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Showing posts with label Investment Gyan. Show all posts
Showing posts with label Investment Gyan. Show all posts

Wednesday, November 20, 2013

Strong Fundamentals are Key to Multibagger Returns

Looking for a long-term winner — a multibagger? It is simple! Buy shares of a company with strong fundamentals and consistently high financial performance.

To evaluate a company’s efficiency and the quality of its management, the two key financial ratios to be keenly observed are return on net worth (RoNW) and return on capital employed (RoCE). Besides, price-to-earnings ratio could be used to determine the market price of a company’s stock and to compare it with peers’ in the same sector. Price to book value measures the value of shareholder's ownership in the company. 

While earnings yield — the quotient of earnings per share divided by the share price — needs to be seen to compare directly against the returns offered by alternative investments such as interest on a bond or savings account, debt-to-equity ratio could measure a company’s financial leverage. A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This could result in volatile earnings because of additional interest expenses. 

TTK Prestige, a leader in the Indian kitchenware market, tops the list of multibaggers, with compound annual returns of 71 per cent in 10 years. In other words, Rs 1,450 invested in 2003 was valued at Rs 2.94 lakh on March 31, 2013. The company has benefited from market growth, driven by rising consumer spend, evolving lifestyle preferences and broad demographic trends. 

TTK’s product range and distribution have complemented the strong brand, helping it clock a revenue CAGR of 24 per cent in 10 years. The profit has grown at an even higher CAGR of 66 per cent, backed by its premium products and a debt-free status, from a debt-to-equity ratio of two in 2004. The efficiency and the quality of its management measured from consistently high RoNW and RoCE helped it become the most valuable company in the past decade. 

Titan Industries, the second in the league has made its investors 89 times richer, with its profit growing at 47 per cent CAGR. However, the top-class performance in the decade may cool a little in the coming years, as demand is expected to slow down, given the tough environment. Among other most valuable companies of the decade are Motherson Sumi (ranked third), followed by Coromandel International, Godrej Consumer, GMDC, SKF India, IndusInd Bank, Bajaj Finance and HDFC Bank.

While constant good financial performance by some companies has fetched handsome returns for their shareholders, some weak performers have underperformed the market, despite quality management and lower debt-to-equity ratio. For example, Hindustan Unilever has given below-par seven per cent annualised returns in 10 years, due to poor single-digit sales and profit CAGRs. Slowdown in growth has also hurt the market performance of some pharmaceutical firms like Dr Reddy’s Labs, Novartis and Ranbaxy.

Stock market investment runs in sector-specific cycles. According to reports of Morgan Stanley India, the stocks in a particular sector get bigger and give better returns as that sector gets popular. For example, between 2002 and 2007, realty, metals and capital goods companies topped the gainers’ list. The demand for housing and strong investment in capital goods and infrastructure projects saw Unitech, JSW Steel, Pantaloon Retail, Sesa Goa, Alstom T&D, Jubilant Life, Crompton Greaves, Siemens and Thermax emerge as top companies on the multibagger list.

Business Standard Research Bureau has analysed these trends through a study of top 200 stocks by market capitalisation with trading history of more than 10 years. There are 158 stocks that have outperformed the benchmark index with 10-year CAGR of more than 17.4 per cent each. Of these, as many as 99 stocks have been multibaggers — giving their stakeholders gains of over 10 times on investment made 10 years earlier, or annual average returns between 26.6 and 71 per cent. Of these, 59 have been long-term winners — the companies that have given very good high returns in 10 years as well as during the economic slowdown seen in last two years.

Among these 59 stocks, 10 have been consistent performers, that is, 20 per cent CAGR in sales and profit over the past decade as well as in last two consecutive years. These companies have recorded very high financial ratios, both RoNW and RoCE, and given strong earnings yield — significantly higher than the other prevailing investment avenues.

The consistent performers are from the sectors like auto ancillaries, banks, consumer durables, pharmaceuticals, housing finance, fertilisers, FMCG and mining. The dropdown list of 59 companies, too, has similar sectoral compositions, with additions from automobiles and capital goods.

Tuesday, November 19, 2013

Simple & Effective Strategy For Buying Winning Stocks

If we stick to basic rules of investing and put our money in fundamentally strong small and mid cap stocks, we will have multibaggers in our portfolio. We have a long list of super-duper multibaggers like Jubilant Foodworks, Page Industries, Amara Raja Batteries, Natco Pharma, De Nora, Cera Sanitaryware and Mayur Uniquoter.
It is obvious that this consistent success is not the result of chance or good luck. Instead, there is a carefully thought out strategy behind it. Below are some of the strategies which an investor needs to always follow for buying winning stocks.
1. First identify the sectors doing well and then the best stocks in it:
There are two well-known strategies for buying stocks – the “top down” approach, in which you focus on the Industry / Sector (e.g. consumer non-discretionary), and the “bottom up” approach, in which you focus on individual stocks (e.g. Page Industries).
We follow a unique method that is a combination of both methods. We buy only the best stocks in the best performing sectors. Applying this method in past, we have avoided investing funds in dud sectors like realty and infra even though individual stocks looked very promising.
2. Buy stocks only if the requirements in the check-list are met:
We follows a rigorous process of checks and balances before we trust a stock offers right investment opportunity. These are:
(a) Know the management and its credentials / pedigree;
(b) Understand the business model and growth prospects of the company;
(c) The company must have positive cash flows;
(d) The debt must be Nil or negligible;
(e) The company must have pricing power and not be vulnerable to excessive competition.
3. Focus on information & not on hype:
In times of boom and bust investors tend to carried away by the noise around them. We advice investors to be rigidly focused on tangible information in the form of financial statements. “Never get carried away by the cacophony and hype on Dalal Street”. Its always wise that investors should “identify the nuts and bolts that drive the growth and profitability of the company”.
4. Recognize your mistakes and cut your losses:
This is very important, most investors suffer from “loss aversion” and like to be in denial that they have made a mistake. If they want to raise money, they will sub-consciously sell the stocks where they have a profit but not those where they have a loss.
Considering our own experience where we made mistake by recommending investments in stocks like Firstobject Technologies and National Plastic. Once we knew that we had committed a blunder, we dispassionately ask our members to cut their losses before they could do further damage to their portfolio.
We are sure that by following our “old-fashioned” style of picking stocks after doing thorough research should help all of us to grow our money and become better investors.

Monday, October 14, 2013

Smart Investors Always Focus on Fundamentals

Fear or greed may move the market over the short term, but sooner or later economic fundamentals take control.

Stock market bubbles happen when greed (or at least the excitement of money to be made) pushes prices to unrealistic heights.

Conversely, bear markets, when there is more pressure on the sell side than the buy side, happen when investors become disillusioned with over-priced equities.

Bull and bear markets tend to raise or lower all stocks, but often hit some sectors harder. Not surprisingly, the stock sectors that take the biggest hits are often those previously floating on the bubble.

We all have experienced last bubble which was lead by Realty Stocks. Stocks like Unitech, DLF, HDIL which were the darling of many Investors in last bull run are making new lows today. These stocks have massively eroded the capital of investors since 2008.

HDIL - A mumbai based realty company, was trading at 4 digit price in Jan 2008, made all time high of Rs. 1114 on 10th Jan 2008, couple of months after listing in stock exchanges, today trades at price of Rs. 43. Investors who bought this stock on that day have lost almost 96% of their capital as on date, Rs. 1 lakh invested in HDIL in Jan 2008 is less than Rs. 4,000 today. Investors during that period was fascinated to invest in these companies.  Every thing was rosy in terms of realty stocks, huge land bank, mega township projects, expansion in tier 1, tier 2 cities etc. No body wants to think and analyse the changed scenario as of today.  

It is easy to assume that markets are either driven solely by fear or greed. While that may be the case when markets are expanding or contracting, it doesn’t explain how the markets behave in between raging bulls and roaring bears.

Stock Fundamentals Rule

During these times, fundamentals rule rational investing - there will always be those who impulsively jump into and out of the market.

It is easy to overlook the fundamentals, both economic and market related, in the heat of a soaring or crashing market, but you do so at your own peril if you are a long-term investor.

Just as in the dot.com boom, companies still need to earn a profit and pay their bills to prosper. There is no excuse for dismissing these fundamental truths.

Point to Ponder

No matter what the market is doing, companies that have a sustainable business model, strong cash flow and little debt are going to come out of any boom or bust in good shape.

Investment Truths

It is worth repeating these investment truths:

• The economy is not the stock market
• Stock prices may or may not represent a company’s true value
• Good companies are long-term good investments

A stock’s price is only important in establishing when is a good time to buy or sell.

Long-term investors have time on their side - time to let aberrations in the market work themselves out. Take advantage of time and let good companies show their true value. Don't be in a hurry to make lot of money from stock market.

Friday, October 4, 2013

What is ROA - Return on Assets?

When you are considering stocks to buy, there are certain metrics and numbers that are more important than others.

They can’t be used as the sole qualifier to determine great stocks, but you can use them to eliminate poor performers.

You must always look at the big picture when considering a stock and that means considering a number of metrics.

Return on Assets

Return on Assets is one of the handful of really important metrics every investor should know.

Return on Assets (ROA) tells you how efficiently (or inefficiently) a company turns assets into net income. It is a way to tell at a glance how profitable a company is.

Consider that companies take capital from investors and turn it into profits, which are in turn returned to the investor in one form or another.

ROA measures how efficiently the company does this. Obviously, the more efficient a company is in converting assets (capital) into profits, the more attractive it will be to investors.

That’s about as simple as it comes: companies that make more money for the owners are worth more than companies that don’t make as much money.

ROA is made up of two components: net margin and asset turnover. When used together, these two metrics tell an important story.

Net Margin:

Net margin is found by dividing net income by sales. Net margin reveals what percentage of each Rupee in sales and company retains.

Asset Turnover:

The other component is asset turnover, which gives you an idea of how well a company does in producing sales from its assets. You find asset turnover by dividing sales by assets.

Once you have net margin and asset turnover, multiply them together to determine ROA. You now have an idea how well a company can convert assets into profits. Companies with high ROA compared to their peers, are more efficient at using assets to generate profits.

You can calculate ROA for yourself or you can use one of the Web sites that has done all the math for you.

Even if you don’t do the calculations yourself, it is important to know how the numbers are generated.

Improving Efficiency

ROA shows how companies have two choices in improving efficiency.

Companies can raise prices and create high margins or rapidly move assets through the company. Either way (or both) improves ROA.

It is important to compare companies in the same industries. Some industries traditionally have higher margins or asset turnover than other industries do.

ROA is an important measure to use and understand, but its flaw is that the metric does not consider the effect of borrowed capital.

Saturday, September 21, 2013

Making Money by Investing in Poor Performing Companies

Sometimes, you can make more money by buying the least attractive stock in a particular industry if you believe the sector is due for a turnaround. Although it is counterintuitive, a little bit of simple math can show why it makes perfect sense and can leave the shrewd analyst with a much fatter pocketbook. These types of operations are for investors that have already built their complete portfolio and are on financially sound footing; they should not represent a substantial portion of your assets and are best left to those who have a good grasp of the economics and risks of the situation.

An Example in the Oil Industry

Imagine it is the late 1990’s and crude oil is $10 per barrel. You have some spare capital with which you wish to speculate. It is your belief that oil will soon skyrocket to $30 per barrel and you’d like to find a way to take advantage of your hunch. Ordinarily, as a long-term investor you would look for the company with the best economics and stick your capital in the shares, parking them for decades as you collected and reinvested the dividends. However, you remember a technique taught in Security Analysis and actually seek out the least profitable oil companies and begin buying up shares.

Why would you do this? Imagine you are looking at two different fictional oil companies:

• Company A is a great business. Crude is currently $10 per barrel, and its exploration and other costs are $6 per barrel, leaving a $4 per barrel profit.

• Company B is a terrible business in comparison. It has exploration and other expenses of $9 per barrel, leaving only $1 per barrel in profit at the current crude price of $10 per barrel.

Now, imagine that crude skyrockets to $30 per barrel. Here are the numbers for each company:

• Company A makes $24 per barrel in profit. ($30 per barrel crude price - $6 in expenses = $24 profit).

• Company B makes $21 per barrel in profit ($30 per barrel crude price - $9 in expenses = $21).

Although Company A makes more money in an absolute sense, its profit only increased 600% from $4 per barrel to $24 per barrel compared to Company B which increased its profit 2,100%. These differences are likely to be reflected in the share price meaning that although the first enterprise is a better business the second is a better stock.

More Information

Typically, these operations are most successful in industries that are dependent upon underlying commodity prices for their profitability such as copper producers, gold mines, oil companies, etc. The wild fluctuations in the underlying commodity can result in huge swings in the earnings of the business, making them good candidates. Of course, unless you are a professional, you should not engage in these types of transactions, instead focusing on building long-term wealth through value based, intelligent, and discipline investments that focus on getting the most earnings at the least risk.

Tuesday, July 2, 2013

Peter Lynch: Making Money by Investing in "Fast Growers"


“The investor of today does not profit from yesterday’s growth.” Warren Buffett

Most of us have relatives who like to fashion themselves as ‘stock-gurus’, with their stories revolving around how they ‘could have been’ millionaires now, if only they had held their nerves. The stock that comes up frequently in these conversations is Infosys. If you had invested Rs. 9,500 to buy 100 shares of Infosys in the IPO (that went undersubscribed in 1993), 12,800 shares (adjusted for bonus issues) worth sum of Rs. 3,15,26,400 would be in your kitty. But, is Infosys still the key to riches? As often repeated, past performance is no guarantee of future results. So, how does one find out the next ‘Infy’?

A Fast Grower is a small yet aggressive & nimble firm, which grows roughly at 20-25% a year. This is an investment category which can give investors a return of 10 to as much as 200 times the investment made by them. No doubt, it remains a favourite of Peter Lynch!

In 1950s, the Utility & Power Sector were the fast growers with twice the growth rates to that of the US GDP. As people got more power-hungry gadgets for themselves, the power bills ran through the roof & the power sector surged with booming demand. Post the Oil Shock in 70’s, cost of power generation became high with power tariffs going up; people learnt to conserve electricity. Demand, thus, fell and power sector witnessed a slowdown. Prior to it, similar decline was observed in the Steel Sector & Railroads. First, it was the Automobile Sector, and then the Steel, followed by Chemicals & Power Utility & now the IT Sector is showing signs of slowing down. Every time, people thought, rally in the fast growers of the age would never end, but it did end, with people losing money as well as their jobs. Those who thought differently like Walter Chrysler (founder of Chrysler Corporation), who took a pay cut and left the railroads to build new cars in the turn of the last century, became the next millionaires.

Three phases involved in their life cycles, are:

1. The Start-Up Phase: Majority of the companies either burn up all the cash or run out of ideas by the end of this phase. Maximum casualties have been observed here, making it one of the riskiest phases. However, maximum returns can be made from them, if one enters near the end of this phase.

2. Rapid Expansion Phase: The Company’s core proposition has worked now, with the strategy being replicated by expansion of product/service portfolio or consumer touch points.

3. Mature Phase: Growth slows down, either due to high debt or low cash, owing to the massive expansion witnessed in early stage. Fall in demand or legal restrictions might also contribute to faltering growth.

The trick is to track, which phase the organization is in, at the moment. If the firm is in late start-up phase with possibility of moving to rapid expansion phase, buy the stock when it is still cheap. Once firm’s earnings start falling with its products witnessing poor demand, it’s time to bid goodbye to the stock.

The key parameters involved in Peter Lynch’s ‘two minute drill’ are:

1. P/E Ratio: avoid stocks with excessively high P/E
2. Debt/Equity Ratio: should be low
3. Net Cash per Share: should be high
4. Dividend & Payout Ratio: should be adequate
5. Inventory levels: lower the better

Stay away from companies which are being actively tracked, followed & invested in by large institutional investors. News about buy back of shares or internal stakeholders increasing their stakes should be construed as positive.

Checks specific to Fast Growers:

1. The star product forms a majority of the company’s business.
2. Company’s success in more than one places to prove that expansion will work.
3. Still opportunity for penetration.
4. Stock is selling at its P/E ratio or near the growth rate.
5. Expansion is speeding up Or stable

One must judiciously walk the tightrope between the unquestioning belief that made the stock to be held for so long and the fear of the end from nose-diving prices due to a one-off bad year. The key is to always keep revisiting the story & ask some pertinent questions like ‘What would really keep them growing?’, ‘What is their next offering? or ‘Are their products & services still in vogue?’ It is here, that one must track the point of time when the phase 2 of the firm’s expansion comes to an end. This is usually the dead-end for organizations as success is difficult to be replicated. Unless, innovation happens, downfall is imminent & thus, an exit is necessary. P/E of these stocks is drummed up to unrealistically high levels by the madness of crowd towards the end. One must keep one’s eyes & ears open to signs, which mark the end of the road for these fast growers. A great case in point is Polaroid which had its P/E bid up to 50, only to be rendered obsolete later by new technologies.

A sure shot sign of a decline is a company which is everywhere! Such a company would simply find no place to expand any further. Sooner, rather than later, such a company would see its ‘Manhattans’ of earnings reduced to ‘plateaus’ of little or no growth, simply because no space is left to expand further.

1.The quarterly sales decline for existing stores.
2. New stores opening, though results are disappointing: weakening demand, over supply.
3. High level of attrition at the top level.
4. Company pitching heavily to institutional investors talking about what Peter Lynch calls ‘diversification’.
5. Stock trading at a P/E of 30 or more, when most optimistic estimates of earning growth are lower than 15-20%, thus, unable to justify the high price.

Fast Growers, which pay, are ephemeral & one misses them more often than not. It is a High Risk & High Gain Category of Stocks. One must remember along the classic risk & return principle, that when one loses, one loses big! So, if you are in the quest for magnificent returns, a Fast Grower can be your bet provided you know when to bid Goodbye!

Sunday, January 13, 2013

How to Time your Purchases & Exits in Stock Market?

Dear Reader,

We think everyone has this question in their minds i.e. How to time their purchases and exits from the stock market.

The above question is more important for you if you have been selling your stock investments after the recent run-up of Sensex to 19800. The question is should you be exiting just because Sensex is approaching the holy figure of 20,000, the 2008 highs or should you remain invested considering the fact that valuations of the overall market are much lower than what they were in 2007-08?

In our opinion, you should not, because if you are selling now you will most likely to re-enter when the Sensex will be at say 35000-40000 some years down the line and will therefore miss all the gains in between.

Do not believe us that you will commit the above mistake, click here and you will understand.

Coming back to the main question of how to time the markets, here’s what Mr. Prashant Jain (fund manager of HDFC Asset Management) had to say in one of his recent interviews:

Q: Do you think retail investors are making a mistake by constantly redeeming from equity funds instead of putting money in now?

A: I have been in this market for 20 years and I have seen three cycles now. Unfortunately, in each of the cycles, the timing has been quite bad. The bulk of the money has always come in at higher than 17-18 P/Es and we have seen that repeatedly.

Almost 80-85 percent of the money comes in above 17-18 P/Es. It is probably unfortunate, but in my opinion, these are the signs that history is going to repeat itself again.

(Our view: The above is the basic irony. Most retail investors exit at low valuations and re-enter when there’s too much hype around any asset class and then they get trapped for a long period with below average returns)

Q: Are you beginning to see any nascent signs of that in any fund because it is the mid-caps that have begun to perform etc? Are you beginning to see more interest perking up in some of these sector-specific or vertical funds?

A: Broadly, the industry has been losing money. We never see inflows at low P/Es and when markets begin to recover, we see outflows because people who feel they have been trapped and now some returns are there, they are taking out money. Almost 80-90 percent of the money over a cycle comes in above 17-18 P/Es and that is why investors are time and again disappointed with equities.

Q: The feeling from a lot of retail investors seems to be that we are approaching 20,000; this is a level where you should be booking out and not making the mistake of getting into another high. Is that kind of an approach a mistake?

A: I think so. When you look at the history of the SENSEX, it has delivered 15-17% compound annual growth rate (CAGR). It started off at 100 back in 1980s. At any point of time, we thought 1000, 2000, 5000 was high; it was a wrong way to look at the markets.

The correct way to look at the markets to my mind is to focus on the P/E multiples (basically valuations). Investor should simply practice low P/E investing and whenever P/Es are below average, they should keep on investing with two to three-and-a-half year’s view. They should either reduce allocation to equities or not invest more money when P/Es are high again with a two-three-four year view. That will lead to better timing than what they have historically been able to achieve.

At the end we would like to add that if you are more than 22-25 years of age, working somewhere or run a business, and able to consistently save some amount every month from your earnings, feel blessed because this is one of the best times to invest in stocks of good companies from a 3-4 years perspective.

Regards,
Team - Saral Gyan

Thursday, December 27, 2012

Do Not Invest in Indian Equities

An advice to investors who are still cashing out and staying off from Equities.

Are you investing in equities? If we look at current scenario, many retail investors are either afraid of investing in equities or have been cashing out after the recent run-up in stock market.

Many experts and advisers on television and other media advise retail investors to invest in equities, but to no avail. There is absolutely no interest in equities at the retail level and mutual funds, too, are seeing record redemptions.

As it happens, retail investors are helping markets more by staying out than by investing in equities, so, from a purely selfish point of view, we (current equity market participants) do not mind if you stay away from equities. Keep your money in low-interest bearing savings accounts and this will help bank raise cheap funds. Then, while you earn taxable 9% per year in fixed deposits and 4% in savings accounts, we will continue to buy HDFC Bank, IndusInd Bank, Yes Bank and the like, which are up 3.5 times, 11 times, and 5.9 times, respectively since December 2008. Also, remember to pay all your EMI installments on time so that retail loans made by the private banks do not get into trouble and we can continue to do well owning their stocks.

Indian retail investors are more or less completely out of equities, and would rather buy gold instead. So, keep buying gold so that we can do better than you by owning stock in Titan Industries and other jewellery companies. You should not care at all that while the gold that you bought is up 2.58 times in four years, the stock of Titan Industries, which sells gold to you, is up 6.9 times during the same period. If Rakesh Jhunjhunwala had bought physical gold instead of shares in Titan when he did, he would not be a billionaire today.

In fact, go ahead and buy real estate, taking mortgages from HDFC and LIC Housing Finance. How else would we have made 2.8 and 5.7 times in these stocks in five years? And when you do buy these apartments and houses, do insist on using the best construction material – cement, sanitary ware and so on. It is only because you do not buy equities and spend on real things that we could make 192% on ACC and 4.5 times on Hindustan Sanitary ware since 2008. A house is not done until it’s painted, so remember to keep a good budget for decorative paints from Asian Paints (stock is up 4.8 times in four years).

Why should you invest in equities when you can buy insurance products? This world is interesting precisely because we think differently from each other – while you are happy buying insurance, we are happy owning shares in companies that sell you insurance. Thanks to you, shares in Bajaj Finserv are up 6 times in value and shares in Max India are up 2 times in the past four years.

Follow your heart and we will follow you. If you like going to malls and spending time there please do some shopping as well – some of us own shares in Phoenix Mills, which is up 2.7 times since 2008. In fact, it may be time for you to upgrade your car. Why buy equities when you can spend the same money on a new car or motorcycle? Let us do the more boring job of continuing to own stocks in Maruti and Bajaj Auto, which are up 2.9 and 10.8 times, respectively, since 2008. Why not add your name to the waiting list for an Enfield this year while we own shares in its manufacturer, Eicher Motors, which is up 12 times since 2008?

Life isn’t just about making and investing money; it’s important to enjoy life’s little pleasures. So go watch a movie at the multiplex and much some popcorn while you are there. Meanwhile, we will buy shares in PVR (up 3 times in four years). You’d rather spend time at home in front of the television? We’ll still love you – shares in Zee Telefilms and Sun are up 3 and 3.5 times because of loyal viewers such as you. Call for pizza delivery at home – Jubilant Foodworks (which owns Domino’s) is up 5.4 times since its IPO in 2010.

While you’re in the mood to be sinfully self-indulgent, don’t make any resolutions to give up smoking or drinking. You may not want to invest in equities, but spare a thought for investors in these stocks. Your actions so far have helped these investors make 3.8 times in ITC, 10.3 times in United Breweries and 2.2 times United Spirits in four years but they still look for your continues patronage of these businesses.

We wish you a very happy and healthy 2013. In case if you fall sick in 2013, take comfort in the fact that you are helping investors in stocks of companies such as Dr Reddy’s (stock up 4 times) and Cipla (stock up 2.3 times).

We invite you over to our side in 2013 but still love you for choosing instead to be loyal customers of the businesses we own.

Now it’s up to you to decide who you would rather be – part owners of Indian companies or just their loyal customers.

Wednesday, December 26, 2012

Do Gold Jewellery schemes really benefit you?

Gold has always been an integral part of any celebration or festival in India. The rise in the price of the yellow metal is gradually making affordability difficult.

Various companies have come up with gold jewellery schemes to attract buyers. Companies are even offering to pay an installment every year. The customer will own the jewellery after the completion of the tenure.

Example: Mrs Sunita from Delhi wanted to buy 20 grams gold for investment, but she did not have enough money for the purchase. The jeweller offered a scheme under which she could buy the gold jewellery after one year at the prevailing market rate after paying 12 monthly installments. The jeweller also offered to pay the 12th installment after Mrs Sunita pays the 11 installments on time. It means that for jewellery worth Rs 60,000, she will have to pay Rs 55,000 in 11 months, and Rs 5000 will be paid by the jeweller. She thought it was a good option as she anyway wanted to buy the gold for investment.

Benefits of a gold jewellery scheme

The only benefit that a buyer gets in this type of scheme is that he gets to pay in installments. However, a buyer has more to lose than to gain.

Why not to buy gold under the scheme?

The buyer is under an obligation to purchase the gold at the prevailing market rate. If at the time of booking the jewellery, the gold rate is Rs 2,800/g but after the completion of instalments the rate rises to Rs 3,000/g, then buyer has to pay Rs 2,000 extra for every 10 grams due to the change in the price of gold. If the main purpose of a buyer is to invest, then buying jewellery is not a wise choice. The jewellery is not made of 24-carat gold, and it also carries some making charges, so the return value of the jewellery would be much less when compared to gold coin, biscuit or bars.

Below is comparative table which indicate basic difference of buying gold jewellary against gold biscuit or bars.


Other attractive options

The buyers have many other options to buy gold at a cheaper cost and at a better quality.

1. If the buyer wants to buy gold after 12 months under the instalment pattern, then it would be a better option if he buys gold ETF in the stock market every month and averages out the inconsistency.

2. Buyer can also buy gold in e-gold format, where he can purchase as less as 1 gram of the metal. After 12 months, he can sell the gold in electronic form and buy jewellery from the proceedings, or if he wants to hold on to it longer then he can keep it in a demat account.

3. If the buyer wants to invest in a coin or bar, then he also has the option to put the money every month in a recurring deposit account for 12 months and earn interest on the money and buy gold with the maturity proceedings.

The basic flaw in the gold jewellery scheme is that jewellers not only earn interest on the buyer’s instalment but also sell the jewellery after earning a handsome margin. For 20 grams gold jewellery, the jeweller earns Rs 600 making charge and sells 22-carat gold at the rate of 24-carat gold. So he earns approximately 8 per cent extra by selling gold of 22-carat purity.

For the jeweller, this scheme is a win-win situation as he gets the chance to sell his product, and at the same time he earns interest on the customer’s instalment. Buyers, who cannot distinguish whether they are buying gold as jewellery or as an investment, are always set to lose out in this type of deal.

Friday, December 21, 2012

10 Basic Principles of Investing in Equities

10 Basic Principles of Stock Market Investing

In the stock market there is no rule without an exception, there are some principles that are tough to dispute. Here are 10 general principles to help investors get a better grasp of how to approach the market from a long-term view. Every point embodies some fundamental concept every investor should know.

1. Ride the winners not the losers

Time and time again, investors take profits by selling their appreciated investments, but they hold onto stocks that have declined in the hope of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice. The following information might help:

Riding a Winner - The theory is that much of your overall success will be due to a small number of stocks in your portfolio that returned big. If you have a personal policy to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever had a tenbagger. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting.

Selling a Loser - There is no guarantee that a stock will bounce back after a decline. While it's important not to underestimate good stocks, it's equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well, as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.

In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses.

2. Avoid chasing hot tips

Whether the tip comes from your brother, your cousin, your neighbour or even your broker, you shouldn't accept it as law. When you make an investment, it's important you know the reasons for doing so; get into the basics by doing research and analysis of any company before you even consider investing your hard-earned money. Relying on a tidbit of information from someone else is not only an attempt at taking the easy way out, it's also a type of gambling. Sure, with some luck, tips sometimes pan out but they will never make you an informed investor, which is what you need to be to be successful in the long run. Find out what you should pay attention to - and what you should ignore.

3. Don't sweat on the small stuff

As a long-term investor, you shouldn't panic when your investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term. Also, don't overemphasize the few bucks difference you might save from using a limit versus market order.

Active traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.

4. Don't overemphasize the P/E ratio

Investors often place too much importance on the price-earnings ratio (P/E ratio). Because it is one key tool among many, using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is overvalued.  

5. Resist the lure of penny stocks

A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a Rs. 5 stock that plunges to Rs. 0 or a Rs. 75 stock that does the same, either way you've lost 100% of your initial investment. A lousy Rs. 5 company has just as much downside risk as a lousy Rs. 75 company. In fact, a penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.

6. Pick a strategy and stick with it

Different people use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick with it. An investor who flounders between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely most investors should avoid. Take Warren Buffett's actions during the dotcom boom of the late '90s as an example. Buffett's value-oriented strategy had worked for him for decades, and - despite criticism from the media - it prevented him from getting sucked into tech startups that had no earnings and eventually crashed.

7. Focus on the future

The tough part about investing is that we are trying to make informed decisions based on things that have yet to happen. It's important to keep in mind that even though we use past data as an indication of things to come, it's what happens in the future that matters most.

A quote from Peter Lynch's book "One Up on Wall Street" (1990) about his experience with one of the stock he bought demonstrates this: "If I'd bothered to ask myself, 'How can this stock go any higher?' I would have never bought it as stock price already went up twentyfold. But I checked the fundamentals, realized that company was still cheap, bought the stock, and made sevenfold after that." The point is to base a decision on future potential rather than on what has already happened in the past.

8. Adopt a long-term perspective.

Large short-term profits can often entice those who are new to the market. But adopting a long-term horizon and dismissing the "get in, get out and make a killing" mentality is a must for any investor. This doesn't mean that it's impossible to make money by actively trading in the short term. But, as we already mentioned, investing and trading are very different ways of making gains from the market. Trading involves very different risks that buy-and-hold investors don't experience. As such, active trading requires certain specialized skills.

Neither investing style is necessarily better than the other - both have their pros and cons. But active trading can be wrong for someone without the appropriate time, financial resources, education and desire.

9. Be open-minded

Many great companies are household names, but many good investments are not household names. Thousands of smaller companies have the potential to turn into the large blue chips of tomorrow. In fact, historically, small-caps have had greater returns than large-caps; over the decades.

This is not to suggest that you should devote your entire portfolio to small-cap stocks. Rather, understand that there are many great companies beyond those in the Small Cap Index, and that by neglecting all these lesser-known companies, you could also be neglecting some of the biggest gains.

10. Don't miss to diversify your equity portfolio

Its always wise to have stocks from different sectors and Industries. Do not expose your self to many stocks from the same sector. Be it IT, Consumers, Finance, Infrastructure, Pharmaceutical or any other sector, you must have a proper mix of all with suitable allocation based on future outlook of that sector and industry. Most of the companies from capital goods and Infrastructure sector have not performed since last 2 to 3 years but private banking stocks, consumers and pharmaceuticals companies stocks are making new all time highs. Hence, its important to stay diversified with your stock investments.

Start building your equity portfolio by making educated investment decisions, subscribe to our Hidden Gems, Value PicksWealth-Builder annual subscription services. Avail attractive discounts and freebies under our ongoing Merry Christmas & Happy New Year 2013 Offer. Hurry! Offer closes on 31st Dec'12, click here to know more about the offer.

Friday, November 30, 2012

Your Investment Profile & Risk Tolerance

To get an idea of your investment profile, start by calculating your investment horizon.

Investment Horizon:

Investment horizon is the period of time, in years, that you wish to remain invested. Investment horizon may be measured as the point in time when you begin taking distributions, or it may be measured as the point in time when you expect to complete taking distributions.

This is the number of years that you can invest. Your investment horizon depends on your financial goal.

Financial Goal:

A financial goal is a goal that involves saving and investing to reach a specific amount by a specific date.

For example, a financial goal may be to save 2,00,000 for a college education fund for a child in 14 years, or it may be to save 30,00,000 for a retirement fund in 20 years.

You can achieve your financial goals through a combination of saving more, saving longer or earning a higher rate of return. Your goal may be to save for college, retirement, or a down payment on a home. Each goal has its own investment horizon.

For example, saving for retirement at age 65 when you're 20 gives you an investment horizon of 45 years. The longer the investment horizon, the longer you can save and benefit from compounding.

Next...

Estimate your Risk Tolerance:

Your risk tolerance is your willingness to accept some volatility in the rate of return of your investments in exchange for a chance to earn a higher return.

If you expect a higher rate of return, you should be willing to accept a higher degree of risk. This is called the risk-return trade-off.

Risk-Return Trade-off:

A basic investing principle that says the higher the potential rate of return, the higher the investment risk. Academic and industry studies support this relationship.

For example, stocks historically offer a higher rate of return than bonds. They also have a higher degree of investment risk. Investment risk is measured by the volatility of investment returns.

To get an idea of your risk tolerance, take a few minutes to complete the below risk tolerance quiz:


To get your own profile add the number of points for all seven questions

Add one point if you choose the first answer, two if you choose the second answer, three for the third and four points for the fourth question.

If you score between 25 and 28 points, consider yourself an aggressive investor.

Aggressive Investor:

An aggressive investor is an investor who is willing to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return.

Investment risk is the volatility of investment returns. A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return.

If you score between 20 and 24 points, your risk tolerance is above average.

If you score between 15 and 19 points, consider yourself a moderate investor.

Moderate Investor:

An investor who is willing to accept some investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns.

A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return. On the risk-tolerance scale, a moderate investor is in between an aggressive and conservative investor.

This means you are willing to accept some risk in exchange for a potential higher rate of return.

If you score fewer than 15 points, consider yourself a conservative investor.

Conservative Investor:

An investor who is unwilling to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns.

A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return.

If you have fewer than 10 points, you may consider yourself a very conservative investor.

This is only an example of a short quiz used by financial institutions to help you estimate your risk tolerance. For specific investment advice, you should always consult your financial adviser.

Tuesday, November 27, 2012

Smart Investors Always Focus on Fundamentals

Fear or greed may move the market over the short term, but sooner or later economic fundamentals take control.

Stock market bubbles happen when greed (or at least the excitement of money to be made) pushes prices to unrealistic heights.

Conversely, bear markets, when there is more pressure on the sell side than the buy side, happen when investors become disillusioned with over-priced equities.

Bull and bear markets tend to raise or lower all stocks, but often hit some sectors harder. Not surprisingly, the stock sectors that take the biggest hits are often those previously floating on the bubble.

We all have experienced last bubble which was lead by Realty Stocks. Stocks like Unitech, DLF, HDIL which were the darling of many Investors in last bull run are making new lows today. These stocks have massively eroded the capital of investors since 2008.

HDIL - A mumbai based realty company, was trading at 4 digit price in Jan 2008, made all time high of Rs. 1114 on 10th Jan 2008, couple of months after listing in stock exchanges, today trades at price of Rs. 103. Investors who bought this stock on that day have lost almost 90% of their capital as on date, Rs. 1 lakh invested in HDIL in Jan 2008 is less than Rs. 10,000 today. Investors during that period was fascinated to invest in these companies.  Every thing was rosy in terms of realty stocks, huge land bank, mega township projects, expansion in tier 1, tier 2 cities etc. No body wants to think and analyse the changed scenario as of today.  

It is easy to assume that markets are either driven solely by fear or greed. While that may be the case when markets are expanding or contracting, it doesn’t explain how the markets behave in between raging bulls and roaring bears.

Stock Fundamentals Rule

During these times, fundamentals rule rational investing - there will always be those who impulsively jump into and out of the market.

It is easy to overlook the fundamentals, both economic and market related, in the heat of a soaring or crashing market, but you do so at your own peril if you are a long-term investor.

Just as in the dot.com boom, companies still need to earn a profit and pay their bills to prosper. There is no excuse for dismissing these fundamental truths.

Point to Ponder

No matter what the market is doing, companies that have a sustainable business model, strong cash flow and little debt are going to come out of any boom or bust in good shape.

Investment Truths

It is worth repeating these investment truths:

• The economy is not the stock market
• Stock prices may or may not represent a company’s true value
• Good companies are long-term good investments

A stock’s price is only important in establishing when is a good time to buy or sell.

Long-term investors have time on their side - time to let aberrations in the market work themselves out. Take advantage of time and let good companies show their true value. Don't be in a hurry to make lot of money from stock market.

Friday, November 23, 2012

Benefits of Investing in Equities for Long Term

Like the fabled tortoise that beat the hare in the race, the investor who stays in for the long term is more likely to achieve his or her goals than the investor who chases “hot tips” for quick profits in the stock market.

Time is an investor’s best friend (or worst enemy if you wait too long) because it gives compounding time to work its magic. Compounding is the mathematical process where interest on your money in turn earns interest and is added to your principal.

Consider the following four investors ages 25 – 55. Each invests Rs 2,000 per year and earns 8%.

At age 65:

The investor who started at age 25 has over Rs. 585,000

The investor who started at age 35 has just Rs. 250,000

The investor who started at age 45 has just Rs. 98,800

The investor who started at age 55 has just Rs. 30,700

The results are quite dramatic and, as you might expect, the youngest investor comes out the best. However, look at the difference starting 10 years sooner can make. The fewer years invested the more dramatic the difference with the next youngest age. The investor who starts at age 45 still earns over three times as much as the investor who starts at age 55. Of course, part of the difference is the 45-year-old investor has 10 years (Rs. 20,000) more to invest, but the rest of the difference is the power of compounding.

This may not be the most “real life” example, since we can’t go back to age 25 and start over. Let’s look at the power of long-term investing from a different goal. What will it take for each of these investors to accumulate Rs 750,000 at age 65, assuming they all earn 8% and ignoring inflation and taxes?

The investor who started at age 25 needs to invest Rs 213 per month

The investor who started at age 35 needs to invest Rs 500 per month

The investor who started at age 45 needs to invest Rs 1,650 per month

The investor who started at age 55 needs to invest Rs 4,072 per month

While all four investors reach the goal of Rs 750,000, it is obvious that the younger investors get a lot more “heavy lifting” from their investments. The lesson is clear: The earlier you start the less you have to invest to reach your goal.

Problems & Corrections

The examples above describe the mathematical advantage of starting early, however they don’t represent a “real world” situation. It is highly unlikely that you could achieve a constant return of 8% over a long period. The reality is there will be times when your investments earn less and other times when you earn more or loose money. There may also be times when you will earn upto 30% annualized returns, obviously by investing in equities and not in FDs.

The investor with a long- term perspective can also correct for mistakes along the way. For example, that stock you thought was going to soar like an eagle turned out to be a turkey. If you have a long-term perspective, you can change investments that aren’t working for other alternatives. However, if you will need the money from your investment in the near future (fewer than 5-7 years), a mistaken investment can create real problems in meeting your goals.

Long-term investors, especially those who invest in a diversified portfolio, can ride out down markets like the one that began in March of 2000 without dramatically affecting his or her ability to reach their goals.

However, for the investor just starting out at age 55, a market downturn can be disastrous. There is no room for error with only 10 years left before retirement at age 65. The reality of investing is that the market will go up and the market will go down. Investors that begin early and stay in the market have a much better chance of riding out the bad times and capitalizing on the periods when the market is rising.

Investors & The Herd Mentality

Many investors react to market conditions like lemmings:

Stampeding up the high mountain when markets are rising and down into the cold deep sea when markets are falling.

This "herd" mentality can be extremely dangerous to your pocket.

Why? Because investors often get into the market too late and get out too early.

You should never let emotions cloud your trading judgment. But you can turn the crowd's fear and greed to your advantage. To exploit market psychology, you must act in a contrarian fashion, taking the contrary course when the crowd falls prey to its emotions.

Extreme optimism can coincide with market tops. People think the sky's the limit and send stock prices flying. Savvier investors sell into this frenzy and run to cash. The market tanks soon afterward.

Extreme pessimism can be bullish. Toward the end of a big decline, the last bulls throw in the towel and sell with a vengeance. Cooler heads smell a fire sale. They dive into the market and buy equities with both hands to launch the next rally.

Studies by economists and psychologists have found that investors are most influenced by recent events -market news, political events, earnings, and so on and ignore long-term investment and economic fundamentals.

Furthermore, if a movement starts in one direction, it tends to pick up more and more investors with time and momentum.

The impact of this lemming like behavior has been made worse in recent years because financial, economic, and other news affecting investor psychology travel faster than ever before.

Capital can also flow now between nations with surprising ease, so that international markets respond more quickly to sudden changes with a domino effect in the direction of investor buying and selling.

How do you stay calm during market drops and restrained during market updrafts?

Here are a few guidelines:

1. Have a plan.

2. Know why you're investing and what you want to accomplish.

3. Pick a strategy and investments that best help you reach your goals.

4. Minimize risks.

5. Don't fall prey to the temptations of greed or fear.

6. Know your investment personality.

7. Pick investment strategies and risks you feel comfortable with.

8. Stick to your investment approach.

If you follow a certain type of investing strategy or a particular investment newsletter, stick with it unless there are sound reasons to change. Different strategies often can end up with similar results over the course of a market cycle. It's the switching back and forth between strategies that can cause problems because jittery investors often abandon a strategy that's temporarily out of favour - just before it makes a strong recovery.

9. Sort out the good from the bad.

Learn to recognize the difference between a poor investment and a solid investment that is having an off period.

10. Diversify.

11. Invest regularly according to your long-term plan &

12. Don't read the daily stock pages.

It's the daily following of the inevitable ups and downs of the market that send the average investors reaching for the phone. Instead, check every two to three months.

Wednesday, November 21, 2012

Look at Value not at Momentum while Buying Stocks

Many investors seem to give more thought to which television to buy than they put into buying a stock. Perhaps that is a bit harsh, however you have to wonder sometimes. Investors sometimes fail to grasp the concept that stocks are not priced like, well televisions.

If a retailer puts a 42" television on sale and attracts a bunch of buyers, you can bet that competitors will soon counter the offer with a lower price or extra features. The result of this competition is the price of televisions go down, not up with popularity.

In the stock market, the more popular a stock (more buyers), the higher price new buyers will have to pay. Unfortunately, as excitement around the stock builds, more investors want in and they often end up paying too much for the stock.

What this illustrates is the need for a plan that identifies quality stocks at great prices and ignores the hype around Dalal Street's latest darling.

If you want to buy a stock, you should be able to state, in writing, the reasons. This is known in the business as a "buy case". A buy case is a simple, to-the-point summary of why this stock makes sense for your portfolio.

It covers five important points about the company and the stock and forces you to do your homework before investing. If you follow this procedure or one similar to it, you'll avoid buying (or selling) as an emotional response.

5 Points of a Stock Buy Case

Here are the five points your buy plan should cover:

1. What does the company do? If you can't explain the major business activity of the company in two or three sentences, you shouldn't be investing in it.

2. What part of the economy does this business serve and is it growing or does the company own a large share of that market? You invest in a company anticipating long-term growth. Companies that are built on fads or outdated technology are not good prospects. The technology sector is more volatile than consumer staples, but also offers more growth potential.

3. Is the company riding a demographic or economic trend that has long-term implications? Companies that serve retirement needs of Baby Boomers have all new babies population as market. Companies that define their market too narrowly limit their potential growth.

4. How do you value the company using standard market ratios? Using many of the tools of fundamental analysis how does the company compare to its industry peers? How does is compare to the overall market? Why do you believe it is under valued?

5. What do you see that makes you believe the company has room for sustained growth? Why do you believe the company is in a good position to grow and the stock is not priced to reflect this potential? Whatever reason, you should have a reasonable answer for why the stock price is lower than it could or should be. This is your growth margin.

When you have built a convincing buy case (at a certain price), you are ready to invest.

Retain the buy case and review it at least once a year or more often if the stock takes a big hit to see if any of your assumptions or conclusions have changed.

Remember, when you build a buy case before buying a stock, you force yourself to make a rational decision.

Investing on instinct is like guessing, sometimes you'll be right and sometimes you'll be wrong - not a great way to a solid financial future.

Sunday, October 21, 2012

Evaluating & Picking Winning Stocks for Investment

It is very important to evaluate company using vital parameters before finalizing it as an investment candidate. Many investors who are new to stock markets simply look at share price, its 52 week high & low and put their hard earned money in equities to work. And as we all know, most of the times this approach never works.

We always suggest our readers to a proper & thorough research before taking any exposure in riskier asset like equities. Below are the 9 important parameters which are broadly used as tools for doing fundamental analysis of a company. Using these key parameters, Investors can pick winning stocks for their portfolio to get rewarded in long term.

1. Company’s History & Promoter's Credentials

This is one of the most important factor when one is looking to buy stock in an unknown company. It is best to look up the accounts for a couple of prior years and also read up the directors’ report. One should also do a Google search on the company and its promoters to see if they have ever been involved in shady or dubious deals.

2. Cash Flow

Cash flow is the amount of money coming in or going out of the business in a given period of time, say, one financial year. It helps to determine how much liquidity the company has. If a company is “cash flow positive”, it means that it is generating more cash from the business than it is paying out. This is a positive sign because it means the company has bargaining power. It is selling to its customers and receiving payment early while it is buying from the suppliers and paying them late.

If a company is “cash flow negative”, it is a dangerous sign because it means that the company has no liquidity and is desperately dependent on its suppliers and creditors. They can hold the company to ransom by choking its credit limits.

3. EBITDA 

EBITDA stands for “Earnings before interest, taxes, depreciation and amortization”. EBITDA tells the investor, the profit that the company is making from its operations. If the EBITDA is negative, then it is a very negative sign because it means that the company is losing money in its core profitability.

The EBITDA margin is computed as a percentage of sales and EBITDA. For instance, in a company had sales of Rs. 100 and an EBITDA of Rs. 12, its EBITDA margin would be 12%. The higher the margin, the better it is.

Example: Hawkins Cookers’ EBITDA in the year ended 31.3.2012 was Rs. 49.61 crores. Its sales were Rs. 383.72 crores and so the EBITDA to Sales margin was 12.92%.

4. EPS (Earning Per Share)

EPS (Earning Per Share) = Net Profit / Number of Outstanding Shares

There are variants such as the “Diluted EPS” which means that even the shares that will be issued in the future pursuant to outstanding warrants or bonds are also considered.

Example: Hawkins Cookers’ net profit for the year ended 31.3.2012 was Rs. 30.08 crores. The number of equity shares were 56.88 lakhs and so the EPS is Rs. 56.83.

“Cash EPS” is worked out by taking the operating cash profits (without reducing non-cash expenditure such as depreciation).

5. P/E Ratio

The Price-Earnings (PE) Ratio is a valuation ratio of the company’s current share price compared to its earnings per share (EPS). In other words, how of a multiple of the EPS is one paying to buy the stock.

This criteria helps to identify, how cheap or expensive a stock is compared to its peers. It is calculated with the formula: 

Market Value per Share / Earnings Per Share (EPS)

For example, if the stock is available at Rs. 20 each and the EPS is Rs.5, the PE ratio is 20/5 = 4.

The PE is usually calculated on the EPS of the previous 12 months (the “trailing twelve months” (“TTM”).

The PE ratio can be used to benchmark companies within the same Industry or sector. For example, if one is comparing two PSU banks, if one has a PE of 5 and the other has a PE of 8, the question is why one is paying a premium for the second one and whether there is a valuation aberration somewhere that an investor can take advantage of.

Example: Hawkins Cooker’s EPS in the year ended 31.3.2012 was Rs. 56.85 (as calculated above). The market price per share is Rs. 1,687 and so the PE ratio is 29.66.

6. Return on Equity (ROE)

ROE or Return on Equity indicates how efficiently the management is able to get a return from the shareholders’ equity. ROE is calculated with the following formula:

Net Income / Shareholders’ Equity

Example: Suppose a company earned Rs. 1,000 in profit and the total equity capital is Rs. Rs. 2000. The ROE is 1000/2000 = 50%.

Suppose another company in the same sector/ industry earned a ROE of 30%. You know which company is a more efficient utilizer of capital.

A variation of the same concept is the Return on Net Worth of RONW in which we take in not only the equity capital but also the retained earnings (reserves).

Example: Hawkins Cooker’s Net Worth (equity + reserves) as of 31.3.2012 was Rs. 51.59 crores while its net profit was Rs. 30.08 crores. The Return on Net Worth is 58%.

7. Debt Equity Ratio

Debt Equity Ratio is the proportion of debt to equity used to run the company’s operations. It is calculated with the following formula:

Total liabilities / equity share capital + reserves

When examining the health of your business, it's critical to take a long, hard look at company's debt-to-equity ratio. If Debt Equity ratios are increasing, meaning there's more debt in relation to equity, Company is being financed by creditors rather than by internal positive cash flow, which may be a dangerous trend.

The debt/equity ratio also depends on the industry in which the company operates. For example, capital-intensive industries such as capital goods, auto manufacturing tend to have a debt/equity ratio above 2, while IT companies / Consumer Goods companies with high brand equity have a debt/equity of under 0.5.

Example: Hawkins Cooker’s equity + reserves as of 31.3.2012 was Rs. 51.59 crores while its debt was Rs. 12.20 crores. The debt equity ratio is 0.24.

8. Market Capitalisation

It is the value for the entire company can be bought on the stock market. It is derived by multiplying the total number of equity shares by the market price of each share.

This helps to determine whether the stock is undervalued or not. For instance, if a stock with a consistent profit of Rs. 100 is available at a market cap of Rs. 200 is undervalued in comparison to another stock with a similar profit but with a market cap of Rs. 500.

Example: Hawkins Cooker’s has issued 52.90 lakh shares. The price per share is Rs. 1,819 and so the market cap of the company is Rs. 962 crores. This means, theoretically, that if you had Rs. 962 crores, you could buy all the shares of Hawkins Cooker.

9. Dividend Yield

‘Dividend Yield’ is a financial ratio that shows how much the company pays out in dividends each year relative to its share price. It is calculated by the following formula:

Interim + Annual Dividends in the year/Price per share x 100

If you find that company is paying consistent dividend year after year with dividend yield of above 7%, you can think to invest in such stocks instead of blocking your money in fixed deposits. Here, you can think of some appreciation in stock price along with 7% returns on yearly basis through dividend payment. 

Example: Oil India declared a dividend of 475% (Rs. 47.50 per share). Because its market price is Rs. 489, the dividend yield is 47.50/489×100 = 9.7%.