1. Be a long-term investor and save on tax: Capital gains on long-term

returns (more than a year) are subject to tax rate of 10%, or else you
have to pay short term gain tax of around 15%.

2. Know your returns well: Calculating your returns on investments is

not very easy. It includes surcharge, education cess and other taxes.
Understand these calculations well and be aware of what you are
paying for.

3. Dividends - cheer to investors: Dividends are additional profits you

make apart from the returns you get from your investment. If you have
low risk appetite then you can invest in high companies distributing
high amounts of dividend.

4. Calculation of Annualised returns does not always give a true

picture: If you are getting 1 per cent return in one month, simply
multiplying by 12 to figure out the annual return (12 per cent) may not
be correct because you may not get the same amount of returns each
month.

5. Include corporate actions (if any) while ascertaining your returns:

In case of stock splits, the price of the share would fall. You will have
to adjust your cost price accordingly so as to ascertain the correct
returns. Similarly, if you have received any bonus shares, you will have
to factor in that into your calculations.
 Chapter 19

TAX ON YOUR EQUITY INVESTMENTS

Chapter 19
TAX ON YOUR EQUITY INVESTMENTS

Equity investments generate returns in a number of ways. The most obvious

form of returns includes the dividends that a company distributes from year
to year and the capital appreciation that could accrue when you actually sell
off your holding. In addition, companies may undertake various corporate
actions such as bonus issues, rights issues, stock dividends, de-merger
plans, etc.

All these actions have some direct or indirect impact on the value of the
stocks held by the shareholders. They also have varying tax implications,
which can often be substantial and hence, must be adequately understood.

Securities Transaction Tax

At the time when you buy or sell shares, you will have to pay a transaction
tax. However, this depends on the type of transaction that you undertake.

Transactions Purchase/Sale of equity Sale of equity shares Sale of

shares (Delivery based) (Nondelivery based) Derivatives
Rates of 0.10 per cent 0.025 per cent 0.05 per
STT cent
Paid by Buyer / seller Seller Seller
For non delivery based transactions, i.e. those that are settled without
transferring the shares onto your name, you have to pay an STT of around
0.025 per cent of the value of the transaction, only when you sell the shares.

On the other hand, if you purchase shares and take delivery, you have to
pay an STT of 0.05 per cent of the value of your transaction, both when you
buy and when you sell the shares.

Dividend Income

Dividend can best be described as regular rewards that shareholders receive

from distributable profits or accumulated reserves. Dividend income is
totally tax free in the hands of the shareholders although the issuing
company is required to pay a dividend distribution tax at the rate of 16.22
per cent (i.e. 15% + 12 % surcharge^ + 4% education cess) on the amount
that is to be distributed as dividend.

For example, if you hold 100 shares of stock X, which has a face value of
Rs 10, and the company declares an annual dividend at the rate of 30 per
cent, you will receive a total of Rs 300 by way of dividend from the
company. This amount is completely tax free where you are concerned.
Whatever tax has to be paid on it has already been deducted before it has
been sent to you.

However, this tax free status of dividends does not apply to dividends from
foreign companies. These are taxable in the hands of the shareholder.

Capital gains

When you sell off your shares, there are two aspects that are taken into
account for tax purposes. These are:

1. Have you made a profit or a loss over the purchase price?

2. How long have you held on to the shares from the date of purchase?
The answer to the first question will reveal whether you have made a capital
gain or a capital loss.

The answer to the second question will tell whether you have made a
long¬term or short-term capital gain/ loss. If you have held your shares for
more than one year, they are considered as long-term capital assets and
those held for less than one year are considered as short-term capital assets.

1 Short-Term Capital Gains (STCG) - If the shares are sold within one
year from the date of purchase for a profit, this profit is called a STCG.
The gain is taxed at the rate of 15 per cent and further increased by the
applicable surcharge, if any, and 4 per cent education cess, for resident
individuals.

2 Long-Term Capital Gains (LTCG) - If the shares are sold beyond

one year from the date of purchase for a profit, this profit is considered
as a LTCG. There is 10% capital gains tax on this profit.

3 Short-Term Capital Loss (STCL) - If the shares are sold within one
year from the date of purchase at a loss, this loss is called a STCL.

4 Long-Term Capital Loss (LTCL) - If the shares are sold beyond one
year from the date of purchase at a loss, this loss is considered as a
LTCL.

Other corporate actions impact the number of shares held by existing

shareholders. For long-term investors, these corporate actions do not
influence the profitability on sale of shares of existing shares as they do not
attract LTCG. Hence, the holding period of a stock is the single key factor
in deciding if gains arising from its sale should be LTCG or STCG.

Issue of Bonus Shares

Companies issue bonus shares as a means to celebrate their growth and

performance with shareholders. Bonus shares get reflected in the account of
existing shareholders on allotment in the ratio decided by the management.
Investors holding the stock on the record date of bonus can avail the benefit
of allotment, failing which they are not entitled to the bonus issue. Shares
received as bonus are issued free and hence, are deemed to have zero cost
of acquisition for tax purposes.

Just like any other listed security, gains arising from the sale of bonus
shares held for more than one year from the date of allotment shall attract
LTCG tax of 10%. Similarly, when bonus shares are sold prior to
completion of one year from the date of allotment, short term capital gains
tax is applicable on the same at the rate of 15 per cent plus surcharge and
education cess. A critical point to note is that since the cost of acquisition of
bonus shares is zero, the entire sale consideration shall be charged as short-
term capital gain.

For example: Suppose you purchase 100 shares of X Ltd. at a price of Rs

600 per share. The total cost of your shares will be Rs 60,000. If the
company announces a bonus issue on a 1:1 basis, on the allotment date, you
will hold 200 shares instead of just 100. However, the theoretical adjusted
market price after the bonus issue will come down to Rs 300.

Case I

As can be seen above, by selling the initially purchased shares at the rate of
Rs 300, per share you can show a STCL of Rs 300 per share. This loss can
be offset by any other STCG. However, while you get the benefit of STCL,
you will not gain anything from this strategy in pure monetary terms, as
your initial cost of acquisition as well as total sale proceeds are Rs 60,000.
Value of Initial Holding
  Quantity Price per share Total Value
X Ltd 100 600 60000

Value of Holding after Bonus (1:1)

  Quantity Price per share Total Value
X Ltd 200 300 60000
 Stock Market Investing
  Quantity Price per share Total Value
X Ltd 100 600-300=300 3000

Short Term Capital Loss (STCL) on sale of

  Quantity Price per share Total Value
X Ltd 100 300-0=300 3000

Case II

Let’s take a look at a scenario wherein you invest for the long-term and sell
your entire holdings a year after the bonus allotment. Suppose the price of
company XYZ has increased to Rs 400. You will enjoy a LTCG of 400 X
100 = Rs 40,000 on sale of your bonus shares. On sale of the original
shares, you will incur a LTCL of (600-400) X 100 = Rs. 20,000. Therefore,
you will make an overall profit of Rs. 20,000 before paying LTCG tax.

Case III

LTCL incurred on sale of shares can be set off against LTCG, but not any
other income. You should plan your taxes in such a way that you can still
preserve the loss from the sale of the original shares. You may do so by
selling these shares at the rate of Rs 400 per share, after holding those for
almost a year (say a week less than a year). Then, you can then show a
STCL of Rs. 200 per share. It is best to sell shares received on bonus,
beyond one year from the date of allotment, in order to ensure that the gains
arising there from are LTCGs and hence taxable at a lower rate.

Just as in case II, you will make an overall profit of Rs 20,000 before
paying a lower rate of tax on capital gains thus made. However, you can
also show a STCL of Rs. 20,000, which can be offset by any other STCG.
This becomes possible due to the fact that you have sold your holdings over
a period of a week, as opposed to selling them off together one year after
the bonus settlement.
Issue of Rights
The holding period of rights shares is considered from the date of their
allotment. The cost of acquisition is the cost paid for acquiring such rights.
If the rights of ownership are transferred or renounced, the difference
between the price of transfer and the issue price of the rights is considered
for the calculation of capital gains.
Value of Initial Holding
  Quantity Price per share Total Value
X Ltd 150 100 15000

Value of Initial Holding

  Quantity Price per share Total Value
X Ltd (Initial Holding 150 100 15000
X Ltd (Rights issued) 30 75 2250
17250

Let us assume that you purchase 150 shares of company X Ltd., which have
a face value of Rs 10 per share at the rate of Rs 100 per share. The company
declares a rights issue of one share for every five held at a price of Rs 75
per share. You are therefore entitled to a rights issue of 30 shares if you
subscribe to the issue. Your cost of acquisition will be the price at which the
rights are offered, which is Rs 75 per share.

If the total holdings are sold within a period of one year from the allotment,
the sale proceeds will attract STCG tax at the rate of 15 per cent. However,
just like bonus shares, if the total holdings are sold one year after the date of
allotment, the gains will be considered LTCG and liable to tax at the rate of
10 per cent.
Let us assume the stock trades at Rs 125 at the time of sale. The STCG will
be as follows:
STCG on Total Holding Amount (In Rs.)
Gain on the Initial Holding (150 X 25) 3750
Gain on Sale of Rights Shares (30 X 50) 1500
Net Gains 5250
Short Term Capital Gains Tax @ 15% 788

Stock Splits

Stock splits result in a change in the face value of shares. The face value is
split to form more than one share. The decrease depends on the ratio, in
which the split is undertaken. A split of 2:1 will indicate that the existing
shares of face value of Rs 10 each will be split into two shares of Rs 5 each.

For computation of LTCG or STCG, the date of the split does not have any
effect on the holding period of the shares. On the event of a split in shares,
the cost of purchase of the initial holdings is spread over the total holdings,
post split. For example, let’s say you purchase 200 shares of company X
Ltd. which have a face value Rs10, at the rate of Rs 1,200 per share.

If the stock is sold at a price of Rs 775 post split, within a period of one
year, the gains on this transaction will attract a STCG tax.
Value of Initial Holding
  Quantity Face Value Price per share Total Value
X Ltd 200 10 1200 240000

Value of Initial Holding After Stock Split (2:1)

  Quantity Face Value Price per share Total Value
X Ltd 400 5 600 240000

Short Term Capital Gains Tax on Holdings

gains on Sales of shares 70000
Short Term Capital Gains Tax 7000

De-merger

De-mergers take place to obtain better operational efficiency and a more

effective functioning of business units. De-mergers are also initiated with
the objective of improving valuations of the existing company and the value
of the resulting entity. To understand the impact of de-mergers on
shareholdings and the subsequent tax incidence, we can consider the classic
example of the de-merger of Reliance Industries (RIL).

All the existing shareholders of RIL were issued shares in the ratio of 1:1
from all the new companies. An existing shareholder, who held one share of
RIL got one share of Reliance Communications Ventures Limited (face
value of Rs 5), one share of Reliance Energy Ventures Limited (face value
of Rs 10), one share of Reliance Capital Ventures Limited (face value of Rs
10) and one share of Reliance Natural Resources Limited (face value of Rs
5). Existing shareholders continued to hold the same number of shares of
RIL, which they were holding initially, while Reliance Energy Ventures
Limited and Reliance Capital Ventures Limited merged with Reliance
Energy Limited and Reliance Capital Limited, respectively. The existing
shareholders of RIL were hence eventually allotted the shares of these
companies.

In a de-merger, the shares allotted to the existing shareholders do not

constitute any kind of share transfer and are, therefore, not subjected to any
capital gains tax.

Further, shares in the new company are deemed to be held from the date of
acquisition of shares in the parent company. Hence, if the shares of the
parent and that of the new entity are held by an existing shareholder for a
period of more than one year from the date of purchase of shares of the
parent company, then there will tax of 10% chargeable on these gains, as
proposed by the Budget 2018.

However, if the shares are sold after holding it for a period of less than one
year, the profits will attract a STCG tax.

Hence, as can be seen, tax can constitute a substantial cost of investment in

equities and must be planned efficiently well in advance.

___________
^ Assuming the total income of the company is over Rs 10 crore.
SUMMARY

• For non-delivery based transactions, i.e., those that are settled without
transferring the shares onto your name, you pay an STT of around
0.025% of the value of the transaction, only when you sell the shares. If
you take delivery of them, you pay STT at the rate of 0.10 per cent both,
when you buy and sell the shares.

• Dividend income is tax-free in the hands of the shareholders, unless

they are dividends from foreign companies.

• If the shares are sold within one year from the date of purchase for a
profit, this profit is called short term capital gains (STCG), and is
taxable at a rate of 15% plus surcharge and educational cess.

• If the shares are sold beyond one year from the date of purchase for a
profit, this profit is long term capital gains (LTCG), and is taxable at a
rate of 10%.

• Shares received as bonus are issued free and hence, non-taxable.

• In an issue of rights, if the rights of ownership are transferred or

renounced, the difference between the price of transfer and the issue
price of the rights is considered for the calculation of capital gains.

• For computation of LTCG or STCG, the date of a stock split does not
have any affect on the holding period of the shares.

Your action points

1. I understand that STT rates on non-delivery based transactions are

lower than on delivery based ones.
2. I know that though dividend income is tax free for me, effective
dividend which I get from the company would be after deducting tax at
source.

3. While subscribing to a rights issue, I will do some research on the

company.

4. I wouldn’t buy a stock just because the company has declared bonus.
Often, managements issue a bonus when they are faced with some
hurdles in order to keep the price of the stock up.

Axioms

1. Be a long-term investor: It is advisable in the equity markets to

research and buy stocks for a longer period. It fetches you good
returns, and your capital gains are taxed at a lower rate.

2. Go for dividends: Investors can check the dividend history of the

company and can buy those companies wherein the dividend yield is
very high. Here, you can rest assured that you will get dividend
income. However, do select companies after due diligence to protect
yourself from investing in tad’ bets whose prices fall after you invest
because this will result in losses even though the company gives out
good dividend.

3. Don’t get ecstatic with bonus shares: Many a time, cash rich
companies declare bonus in order to maintain the upward movement of
their share price which in turn would keep their market cap intact.
However, if the growth prospect of the company is not good, then the
stock price would eventually plunge and you will not gain much from
it.

4. Be aware of the corporate actions of the company: As an investor,

you should be aware of various corporate actions of the company like
declaration of rights issue, bonus shares, declaration of buyback, etc.
You should also be aware of the implication of these actions.
5. Buyback of shares by the promoters - an opportunity for exit? - If
you have owned a share of the company for a long time and it has not
given any returns at all, then you would naturally want to sell the stock.
However, be patient! Announcement of buyback itself would drive the
stock price up in the hope that the promoters are confident of the
growth of the company. Here, you also would get an opportunity to
exit the stock in the market and make the much awaited gains.
 Chapter 20

GET YOUR COMPLAINTS RESOLVED

Chapter 20
GET YOUR COMPLAINTS RESOLVED

Investing in equities involves various procedures and requires dealing with

a number of entities like your broker, your bank, the depository participant
where you have opened your demat account, etc. You may face problems
with your transactions. For instance, you may not receive shares purchased
by you from your broker on time, which may result in losing dividends
declared by the company whose shares you have purchased. Or you may
not receive your money on sale of shares from your broker.

Besides, once you purchase shares of a company, you are also entitled to
certain rights such as receiving the company’s annual report, being able to
attend the company’s annual general meeting, etc. You may face a situation
where you don’t receive the annual reports or the annual general meeting
notice comes to you late resulting in you not being able to attend the
meeting.

Benefit from regulation

You can resolve such complaints/grievances since the equity markets are
strictly regulated. The regulations that govern the equity markets include
The Securities Contracts (Regulation) Act, 1956; The Securities and
Exchange Board of India (SEBI) Act, 1992; The Depositories Act, 1996
and The Companies Act, 2013. Apart from these key regulations, stock
exchanges also have their own sets of rules and regulations.
Step 1- Approach the entity against which you have a grievance

If you have any grievance against a listed company or a market

intermediary registered with SEBI, you should first approach the concerned
company or market intermediary against whom you have a grievance.

Step 2 - Approach the regulator

However, in case you are not satisfied with their response, you can
approach various regulatory authorities to have your grievance redressed.
Broadly, SEBI takes up grievances related to the issue and transfer of
securities and non-payment of dividend by listed companies. In addition,
this regulator also takes up grievances against various market intermediaries
registered with it and issues related to these intermediaries.

SEBI, the regulator

Investors can approach Securities and Exchange Board of India (SEBI) to

redress their grievances. The categories under which grievances can be
lodged are as follows:
1 Type-I: Refund order/allotment advice

2 Type-II: Non-receipt of dividend

3 Type-Ill: Non-receipt of share certificates after transfer

4 Type-IV: Debentures
5 Type-V: Non-receipt of letters of offer for rights shares

6 Type-VI: Collective investment schemes

7 Type-VII: Mutual funds/venture capital funds/foreign venture capital

investors/foreign institutional investors/portfolio managers, custodians.

8 Type-VIII: Brokers/securities lending intermediaries/merchant

bankers/registrars and transfer agents/debenture trustees /bankers to
issues/underwriters/credit rating agencies agencies/depository
participants

9 Type-IX: Securities exchanges/clearing and settlement

organizations/depositories

10 Type-X: Derivatives (futures and options) trading

11 Type-XI: Corporate governance/corporate restructuring/substantial

acquisition and takeovers/buybacks/delisting/ compliance with listing
conditions

You can file your grievances through post, via fax or by email to Securities
and Exchange Board of India (SEBI). The formats of forms for various
kinds of complaints are available on SEBI’s (Securities and Exchange
Board of India) website, www.investor.sebi.gov. in. Such forms, duly filled
can be submitted to the main office in Mumbai or also to various regional
offices. The addresses and other contact details of regional offices are
available on SEBI’s (Securities and Exchange Board of India) website. As
mentioned earlier, there is also the option of getting grievances sorted out
the online way. For more details on online filing of grievances, you can
refer to www.investor.sebi.gov.in.

Stock exchanges/depositories

Let’s suppose you have not received a contract note from your stock broker
for a transaction executed on the stock market. As a first step, you should
contact your stock broker for the contract note. However, if he is not able to
provide you with one, you can lodge a complaint against your broker with
the Investor Grievances Cell (IGC) of the National Stock Exchange (NSE)
presuming that the transaction was executed on NSE. You can also
approach IGC for trade disputes such as non-receipt of shares or non-
payment of funds. The IGC in turn would take up such complaints with the
concerned broker or sub-broker.

Likewise, the Bombay Stock Exchange (BSE) redresses complaints through

its Investors’ Services Cell (ISC). The ISC looks into investor grievances
against listed companies and members.

In case you have any grievances relating to the depository services of your
depository participant, you can approach the Investor Grievance Cell of the
respective depository, viz. NSDL or CDSL.

Arbitration

You also have the option of arbitration for resolution of your disputes.
Arbitration is an alternative dispute resolution mechanism provided by the
stock exchanges and depositories for resolving disputes. The Arbitration
Panel consists of independent persons of ability, integrity and esteemed
standing such as retired judges.

Presentl y, arbitration is conducted by NSE, BSE and NSDL at Mumbai,

Delhi, Kolkata, Chennai, Ahmedabad, Bangalore, Hyderabad, Indore,
Jaipur, Kanpur, Pune, Patna, Lucknow and Vadodara.

Safety first

The two important safety measures that you should bear in mind while
dealing in equities are:

1 Do not deal with unregistered intermediaries. If you are dealing with

an unregistered stock broker, it would expose you to a counter party
risk.
2 Always keep a record of all instructions that you issue to market
intermediaries such as brokers and/or sub brokers.
SUMMARY

• Many things can go awry in equity transactions. These include your

broker not carrying out your instructions properly or not receiving
company annual reports.

• Equity markets are strictly monitored and the regulations that govern
the equity markets include The Securities Contracts (Regulation) Act,
1956, The Securities and Exchange Board of India (SEBI) Act 1992,
The Depositories Act,1996 and The Companies Act,1956.

• Stock exchanges also have a set of stringent rules and regulations.

• First, approach the company or market intermediary and then SEBI.

• SEBI has 11 categories for filing grievances, which can be filed through
post, via fax or email to SEBI. Form formats are available on SEBI’s
website, www.investor.sebi.gov.in. You can also access
http://scores.gov.in and click on the ‘complaint registration’ tab under
‘Investor Corner’. You can choose from one of the categories and file
your complaint.

• You can lodge a complaint against your broker with the Investor
Grievances Cell (IGC) of the NSE or the Investors’ Services Cell (ISC)
of the BSE.

• For arbitration in resolution of disputes, contact the arbitration panel of

stock exchanges and depositories. Arbitration is conducted by NSE and
NSDL at Mumbai, Delhi, Kolkata and Chennai.

Your action points

1. I will not panic in case anything goes wrong in my investments.

2. I know there are strict regulations for stock market participants.

3. I shall approach the right channel to lodge my grievance.

4. I know I can access SEBI for filing complaint.

5. I know I can also access IGC to lodge complaint.

Axioms:

1. Right Complaints…write complaints: The stock market in India is

very well regulated. In case of any discrepancy, you can easily write to
the concerned department or the person about them and can expect
appropriate response. At the same time, make sure you are writing a
right complaint to the right person.

2. To get heard, follow the regulated route: Stay away from

unregistered brokers or sub-brokers while making stock market
transactions. Only then you can approach the regulated bodies to file
your grievances.

3. Not received dividend, letters to rights issue, etc.? In such a

situation just visit the SEBI site and enrol your complaint. You can rest
assured that your grievance will be resolved.
CONCLUSION

Going through this book may or may not have been your first tryst with
basic literature on the stock market. Yet you yourself will realise that there
is a definite increase in your level of knowledge and confidence as
compared to before you began reading it.

You have been introduced to the concepts and relevance of financial

planning and investment planning, instructed on the risk and returns that
accompany various investment options and informed about the golden rules
of investing. Then you have been taken on a step by step tour of all the
aspects of investing in equity - right from the keystones of this investment
instrument to IPOs and secondary markets and how they function.
Gradually, and without even feeling the strain, you have understood how to
choose an ideal broker, bank and depository and what you require to help
you wade through the whole process of buying and selling of shares. This
book has also briefed you about various ratios and indicators that can be
considered while you choose stocks and investment strategies such as the
top-down approach and the bottom-up approach and their respective
benefits. It has introduced you to the trend of online investing and told you
about various corporate actions that impact the value of stocks that you may
hold or consider

Going through this book may or may not have been your first tryst with
basic literature on the stock market. Yet you yourself will realise that there
is a definite increase in your level of knowledge and confidence as
compared to before you began reading it.

You have been introduced to the concepts and relevance of financial

planning and investment planning, instructed on the risk and returns that
accompany various investment options and informed about the golden rules
of investing. Then you have been taken on a step by step tour of all the
aspects of investing in equity - right from the keystones of this investment
instrument to IPOs and secondary markets and how they function.
Gradually, and without even feeling the strain, you have understood how to
choose an ideal broker, bank and depository and what you require to help
you wade through the whole process of buying and selling of shares. This
book has also briefed you about various ratios and indicators that can be
considered while you choose stocks and investment strategies such as the
top-down approach and the bottom-up approach and their respective
benefits. It has introduced you to the trend of online investing and told you
about various corporate actions that impact the value of stocks that you may
hold or consider purchasing. As supplementary support, it has given you
access to information on costs associated with equity investing and related
tax aspects; you have even been guided on how to resolve grievances. Last
but not the least, the book has guided you regarding how to monitor and
maintain a healthy portfolio and offered you a round-up of rules for
investing.