Investing in what you know

In a world dominated by lot of institutional investors what can an individual investor do to stand-out and take advantage of the opportunities that lie ahead of him/her?

Unlike institutional investors, individual investors need not remain invested all time.

The individual investors have inherent advantages over large institutions as large firms either wouldn't or couldn't invest in small-cap companies that have yet to receive big attention from analysts or mutual funds.
To take advantage of the opportunities, individual investor can invest in stocks of companies that he/she understands or knows, provided the valuations are attractive.

For example : As an individual, in your daily routine, you would use lot of products and services from various companies.

Here, let us examine the products & services that you may come across in your daily routine:

Once you wake up you might read a 'Deccan Chronicle' newspaper, thereafter use your 'Colgate' toothpaste/brush, shave with Gillette and use a shampoo made by P&G or HLL. For Breakfast, you might be having 'Britannia's' Cakes and Glaxo's 'Horlicks'. After wearing the dress from 'Zodiac', 'Titan' watch and 'Bata' shoes you might ride your 'Hero Honda' or drive a 'Maruti Suzuki' 4-wheeler to reach your destination. Through the day, you might call your friend from your 'Airtel' mobile and plan a movie in 'PVR' over the weekend.

In most of these cases, you have been using the products or services for quite some time and liked them, and knew that the company was doing well, but might not have taken advantage of the opportunities provided by the stock market to invest in these company's stocks and benefit from the
growth of these companies.

For example: X and Y purchased their 'Whirlpool' refrigerators last March, ahead of Summer, at Rs.20,000. Y, also an investor, investing in the stock market noticed that the company is performing well, and found the valuations were reasonable and purchased Rs.20,000 worth of whirlpool stock as well (800 shares @ Rs.25). After about an year, while 'X' is happy with the refrigerator, 'Y' is not only happy with his refrigerator, but also with his decision to invest in 'whirlpool', which worked wonders for him! You may wonder how? The 'Whirlpool' stock went up by nearly 10 times in the last one year and is currently trading at Rs.250 and value of Y's investment multiplied to Rs.2,00,000(ie.800 shares @ Rs. 250)

Here, we should add a caveat before you think investing is too easy and you want to buy shares of all the companies that you know. A good company is the starting point of investing; we should also study if it is available at reasonable valuations.

Going back to March last year when ‘Y invested in the stock, Whirlpool India, whose parent company was the largest consumer durable company in the world was quoting at around 6 times P/E. It was a debt free company where both sales and the profits were growing at a steady pace and the valuations were certainly attractive.

Buying the stock in a company, just on the basis of its attractiveness may not always be a correct decision. For example, if you would have purchased 'Titan' shares 7 years ago, along with your watch, the amount invested in that stock would have gone up by 40 times, however, if you had invested in 'Jet Airways' after flying with them nearly 5 years ago then you would have lost 60% of your investment.

Finally, identifying the growth potential of the company through positive experience of the company's product or services is not sufficient. One should take an investment decision based on the valuation of the company and future prospects through due diligence.

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Study Yourself before...

....you study the market.

Investment success or failure depends on your ability to formulate a successful investment strategy and to have the discipline to follow the chosen investment strategy. Understanding one’s own personality traits is essential, both for formulating a successful investment
strategy and in implementing the strategy with discipline. For example: if you are prone to take impulsive decisions, you could end up buying stocks on tips without doing detailed research in stocks where you are investing, whereas if you have an aggressive personality, you might be trading/investing in stocks with high risk-reward ratio.

New investors should make prudent stock investments in the beginning by investing small amount of capital until they gain confidence on their investment strategy. While investing, they should also gain clarity about how their personality traits could affect the successful outcome. Although the investors might not gain during the initial learning period, they can successfully deploy their experience while managing a bigger pool of funds.

If you are an existing investor, the best way to learn and improve the success in investing would be to study whether you are taking buying/selling decisions based on the emotions or based on a sound investment strategy and review the performance of your past investment decisions.

Before you evaluate your performance you need to gather data about your past transactions. Thereafter, you should be reviewing your reasons for purchase and/or sale of your investments.
Check whether the reason to buy a stock was based on some rumour/hot tip from your friends or based on information about the expected stock price movements? Have you bought any stock because it seems to be moving a lot off late and you expect it to continue to rally after you have purchased it?
Did you buy some stock because all your friends and most of the investing crowd seem to be buying it and you do not want to feel left out?
Have you bought a stock because you had a gut feeling that it would go up and you did not want to miss the upside opportunity?

In most of the cases above, 'greed' was the predominant emotion that has dictated the purchases by the investors.

Check whether you have sold the stock, after it witnessed a steep fall and you were afraid that it would continue to fall?
Have you sold your investments because other investors were also exiting and there is panic in the market place?
Have you sold because you had notional losses and were afraid that there could be some negative developments in the company and the stock would fall further?

In most of the cases above, 'fear' was the predominant emotion that has dictated the sales by the investors.

Investors also need to review their current holdings periodically to check whether they are holding stocks as a part of their investment strategy or due to decisions based on the emotions such as hope, love, disbelief.

If the stock you have bought witnessed a steep fall, are you still hoping that the stock would recover to reach your cost price where you bought, so that you can recover your amount?
Are you in love with some of the stocks that you hold, and as a result you do not want to sell those stocks even though the performance of the stock is poor?
Are you still holding the stocks that you have bought at higher prices in an up trend because there is disbelief that the market has turned around and entered a downtrend?

If your answer to the above questions is yes, then you might not be holding
stocks that give you the best upside opportunities in a recovery.

Pls. note that investors whose decisions were dictated by the emotions such as Greed, Fear, disbelief and love are the ones who are not able to establish a proportionate balance between risk and reward. Once they understand their personality traits they can remove the distortion caused by their emotions and they would be able to take a more disciplined approach towards investing.
By reviewing the past experiences in the market and learning from them, investors can improve their success rate in stock market investing. Based on their learning, investors can redefine their investment strategy and apply it successfully to invest in Stocks, Commodities and Real Estate markets!

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Open Offer

What is Open Offer?

An open offer is an offer made by an acquirer to buy a fixed quantity of shares, when his stake in the target company crosses certain pre-defined limits. In case of takeovers, an open offer can be an exit opportunity for existing shareholders
as the offer price is usually at a premium to the prevailing market prices.

When would an open offer be triggered?

~ If an entity’s stake in a company crosses 15% of the total shares outstanding, then he needs to make an open offer for a further 20% of total shares outstanding.
~ If an acquirer has 15% or more but less than 75% of shares, to get more than 5% of the voting rights of the company in a year, the acquirer needs to make an open offer for further 20% of shares of target company.
~ An acquirer, who already has a stake of 75% or more in a company, can acquire further shares only through an open offer from the shareholders.

Regulatory View

● SEBI's (Substantial Acquisition of Shares and Takeovers) Regulations, 1997: Provides regulations and suggests measures to protect interest of the investors.
● If the shares received by the acquirer under the offer were more than the shares agreed to be acquired by him, the acceptance would be on a proportionate basis.
● After the public announcement of open offer, it should be opened on or before 55 days. The open offer is kept open to the public for a period of 21 days.

How does one determine the offer price?

SEBI does not decide or approve the offer price. The acquirer is required to ensure that all the relevant parameters are justified in the offer, which are
● The highest price at which the acquirer has acquired the shares of the target company as per the agreement.
● If the target company is frequently traded, then the average of weekly high and low prices of shares is taken for 26 weeks or during two weeks prior to the date of the Public Announcement, else the fundamentals of the company are
considered.
● In case of abnormal cases, amendments of regulations are expected from SEBI to deal with pricing issues. (Ex. Satyam Computers)

How can an investor benefit?

● Short-term players might enter for arbitrage when the market price of the stock is lower than offer price, and exit the stock before the close of open offer, as there is a possibility of share price moving towards the offer price.
● If the acquirer is accepting more number of shares, then there is a greater possibility that the shares tendered by the investor would be accepted under the open offer.

More Importantly - The Conclusion:

An investor can benefit under an open offer, as it is an opportunity for him to exit his position in a stock, at a price that is usually higher than the prevailing market price. Short-term traders can also benefit from the arbitrage opportunity in the
open offers as the stock price usually moves closer to the offer price, once the company announces an open offer.

However, if the number of shares tendered by the investors were more than those available under the open offer, the company would acquire the shares on a pro-rata basis. Also there is a risk of a steep fall in the share price once the open
offer concludes. As a result, the investor could end up having to sell the unaccepted stock at lower prices.

On the tax angle, both short-term investors and long-term investors are taxed with the applicable tax rates as open offers are treated as off-market transactions (hence the lower capital gain taxes that are applicable for normal investors in the market would not be applicable to the gains made by submitting the shares in an open offer).

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FCCB - What?

Foreign Currency Convertible Bonds (FCCBs) are debt instruments issued in a currency different than the issuer’s domestic currency with an option to convert them into common shares of the issuer company at the option of the lender. FCCB acts
like a bond by making regular coupon and principal payments and also gives the bondholder the option to convert the bond into a pre-specified number of equity shares.

Features
● FCCB issues have a ‘Call’ and ‘Put’ option to suit the structure of the Bond. In India, both the options are subject to RBI guidelines.
● FCCBs are of either secured or unsecured type and can be converted into Indian shares or ADRs/GDRs (Depository Receipts).

Regulatory View
● FCCBs can be raised through automatic route by all Indian corporates except by financial intermediaries such as Banks, FIs, NBFCs, etc. For the financial institutions dealing exclusively with infrastructure or export finance and banks, FCCB issues have to be approved by the RBI.
● RBI approval is not required for issues up to $500 million during the financial year and this form of financing is treated as FDI and companies have to comply with sectoral FDI regulations. The funds generated should be parked abroad until the actual requirement arises.
● FCCB proceeds should be used for investment purposes and for overseas direct investment in JVs or wholly owned subsidiaries, or acquisition of shares in divestment process etc.
● FCCB coupon rates are capped: 6 month LIBOR plus 300 bps for 3 to 5 year FCCBs; 6 month LIBOR plus 500 bps for FCCBs above 5 years.

Pricing & Buy-back
● FCCB issues are priced higher than the average of weekly high & low of the closing prices of the issuer company, subject to certain conditions for calculating the average price. The option price is fixed at a premium of around 30% to 70% to the prevailing stock price.
● The right to buyback is vested with the issuer of FCCBs. However, the actual buyback is subject to the consent of the bondholders.
● Buy back of FCCBs upto $500 million does not require RBI’s approval but the buyback value should be at a minimum discount of 15% on the book value and the buyback is to be funded by existing foreign currency funds held either in India or abroad.

Advantages
● The issuer has a possibility to skip paying the interest/principal on the FCCBs if the stock price appreciates, while the lender can have an option to take advantage of any favourable movement in the stock prices, apart from earning regular interest/principal payments.
● FCCBs carry a low/zero coupon rate, providing the issuer company with low cost funding.

Disadvantages
● If FCCBs are not converted into equity shares on account of depressed stock prices, there can be a sizeable redemption liability for issuing companies, along with regular interest expenses.
● Conversion of FCCBs can result in equity dilution for the promoter group.

Get more insights in to financial and investment management from us.

Buy Back Shares?

What is a Buyback?
Buyback is the process wherein a company offers to buy its shares owned by the investors, at a premium over the prevailing market price. The offer can be binding or optional to the investors. The trend of buyback offers is usually seen during the bear markets where the promoters feel the stock prices of their companies are undervalued.

The Company Can Buyback Shares From...
● The existing shareholders on a pro-rata basis or
● The open market through a book-building process/stock exchanges or
● Odd lots, that is from shareholders who own a small number of shares or
● The employees of the company pursuant to a scheme of stock option or sweat equity.

Why Companies Go For Buyback?
● Some companies buyback stock to contain the dilution in promoter holding and to block takeover bids.
● Buyback option is also exercised when a company has extra cash reserves and not many investment avenues.
● To enhance its performance metrics such as EPS, ROA and ROE etc and to maintain their target capital structure.
● To reward their investors, companies prefer buyback to dividends, as the dividend attracts taxes at both the company and the investor level.

Regulations For Companies
The government has imposed some restrictions on companies resorting to buyback to protect small investors and also to restrict them from using stock markets as a source of short-term profits.
● Buyback should not exceed 25% of the total paid-up capital and free reserves. While companies can buy-back shares upto 10% of its paid-up equity capital and reserves through a board resolution, companies need shareholders resolution to buyback anything above that.
● A declaration of solvency has to be filed with SEBI and Registrar Of Companies.
● The shares bought back should be extinguished and physically destroyed and the company cannot issue any further buyback upto six months. In a fiscal, the company can normally buyback upto 5% of its outstanding equity without notifying the regulators if the promoter’s stake ranges from 55% - 75%.

Checklist For Investors
While the buyback offers are good entry points for short-term due to arbitrage opportunities arising out of differential in the market price and the buy-back price, investors need to check the following reasons behind the buyback.
● If the P/E ratio of the company is higher than the industry average, the buyback by the company may not be justified. The investors should watch out if the buy-back is being done at the cost of capital expenditure, as it may dampen future prospects.
● The higher the price & the percentage of the buyback, greater is the scope of profits for investors.

The Final Word
Though buyback is an arbitrage opportunity in the short term, investors are advised to look at the company’s fundamentals as well as corporate governance practices before taking a call. One has to also see how many shares the company is buying back and the chances of implementing the buyback announcement as scheduled, without any delay/cancellation. If the company’s fundamentals, corporate governance are strong, the investors may have the advantage of immediate arbitrage and long-term growth potential for their capital.

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Auction Vs Discount

Do you get to buy the stuff that you would like to buy cheaper in an auction or in a discount sale?


Buying near the peak of the bull market is typically like buying in an auction, where the bidder who bids the highest price gets to own the shares that he or she bids! Conversely, buying near the bottom of the bear market would be like buying in a discount sale, in which one could get shares at a steep discount to its actual value.

In the bull market peak, while the market is going up most of the investors believe that it would continue to go up forever and are keen to participate in the expected gains. As more number of investors enter the market and the demand is much more than the supply of the shares, the market would witness an auction like scenario where the investors who quote higher prices get to buy shares in the market.

The ‘bigger fool theory’ is usually prevalent at the peak of the bull market. According to this theory, the
investors continue to buy stocks at higher prices with an assumption that they will be able to sell it later to "a bigger fool”; to be precise, buying something not because you believe that it is worth the price, but rather because you might be able to sell it to someone else for an even better price. At this stage, most of the investors get into the market with an expectation of immediate gains i.e. they expect to re-auction at higher prices at the earliest!!! While, most of the early entrants into the market do gain from the bull market, the late entrants typically tend to be stuck up with high priced stock whenever the tide turns. Most of the stocks bought at the peak, would be worth a lot less than the price at which they were bought.

This kind of behavior repeats at every market peak, as greed usually dominates the human behaviour during this period.

In a bear market bottom, investors tend to behave as if the market would continue to fall forever. Existing investors tend to sell stocks at less than their value, as they fear that the stock prices could fall further because the supply of the shares is more than the demand. New investors tend to wait further as they anticipate buying stocks at cheaper prices.

As the downside risk in equities is more evident in a bear market, investors tend to forget the upside potential of the equities. Investors should keep the long-term track record of the markets in mind, and not the immediate short-term track record of the market, which is usually quite volatile. To illustrate the long-term track record of the market, one can study the return given by the Sensex from its base of 100 on April 1st, 1979. In the last 30 years, the markets have given a 16.48% compounded return to investors. This is not taking into account the dividends that the investors had received and the tax advantages of long-term investing in equity. However, the returns were quite volatile in the short-term. For Example: the market lost nearly 52% in 2008 after gaining nearly 47% per year both in 2007 and 2006.

The fact remains that equity has been one of the most attractive long-term investment avenues. Though
in the short to medium term it is usually quite volatile, the longer the time frame of the investor, the lesser
is the chance of the downside risk in equities, if invested in quality stocks, especially in a bear market when the valuations are attractive.

In a bear market, investors should focus on buying quality stocks at a discount to their true value, but not
because they are getting it at a discount to the prices seen during the previous peak!

What do successful investors do? They usually tend to buy quality stocks in a discount sale and sell in an auction.

Tomorrow we will discuss about buyback of shares. Until then let us know how you feel about our tips and articles.

Should you Invest in IPOs - Investment in IPOs part 2

Welcome back to the ABCs of investing in IPOs. So how do investors protect themselves and take advantage of the IPO opportunities?

Dos:
● Do check the quality of the promoters before investing in the stocks. What is their track record? Are the promoters/management trustworthy? Did their other group companies that have earlier gone for IPO provide adequate returns to investors? At what price did the promoters and other investors invest in the company? What would be the promoter stake post the public issue? Whether they have any strategic/technical tie-ups or alliances with well-known companies etc.
● Do check the basic valuation metrics such as EPS, P/E, Book Value, Dividend yield etc. Has the company been able to increase its revenues and profitability over a period of time? What is the valuation of the company when compared to its industry peers?
● Do check, where would the company utilize the IPO proceeds and how would the company benefit by going for an IPO?
● Do check the future prospects of the company and whether the company can grow its revenues and profits, going forward.
● Do check the IPO grading: Before the issue, the issuing company needs to get itself graded by the credit rating agencies registered with SEBI. The grade represents a relative assessment of safety, return, risk of IPO vis-à-vis other listed equity shares. The higher the grade the better it is, though a higher grading would not guarantee any returns to investors, if the issue were expensive.

Donts:
● Do not invest in the IPO just because everyone else is doing it and you would not like to miss the opportunity. Remember that if more number of people applying (i.e. the demand is high) the price is usually not cheap and the possibility of making return post listing would also diminish.
● Do not invest in IPO with the hope of making instant return (especially if the IPO is expensive), because the ‘grey market (unofficial price)’ premium is high. This grey market premium is usually manipulated and it could (and most likely it will) change before the listing and the investors hoping to make a quick profit could end up making a loss.
● Do not invest because the current IPO is relatively cheaper than the listed stocks in the same space, if on absolute basis the stocks in the industry are expensive.
● Do not invest if there are significant risks in the horizon especially where there are execution risks, compliance risks, contingent or regulatory risks. As any developments on these fronts can risk the value of the investments in the company.
● Do not invest in IPOs if one is not ready to take the risks associated with investing in equity shares.
While the current regulations are tighter than in the past, and have resulted in the improvement in the quality of promoters that are accessing the capital markets to raise funds, investors need to be alert to the hype surrounding the IPO issues and focus more on the downside risks and potential returns based on the company’s valuation.

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Should you Invest in IPOs - Investment in IPOs part 1

Should investors invest in the primary market or the secondary market? Which would
provide investors better returns? What are the precautions that investors should take
while investing in the primary market IPOs?
Historically, the valuations have determined the kind of returns that investors would get
from a stock, irrespective of the fact whether the company is already listed or is a new
IPO. Investors have burnt their fingers while investing in stocks at the peak of bull
markets, whether they have invested in these stocks through IPO route or in the secondary
market. On the other hand, many investors who have invested in IPOs whenever the
stock is attractively valued have made good returns on their investments.
In the past, we have seen many investors investing in the IPOs, even though these IPOs
were expensive or the quality of promoters was suspect and thus losing money on their
investments.

Tomorrow, a peak at the Dos and Donts of investing in IPOs. If you think you need immediate advice on your portfolio management, don't hesitate to get in touch with us.

Weekly Market Outlook 12/07/2010

The market closed the previous week at a new 13-week closing high indicating that the current market sentiment remains robust. The Nifty is currently hovering the 2-year high level of 5400, a decisive move above these levels could result in Nifty rallying towards 5750 levels.

The market would be keenly watching the IIP data that is scheduled for release on Monday. While a positive number could propel the market higher, any negative surprise would hit the market sentiment.

The market would also be keenly looking at the monthly WPI inflation data and a fall in the inflation would help further reduce the concerns of more rate hikes before the RBI policy review meeting.

The market would closely watch the first quarter results season to witness if the current earnings growth momentum indicate any further upside in the market. Stock specific movements would be witnessed based on the results.

The market would keenly follow the outcome of the meeting of PSU refineries regarding the fuel price norms that is scheduled for July 17th and Oil & Gas space is expected to witness increased activity.

With Agriculture Minister pitching the decontrol of sugar prices, sugar related companies are expected to witness activity during the week to come.

The market is expected to continue to take cues from the global market and FII inflows. On the global front, the market would watch the US industrial production, jobless claims, etc to ascertain if the economy is on the sustained recovery path.

5277, 5210 and 5182 are the immediate support levels for Nifty, 5400, 5500 and 5545 are the immediate resistance levels for the Nifty.

17536, 17396 and 17277 are the immediate support levels for Sensex, 18048, 18274 and 18593 are the immediate resistance levels for the Sensex.

The market is expected to rally further once the Nifty decisively crosses the 5400 levels.

In case you missed this good story in Business Line today

Investing in stocks is the best bet to beat inflation

20-year analysis shows returns outstrip gold, bank deposits and commodity futures.

With prices rising at double-digit rates, where does it pay to invest? An analysis of stock returns over alternative avenues of investment such as gold, bank deposits and commodity futures shows that equities have been most successful in giving inflation-beating returns.

Over a 20-year period, according to the analysis, equities have managed a higher return compared to other asset classes during years of high inflation (Consumer Price Index in excess of 7 per cent).

The Consumer Price Index has been above 7 per cent annually in all the years since 1990. Equities have managed to out-perform other asset classes for six years during the period.

In 1991, when the Consumer Price Index rose above 14 per cent, equity investors made an 80 per cent return (measured by Sensex) on their investment. In 1997, when the CPI rose over 7 per cent, the equity market delivered a close to 20 per cent return. In 2009, when inflation was at a 10-year high of 11 per cent, investors could have raked it from the market had they only been venturesome enough.

Equities outperform

In the years when the inflation was over 7 per cent, returns from equities oscillated between 17 and 80 per cent. Adjusting for inflation, the real return has been at least eight percentage points higher. The reward for investing in equity has also widened in recent years.

An investor who bet on equities, rather than gold in the last five years, generated a 12-percentage-point higher return compared to the eight-percentage-point excess return in the mid-1990s. Needless to say, the equity returns are much higher than the returns on investments in bank fixed deposits too. Interest rates on fixed deposits have fallen sharply since the mid-to-late 1990s.

Gold was the second best choice for hedging against inflation in the last two decades. In 2008 and 2009, for instance, when inflation was over 10 per cent, gold yielded a 15 per cent return.

Gold as choice

Gold has caught investor fancy only in the last seven years. Perceived as a safe-haven in times of crisis, the investment demand for gold has been going up.

The data of the past 20 years, however, do not throw up any precise trend of gold being an out-performer in inflationary times.

Indeed if it outshone stocks, it was only when there were external shocks such as the one that happened in 1997, and more recently in 2008, when there was a crisis of confidence with the equity market across the globe. The conservative investors who preferred the fixed deposit route to investment saw negative real returns in most of the years of high inflation.

In 2009, the interest rate for deposits of one-to-three years was 7.25 per cent, with negative real return (factoring in the inflation rate) of 4 per cent.

This year, too, as inflation continues to remain at 12-13 per cent, bank FDs offer interest rates of 6-6.5 per cent.