Why stock markets?

Stock markets is the only place where you can start creating wealth
with a little money. All it requires is a bit of discipline, average
intelligence and good temperament. Any other form of investment (like
real estate, gold etc..)are not strictly regulated like stocks and they
may also require substantial capital investment.
The reality however, is just the opposite. People have made more
money by investing in assets like real estate and the stock market still
remains infamous for destroying common man’s wealth. Worldwide,
you’ll find more people who have invested and destroyed their wealth
in stock markets. People with bad temperament and emotional
attachment generally fail in stock markets.
The reason for this is that, profitable investing in stock requires proper
financial knowledge and a cool mental attitude. Hence, this session is
for anyone who aspires to get knowledge in stock markets and if you
are one among them, we’re sure this site is going to help you a lot.
Choosing Stocks (or any other asset for that matter) to invest from the
many choices available is not an easy task to do. Depending on the
type and nature of investment you choose, there are varying degrees
of risk associated with it. As you will realise from my basic lessons on
investing, risk is part and parcel of all type of investments and success
of any investment you’ve made depends on how well you have
managed the risk part of it.
Another reason why you’ve navigated to this session is because you
realise that money is a precious tool. We work hard for it and we try
our best to save as much as possible. However, in these uncertain
times, just working hard and saving money may not be enough to
maintain a comfortable living. You are supposed to protect and grow
your money so that you are safe from financial crisis at any stage of
life.

You also need to assess the way you handle your money and take
corrective measures if required. The degree of financial discipline you
have will decide how much you can save and invest. We hope my
sessions on financial planning will throw some light on the right path.

What you shouldn’t expect.

Easy formulas to make quick bucks. There will not be any daily stock
calls or ‘sure profit’ tips ‘n tricks. Such tactics don’t work in stock
markets.

The reality is in front of us. Do you think you should take chances with
your hard earned money? Stop for a moment and know what’s going
on ..

FINANCIAL DISCIPLINE FOR ALL.

Adolf Merckle was one of Germany’s richest business man. He

developed his grandfather’s chemical wholesale company into
Germany’s largest pharmaceutical wholesaler, Phoenix Pharmahandel
. He was educated as a lawyer, but spent most of his time investing.
He lived in Germany with his wife and four children.
In 2006, he was the world’s 44th richest man. Merckle’s group of
companies employed 100,000 workers and had an annual turnover of
30 billion euros (around 39.9 billion U.S. dollars).
All this turned upside down after his business empire was plunged into
difficulties due to the financial crisis. Merckle hit the headlines in 2008
when he suffered massive losses on investments he had made on
movements of the share price in Volkswagen, Europe’s largest car
company.

On Jan 06,2009 German news agency DPA reported that – Merckle,

74, threw himself under a train at his hometown of Blaubeuren, a small
town near southern Germany city of Ulm, and a railway worker found
his body by the side of the track.

Karthik Rajaram, 45, who had made almost £900,000 on the London
stock market, shot his wife, three children and mother-in-law in the
head before shooting himself at the family home near Los [Link]
did this after seeing his family’s fortune wiped out by the stock market
collapse.

Thousands commit suicide unable to bear the pressure and crisis, that
mismanaged investments create.

People spend lakhs to get a doctor’s degree or a MBA from the most
prestigious of institutes. They spend a lot to pursue their hobbies such
as music and salsa. But when it comes to managing their money ,
they hardly make any effort to learn at-least the basics , forget about
gaining specialised knowledge.
Principle [Link] money !

To most of us Savings = Income (or salary)- Expenses . However,

this formula doesn’t work ( as you would have already experienced )
since when money is in your pocket, you get trapped by advertising
tricks like discount offers on Clothes or new gadgets which tempts you
to spend more. It’s difficult to control expenses. As a result, your
savings never hits the target. If what we said holds true for you and
you seriously want to save a fixed 10% or 20% of your take home
salary each month, you need a different approach to savings. I
suggest Robert Kiyosaki’s method from his famous book ‘Rich Dad
Poor Dad’.

What kiyosaki said is very simple. Instead of trying to limit your

expenses every month, first deduct an amount which you intend to
save and keep it in a separate account so that you live with only what’s
left. So our formula has to be modified like this :
INCOME – SAVINGS(INVESTING FUND) = EXPENSES

The other side of this formula is a forced discipline. You hold your
expenses to no more than 90% of your take home pay.
You can even automate the process by having 10% (or any amount
you want) deducted from your Salary account and transfer it into a
separate account or fixed deposit, recurring deposit or other savings
instrument .
So that’s the basic trick to find money!

But, that’s not all. You can also find money from many other sources.
For example, Instead of going for parties and shopping, you can set
aside extra payments like bonuses, commissions and so forth into
your savings Fund.
So try to make it a habit to set aside 10% ( or what ever percentage
you would like to set aside) and live with rest. If you do that, you have
a great chance to succeed.
MORE TIPS TO CONTROL YOUR EXPENSES:

SPEND LESS
This is one simple method to save more. Sit back and analyse your
spending habits and look where you spend more unnecessarily. Once
you have identified certain areas of high spending, try to find ways to
cut back. Take a decision that you’ll not spend more than a fixed
budget.
MAKE A BUDGET
A budget is a very important tool to control expenses. Be it individuals
or corporates. A budget is nothing but a chart or a statement that
shows how much you earn and hence, how much you can spend.
PAY OFF YOUR LOANS
Loans carry high rates of interest. If you have a lot of EMI’s to pay, it
naturally reduces your capacity to save more. It also shows that you’re
living on high levels of debt which is not a right thing to do. If you have
loans, first look for ways to pre-pay it as soon as possible. Another
common area where you could lose a lot of money is credit cards.
Credit cards companies slap huge interest for delayed payments.
TRY TO AVOID LATE PAYMENTS
Any bills – like electricity or telephone or internet or credit card has a
deadline within which you are supposed to pay the dues.
Unnecessarily delaying such payments results in payment of fines.
Such expenditures can be avoided if you can get organized on your
bill payments. Make a list of monthly payments and the deadline within
which you are supposed to pay. These days banks also allow their
customers to automate or link their periodic bills to their savings
account or credit card.
Credit cards over dues need particular mention here. Credit card
companies slap huge interest and fines for delayed payments.
THINK BEFORE YOU BUY
Do not buy anything on impulse. Before laying your hands on any
fancy thing which is up for sale, think if it’s really needed.
SHOP SMART
Most of the big brands will be available at throw away prices once
there’s an off season sale or sales promotion drive. For example if you
want to buy an expensive watch, wait for the company to announce
some discount offers. All the big brands announce discount offers at
least twice a year.
KEEP DISTANCE FROM LAVISH FRIENDS
High spending lavish friends are may hinder your route to save money.
It’s natural for you to get tempted by such friends to buy new gadgets
every year. They may be nice guys and may not harm you in anyway,
but to keep up with them , it may become necessary for you to spend
high ( for example latest electronic items or cars , parties, expensive
dress etc ) which other wise ay not be required !

SAVING ENOUGH IS HALF THE JOB DONE

If you have saved enough,good. but saving is only half the job
[Link] have to give your savings the right opportunity to grow.
Putting all your funds in fixed deposits or fixed income bonds is not a
good idea. Your investments should have the right mix of equities,
bonds, gold and fixed [Link] the ‘right mix’ of investments
is something an investment expert can do. It depends on an
individual’s age and risk profile.

KNOW IT
Finding money is a matter of making it a priority.
Pay yourself first and learn to live off with what is left. You will always
have money with you. It may be difficult at first. But gradually, you
will see your fund growing and that would encourage you to stick
to it until you reach your goal of finding enough money.
Bonuses and extra pays you get are opportunities to buy the
latest iphone or Blackberry but a prudent option would be to
create a savings out of it
You can save a lot of money if you control your expenses.
As time goes by, your small saving will also give you additional
money in the form of interest. Finally, you’ll find that you’ve done
a great job,creating more money than expected.
Take my word. It’s fool proof !!

Principle [Link] value of money

The best money advice anyone can ever give you is the “time value of
money” concept . It is a vital concept in finance. Every financial
decision involves the application of this concept directly or
[Link] calculation of time value involves simple mathematics
and it’s easy to calculate. Since this topic is a very important to
everyone, we put it down as principle number two.
ENTER-TIME VALUE OF MONEY
The principle is – Rs 100 today is more valuable than Rs 100 a year
from now. The reasons for this is quite simple to understand -
First, since the cost of living goes up , your money will buy less
goods and services in the future .So, today, money has more
value or the purchasing power of your money is more
 Second, if you have that money today, you can invest and earn
[Link] you receive the money at a future date instead of
receiving it today, you lose the interest or profit you would have
made, had this money been with you now
Third, you prefer to have money today since the future is
uncertain.
EXAMPLE :
Lets’s assume that you are 25 years old. You have Rs.2500 with you
now. You can either put it in bank FD or buy yourself a new dress.
Now, let me further assume that you opt for buying new [Link]
reality is that you are spending far more than that Rs 2500. How? Let’s
try to calculate the real cost of not investing that money.
FV = pmt (1+i)n
FV = Future Value
Pmt = Payment
I = Rate of return you expect to earn
N = Number of years

HOW TO SOLVE THE EQUATION?

N = Number of years invested - The money you’ve spend on a dress

is lost forever. That means, that Rs 2500 could have compounded in
the bank for atleast 35 years. How did i get that ’35′ figure? I assumed
that you’ll retire at 60 and since you are 25 now, there’s 35 years left.
let’s substitute 35 for “n” in the equation.
I= Rate of return expected – The ‘I’ in the formula stands for the
expected rate of return. Since bank fixed deposits would pay around
8% and stock markets have returned an average of 15 %- 17% ,
Let’s assume you would earn some where in between – an average of
10% rate of return. So, we’ll assume ’I’ as 10% .
PMT – is the value of the single amount you want to invest (in this
case Rs 2500).
Now substituting the figures, our formula would be – FV = 2500
(1+.10)35.
Enter 1.10 into your calculator (this is the sum of 1+.10). Raise this to
the 35th power. The result is 28.1024. Multiply the 28.1024 by the pmt
of Rs 2500. The result (Rs 70,256 ) is the true cost of spending the Rs
2500 today (if you adjusted the Rs 70256 for inflation of 6 % , it would
probably work out to about Rs 9150 That means your real purchasing
power would increase approximately 4 fold).
Now, after realizing the actual cost of spending Rs 2500, would you
prefer to buy a dress for Rs 2500 today or Rs 9150 in the future. The
answer is entirely personal.
Once you understand this vital concept, you would realise that
all those bits and pieces of money you spend unnecessarily are
costing you thousands in future wealth. This is why time value of
money is considered as the central concept in finance.
MORE EXAMPLES..
Future value of money –compounded annually.
You deposit Rs 50,000 for 5 years at 5% interest rate compounded
annually. What is the future vale?
FV= PV ( 1 + i )
N

FV= Rs. 50,000 ( 1+ .05 ) 5

FV= Rs. 50,000 (1.2762815)

FV= Rs. 63,815.

Future Value of money – Compounded Monthly

You deposit Rs 50,000 for 5 years at 5% interest rate compounded
monthly. What is the future value?
(i equals .05 divided by 12, because there are 12 months per year. So
0.05/12=.004166, so i=.004166)
FV= PV ( 1 + i ) N

FV= Rs. 50,000 ( 1+ .004166 ) 60

FV= Rs. 50,000 (1.283307)

FV= Rs. 64,165.

KNOW IT
A rupee received today is greater than a rupee received
tomorrow because money has ‘time value’
The time value of money is the compensation for postponement
of consumption of money. It is the aggregate of inflation rate, the
real rate of return on risk free investment and the risk premium.
‘Time value of money’ can be different for different people
because each has a different desired compensation for
postponing the consumption of money.

Principle 3. Compounding
Let’s try to understand why he said so with a very simple example:
Abhilekh starts saving when he turned 25 and invests Rs 50,000
every year. He earns a return of 10% every [Link] the end of ten
years; he has been able to accumulate Rs 8.77 lakh. After that,
he dosen’t invest Rs 50,000 anymore. He leaves that investment
there until he’s retires at 60. At that time, he would have
accumulated around Rs 95 lakhs .
Zeeshan, had fun and lived his first few years spending on all
kinds of things and did not think of investing regularly. At 35, he
starts to invest Rs 50,000 regularly every year until he retires at
60. I.e. for 25 years. But, he would have managed to accumulate
only Rs 54.1 lakhs which is around Rs 41 lakhs less in
 comparison to Abhilekh.
5 simple points spell out from this story:
Even by investing two-and-a-half times more than
Abhilekh,Zeeshan has managed to build a corpus which is 43%
less!
Why? Because,Abhilekh’s Rs 5 lakhs was allowed to compound
for a longer period of time than Zeeshan’s.
As the fund grows, the impact of compounding is
[Link] starts at 25, accumulates 50,000 for ten years,
stops at 35 and then, his 8.77 lakhs (5 lakhs + Interest) is
allowed to compound for 25 years till he’s 60. Whereas Zeeshan
starts at 35 and invests Rs 50,000 for the next 25 years,
accumulates 12.5 lakhs (50,000 x 25) only to get 54.1 lakhs at
60.
Now let’s assume that Abhilekh had allowed the fund to
compound for only 20 years i.e. Till he turned 55. At 10% return
every year, he would have accumulated an amount of around Rs
59 lakhs. By choosing to let his investment run for 5 more years,
he accumulates Rs 45 lakh more.
Essentially, compounding is the idea that you can make money
on the money you’ve already earned.
Compounding is very powerful. As Napoleon hill has said- “make your
money work hard for you, and you will not have to work so hard for it”
To take advantage of it, you have to start investing as early as
[Link] earlier you start, the better it gets.

Here is a comparative chart for you to understand.

Let’s assume that you invest Rs 10,000 annually. Your retirement age
is 60. Let’s also assume that the interest rate you get is 10%.
At the age of 60 you will have -
 49 lakhs -if you had started investing from age 20.
30 lakhs -if you had started investing from age 25.
18 lakhs – if you had started investing from age 30.
11 lakhs – if you had started investing from age 35.
Just 6 lakhs – If you start at 40!! Take note of the impact.
Oh! That’s a huge difference! Now that you realised it late, what can
you do? You can start now, invest more and reach the target of 49 lakh
at age 60. This would mean more hard work and budgeting for you.
Let us see how much more you would need.
To get 49 lakhs at age 60 –
Invest 10,000 annually – at age 20
Invest 16,500 annually – at age 25
Invest 27000 annually – at age 30
Invest 45,000 annually- at age 35
Invest 78,000 annually – at age 40!!

THE MORE YOU DELAY, THE MORE YOU NEED TO INVEST.

Principle 4. Interest rates.

INTEREST ON LOANS
Interest rates are always tricky. In most of the cases, interest rates
advertised by the banks are not the actual rate of interest you pay. It’s
something more than that.
Trap 1.
When you apply for a loan, there are a lot of financial charges you
need to consider before deciding whether to avail it or not. For
example – you are offered a loan for Rs.2 lakhs and your EMI works
out to say, Rs. 18000 with 2 EMI’s payable in advance. Effectively, you
are getting only Rs 164,000 in hand. But since the interest rate is
calculated as if the entire 2 lakhs is given to you, the rate of interest
you pay is actually very high.
Is that all? No. The bank will also deduct a processing fee of 1 % of
the ‘total amount’ ie. Rs 2000 for a 2 lakhs loan. So on net, you get Rs
162,000.
Trap 2.
You are offered the same loan for reducing balance interest. You feel
light thinking of the fact that interest is charged only on the balance
outstanding. But look closer – reducing balance can be on monthly
basis, half yearly basis or on Annual basis. If it’s on annual basis –
your interest is calculated on the amount outstanding at the ‘beginning’
of the year. So, you keep paying interest on a higher amount even
though your loan is decreasing every month. This pushes up the
effective rate of interest you [Link] always confirm whether the
reducing balance is on annual basis or half yearly basis.
Trap3.
Higher loan pre-closure charges. The bank would like you to pay your
EMI’s regularly. If you do that, the bank likes you so much that on the
basis of that regular loan track, they will sanction a second loan if you
want. But – if you try to close off your loan liability before the stipulated
loan period – the bank will charge an additional amount of 3% to 4%
on the outstanding principal. They don’t want their customers to be
‘Too regular’. strange isn’t it?. That’s the way bank deals with it’s
customers. If you try to be too good , you’ll be fined This pre-closure
charge you pay effectively raises the cost of your loan.
The solution-
The best way to deal with these traps is to stop comparing the interest
rates and instead, compare the EMI’s and compute the total amount
going out of your pocket including processing fee and pre-closure
charges. This will give you the right picture of which loan is actually
right for you.
INTEREST INCOME
The principle to be applied is quite simple – The earlier you get it, the
better it is.
This principle will help you to compare different offers. For example –
A bank offers 8% P.a interest on FD , payable annually. NSC also
offers 8% P.a but, payable half yearly. You get another offer on FD
which pays interest at 8% p.a – payable monthly. Which is better? The
one you get on monthly basis, of course!. Why? Because, the bank’s
effective rate is 8% , the NSC’s effective rate is 8.16% and the third
option of FD gives you an effective annual interest rate of 8.30% !
How? Let’s calculate with an example –
Let’s assume that you have 2 lakhs with you.
The first bank would give you 8% – annually so, you receive an
interest income of Rs.16,000 at the end of one year.
Suppose you deposited the same with NSC, They would give
you 8% -half yearly. So, at the end of 6 months you get Rs 8,000
which can be again invested for 8% interest for 6 months which
gives you an additional interest of Rs. 340. So, the total interest
you receive is now Rs 16,340. effective rate – 8.16%
Similarly , when you work out 8% interest received on a monthly
basis the effective interest rate would workout to 8.30%.

Principle 5: Never stretch beyond your limits.

Money will come and go; after all, you just have a life to live –why not
live it to the fullest? Sounds perfect and positive, isn’t it? Unfortunately,
if you are living your life like that, not everything is positive and perfect.
You will realize the perils of reckless spending when you face a
financial emergency. I have done it in my initial investing life– reckless
spending – but soon realized that you cannot discount uncertainties in
life. A sudden drop in my monthly cash flows turned my life into a
nightmare. So, when i write my sixth principle, I have my own
experiences to back it up!
The principle is not very hard to follow – never take money from your
savings or borrow temporarily from your friend’s pocket to buy a little
more luxury. Be it a slightly bigger house that caught your wife’s
imagination or the latest electronic gadgets.

WHERE IS THE PROBLEM?

The lifestyle you want to maintain depends on three factors:
[Link] circumstances in which you were born and bought up
2. The kind of friends you have
3. The place or community where you live.
Have you asked your parents about how they started their life? They
din’t have a big car or latest electronic gadgets. They probably didn’t
live in the big apartment or villa they’re living right now. They built
everything brick by brick. It would have taken a lot of time, effort and
disciplined life to get to where they are now. That’s exactly the way you
should also start off. If you try to achieve all the life’s goodies in very
short time, there’s every possibility that you’ll borrow a lot of money
assuming that you’ve the ability to re-pay everything in 5 or 10 years
and chances are that you’ll get into debt trap should there be an
unexpected fall in your monthly income.
Another problem among youngsters is that spending habits are greatly
influenced by their friends and colleagues. Bank balance doesn’t
matter, the car or home doesn’t matter – what matters is the answer
‘yes’ to this question- Are you better off than your neighbour , friend ,
relative or colleague? If the answer is yes, you are confident, you feel
happy. Or else – you stretch beyond your limits to maintain yourself
the standard of living that your friend has! You will over borrow, over
spend or do something to satisfy your ego. This category of people
falls into the trap of personal loan providers. Personal loans are easy
to get. There is less documentation and there are no restrictions on
how you use the money. Since money comes in quickly with minimum
documentation, you won’t mind the higher rate of interest.
Another reason for reckless spending is that these days, a lot of
technologically advanced gadgets and appliances are introduced into
the market that drives everyone crazy. Financial schemes are
introduced by institutions which would seem like a very simple deal.
These schemes are advertised in such a way as to lure customers.
Such facilities tempt us to spend more. When you buy into such
schemes, what you are actually doing is getting into the finance trap. I
am sure 99% of people reading this would have done this in some
form or other.
That’s principle 6 for you. It’s always wise to stay within your limits.

Principle 6. Have a Monthly budget

WHAT IS A BUDGET?
Budget is a careful allocation of your monthly income. Based on a
study of your income, present expenses and future plans, a set of
spending rules are identified. You spend your money only according to
the pre-decided rules. The idea is to control expenses and make a
surplus so that you financial goals are achieved.
HOW TO MAKE A BUDGET?
Budget is vital in keeping your finance in order. Before you begin to
create your budget, it is important to list out all your sources of income
and expenses separately. Here’s a step by step general guideline to
make a good budget.
Step 1. Write down your sources of income
The first step is to write down all your sources of income. Apart from
salary or business income do have any other sources like rent or
agricultural income? Have fixed deposits? Remember to include all
such sources of income.
Step 2. Set aside a sum for income tax.

You cannot start dividing your money straight away. The first and
foremost thing to understand is that whatever income you earn, you
are liable to pay tax to the government. That’s mandatory everywhere.
Some of you may get income only after deduction tax. Depending
upon your expected tax liability, you are supposed to set aside an
amount to meet the tax commitments.
Tip: if you can consult a tax practitioner, he will tell you the exact
amount of tax!
Step 3. Make a list of fixed commitments.

Once you have computed your total income after tax, the next step is
to find out your monthly fixed commitments. Fixed commitments
include your monthly rent, school fees for children, EMIs, SIPs etc..
These are expenses that stay the same every month and you cannot
bring it down by adopting any cost cutting measures. First deduct the
total of fixed commitments from the amount you computed in step 2.
Now, what’s the balance left?

For example, you have a monthly income of 50,000 from which you
have to pay a tax of 10% which is 5,000. you find that your monthly
fixed commitments works out to 28,000. So, 17,000 (45,000 – 28,000)
is the balance left with you. This is the amount which is absolutely in
your control. You can save it or spend it!
Step 4. Variable commitments

Step 2 minus step 3 gives you a clear idea about how much you can
spend on variable expenses. Variable expenses are those on which
you have absolute control. Expenses on Items such as entertainment,
eating out, gifts etc are variable. It depends on how effectively you
control it. It is in this category of expenses that you make all the
adjustments.
For example, if you have decided to subscribe for one more
Systematic investment plan, you need to cut down and find money
from your variable expenses part.
HOW TO TRACK YOUR BUDGET.

Total your monthly income and monthly fixed expense and

monthly variable expenses and see if your income is more than
your expenses. If yes, you’re doing well. The surplus can be
used to pre-pay your loan commitments as soon as possible.
However, If your expenses are higher than income, that’s an alert
sign. In this case, you’ll have to control your expenses. If you
have some surplus cash left, try to pre-close your loans to the
maximum extent possible so that your fixed expenses part can
be reduced to that extent. That step may be a bit difficult to do
since it involves cash outflow. But, you can definitely control your
variable expenses part.
A budget once drawn will not remain fixed for ever. It may have to
be re-drawn when your income or fixed expenses part has a
change in it.
Good financial budget planning should include provision for
 emergency funds. It’s better to include the emergency fund in
your fixed expenses. Because it is very important to have some
money in the bank in case you need it for something unexpected
such as a medical treatment.
Just in case you had to spend a little more than your budget this
month, make sure you cut back your expenses in the following
month and compensate for the overspending.
Instead of writing budgets on paper, it will be more convenient to
use a spreadsheet like excel where you can easily add or
subtract or mike any corrections. Corrections are possible
without much fuss and you can also easily plot a variety of
different graphs to clearly see things visually.
CONCLUSION.
What’s said above are very simple steps. We all do budgeting to a
certain extend every month through mental calculations, although
unsystematically. If you are not budgeting you will never know how
your income vaporised.

Principle 7. Lending money to friends and

relatives.

It’s difficult to watch your friends or relatives struggling financially. If

you’re well off and good at heart, you might want to reach out to them
as well. There’s nothing wrong to lend a helping hand. Infact, we are
supposed to help them in whatever way you can. That’s helping –
quite different from lending. When you help them with an amount, you
don’t expect it back. It could be a small amount. It’s ok if you don’t get
it back.
But lending is different. You lend money when your friend or relative
officially asks for some money, stating a purpose and with a
repayment term loosely said ‘I will return it as soon as possible’.
What happens in such situations is that you will be held up in a
dilemma-
It would be difficult to say ‘no’ given the depth of relationship
between you guys
It would be difficult to ask for a written agreement.
If you are good in finance, you may also have a calculation of the
interest that might be lost at the back of your mind
Since the repayment terms says ‘as soon as possible’ and not a
definite date, practically it could prolong for an indefinite time and
you may feel very awkward to remind him about your money.
If you don’t help him, you might just lose that relation also.
It’s actually a trap. If you have lend money like that, you have only two
solutions left –
Politely ask back the money indirectly.
Write it off !
HERE’S SOME TIPS
Remember, it is your money. Whether you decide to lend the money is
up to you. Here are some tips that will help you take a decision to lend
or not.
Ask your friend why he needs so much of money? If he cannot
give a genuine answer immediately, he’s hiding something fro
you.
Watch what he is answering! if he needs fund for a medical
emergency, consider helping him. But if he needs funds to pay
off another person from whom he has borrowed money or to
settle some financial deals which you find is not proper, you need
to think twice.
 Think about how he has dealt with money in the past. Is he a
reckless spender? Is he constantly in a debt trap? What has he
done with his salary so far? Does he party all night and lives a
lavish life ? If you are not comfortable with his life style and
attitude, stay off. Politely say that you can’t lend him money.
If he asks for a huge sum which you cannot afford, say no
immediately. Also if he’s asking funds because he knows that
you’ve got a loan from elese where, do not lend.
Remind him about the money, just before the due date. Politely
say that you’ll need the funds very soon. I case he couldn’t make
the payment on that day, ask him when you can expect the
payment. Let him say a date. Also let him explain the reasons
why he couldn’t give you the payment as promised.
Based on what he has explained, set another date and time and
tell him that he cannot miss the date this time. Always keep your
cool and never let show any frustration. Keep a broad smile on
your face while asking back your money. There should not be
any mistake from your part.
Visit his home. Indirectly tell his parents / siblings / spouse that
there’s some money deal between you and him. That would
automatically create pressure on him.
If you really want your money back, keep pressuring indirectly
but at the same time never utter a rough word or show a
frustrated expression. Once he gives your money back, it’s
possible that you guys may not be friends any more. Carefully
think if this situation is going to have any negative impact – at
work place or between other friends.
CONCLUSION.
Experts warn that loans given to friends or relatives ca lead to strained
relationships.
With the following words, we sum up our advice about lending money
to your friends / relatives:
If you can afford to lose a friend, go after your money ;
if you can afford to lose your money , lend as much as you can ;
if you cannot lose both, try to strike the golden mean !”

Principle 8. Think of retirement when you’re

young!

RETIREMENT.
Retirement is a stage in your life where you stop doing a regular job.
From that day onwards, your money flow is limited.
For businessmen and self employed professionals, retirement is by
choice. For employees, there is an age fixed by the organisation, for
sports men when their body doesn’t listen to their minds and for
actors, when they are no longer accepted. However, it’s not necessary
that all of us would work till retirement age as said above. For some of
us, a compulsory retirement may be required due to health issues or
any other unforeseen circumstances. Irrespective of whatever
job/profession you’re in , retirement reduces (or stops) your monthly
income. However, since expenses will only keep increasing, your post
retirement life is not secure unless you’ve financially planned ahead
for it. Hence, the most prudent retirement is when you have made
enough money to retire. This thought brings us to two basic realities
about retirement -
Retirement is not when you cross a particular age or health
condition. You can think of retiring when your wealth crosses a
certain limit.
 Retirement can happen unexpectedly. All your plans may turn
upside down in a day. Hence, it’s very important not to postpone
your plans to make a retirement corpus.
Retirement doesn’t mean that your monthly income has come to a
dead end. For example, my cousin who retired as an RTO, now takes
road safety classes and keeps his monthly income alive. May be he
can do this until he turns 65 or 70. So, post retirement, some of you
may have some income coming from sources like the one mentioned
above. It depends from person to person. It is after this stage that you
rely solely on funds that would generate a solid monthly income- like
fixed deposits and RBI bonds.
4 EASY STEPS TO A GOOD RETIREMENT PLAN.
Step 1. The first step in retirement planning is to know how many
years are left to retire.
Step 2. This step is very personal. You have to estimate how long
you’re going to live ! God knows, isn’t it? Well, nobody can estimate
that correctly but, for the purpose of calculation, some sort of an
‘estimated remaining life’ has to be arrived at. From these figures, you
should calculate the length of post retirement life you expect. Nobody
can help you on this. This is an entirely personal calculation.

Step 3. The third step is to project your retirement needs. How will
you estimate your post retirement expenses at a young age? The first
task is to assess your present life style. Your post retirement life style
you would like to maintain will not be much different from your present
one. The key to estimating expenses is to know the concept of inflation
and then know how to compute inflation adjusted expenses.
We will explain this with an example. We assume that you are 45
years old and hence 15 years away from retirement. Right now your
monthly living expenses are Rs 10,000 and the inflation rate is 8%. To
know the equalent monthly expenses after 15 years, this is what you’ll
do-
Present expenses x (1+inflation %) N (number of years left)

How to apply the formula ?

First, calculate 8/100 = 0.08
1+ 0.08 = 1.08
Type 1.08 on your calculator , press the multiply sign and hit ‘=’
button 14 times. You’ll get 3.17 as the answer. (If you are
calculating for 20 years hit the ‘=’ button 19 times!)
Multiply Rs 10,000 with 3.17 = Rs 31,721. This is the answer.
What does that mean?
This means that, today if your living cost is Rs 10,000 per month, then
15 years later you’ll have to spend Rs 31,721 to maintain the same
standard, assuming that the cost of living rises 8% every year.
You‘ll have to estimate your future expenses using the same logic.
Generally in India, 8% can be assumed to be the average inflation
rate. The only difference you have to make in your estimation is that
certain expenses like traveling expenses tend to come down when you
retire (because you may not travel as frequently as you do today) and
certain expenses like medical expenses will go up (because as you
grow older, your health deteriorates). Applying this logic, you’ll have to
estimate your reasonable future living costs.
Step 4. From the estimate, you will be in a position to find out how
much fund you need in fixed income generating instruments so that
you can maintain your present standard of living in future. If you
require Rs 30,000 per month in future, then you need roughly 35 lakhs
in FD at 10.50% interest rate, 15 years hence.
Now that you know your goal, start investing in various assets !!

TIME IS ON YOUR SIDE.

The biggest mistake most of our parents did was that they failed or
they kept postponing about their retirement plans until it was very late.
Right now- for all the working youngsters out there – the advantage for
you is that there is plenty of time to plan and accumulate wealth for
your retirement life. Earlier the start, lesser the effort. An early start will
also give you a lot of freedom to make risky choices like equities and
mutual funds.
What is investing?

INVESTING

Investing is not just about depositing your savings in the bank every
few months. It’s about growing your money. It’s about making your
money work for you.
INVESTING IS A LONG TERM ACTIVITY
When you invest, you buy an asset like shares, mutual funds, gold or
real estate when it’s available at a bargain and wait till its price go up.
You may have to wait for a long time, say 5 or 10 years to get a real
appreciation for your invested funds. So, investing is a long term
activity, you have to wait for your rewards.
IT’S ALSO ABOUT GROWING YOUR MONEY PRUDENTLY.
Money is a weapon that’s to be used very very carefully or else, it can
backfire within no time resulting in a total ruin of your life. By being
‘prudent’ we mean, determining an action or a line of investing that’s
practically wise, judicious and careful.
When you look around for opportunities to invest, it’s natural to
stumble upon ideas like multi level marketing of certain financial
schemes or money chains etc that may seem to be too good an
opportunity to make a quick buck. It’s important not get tempted by
such investment offers. Any investing decision you take must be
practical, legal, safe and capable of creating wealth for you in the long
run.
REWARD FROM INVESTMENTS
Investments range from risky types like stocks to very safe ones like
fixed deposits. Depending on the type of investment you’ve made you
get return in the form of rent, interest, dividends, premiums, pension
benefits or appreciation in value. The more risk you take, the more you
earn as rewards.
OBJECTIVES OF INVESTING
Objectives or purpose of investing would be different for different
people. By choosing to budget your expenses, accumulate money,
invest that accumulated fund and limiting the amount of debt – you
can achieve most of your life’s goals. Normally, a person would invest
with one or many of the following objectives in mind:
A Regular Income
Creation of wealth
Preserving his capital
Planning for retirement life
Education /marriage of his children.
To start a business
THE PROCESS OF INVESTING
The process of investing is quite simple-
Depending upon the money you got, you will have to short list the type
of asset suitable for investment.
Next, you’ll have to assess yourself and find out how much knowledge
you have in that particular asset category. This assessment will tell
you where you stand right now, and the amount of preparatory work
you need to do before investing you money in it.
Once you gain enough knowledge, try to draw a plan to invest
systematically – get access to the right information, plan properly and
make the right choice.
REASONS TO INVEST
Why does investing acquire so much of importance?
That’s because of three core benefits of investing-
First, the probability that you’ll beat inflation.
Second, the probability of achieving your financial goals quickly.
Third, the probability of building something for your next generation.
An investor’s main focus should be to beat inflation. Inflation and it’s
after effects were discussed in our previous articles. You’ve to invest
in such a way that the rate of return beats the inflation rate. If you don’t
do that, it eats away your returns. Unless your rate of return beats the
inflation rate, you’re not growing your [Link] said
‘probability’ because, investments carry the risk of not hitting the
desired targets. When you set higher targets ( higher returns) the risk
of not achieving it is also high.
Apart from achieving financial goals and securing your children’s
future, another important reason would be to plan for your retirement.
When do you plan to retire? At 60 or at 50? You can opt to retire when
you have a sufficient amount of wealth so that, you can maintain the
standard of living that you are maintaining today. The earlier, the
better!
In the coming lessons, we take to you through different aspects of
investing. Each lesson has a concept to share. At the end, you’ll know
what investing is all about, why it’s essential to invest early, different
avenues to invest etc..In our next article , let’s see why investing is the
most important activity one should have.

PLAN AND INVEST

The key to wealth is to plan and invest. Your job is only half done
when you save money. That money has to be invested in wealth
creating assets in prudent ways. As a first step, you have to clearly
define your short term and long term financial targets. Once you have
a clear idea about your financial goals, the next step would be to draw
a clear road map to reach your target. However, readers should not
think that financial planning is all about creating wealth. Financial
planning, in fact, is a very broad term and Investing is only a part of
your financial plan. A proper financial planning can be done only if you
can clearly chart out your strengths , your goals and your capacity to
take risk.
Later on, we will discuss what financial planning is all about and the
advantages of having a definite [Link] now ,our next chapters
would explain more helpful topics on when do you want to start
investing and the right mind set of investing.

What are the stages in investment process?

There are 4 stages –
1 Investment style / policy
2 Investment analysis
3 Valuation process
4 Right mix of investments
INVESTMENT STYLE / POLICY
This stage involves taking decisions. It involves finding answers to the
following questions.
What’s the risk you’re willing to take? Risk and returns are
closely related. The more risk you’re willing to take, the more
returns you’d expect. Where do you stand – are you a moderate
risk taker or a heavy gambler? Or are you a really risk averse
person?
How much money can you set aside to invest?
With the money you have, what are the assets in which you can
invest?
How much time can you wait for your investments to grow?
 What are your financial objectives? Do you think that you will be
able to achieve your objectives with the money you have decided
to invest? If yes, have you arrived at that decision by calculating
the returns at a reasonable rate?
If your answer to the above question is ‘no’, how would you strike
a balance? Will you bring down your financial goals by cutting off
certain goals or would you try to increase your investable fund?
If you decide to invest in different assets like shares, real estate,
gold etc.. How much are you willing to allocate to each type of
assets and why?
Would you like your investments to be actively managed? That
is, would you like to utilize the services of investments experts
who would do their best to extract maximum gains for you using
their expertise and experience? Are you willing to pay for their
services?
If you’ve decided to take the stock market route, would you adopt
a growth investment strategy or a value investing strategy? Or
would you try to strike a balance in between ? Whatever may be
the style you adopt , would you prefer to invest in a mix large
caps , mid caps and small caps or would you like to stick with
one category?
Finding answers to the above questions would reveal your preferred
investment style.
INVESTMENT ANALYSIS
A Comparative analysis of your chosen mix of investments. This would
help you to decide whether the mix is optimal to achieve your goals.
At the base level it includes the analysis of your chosen
investment asset – equity, debentures, bonds, commodities, real
estate etc..
Broader level analysis would include analysis of the economy
 and industry, qualitative and historical analysis.
INVESTMENT VALUATION
This is the most important part of investment. Valuation is the process
of estimating what the assets is actually worth. Valuation can be done
for all assets. It is an attempt to determine the ‘reasonable price’ at
which an asset can be bought so that it increases in value over a
period of time. It is quite different from the ‘market price’ which is what
a willing and able buyer is prepared to pay.
For example – if a builder offers an apartment for 65 lakhs, would you
blindly buy it without analysing the builder’s track record and the
facilities offered? Won’t you try to find out why he charges 65 lakhs for
that apartment? Finally you would buy that apartment only if you find it
attractive at that price. It is an individual decision after considering all
the factors.
The same process needs to be done in any form of investment –
whether it’s shares or mutual funds or commodities. You have to make
sure that the asset you get is worth the money you spend.
RIGHT MIX OF INVESTMENTS
Putting all the eggs in one basket is not a good idea. There are some
people who think that putting it all in one is better since they can
concentrate on it and escape from the trouble of carrying multiple
baskets at the same time. That’s a very wrong approach in
investments and it needs to be corrected.
For example – if you put your money in real estate alone, should the
real estate prices crash- as we saw 3 years back, you’re locked up
with no other options. Instead, if you had your money diversified in
stocks, gold, real estate etc you’d be better off since when your money
goes down in some, you gain in another and thereby reduce the risk
of losing all your money.
Deciding the right mix is technically called ‘portfolio’ and managing it
to achieve maximum results- in terms of risk reduction, capital
preservation and returns is called ‘portfolio management’.

Where can you invest?

Wealth creating assets in which you can invest can be broadly

classified into the following classes:
Equity or stock market investments including mutual funds
Debt or fixed deposits and government bonds
Gold & diamonds and other precious metals
Real estate
Art and Antiques
So, it’s either financial assets including securities market related
instruments or physical assets.
EQUITY
When compared to any other class, investing in equities is definitely
riskier, more rewarding than you can imagine and every exciting too.
World over, and in India stock have outperformed every other asset
class in the long run. An investment of just Rs.10,000 in companies
like Infosys , Ranbaxy , Cipla and Wipro in 1980’s would have grown
into Crores and Crores of rupees by now . As an equity investor of a
company, you become part owner of that company and hence
participate in the overall growth opportunities of the same. However,
as said earlier , equities are risky investments. Hence, you cannot put
all your money into equities.
DEBT
Debt investments includes fixed deposits with banks, debt mutual
funds and government schemes where you will be rewarded a fixed
rate of interest year on. Debt schemes are popular because it carries
less risk, you get definite income by the year end and your income is
always predictable. This is not to say that debt instruments are risk
free. They too, carry risk. Even governments can default in repayment.
Secondly, inflation is another serious risk.. We have already talked
about inflation [Link], putting all your money in debt is not a good
idea. Yet, it is essential to have some amount of money invested in
debt – to bring stability to your investments.
GOLD
Investors must have this item in his portfolio in order to diversify and
also reduce the risk and volatility in his portfolio and to bring
consistency. Especially in India, gold is the most liquid investment.
Bank fixed deposits, national savings certificates etc would take at
least 3 to 6 days to concert to cash. But gold can be converted to cash
almost instantly over the counter.
REAL-ESTATE
If you have lakhs or millions in your bank account, real estate
investments are for you. This class of investments gives high returns
at lowest risk. The benefits of investing include – higher risk adjusted
returns, assured regular income and definite capital appreciation.
However, you need to be careful in this filed too. In most Indian cities,
real estate prices are at its peak and consequently, getting target
returns out of it has become quite confusing. Nature and volume of
income from it depends whether your property is in a residential area
or commercial area or is it a vacant space fit for godowns/storage
houses or is it an open space fit for wind mills and industries. Real
estate investments are one of the most illiquid investments. Normally it
takes at least 5 to 6 months to convert it to cash. One more
disadvantage is that you need at least 15-20 lakhs to start investing.
ARTS AND ANTIQUES
If you have the money and the guts to try something new and exciting-
consider arts and antiques. Especially art. It is supposed to be the
next big asset class. Earlier, it was not considered as investments but
now, works of great artist are sold for millions. The key is to find out
artists who have the potential to become high profiles in he future. But,
for that you need to know about the subject thoroughly. Experts say
that the Indian Art market is growing at rate of 40% yearly. However,
art , as an investment vehicle, has many negatives. You cannot go out
and suddenly sell off the masterpiece you own. The art market is risky
because -
The valuation is always subjective and there are no hard and fast
rules for valuation.
There is no regulation what so ever to ensure any sort
of transparency.
The liquidity part is always doubtful.
It’s one asset class which cannot be pledged.
It’s difficult to store fine art pieces.
WHAT’S NOT CONSIDERED AS PURE INVESTMENTS
INSURANCE
Insurance is nothing but an agreement between the insurer (The
Insurance Company) and the insured (You) to pay an amount as
compensation if any unexpected event [Link] goals of
Investment and Insurance are totally different. A lot of us take
Insurance policies as investments. It’s a wrong approach and
needs to be corrected.
DERIVATIVES
Derivatives( futures and options) are very destructive. These are
not investments. Derivative financial instruments can be used for
protection from losses (technically called hedging).If derivative
investments used in amateur hands, they can be very dangerous
by bringing excitement: fast results, quick loss or thousand fold
 profits may pull in the vortex of emotions and don’t let out until
everything will be [Link] as investment instrument
should be considered only in careful professional hands.
CONCLUSION
Equities , debt and gold and within the reach of any one. You can
always invest small amounts of your savings into those three
categories. These three category of investments are well regulated by
the government. Real estates are solid investments, but requires lot of
money. Art and antiques are risky investments. They are not
regulated.
A proper investment plan would be to create a balanced portfolio that
consist of equities, debt and Gold. Real estate is also preferred –
Provided you have the money to invest.

What is the risk involved in investing?

RISK.
In simple terms, risk is the probability of loss. Your knowledge in
investing is never complete until you learn about risk and it’s relation
with returns.
When we talk from the angle of an investor, risk is the combined effect
of –
Probable Loss of money invested.
The estimated loss of interest, should the money be invested in
secured deposits.
Inflation that reduces your money’s worth.
When you invest, deviations can happen from the expected
outcome. That deviation can be positive or negative. If deviation
happens to the positive side, that would be considered as windfall
gains. The negative part is called risk. Risk is part and parcel of every
investment. Every type of investment involves risk of varying degrees,
which can be very low in the case of government bonds to high as in
the case of stocks.
We talk from the angle of an investment, different invest assets have
different degree of risk. For example – government bonds are
considered to be the least risky asset and logically, have the lowest
potential return. Equities are considered to be highly risky and have
the potential to gie you very high returns.
RELATION BETWEEN RISK AND RETURN.
The above example also brings to light the relation between risk and
return. If you target for a high return, there is an equal possibility of a
high loss. So, Higher the risk; higher the returns. What we mean to
say is that risk and returns are directly related.
RISK TOLERANCE CAPACITY
Tolerance means ‘easiness’ or ‘acceptance’. I simple words, it’s your
capacity to sleep peacefully when the market is falling!! Risk tolerance
capacity is our ability to accept or to live with a potential risk. Risk
tolerance capacity would be different for different investors. It could
also vary according to one’s knowledge about investing, his emotional
balance, his age and life stage , his sources of finance, marital status,
number of dependents etc.. Your views about risk will keep changing
with variations in these factors.
So one point we would like to say here is that, before you invest in any
asset, you should have a clear idea about –
The risk such an investment carries and
Your risk bearing capacity ( which should match with the risk of
the investment)
For example – You are interested to invest in stocks. After a self
evaluation, you realise that you can afford to loose only 5% of your
invested fund. Naturally, a proposal from your investment advisor to
invest in a stock that may move 10% in either direction will not suit
your preferences. That’s because, if risk works out, your loss would be
10% of the amount invested. Alternatively how about an investment
call that has the possibility to give you 5% either way? You may
accept. Because, if you gain, you get 5% but if you lose, you lose only
5% which is ok with you.
CATEGORIES OF INVESTORS BASED ON RISK
Now, depending upon how well you’ll adapt to risk, you’ll either be a
conservative investor or a moderate investor or an aggressive investor.
Conservative investors should not invest more than 20% of their
money in high risk investments like stocks. Bonds and fixed deposits
will be more comfortable for them. Aggressive investors can invest 90
or even 100% of their money in high risk investments like stocks.
Moderate investors should try to strike a balance in between. Asset
allocation and diversification becomes more relevant for moderate risk
takers. That’s because, the risk averse would concentrate more on
debt funds and hence they need not think about risk tolerance anyway.
The aggressive would put major chunk of their money in stocks and
have high capacity to tolerate risk. Hence, it’s the moderate risk takers
who will be caught in the middle. For them , it’s necessary to create a
balanced combination of high risk, moderate risk and low risk
investments.
THE REAL RISK.
Sometimes, in order to achieve your financial goals, you may have to
take a risk which may be higher or lower than your tolerance capacity.
That risk which you should actually bear is called the real risk. For
example – you have just 4 years to invest but you are targeting a
return of 200%. To achieve this you may have to take a risk that may
be higher than your risk tolerance capacity.
MATCHING YOUR RISK.
Your risk tolerance capacity and the real risk should match in order to
take effective investment decisions. This may be a confusing process.
If you are not sure about how to do this, a financial advisor should be
able to help you out.
CONCLUSION.
Investors jump head on to buy investment with great potential for
returns without assessing their risk tolerance capacity and the real
risk. It’s easy for such investors to get burnt in the process. The rule is
simple, and you have heard it many times before- The higher the
returns, the greater the risk. The lower the risk, the lower the returns.
We will take up the topic of ‘optimum risk’ and allocating assets
accordingly in a different chapter. Right now, at this beginning stage,
it’s enough for you to understand that there are two types of risk – one
from the investor’s angle and the other from the investment’s angle.

What should be the right mindset for investing?

Keep these simple thoughts in mind while you invest –

Make sure that you have done your home work well. When you
invest your money, you should be clear about the objective- how
much profit do you expect? How much time will you hold on to it?
Why are you buying it –do you have enough reasons to justify
your actions? Most importantly, how much loss are you willing to
tolerate?
Always try to avoid pointless conversations about what could
have been done. Don’t look at the past and count the profits you
lost because of a wrong decision you made.
 Realise that however badly you have done, it could have been
worse.
Instead of analysing individual investments, evaluate your entire
portfolio. You might have lost in one, but won the other.
If you are invested for the long term there is no point in getting
worried over the current value of your investments. Current value
may be down due to various reasons.
If you have been experiencing a streak of good luck, it’s better to
slow down. Do not rely on your instincts or gut feeling or
excellent luck every time.
Cook your own recipe for achievement. Sure, a sound knowledge
in every aspects of investing is required to produce a good result.
You have to learn from others, use books and web based
material a lot. But, make sure you are using the right resources.
Investing is a tough and serious business. On the contrary never
be too hard on yourself. Relax. Have fun. Keep your mind clear
and concentrated. Having a positive mindset can give you
immense results and at the same time, have fun while you earn
your bucks.
Always focus on the positive aspects of what you have done.
Take investing like a sport where you win in some games and
you lose in some other. But be sure to learn from both
experiences-and never forget what you learned.
What is Financial planning?
FINANCIAL PLANNING
Financial planning is a broad term and investing is just a chapter in it.
Financial planning is all about listing down all you sources of finance,
assessing your financial needs for the future, assessing your appetite
for risk and then charting a plan to achieve your dreams. It also
involves planning for your child’s future , your new home, planning for
tax and retirement. So, it’s a very broad term and you might need an
expert to draw it for you.
FINANCIAL GOALS-LONG TERM VS SHORT TERM
When you chart your financial goals for the future, it important to
classify them into short term goals and long term goals. A short term
goal is anything that needs to be done in , say , 5 years. For example
– buying a 3 BHK flat. Any financial goal like your son’s higher studies
or your daughter’s wedding which has ample time left to think and
plan, can be said to be a long term goal
WHAT’S THIS FUSS ABOUT? WE ARE AWARE OF ALL THIS.
..But still, the importance of financial planning needs to be
emphasised in today’s world. Today, the work pressure is so high that
people want to opt for early retirement from their full time jobs,
preferably in their mid 40’s or early 50’s. They have realised the
importance of living their life to the fullest. Thanks to advancement in
medial sciences, the average life expectancy has increased to 70 or
80 which means that a person who has retired at 50 has another 30
years to live, without depending anyone (Preferably!).
Financially, this means that during you working life, you should create
wealth enough to help you maintain the same standard of living after
you retire and also take care of your medical expense which keeps
going high as you get older. Planning for all this is definitely a difficult
and disciplined task. Such a target is not easy to achieve and it
requires meticulous planning and disciplined carry through. That’s why
financial planning is so important.
DO I NEED A FINANCIAL PLANNER?
May be or may be not. That depends on who you are. A financial
planner is a person who is an expert in his field. It’s better if you can
consult a financial planner because even though it’s possible that you
are well versed in finance; you’re still not a financial planner. A planner
will be able to analyse of your current financial situation quickly and
suggest recommendations that are right for you. There are also
personal finance magazines and self-help books to help you do your
own financial planning. At the end of the day – the right amount of
money should be at your disposal at the right time.
Seek the services of a financial planner if:
You find it difficult to analyse your risk profile. Most of us are not
fully aware of where we stand in terms of risk.
You don’t have time to do your own financial planning.
You want to take a professional opinion about the financial plan
you have done.
You think that you should improve your current financial situation
but still don’t know where to begin and how to implement those
changes.
FINANCIAL PLANNING ISN’T JUST FOR THE RICH
All right, anyway I don’t have much money to invest. What’s there to
plan? If you’re thinking on these lines, you’re wrong. People with
limited income should definitely plan you finances – at some point of
time you need to get married, buy a home, raise children and look
after your ageing parents. The rich will always manage all this even if
they haven’t planned their finances properly. But if you’re from a
middle class background, you just cannot ignore financial panning.
Basic financial planning is not so complicated. If you have loans first
pay them off at the earliest. Loans will anyway carry a higher rate of
interest. Be debt free. That definitely is the first step. Then , think
about how much you can save. Start a recurring deposit. Accumulate
small amounts fro your monthly income even if you have to live on a
shoe string budget. Two years down the lane, you’ll find that you’ve
done a good job accumulating some money. Once you have some
cash, start a systematic investment plan. Take insurance policies. Buy
gold when ever you can, even if it is a tiny piece. You’ll be on your way
…
Should you Borrow Money to Invest?
BORROWING TO BUY SHARES.
You know that stocks have returned an average of 17 to 18%. So you
borrow some money at 9% interest and invest that amount in stocks.
Until you realize the profit, you’ll pay interest or EMI from your
[Link] you look at it, it’s going to be profitable. How about
that? If you are planning to do something like that – you’re at the right
time reading this article. Calculations on paper may show that it is
practical. But in real life, such strategies are extremely risky. We
advice not to leverage (that’s the financial term for using borrowed
funds) your investments in any form. It’ not a good idea at all. There
are three perils waiting for you when you leverage –
It multiplies your risk.
Even when the value of your holdings go down, you have to pay
your loan instalments. The effective cost you pay is very high.
There will not be any peace of mind. Guaranteed!
HOW DO INVESTORS LEVERAGE?
There are different ways:-
Take a personal loan or pledge you home or property or gold.
Borrowed funds from others like friends. The attraction here is
that, it normally comes interest free.
Using borrowing facilities at the brokerage firm.
Short sell the stock. It is same as selling what you don’t have.
Hence effectively, you are borrowing shares from someone and
selling it.
Take the derivatives route ( futures and options)
The first two options need not be explained .It’s straight, simple and
needless to say, totally dangerous. In the first case, If you could not
pay back the money, your lose your home. In the second case, you’ll
lose your friends and may also have a difficult time facing them. It
might also put your friends in trouble. So stay away from such tactics.
The other three points need some explanation. Brokerage firms allow
you to borrow money from their account based on the current total
holding you have in your demat account maintained with them. What
they do is very simple. They will take pledge of all your share holdings
and give you a loan which would be a percentage calculated on the
market value of the holdings. In case you couldn’t pay back the money
to the broker, they will immediately sell off those shares in the market
and realise the amount. At the time of signing the agreement itself,
such clauses are already built into the agreement. The interest
charged for this kind of temporary funds is also very high and it’s
calculated on a day to day basis.
You can adopt this way of leverage when you do it for a very
temporary purpose. For example – you were eyeing a particular stock
and that stock is now at the price where you want to enter. You have
money in your bank, but you’re travelling and not in a position to
transfer it now. You can use money from your broker and pay it back in
two days.
Another way to leverage is short selling. When you short sell a stock,
you are selling stocks which you do not own. What you are effectively
doing is, you borrow shares (instead of money) from the brokerage
firm and when the price falls, will buy it gain and give it back to the
broker. Short selling is a dangerous method to make money. What will
you do if your calculations go wrong? You will have to pay more
money and buy back the shares from the market and return it to your
broker.
Through derivatives, you leverage in a different way. For a small sum
(called margin money / premium) you can take big positions in the
markets. It’s like playing a Rs 100,000 game with just Rs 10,000 in
hand. The risk in such cases is very high. It has the potential to wipe
off all your money. Derivatives are the favorites of speculators,
although these instruments are basically meant for managing risk.
In short, if you ask us whether you should borrow funds, our
suggestion is:
No, if you’re just a beginner or amateur.
No, if you don’t have any other sources of income to suddenly
raise funds if calculations go out of control.
No, if you do not have an alternate plan to pay off these debts.
Yes, if you can get some funds totally interest free for a long
period of time
Yes, if you are a very seasoned investor and you know with
some certainty how the markets will move.
Yes, if you want to utilize a sudden surprise opportunity.
Yes, if you have fully understood the risk and the financial
destruction it can bring, but still, you’re the daredevil type – ready
to face anything.
BORROWING TO BUY OTHER ASSETS.
if you can get loan funds at a lower rate of interest (NRIs can get it ,
say at 4%) you can bring that funds to India and invest here in debt
funds or NCDs that give as high as 13% per annum in return or they
buy gold or just put it in fixed deposit with banks. Anyway , that’s not
going to be a loss.
One factor that needs to be considered while buying assets with
borrowed funds is that the loan to asset value should be preferably be
kept at around 60%. That is, to buy an asset worth 10 lakhs, it good to
borrow up to 6 lakhs and pay the balance in cash.
And remember, cars and electronic gadgets are not assets hence,
relying on loans to buy such things Involves great [Link] loans
carry high rate of interest and these items depreciate heavily with time.
CONCLUSION.
Investing with borrowed funds is not recommended, except in very
special circumstances. It is a very risky and aggressive strategy and
should be used with a lot of caution.

Thumb rules to build wealth

‘Building wealth’ is a topic that’s searched by millions of people.

Thumb rules to build wealth tries to summarise all the concepts that
were discussed earlier, in a different format.
TWO STEPS
Basically, The entire process of building wealth boils down to just two
steps:
The first step is to control your expenses according to your
income and make a surplus out of it. It demands a lot of financial
discipline to achieve this step. Many financial principles that
would help you to save money were discussed in our first
sessions.
The second step would be to find assets that have the potential
to grown in value and invest your money in [Link]’s it.
The first step is completely under your control and no one can help
you out. You have to work hard, get a job , make a steady income and
save some money for yourself. The earlier you start saving, the better
it is.
Once you start earning, it’s natural for anyone to think about availing
loans to realise their dreams –for example a big car. The bad news is
that, more debts prevent you from saving more at the initial years. All
successful investors have accumulated more money in their initial
years. Early investing has many advantages as we have already
explained in one of our previous posts.
Hence, the second step is to gain some basic financial knowledge.
You are supposed to know some basic rules and concepts like
inflation, compounding, opportunity cost, a bit of taxation and
accounting. Learning the basic money magic will dramatically alter
your view about finances and investing
The third step – investing, is the one where you will have to consider a
lot of things. You’ll have to draw up a plan, list out your financial goals,
assess your risk profile, seek the help of experts for valuation of
different assets, assess the pros and cons of each type of asset and
finally choose the best investment style and vehicle.
In this, drawing a plan and listing out your financial goals with some
accuracy is the initial step. Clear cut and realistic financial goals have
to be drawn. The most important factor that would help you to bring in
realism into your plans would be your level of savings. You can’t draw
up big plans if you expect to save only little.
Once you have drawn you plans, you can look for avenues to invest.
Here, the best lesson you can get is from Warren Buffet, one of the
richest stock investor. He never invested in businesses which he
couldn’t understand. His advice is simple “If you don’t know the
business model, what the company does on a day to day basis, or
how it generates revenue now, and in the future, then it’s better to stay
away from it”. This principle can be applied to all types of investing.
You have to make sure that you understand the basics. This advice
assumes significance because; investors have a tendency to follow
what the crowd is doing. If a particular stock is doing well at the
bourses, investors jump in and put money without bothering to analyse
what business the company is into. In short, you have to be through
with the basics.
Diversification is the next area to be addressed. Diversification of
money into different asset classes is required since you cannot predict
the movement of asset prices and you cannot say which asset would
perform best in a year. So, must have some money in all possible
asset types. That’s what diversification is all about.
When you have a mix of assets in your kitty, what you have is a
portfolio. Your portfolio will have to be periodically checked, reviewed
and rebalanced since the value of assets with you will keep changing
from time to time. For example- you have a portfolio in which 60% of
the funds are in large caps and balance in mid caps. That year, if the
equities go up by 30% and the mid caps fall by 2%, it will imbalance
your portfolio and to make it back to that 60:40 levels, you will have to
sell large caps that went up and buy mid caps that came down.
All the principles put together, you should be able to make a good
return from your money. The thumb rules are:
Rule 1. Make money
Rule 2. Learn the basics of investments
Rule 3. Identify the assets to invest.
Rule 4. Diversify
Rule 5. Review your portfolio.
How to compute returns?
Lessons in computing returns- I percentages

Hi there,
Most of the financial calculations are expressed in percentages. Not
only profits, there are many other places where this knowledge can be
very useful. Let’s catch up with it:
PERCENTAGE POINTS
A percentage point = 1%
Example
You go to a bank to open a fixed deposit account. The bank says,
interest rates have gone up from 8% to 10%. How much is the
increase? Is it a 2% rise?
The answer is No. An 8% to 10% rise is 25% rise in interest rates.
This is how we calculate it:
10 / 8 = 1.25
1.25 * 100 = 125% or 25 % increase in interest rates.
Another way to ay it correctly is – you can say that the interest rates
have increased by ‘2 percentage points’.
In financial markets, Instead of percentage points, the term used is
‘basis points’. 1 basis point is equal to 1 / 100 of a percentage point.
th

1 basis point = 1/ 100 of a percentage point

th

So, 100 basis points = 1 percentage points.

Next time , when the Reserve bank revises the interest rate by ’25
basis points’ , understand that what the bank means Is that it has
revised the interest rates by 0.25%
Here are some questions for you to try out-
 1 A bank is offering a 30% increase in the interest rates on fixed
deposit. The old rate is 6%. What is the new rate?
2 You see an advertisement in paper saying that loan rates have
slashed from 12% to 10%. What is the actual drop in loan rates?
3 The RBI increases rates by 25 basis points. If the old interest
rate was 6%, what is the new rate?
4 A bank cuts interest rates by 125 basis points for the 2 rd

consecutive month. If the interest is 8 % now, what was the

interest 2 months back?
5 The fixed deposit interest rate has gone up from 8% to 10%.
What is the rate of increase in percentage and in percentage
points?
Answers:
1. The old rate is 6%. The increase is 30%. So, the increase in
rate is 6* 30% = 1.8%. The new rate would be 7.8%
2. The loan rates have been slashed fro 12 % to 10%. The
decrease in rate is 2 percentage points or 200 basis points or
16.66%
3. The new interest rate would be 6.25%
4. The present interest rate is 8%. So, last month the interest rate
was 9.25% therefore, 2 months back, the interest rate was
10.50%.
5. Increase in terms of percentage points = 2 and increase in
terms of percentage is 25%

Lessons in computing returns – II Simple returns

SIMPLE RETURNS:
Simple returns are used for evaluating short term returns.
BASICS FIRST:
The formula for computing simple returns is
Simple Return = FV / P - 1
Where,
FV is the amount received on maturity date and
P is the amount invested
Example 1
You deposit Rs 10,000 in a bank for a year and gets Rs 11000 in
return. The simple return would be –
11,000 / 10,000 – 1 = 0.1 or 10%
Example 2
You purchased 200 shares of ABC Company at 50 per share. You
paid Rs 300 as commission to your broker. On a later date, you sell
the stock for Rs 75 and pay a commission of Rs 450 to the broker.
What is the simple return on investment?
Total cost of the share = number of shares x rate + commission paid =
Rs 10,300
Sale proceeds = number of shares x rate – commission paid =Rs
14550
So, the simple return will be as follows:
14550 / 10300 -1
1.41 – 1 = .41 or 41%

Example 3
You purchased 200 shares of DEF Company at 50 per share. You paid
Rs 300 as commission to your broker. On a later date the company
declares dividend of Rs 2 per share. You sell the stock for Rs 75 and
pay a commission of Rs 450 to the broker. What is the simple return
on investment?
The simple return will be as follows:
Total cost = 10,300
Total returns = 14,550 + 400 = 14, 950
Simple returns would be
14950 / 10,300 – 1
1.45 – 1 = 0.45 or 45%
That’s about simple returns. Remember, simple returns are useful only
for short term investments.

Lessons in computing returns – III Compounded

returns.

Hi there,
Let’s catch up with compound interest in this article..
BASICS FIRST.
The formula for compound return is as follows:
·
FV = P ( 1+ r)
n

Where FV is the future value

P is the money invested
r is the rate of return
n is the number of years for which the amount is deposited.
Situation1.
You invest Rs 50,000 today and it grows to Rs 100,000 in five years.
The five-year return is 100 per cent; but what is its annual return?
To calculate this, you need the formula on compound interest. Using
Rs 50,000 as principal, Rs 100,000 as future value and five as the
number of years, let’s find out the annual rate.
 FV = P (1+r) n

Therefore, r = (FV/P) – 1
1/n

Here, the first step is to calculate 1/n = 1/5 = 0.20

Now, r = (50000/ 100000 ) -1
.2 0

r = 2 -1
.20

2 = 1.1487
.20

1.1487- 1 = 0.1487
Therefore r as a percentage would be (0.1487 * 100 ) = 14.87 %
This 14.87 per cent is the compound return, and is the only relevant
return when you analyse an investment.
If you divide the 100 percent by the number of years, you get the
answer as 20%.This is the simple return.
The 100 per cent is referred to as holding period return. The holding
period return keep on changing with the period of holding.
That brings us to the first moral of computing long term return.
compounded returns is the best measure for long term return.

You can also use the rule of 72 which will be discussed in future
sessions and arrive at the approximate rate of return since in this
question, the investment has doubled in 5 years.
Situation 2.
Suppose you want to make an estimate of future rate of return of a
stock. One way of doing so, is to look at the past rate of return as an
indicator of the future. Here’s how the return is computed in this case.
Consider a stock, A Ltd, whose return during each of the last five
years has been 10 per cent, 20 per cent, 15 per cent, minus 30 per
cent and 20 per cent per annum. Hence its simple average is 7 per
cent per annum. Consider another stock, B Ltd, whose return during
the last five years has been 10 per cent, 15 per cent, 20 per cent, 10
per cent and minus 20 per cent. Its simple average return too is 7 per
cent per annum. So should we say that they are identical performers?
Surprisingly, the answer is ‘No’. Here’s why.
If the stock price of A Ltd began at Rs 100, it would have grown to
Rs 110 ( 100 * 110%) in the first year
Rs 132 (110 * 120% ) in the second year
Rs 151.80 ( 132 * 115% ) in the third year
Rs 106.26 (151.80 * 70%) in the forth year (the company grew at
-30%)
Rs 127.51 (106.26 * 120%) in the final year.
Rs 100 growing to Rs 127.51 is a compounded rate (CARG) of 4.98
per cent using the compound interest rate formula.
Similarly Y Ltd, which began at Rs 100 at the beginning of the first
year, would have sequentially grown to Rs 110, Rs 126.5, Rs 151.8,
Rs 166.98 and Rs 133.54 at the end of each of the five years. Rs 100
growing to Rs 133.58 is a compounded rate of 5.96 per cent.
See the difference in the compounded rate. Yet the simple average of
the growth rate was same.
Clearly, Rs 100 growing to Rs 127.51 is not the same as Rs 100
growing to Rs 133.58. So, compounded annual growth is considered
the right measure of return;
The simple average is used for purposes of year on year
measurement or short term measurement of returns.

Lessons in computing returns – IV Returns from

shares.

Hi there,
In the case of shares, there are two types of returns you expect –
 Dividends
Capital appreciation
How would you compute returns in such cases? let’s discuss with two
examples.
Example 1
You invest in 1000 shares of AB Ltd for Rs 100,000 a year back. At
the year end, the shares are quoted at Rs 150 and the company also
pays you a dividend of Rs 2 per share. That is, you get Rs 2000 as
dividend, and at the same time, you investment is now Rs 150,000.
You sell the share.
How would you compute your overall return from this investment?
The gain you made is as follows –
Appreciation in market price – Rs 50
Dividend received – Rs 2
Total gain – Rs 52
Return = Rs 52 / Rs 100 = 52%
Example 2
You invest in 1000 shares of AB Ltd for Rs 100,000. You hold on to it
for 3 years. The dividends paid during these 3 years are follows- Rs 2,
Rs 2.50 and Rs 3. The market prices at the end of each year are – Rs
90, Rs 95 and Rs 110.
How would you compute your yearly return from this investment?
The cost per share at the point of investment was Rs 100
Fist year return would be – fall in market price Rs 10, dividend
paid Rs 2
Therefore, net loss = Rs 8
Return = -8 / 100 * 100 = loss of 8%
Second year
The cost of share at the end of first year = Rs 90
Year end price = Rs 95 , dividend paid = Rs 2.50
 Therefore , net gain = Rs 7.50 ( 95-90 + 2.50)
Return = 7.50 / 90 * 100 = 8.33%
Third year
The cost of share at the end of second year = Rs 95
Year end price = Rs 110 , dividend paid = Rs 3
Therefore , net gain = Rs 18 ( Rs 110-95 + 3)
Return = Rs 18/ 95 * 100 = 18.94%
Overall return from investment would be = (-8%) + 8.33% + 18.94% =
19.27%
So, while computing yearly returns from investment, you should
consider capital appreciation or depreciation (although it’s notional)
and also the dividends received.

Lessons in computing returns – V The Rule of 72

Hi ,
So we were playing some games with percentages in the last few
posts.
In this article, let me introduce a short cut – an approximately 500 year
old formulae to help you in your calculations- Rule 72.
For those who love math and accountancy, the rule 72 may not be
new. Luca Pacioli (1445–1514) , in his book ‘summa de arithematica’
discusses the rule when he talks about the estimation of the doubling
time of an investment. However, it’s not Pacioli who invented this rule.
RULE 72
The rule is very simple – Divide 72 by the Interest Rate. What do you
get?
You get the number of years it would take for your investment to
Double. Practical, very simple. The Rule of 72 is not absolutely
precise, but it gives you a practical estimate that you can work out in
your head.
Example 1.
You go into a bank that offers 9.50% annual interest on your FD. How
many years will it take for your capital to double?
It’s Simple- Divide 72 by 9.50. Roughly 7 and half years.
Example 2.
At what rate should you invest to double your money in 5 years?
Divide 72 / 5 . The answer is 14.40%. so if you can manage to get
14.40% return on your investment, your money doubles in 5 years.
Example 3.
The rate of interest you pay for your credit cards is 24%. Your credit
card liability is Rs 25,000. What happens if you keep paying your
minimum due for 3 years?
In 3 years (72/24), you end up paying Rs 25,000 as interest alone.
You’ll still have the Rs 25,000 liability remaining.
Example 4
You read from papers that the country’s GDP grows at 7% a year. How
long would it take the economy to double it’s growth?
The answer is (72/7) 10 and 3 months approximately.
Example 5.
The inflation rates are at 9%. What the effect of it on your money?
Your money will lose half its value in 8 years ( 72/9)
Example 6
At 8% interest your money would double in (72/8) 9 years. If you
decide to remain invested for 27 years, a small deposit of Rs 50,000
would become Rs 400,000!
Not only in years, can you apply this rule in any time frame.
So that’s Rule 72. Nice little mathematical formula that helps you to
take financial decisions. The rule is not perfect and it does not account
for taxes.
Lessons in computing returns – VI Rule 114 and
Rule 144

RULE 114-HOW LONG TO TRIPLE YOUR INVESTMENT

To find out how long it will take to triple your investment at x% interest
rate, take 114/x.
So, it will take 114/12 (or 9.5 years) to triple your money at 12%
interest rate.
Want to triple your money in 6 years? You will have to generate an
annual return of 114/6 (or 19 %!)

RULE 144 – HOW LONG TO QUADRUPLE YOUR INVESTMENT

To find out how long it will take to quadruple your investment at x%

interest rate, take 144/x.
So, it will take 144/12 (or 12 years) to quadruple your money at 12%
interest rate.
Again, If you want your investment to quadruple in 6 years, you will
have to generate an annual return of 144/6 (or 24 %!).
I would like to repeat what I said in my previous article. The above
rules are not 100% accurate. However, it gives you a reasonable
estimate of time required to triple or quadruple your investment at a
particular rate of return.
I hope this article was interesting! It will greatly help you with your
financial decisions.
For example, if calculations show that 20% is necessary to accomplish
your goal and the risk-free interest rate is 8%, you have some choices
to make. First, if you insist on the risk-free rate then you must extend
the time period you are willing to wait for that money. On the other
hand, if you cannot extend the time, you’ll have to accept a little more
risk.
Lessons in computing returns – VII Break even
return

Hi there,
In economics and finance, there’s a concept called break even point.
Break even point is that point at which you make no profit or no loss.
This concept is also applicable while targeting returns on investments.
We will call it the ‘break even rate of return’. That is, the minimum rate
of return that your investment should generate in order to maintain a
no profit-no loss situation.
How to find out the break even target?
The only two factors that eats into your returns are –
Inflation and
Taxes.
Inflation, as explained in previous articles, reduces your purchasing
power and taxes reduce your disposable income. In other words, your
investment should generate a minimum return that will cover the
inflation and income tax. So, the key is in finding out the rate of both
these factors and generating a return that’s equal to it so that you are
position is safe – No profit – No loss.
To do this –
The first step is to find the inflation rate in your country. Inflation rates
are published in almost all financial newspapers and web sites.
The second step is to find the income tax rate of the particular
investment. In India, only incomes like long term capital gains are
taxed at special rates. The rest falls into the general slab system. So
find out the slab rate or the special rate you’d be taxed.
Apply the following formula –
I / 100 – R
Where –
I = The rate of inflation ( you can also take the average rate of
inflation)
R= the effective personal income tax rate on investments
For example – If the current rate of inflation is 7% per annum and your
effective tax rate is 30% , your required return from investments to
break even would be –
7 / 100-30
= 7/70
= 0.10 0r 10%
This means that your investments should earn a minimum of 10%
return just to break even and maintain the purchasing power of your
money. If you earn less than 10% you are losing money.

5 steps to become a smart investor

INVESTING in can probably be more rewarding than you can imagine

and certainly very exciting! World over the wealthiest people are those
who have invested wisely.
If you are scared to take the plunge, these are the 5 steps you should
be following.
STEP 1. UNDERSTAND HOW THE WHOLE PROCESS WORKS

How did you learn to read ? you started off with A-B-C. First you
learned capital letters, then came the smaller ones and finally those
running letters. At the end ,you have your own distinguished style of
writing and reading . Follow the same logic here. For investing in
anything, the first step is to Learn the basics.

STEP 2. LEARN HOW TO CHOOSE

It is important to know how to go about selecting an investment at the

right price-be it shares or gold or real estate. A little bit of research,
some theoretical and practical knowledge will ensure that things
seldom go wrong.

STEP3. DECIDE HOW MUCH TO INVEST

You should not throw all your savings at one particular investment
because, any investment would carry certain amount of risk. So the
answer to the question how much to invest would depend on your risk
profile. ( i.e. your risk tolerance capacity )

[Link] AND REVIEW

Monitoring your investments regularly is recommended. This is more

important during volatile times when there can be great opportunities
for buying and averaging your cost of investment..

STEP5. LEARN FROM YOUR MISTAKES

Investing is a long, learning experience. You will make mistakes, but
also learn from them .When reviewing, do identify and learn from your
mistakes. Nothing beats first-hand experience. These experiences will
help you emerge as a smart investor.
Stick to these basics and sail smoothly into your financial bright future.
Stock Markets-
Some truths about stock markets

Hi there,
From this post onwards, I am going to kick off the discussion on
shares as an option to create wealth. Let me start by saying 7 straight
truths about stock markets.
First, nobody gets rich quickly in stock markets. Some of your friends
might have blindly invested in some stocks which, to their luck, gave
them exceptional profits. Yet, they never became rich. Did they? So
that’s the first truth about stock markets – it’s not a place where you
get rich [Link] takes time to grow your money.
Second, it isn’t easy for beginners to make money on the stock
exchange. If it was such a simple exercise, Mr. Warren buffet wouldn’t
have become so famous. It takes genuine effort to spot profitable
investments.
Third, your broker, friends, neighbor, colleagues et al would come up
with ‘sure shots’ everyday; there are too many stock analysts out there
giving out fee based stock recommendations. It’s easy to get tempted
by all these people around you. After many years in the market, my
thoughts keep wavering when somebody comes up with such ‘sure
shots’. Should I explain the fate of a beginner? It’s important to stay off
from these temptations. It implies that you ought to have ‘independent
thought’. Independent thought is something very hard to carry through.
Fourth, most of the investors are a bit too casual with stock markets.
They ‘play’ in stock markets. Stock exchange is a wrong place to have
fun, speculate and try luck. The Stock market is actually a place
dominated by big investment houses and financial experts. This is a
place where the world’s brightest finance professionals put their best
efforts to make right investment decisions. Nobody is playing around.
So, to be successful, you too, need to be serious. You have to view it
as a business. When you buy shares, you are buying a company to
that extent. Buying a company is no Fun!
Fifth, realise the fact that broker’s income is the commissions you
give. The more you trade, the more they get. When I was serving as
the manager of a broker, I used to get monthly targets for the volume
of brokerage that should be generated. If I don’t do that, my salary
payment gets delayed. Each branch was viewed as a profit center.
Myself and my colleagues used to hit our targets but our investors
rarely did! Most of the brokerage houses encourage their clients to do
as many trades as possible whether it’s good for them or not, and
keep doing it until you have used up all their money. If you get too
many frequent ‘Sure shot market tips’ thru sms, mails and phone calls
– think twice. Your broker may be interested only in generating
commissions. Make sure you don’t get into such traps. Do have faith in
your broker, but don’t blindly follow them. They can give you advice but
they can’t guarantee that you will make a return on any investment in
the stock market.
Sixth, as you begin to study the principles, you’ll hear about derivative
instruments like futures and options. Instruments like options and
futures are NOT for beginners with limited resources. They are highly
technical, involve the potential to lose all of your investment quickly
and need constant monitoring. Playing Futures and options without
adequate working knowledge is like gambling at Las Vegas.
Finally, you have to keep on working on your stock picking skills.
Keep following the market developments. You’ll also need to study
some basics on economics, accountancy, income tax and
mathematics.
So, # No quick riches in stock markets # it’s not the place to have fun
with money # you shouldn’t be blindly believing your broker’s
recommendations # never try your luck # and, learning is the only way
-to make right choices in stock markets.
So, let’s begin from the roots. My next post would explain what shares
are.
Before you take the plunge, think about what’s said above. To
succeed in stocks, you’ll have to put maximum efforts to learn the
game and be serious with investments.

Stocks-explained

INTRODUCTION
The first step for anyone who aspires to invest in stocks , is to
understand stocks ! The words stocks and shares mean the same
thing. Share means a portion of anything. In our context, share means
a portion of ownership of a [Link],it would be better to discuss
this concept with the help of an example. This will help you to get a
clear idea of what a share is. Lets try to explain that with the story of a
company called ‘Say-it-with-flowers’.
SCENE 1- The beginning
A group of girls decides to start a business. Since they knew floral
decorations, they decide to start a flower shop. They name their
business as ‘Say-it-with-flowers’. For initial expenses, they borrowed
some money from the local bank and opens their shop in a small
space. The business was successful. However, they made little profit
because; all the earnings were invested back into business since the
customers were increasing and they had to meet the growing demand
for their floral decorations.
SCENE 2- A decade after.
Ten years later, the bank loan has been paid off. Profits are over Rs 10
lakhs per year. It also has a book value of Rs 50 lakhs. (Book value is
the net value of what the company owns- machinery, furniture, building
less any loans). Having made their business a success, the girls now
wants to expand their business. Their idea is to open two more
branches at neighboring towns. After a detailed study, they find out
that it’s going to cost over Rs 52 Lakhs to open two outlets. To find this
52 lakhs, they had two options- one, take out a loan from the bank.
Two, sell part of their company. Since interest rates are high, they
decide to take the second route. But how? What would be the cost of
a share in say-it-with-flowers? Who will do the valuation? There were
several questions to be answered.
SCENE 3-The big leap
To sell part of their company, the company has to be valued. The
person who values a company is called an ‘underwriter’. So they
approach an underwriter who checks their past records, future
prospects, background of the promoters etc, The underwriter decides
that the company is worth 10 times its current profits.
The current profits is 10 lakhs. So 10 times 10 lakhs is 1 crore. This
one crore is actually an estimate based on various qualitative factors.
Add book value to it, and you arrive at Rs 1crore and 50 Lakhs. This
means, “Say-it-with-flowers” is worth Rs 150 lakhs.
40% of 150 is 60 lakhs. So, the girls decide to sell 40% of their
company.A group of investors who were willing to buy the 40% shares
in that company gives a check for Rs 60 lakhs. The girls still have
control over the operations of the company since they still have 60%
share.
SCENE 4- The benefit
Now, For the girls, 40% stake is lost but they get 60 lakhs in cash.
They have the money to expand their [Link] planned, they
opened two new outlets for Rs 52 [Link] balance 8 lakhs is used
for day to day operations of the three shops.
Both the new stores hit a profit of 10 lakhs a year. That means the total
profit of the company Say-it-with-flowers is now Rs 30 lakhs. ( 10 lakhs
x 3 shops ). The value of the business is now Rs. 450 lakhs (3 shops x
10 lakhs x 10 times + 50 lakhs x 3) and the couple’s 60% stake is
worth Rs 270 lakhs.(450 x 60%)
SCENE 5 – At the stock market.
Since the investors who bought 40% of the share for 60 lakhs, is now
worth 180 lakhs, the shares of say-it-with-flowers is in great demand.
Since the company increased the wealth of shareholders 3 times,
there are investors who are willing to purchase the shares even for an
amount higher than 180 lakhs. Each day, shares of say-it-with-flowers
are sold to the highest bidder. The place at which the bidding and
buying process takes place is called the stock market.
SCENE 6 – You as an investor..
Let’s assume that the total shares of the company are 50,000 shares.
So, 40% available to the public is 20,000 shares. The issue price was
Rs 300 (60 lakhs/20000) but, now the share is worth Rs 900(180 lakhs
/ 20000). Since a section of the public feels that this winning streak of
the company would continue, there is heavy demand for the share and
due to this, the price keeps moving up.
Suppose the price is Rs 1250 now. Should you buy?
The answer is –no. Why? Because, the shares are trading above the
‘real value’ of Rs 900. This real value is also called ‘intrinsic value’.
Price drops to Rs 750. Should you buy?
Now, one day, due to some rumors, the stock market crashes, and
consequent to that, the price of the share plummets to Rs 750 per
share.
Should you buy? May be, yes! Why? Because, now the share price is
below the real value and some time later , you can expect the rumors
to settle and that will result in the prices moving back to it’s original
level of Rs 1250 or more.
Where should you sell?
Although the price may move back to Rs 1250, your selling
point theoretically should be at Rs 900 . Why? Because that’s the
actual value point. The price rise above Rs 900 may be due to several
reasons like investor sentiment which should be ignored.
CONCLUSION.
The good investor’s job is to identify companies like say-it-with-flowers
that are selling below their true worth due to some illogical reason and
invest in such stocks.
Basic charcteristics of shares

SHARES OR STOCKS?
That’s right. The first step is to clarify that point. ‘Shares’ and ‘stocks’
mean the same thing. Shares are collectively called stocks. So if your
friend says that he owns stocks, what he means to say is that he has
bought shares in many companies. But if he says he owns shares,
he’s being specific there. What he means to say is that he has bought
shares of a particular company.
CHARACTERISTICS OF SHARES
Shares have these following distinctive characteristics:
Ownership rights.
When you buy a share, you are buying a piece of that company – you
become its part owner. That ownership gives you certain rights,
including voting on important matters of the company and participating
in the profits.
High profit potential.
When you buy stocks, you become the owner to that extent and when
the company makes more and more profits and expands, the demand
for its shares will also rise. As a result, the share prices also move up.
As an owner, you already have rights in its profits. Now, as the
demand for the shares goes up, a second benefit in the form from of
appreciation in capital invested opens up.
For example: Many of the early employees of Infosys are millionaires
because their stock has gone up dramatically.
Risk
However what if the company dint make profits as expected? There
won’t be much demand for it’s shares nor it will carry a high rate of
profit share. Hence, along with the potential for extraordinary gain
comes the potential for high loss. These two go hand in hand. If you
are not careful in choosing a company, you can lose money by
investing in stocks. Not only in stocks, in fact, have even the safest
savings deposits carried unseen risks. When you account for inflation
and taxes, you’ll find that most of the so called risk free investments
are not so safe.
Source of Income
We have already explained that. Since share holders are part owners
of the company, they are entitled to get a part of the annual profits of
the company. Shareholders get income by way of dividends and bonus
shares.
KNOW IT

Shares and stocks mean the same thing. Shares are collectively
called stocks.
Shares give you right to ownership, voting, decision making and
profits in a company.
 Investment in shares can be risky if recklessly done.
Share investments have the potential to make you millionaires.
It gives you income in the form of dividends and bonuses.
Should you invest or trade in stocks?

THAT’S AN ENTIRELY PERSONAL QUESTION !

Should you invest or trade in stocks? The answer to this question is
entirely personal and it would depend on lot of factors.
However, we will not recommend trading to anyone. In our opinion,
shares should be considered as a long term investment.
The reason why we don’t recommend trading is that, in our
experience, most of the traders ( especially beginners) feel that it’s
quite easy to buy at lows and sell at highs. But, it’s not so. Trading is a
highly technical activity. Newbies tend to underestimate the difficulties
of day trading and overestimate their ability as a beginner. 90% of
them lose money and get out of the markets in the first 2 [Link]
would be better to study the fundamentals and try to invest ( at least
for a short term) rather than doing day trading. However, It’s your
money and the decision is yours. What we can do is, we’ll list out
some suggestions based on which you can take a decision whether to
trade or invest or do both.
1. People who cannot monitor the market regularly should not get
into share trading. Share trading requires constant monitoring of
price, volume, trend etc.. Most of us may not have the tools to
analyse all these factors on a real time basis.
2. Young guns out there who cannot actively take part in share
markets should start investing small amounts in shares. The idea
is to accumulate small amounts of shares that will eventually
grow into millions. Young investors can also consider trading in
 shares for short term profits to build up their capital initially.
3. Those who are planning to be active in share markets should
allocate their available funds into two categories- one part for
investing and the other part for trading.
4. If you are nearing retirement and haven’t started saving,
heavily investing in the stock market is probably not a good idea.
However, if you have enough funds to meet your financial
requirements for next five years, you may enter into stock
markets.
5. Markets are always risky in the short term. Hence trading
involves more risk than investing. Markets will keep moving up
and down and it’s easy to get emotionally disturbed when you
keep watching those price fluctuations.
6. Investing, if done right, would result in huge results in the way
of capital appreciation, dividends, bonus shares, rights issue etc.
trading does not have such advantages. Trading results depends
on the price movements and how well you time the market.
7. Short term profits or trading profits are taxable income in India.
Where as profits from long term investments are tax free.
8. Trading tends to become more speculative as you try to make
profits from every price movement. Some of these price
movements may be due to rumours or manipulations and it’s
easy to get trapped in such situations. When you invest, you take
a lot of time to study the fundamentals and about what’s
happening around. Hence it’s highly unlikely that you get into
such traps.
CONCLUSION
To trade or to invest in stock markets would depend on one’s age,
nature of income and attitude. In any case, you should go by the
fundamentals supported by the technical factors. Technical analysis
and fundamental analysis are seen by many as polar opposites but
many market participants have experienced great success by
combining the two. Having both the fundamentals and technicals on
your side would only have advantages. We will be discussing in detail
about fundamental analysis and technical analysis later on.

Benefits of owning shares

What are the benefits if you own shares? There are many other
benefits as we have explained in the following paragraphs:
EARN DIVIDENDS.
Dividends are nothing but a part of company’s profits distributed to its
share holders. The company’s management may declare dividends
either in between a financial year (called interim dividends) or at the
end of the financial year (called final dividends).However, it is not
mandatory for the companies to pay dividends. It can use the profits
for alternative uses like expansion. The decision to pay or not to pay
dividends is taken at the annual meeting by the majority voting of the
shareholders. Blue-chip companies (large companies) generally are
consistent dividend payers.
CAPITAL APPRECIATION.
As the company expands and grows, it acquires more assets and
makes more profit. As a result, the value of its business increases.
This, in turn, drives up the value of the stock. So when you sell, you
will receive a premium over what you paid. This is known as capital
gain and this is the main reason why people invest in stocks. They aim
capital appreciation.
RECEIVE BONUS SHARES
For the time being, let us understand that bonus shares are – Free
shares are given to you .Later on we will discuss about bonus shares
in detail.
RIGHTS ISSUE
A company may require more funds to expand it’s business and for
that, it may need more funds. I such cases, the company can issue
further shares to the public. However, before approaching the public,
the existing shareholders will be given a chance to subscribe to more
shares if they want. That’s called a rights issue. This is done in order
to ensure that the existing shareholders maintain the same degree of
control in the company. Thus you can maintain the participation in the
company profits.
SHARES CAN BE PLEDGED

Shares are considered as assets and hence, banks accept shares as

security for raising loans. Should there be an an emergency, shares
can quickly pledged to raise funds. Apart from that, Brokerage firms
allow you to borrow money from their account based on the current
share holding you have in your demat account maintained with them. If
you want to utilize a sudden surprise opportunity in markets, but if you
don’t have the cash right now, you can adopt this route.
HIGH LIQUIDITY
Shares are highly liquid. It can be converted into cash in no time. With
online trading, all it takes is the click of button to sell you holdings. You
can receive your cash in two days.
CAPITAL APPRECIATION OR DIVIDENDS?
The above mentioned income sources may not be present in every
company you buy. For example- if you’re buying company that has a
huge potential to grow, it may not pay it’s surplus as dividends.
Instead, it will be used for further growth. In such cases, huge capital
appreciation may happen. So depending upon your investment
strategy, you’ll have to choose what you want. It’s always wise to go
for capital appreciation rather than dividends.

Stock markets in india

THE HISTORY OF BOMBAY STOCK EXCHANGE

The Bombay stock exchange traces it’s history back to the 1850s,
when 4 Gujarati and 1 Parsi stock broker would gather under a banyan
tree in front of mumbai’s Town [Link] location of these meetings
changed many times, as the number of brokers constantly
[Link] group eventually moved to Dalal Street in 1874 and in
1875 became an official organisation known as “The Native Share
stock Brokers association.”
THE PRESENT SCENARIO
There are 19 recognised stock exchanges in India. The Bombay stock
exchange (popularly known as The BSE ) and The National stock
exchange (popularly known as The NSE ) are the most prominent in
terms of volume and popularity.
The Bombay Stock Exchange Popularly called “The BSE” is the
oldest stock exchange in Asia and has the third largest number of
listed companies in the world, with 4900 listed as of Feb 2010. It is
located at Dalal Street , Mumbai , India . National Stock Exchange
comes second to BSE in terms of popularity.
Over the decades, the stock market in the country has passed through
good and bad periods. Till the decade of eighties, there was no
measure or scale that could precisely measure the various ups and
downs in the Indian stock market. BSE, in 1986, came out with a
Stock Index-SENSEX- (SENSitive indEX) that subsequently became
the barometer of the Indian stock market.
WHAT IS A STOCK MARKET INDEX?
Stock market indexes provide a consolidated view of how the market is
performing. Stock indexes are updated constantly throughout the
trading day to provide instant information.
The SENSEX and other indexes
The BSE SENSEX (SENSitive indEX)is a basket of 30 stocks
representing a sample of large, liquid and representative companies.
The base year of SENSEX is 1978-79 and the base value is 100. The
index is widely followed by investors who are interested in Indian stock
markets. During market hours, prices of the index scrip, at which
trades are executed, are automatically used by the trading computer to
calculate the SENSEX every 15 seconds and continuously updated on
all trading workstations connected to the BSE trading computer in real
time
30 stocks that represent SENSEX.
ACC Ltd.
Bharat Heavy Electricals Ltd.
Bharti Airtel Ltd.
Cipla Ltd.
DLF Ltd.
Jindal Steel & Power Ltd.
HDFC
HDFC Bank Ltd.
Hero Honda Motors Ltd.
Hindalco Industries Ltd.
Hindustan Unilever Ltd.
ICICI Bank Ltd.
Infosys Technologies Ltd.
ITC Ltd.
Jaiprakash Associates Ltd.
Larsen & Toubro Limited
Mahindra & Mahindra Ltd.
Maruti Suzuki India Ltd.
NTPC Ltd.
ONGC Ltd.
Reliance Communications Limited
Reliance Industries Ltd.
Reliance Infrastructure Ltd.
State Bank of India
Sterlite Industries (India) Ltd.
Tata Consultancy Services Limited
Tata Motors Ltd.
Tata Power Company Ltd.
Tata Steel Ltd.
Wipro Ltd.
The BSE Sensex is not the only stock market index in India. The NSE
has The NSE S&P CNX Nifty 50 index – a well diversified 50 stock
index accounting for 24 sectors of the economy. While both SENSEX
and NIFTY would give you an overall direction of the stock market
there are other indices which track a particular sector.
For example – The NSE CNX IT Sector Index tracks companies that
have more than 50% of their turnover (or revenues) from IT related
activities like software development, hardware manufacture, vending,
support and maintenance. So for those who are tracking the
performance of IT Sector this index would become a benchmark for
investing. Yet another example is the BSE BANKEX index which
tracks the banking sector shares.

WHAT’S GOOD ABOUT INDEXES

Indexes provide useful information including:
Trends and changes in investing patterns.
Snapshots, even if they are out of focus.
Yardstick for comparison.
KNOW IT
A stock market index is a statistical indicator which gives an idea
about how the stock market is performing. In India the main
indexes to be tracked are – The BSE SENSEX and The NSE
NIFTY.
The SENSEX comprises of 30 companies representing different
sectors and the broader NIFTY comprises of 50 companies from
24 sectors. There are many other indexes that track particular
sectors of the economy. These indexes would give you an idea
about how that particular sector is performing.
World over, there are a number of indexes as there are stock
markets. DOW JONES INDUSTRIAL AVERAGE and NASDAQ
COMPOSITE INDEX – both track US stock markets. NIKKEI 225
is the stock market index of Japan, HANG SENG index for Hong
Kong, FTSE 100 For UK, KOSPI for Korea, SHANGHAI for China
etc. All these indexes serve the same purpose. It gives an idea
about where the financial growth of a country is headed to.
Next time you watch CNBC or NDTV Profit, watch these indexes
flashing on the corner of your screen.

What is a stock index?

STOCK INDEX.
The stock index function as an indicator of the general economic
scenario of a country / region / sector. If the stock market indices are
growing, it indicates that the overall general economy of the country is
stable and that the investors have faith in the growth story of the
economy. If, however, there is a plunge in the stock market index over
a period of time , it indicates that the economy of the country is in
troubled waters. It’a also an indication of what the corporates in that
country are facing.
A stock index is created by selecting a group of high performing stocks
. For example – The FTSE 100 ( the stock index of London stock
exchange) is constructed from the top 100 companies trading in the
London stock exchange. If the FTSE 100 records a jump over a period
of time, it indicates that most of the top 100 companies in England are
doing well at that point of time and that the investors are positive about
putting their money in England.
TYPES OF INDICES
There are different types of indices and FTSE 100 was just an
example. Stock indices can be constructed -
For the entire world ( global indices)
For an entire continent ( regional indices – for example
S&P Latin america 40)
For an entire country ( national indices – for example Sensex &
Nifty for India )
For a particular sector in a country – ( sectoral indices – for
example BSE BANKEX which tracks top banking companies
in India)
For any other theme / group of economy / companies you want to
track. ( example Dow Jones Islamic world market index)
The MSCI global and the S & P Global 100 are examples of world
stock indices which tracks the largest companies in the world
irrespective of their country of origin . The MSCI global id an index
with over 6000 stocks included from different parts of the developed
world. It specifically excludes companies from emerging economies.
When stock indices are constructed to track the performance of the
economy of a country ( like Sensex in India), it called a national index.
Irrespective of the type of index, the purpose of any index is the same.
It provides to the public, a quick view of how the economy ( based on
which the index is constructed) is functioning. A sudden slide in
indices denotes that the investors have lost faith . There could be
several reasons for that like poor economic reforms , high inflation,
high borrowing costs, amendments in laws that not well received by
the business community, downgrades by world credit rating agencies,
scams , corruption .. the list is end less.
These indices also serve as benchmarks
for measuring performance of fund managers or for measuring
the performance of an individual’s stock portfolio.
CONSTRUCTION OF STOCK INDEX
A stock index can be calculated in two ways -
By considering the price of the component stocks alone. This
method is called the price-weighted method.
By considering the market value or size of the company – called
the capitalisation weighted method.
To conclude, stock indices are barometers to measure general
economic performance of an particular country / sector. It’s updated
every second throughout on every trading so as to reflect the exact
picture of the economy. It’s also a permanent record of the history of
markets – it’s highs and lows, booms and crashes.
BSE stock classifications

SIX HEADERS- A, B, T, S, TS and Z

Hi there ,
Do you know that he BSE classifies stocks under six headers?
The Bombay Stock Exchange classifies stocks under six grades — A,
B, T, S, TS and Z — that scores stocks on the basis of their size,
liquidity and exchange compliance and, in some cases, also the
speculative interest in them. You can look up any stock’s grade in the
‘Stock Reach’ page in the BSE Web site, under the head ‘Group’.
Alternately, you can also follow the link below:
[Link]
A GROUP – HIGHLY LIQUID
These are the most liquid counters among the whole lot of stocks
listed in the BSE.
These are companies which are rated excellent in all aspects.
Volumes are high and trades are settled under the normal rolling
settlement (i.e. to say intraday buy-sell deals are netted out).
These are best fit for a novice investor’s portfolio considering that
information about them is extensively available. For instance, all
the 30 stocks in Sensex are ‘A’ grade stocks.
T GROUP – TRADE TO TRADE
The stocks that fall under the trade-to-trade settlement system of
the exchange come under this category.
Each trade here is seen as a separate transaction and there’s no
netting-out of trades as in the normal rolling system.
The trader needs to pay to take delivery for his/her buys and
deliver shares for his/her sells, both on the second day following
 the trade day (T+2). For example, assume you bought 100
shares of‘T’ grade scrip and sold another 100 of it on the same
day. Then, for the shares you have bought, you would have to
pay the exchange in two days. As for the other bunch that you
sold, you should deliver the shares by T+2 days, for the
exchange to deliver it to the one who bought it.
Failure to produce delivery shares against the sale made would
be considered as short sales. The exchange will, in that case, on
the T+3rd day, debit an amount that is 20 per cent higher than
the scrip’s closing price that day. This means unless the scrip’s
price falls more than 20 per cent from the price of your sale
transaction, you would have to pay a penalty for the short sale so
made.
Even so, there will be no credit made to you in the case of
substantial fall in the share price. The exchange will, instead,
credit the gain to its investor fund.
Stocks are regularly moved in and out of trade-to-trade
settlement depending on the speculative interest that governs
them.
S GROUP – SMALL AND MEDIUM
These are shares that fall under the BSE’s Indonext segment.
The BSE Indonext comprises small and medium companies that
are listed in the regional stock exchanges (RSE).
S’ grade companies are small and typically ones with turnover of
Rs 5 Crore and tangible assets of Rs 3 Crore. Some also have
low free-float capital with the promoter holding as high as 75 per
cent.
Besides their smaller size, the other risk that comes with
investing in them is low liquidity. Owing to lower volumes, these
stocks may also see frenzied price movements.
TS GROUP – A MIX OF T AND S GROUPS
Stocks under this category are but the ‘S’ grade stocks that are
settled on a trade-to-trade basis owing to surveillance
requirements.
This essentially means that these counters may not come with
an easy exit option, as liquidity will be low and intraday netting of
buy-sell trades isn’t allowed either.
Z GROUP – CAUTION
‘Z’ grade stocks are companies that have not complied with the
exchange’s listing requirements or ones that have failed to
redress investor complaints.
This grade also includes stocks of companies that have
dematerialisation arrangement with only one of the two
depositories, CDSL and NSDL.
These stocks may perhaps be the riskiest in terms of various
grades accorded. For one, not much information would be
available in the public domain on these companies, making it
tough to track them. Second, the low media coverage that keeps
them relatively hidden from public scrutiny also makes them
more vulnerable to insider trading. Third, these companies
already have a poor score in redressing investor complaints.
B GROUP – LEFT BEHIND
This category comprises stocks that don’t fall in any of the other
groups.
These counters see normal volumes and are settled under the
rolling system. In all respects these stocks resemble their
counterparts in ‘A’ but for their size. Typically, stocks of mid- and
small market capitalisation come under this grade.
SLB GROUP
Securities Exchange Board of India, in 2007, has announced the
introduction of Securities Lending & Borrowing Scheme (SLBS).
Securities Lending & Borrowing provides a platform for borrowing of
securities to enable settlement of securities sold short. There are 207
companies in the SLB list. Investors can sell a stock which he/she
does not own at the time of trade. All classes of investors, viz., retail
and institutional investors, are permitted to short sell.
OTHER CLASSIFICATIONS
The “F” Group represents the Fixed Income Securities.
Trading in Government Securities by the retail investors is done
under the “G” group.

What is Sensex? How is it calculated?

SENSEX
The SENSEX-(or SENSitve indEX) was introduced by the Bombay
stock exchange on January 1 1986. It is one of the prominent stock
market indexes in India. The Sensex is designed to reflect the overall
market sentiments. It comprises of 30 stocks. These are large, well-
established and financially sound companies from main sectors.
METHOD ADOPTED FOR SENSEX CACULATION

The method adopted for calculating Sensex is the market

capitalisation weighted method in which weights are assigned
according to the size of the company. Larger the size, higher the
weightage.
The base year of Sensex is 1978-79 and the base index value is set to
100 for that period.
WHY IS THE BASE VALUE SET TO 100 POINTS?
The total value of shares in the market at the time of index
construction is assumed to be ’100′ in terms of ‘points’. This is for the
purpose of ease of calculation and to logically represent the change in
terms of percentage. So, next day, if the market capitalization moves
up 10%, the index also moves 10% to 110.

HOW ARE THE STOCKS SELECTED?

The stocks are selected based on a lot of qualitative and quantitative

criterias. You can view the listing criteria here.
HOW IS THE INDEX CONSTRUCTED?
The construction technique of index is quite easy to understand if we
assume that there is only one stock in the market. In that case, the
base value is set to 100 and let’s assume that the stock is currently
trading at 200. Tomorrow the price hits 260 (30% increase in price) so,
the index will move from 100 to 130 to indicate that 30% growth. Now
let’s assume that on day 3, the stock finishes at 208. That’s a 20% fall
from 260. So, to indicate that fall, the Sensex will be corrected from
130 to 104(20%fall).
As our second step to understand the index calculation, let us try to
extend the same logic to two stocks – A and B. A is trading at 200 and
let’s assume that the second stock ‘B’ is trading at 150. Since the
Sensex follows the market capitalisation weighted method, we have to
find the market capitalisation (or size of the company- in terms of
price) of the two companies and proportionate weightage will have to
be given in the calculation.
How do we compute size of the company- in terms of price?
That’s simple. Just multiply the total number of shares of the
company by the market price. This figure is technically called
‘market capitalisation’.
Back to our example-
We assume that company A has 100,000 shares outstanding and B
has 200,000 shares outstanding. Hence, the total market capitalization
is (200 x 100000 + 150 x 200000) Rs 500 lakhs. This will be
equivalent to 100 points.
Lets assume that tomorrow, the price of A hits 260 (30% increase in
price) and the price of B hits 135. (10% drop in price). The market
capitalization will have to be reworked. It would be – 260 x 100,000 +
135 x 200,000 = 530 lakhs. That means, due to the changes in price,
the market capitalization has moved from 500 lakhs to 530 indicating a
6% increase. Hence, the index would move from 100 to 106 to indicate
the net effect.
This logic is extended to many selected stocks and this calculation
process is done every minute and that’s how the index moves!
CALCULATION OF SENSEX.
What we said was the general method to construct indices. Since, the
Sensex consists of 30 large companies and since it’s shares may be
held by the government or promoters etc, for the purpose of
calculating market capitalization only the free float market value is
considered, instead of the total number of shares.
What is free float?
That’s the total number of shares available for the public to trade
in the market. It excludes shares held by promoters,
governments or trusts, FDIs etc..
To find the free float market value, the total value of the company
(total shares x market price) is further multiplied by a free float
market value factor, which is nothing but the percentage of free
float shares of a particular company.
So logically, the company which has more public holding will
have the highest free float factor in the Sensex. This equalizes
 everything.
Example- let’s assume that the market value of a company is Rs
100,000 Crore and it has 100 Crore shares having a value of Rs
1,000 each but only 20% of it are available to the public for trade.
The free float factor would be 20/100 or 0.20 and the free float
market value would be .20 x 100,000 = 20,000 Crores.
You need not calculate the free float market capitalisation since
its available straight on the BSE website – Click this link to get it.
NOW, LET’S SE HOW THE SENSEX MOVES.
Sensex value = Current free-float market value of constituents
stocks/Index Divisor
So, the numerator is available straight from the BSE site. It’s the total
of free float factors of 30 stocks x market capitalisation.
NOW, THE DENOMINATOR.

The index divisor nothing but the present level of index.

So, now, we have all the figures.
Lets assume that the free-float market capitalisation is Rs 10,00,000
Crore. At that point, the Sensex is at 12500. What would be the value
of Sensex if the free-float market capitalisation is Rs 11,50,000 Crore?

Bulls, Bears and Stags

Hi there,
Let’s catch up with ‘Bulls’ and ‘bears’. The two most commonly used
terms in stock markets.
A common story is that the terms ‘Bull market’ and ‘Bear market’ are
derived from the way those animals attack. Bulls are supposed to be
aggressive and attacking while bears would wait for the prey to come
down.
Another story is that long back, bear trappers would first trade in the
market and fix a price for bear skins, which they actually din’t own.
Once the price is fixed , they would go hunting for bear skins. So
eventually even if the prices go down, they will still be able to sell if for
a high price. This term eventually was used to describe short sellers
and speculators who sell what they do not own and buy it when the
price comes down and makes money in the process.
However, it was Thomas Mortimer,in his book called ‘Every Man His
Own Broker’ (1775) who first officially used the terms Bulls and bears
to describe investors according to their behaviour.
BULL MARKETS
When can you say it’s a bull market? When the prices of stocks moves
up rapidly cracking previous highs , you may assume that it’s a bull
[Link] there are many bullish days in a row you can consider that as
a ‘bull market run’. Technically a bull market is a rise in value of the
market by at least 20%.
BEAR MARKETS
A bear market is the opposite of a bull market. When the prices of
stocks moves crashes rapidly cracking previous lows , you may
assume that it’s a bear market. Generally markets must fall by more
than 20% to confirm that it’ a bear market.
STAGS
This is another category of market participant. The stags are not
interested in a bull run or a bear run. Their aim is to buy and sell the
shares in very short intervals and make a profit from the fluctuation.
It’s a daily tussle for stags in the stock market.
MARKET TIMING
The basic idea behind stock market investment is simple- Buy low, sell
high and make money. So to make money, you buy stocks in a bear
market when stock prices are low and sell stocks in a bull market
when stock prices are high.
However, knowing the exact time when a bear market would start or
when a bull market run would come is not possible. Just when you
thought the markets would go up, it may surprise you by trading low.
Your strategy should be to pick up shares in the bear market and sell it
when there’s a bull market run.
HERE’S THE CRUX..
Technically a bull market is a rise in value of the market by at
least 20%.Anything less than 20% would be considered as a
minor rally.
A market launches into a bull phase when sentiment turns
buoyant, which is usually because of a series of positive
developments that beat expectations
Reverse is also true. A 20% or more fall in value is considered as
a bear market. Anything less than 20% would be considered as a
‘correction’.
Bear markets occur when news flow tends to be worse than
expectations, causing investors to sharply punish stocks or
sectors. This has happened in the US where more bad news on
the sub-prime front and US economy data has stifled even the
briefest of market recoveries.
To confirm a bear market, this weakness should persist for at
least two months. In bear markets, liquidity is extremely tight,
volumes tend to be low and market breadth tends to be poor
Some experts believe that for emerging markets such as India,
which tend to be more volatile, the correction needs to be
steeper at 30-35 per cent.
In every bear market, there tends to be bear market rallies or a
 bear market pullback, where the market rises 10-15 per cent only
to decline yet again. The bounce-back usually occurs when
some stocks or sectors are ‘oversold’, to borrow a term used by
technical analysts.
Worst bear market conditions are followed by great bounce
backs.

How much money should you invest in stock

markets?

People often end up investing majority of their savings into stock

markets, especially if they get a handsome profit on their first trade
[Link] also commit more money to recoup all the loses they made
earlier.
Both these situations are dangerous. More than 80% of the retail
investors in India have this problem of committing more. In the first
case, they do it because they are excited about making more money
quickly and in the second case they do it out of despair – to somehow
recoup the losses and get out of the market. Ask any broker whom you
know personally – he will have a list of hundreds of clients who came
in –opened de-mat accounts and vanished in a year’s time.
HOW MUCH ? IS THERE A FORMULA?
So what we are trying to give you is a set of two tips that would help
you have control over your money invested in stock markets:
First of all – never try the ‘daily money making process’ in stock
markets. I know quite few of them who has tried ‘playing in stock
markets’ to make a daily income-and lost all their money.
Secondly, There is a limit to which you should expose your money in
stock markets. There’s no hard and fast rule as to how much should
be exposed. However to help you out, here’s a formula which gives
you a rough calculation about how much money should go into stocks
based on your age.
It is:
90 –(minus) YOUR AGE = % of income to be exposed In stock
markets.
So, if you are 35 years old , you can expose a maximum of 50% of
your income into stocks. Ok. Fine. so does that mean you can expose
15% of your income at 75? May be not. Investments in stock markets
ideally should be stopped at the age of 65 or 70 maximum. Again , as I
said earlier , investing is entirely personal. If you have the money,
health and will to invest at 70 or even at 90 , Go ahead ! ! Sir Warren
Buffet is 81 years old now, and he hasn’t stopped investing !
Clearly, when you are young , you can afford to take more risk and
hence, you should be investing in stocks rather than debt funds. when
you grow older, the proportion of money invested in stocks should be
brought down and the the debt or fixed income potion in your
investments should be increased.

What drives the stock market ?

WHAT DRIVES THE STOCK MARKETS?

Basically, investors respond positively to good news from the

government and corporate world and would stay back from the market
when they face negative news. From the government’s side, they
would expect relaxed monetary polices and interest rates that would
enable companies to expand, grow and do business. They would also
expect the laws and regulations to be corporate friendly. From the
corporate’s side, investors expect better results and profitability. Over
the long term, the growth of the business and profitability is the
concern of all investors. Since the current stock prices are nothing but
the present value of expected future earnings, we can say that, in the
long term, earnings drive stock prices.
WHY EARNINGS?

Investors buy stocks to get to sell it off at higher prices. Stocks will rise
in price only if it is in great demand. Demand for a stock rises only if
the investors feel that the company has the potential to grow and
would increase earnings every year.
The stock market is a discounting mechanism where it’s not the
current earnings but, the ability of a company to generate earnings in
the future keeps driving it. The present has already been discounted
by the market 6 or 12 months ago. So, if investors expect a good
season in the future, the stock prices will respond by an increase in
price now. Should they expect the reverse, the stock price would
tumble. This is a continuing process in the markets – and will be so in
the future.
So if you ask us which is the best time to buy stocks, our answer is –
it’s when the earnings are declining and when the economy is in
recession.

OTHER FACTORS.

Earnings are not the only factor that drives markets. Other factors that
drive stock markets include sentiments, valuation, interest rates,
inflation and the economic policies in general.

In this, Sentiments has more to do with investor’s psychology.

Sentiments represent a collective view of all the participants at a give
point of time. The moment there’s a change in stock prices, common
investors would assume that it’s going to continue for a long time and
would react accordingly. For example – if the stock market responds
with a 50 point slide due to increase in interest rates, investor’s
negative sentiments may kick off a series of downfalls since, they
would keep selling their positions expecting further damage.

VALUATION

Investors will be attracted to the option which appears cheap in

valuation. Valuation can be relative valuation or absolute valuation. By
relative valuation we mean comparing the stock market to other form
of investments like gold or real estate. By absolute valuation we mean,
valuating the stock itself with its past price and present and expected
performance.
MONETARY POLICIES AND INTEREST RATES
If the interest rates are increased, it affects the borrowing costs of
companies and hence, high borrowing cost would bring the earnings
down and it will also prompt the companies to post pone their
expansion plans. Changes in interest rates will also affect the rate at
which future earnings are discounted by the market.
Fixed income earning instruments like fixed deposits become more
attractive at high interest rates and that would impact the markets
negatively. Investors would move their money from the markets and
will park it in fixed instruments since the rate is high.
One major cause of high interest rates is inflation. As inflation in a
country increases, the government will be forced to keep the interest
rates high in order to restrict the money flow into the economy. As we
said earlier, higher interest rates are not good for the stock markets.
When the interest rates are low, fixed income instruments are no
longer attractive and this would induce investors to enter stock
markets.
So the interplay of all these factors keeps driving the stock markets.
What are Blue-chip shares?

BLUE CHIPS
‘Blue-chips’ is one word that you’d be hearing a lot of times once you
start following the stock markets. So this post is about blue chips or
‘bellwethers’ as it is sometimes called.
Blue chip stocks are large companies whose shares are considered to
be relatively safe than normal shares. It gains that status from its past
record of being a high growth, high dividend paying company. These
companies would be leaders in its field. For example-Infosys
technologies is described by Medias as an ‘IT bellwether’. It reflects
the investor’s confidence in that company’s capacity to maintain its
status as the leader of the pack and its past record of excellent
management and of giving good returns to it’s share holders.
The term ‘blue-chip’ is coined from a game called poker where the
chip with the highest value is blue in color. In stock markets, the term
is used to describe the stock that has highest quality – in terms of
investor confidence.
There is no hard and fast rule to find out which a blue chip company is
and which one is not. A blue-chip typically would have stable earnings
and dividend history, a strong asset position, high credit rating and an
excellent record of being a leader in its field. These are huge
companies in terms of market capitalization and revenues.
All the 30 stocks in Sensex index can be considered as blue-chip
companies. You can also see the Dow Jones list of Indian blue chips
at –
[Link]
ARE THESE SHARES SAFE FOREVER?
No. These shares may be assumed to be relatively safer than others,
provided, the positive factors that drive the company remain intact.
Just like any other company, a blue chip company can also run into
financial troubles and become dead one day. No one can guarantee
you that a blue-chip will remain like that in future also.
May be, some of the future blue chips are hidden in mid caps right
now. If you have managed to spot them right now, you have a chance
to become a millionaire soon.
SHOULD YOU INVEST IN BLUE-CHIPS?
Of course, Yes! You must have some portion of your investments in
Blue-chips. They bring the required solidity in your portfolio, since they
do not fluctuate heavily like mid caps or small caps.
Investing in blue chip also requires lot money because; typically these
shares will cost more. Hence, there is a necessity to valuate it
meticulously.

Invest for a long term or short term?

Imagine the thrill when the stock you just invested in, zooms! What an
easy way to make money! Are not good returns over a short period
very tempting? Your next move: Identify other stocks that have this
potential. From now on, all your energy will be directed towards
making that quick buck, daily.
You will find yourself taking tips from every trader, reading every
available material on the subject, spending hours studying charts and
sighing at every small fall in the indices. Yet, with all the time and
energy spent on it, you may end up burning your fingers. This is a
reality that every newbie has faced, I am [Link] only newbies- I
have seen most of the investors trying the same. If you have decided
to invest money in stock markets, it’s always better to remain invested
for a long term. Here’s why:
BENEFITS OF LONG TERM INVESTING
Short term investments may have the potential to give you quick
bucks, but long term investment has several significant advantages.
Advantage #1:Compounding: Time can be investor’s best friend
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.
Advantage #2: Dividends: Holding a stock to take advantage of
payouts from dividends is another way to increase the value of an
investment. Some companies offer the ability to reinvest dividends
with additional share purchases thereby increasing the overall value of
your investment. Consistent dividend payout is a reflection of a
company’s overall business strategy and success.
Advantage #3: Reduction Of The Impact Of Price Fluctuations:
When you invest for a long term, your investments are less affected by
short term volatility. The market tends to address all factors that keep
changing in the short term. So a person involved in long term
investment will not be affected as much by short term instability due to
factors such as liquidity, fancy of a particular sector or stock which
may make the price of a stock over or undervalued. In the long term,
good stocks which may have been affected due to some other factors
(in the short term) will give better than average returns.
Long-term investors can ride out down markets without dramatically
affecting his or her ability to reach their goals.
Advantage #4:Making Corrections: It is highly likely that you could
achieve a constant return over a long period. The reality is that there
will be times when your investments earn less and other times when
you make a lot of money in short term. There may also be times when
you lose money in short term but as you are in quality stocks and have
long perspective of investment you will earn good returns over a
period of time.
There are always times when some stocks do not perform and it is the
wise choice to pull out of an investment. With a long term perspective
based on quality stocks, it is easier to make decisions to change in a
more timely manner without the urgency that accompanies short term
and day trading strategies chasing volatile changes.
Advantage #5: Less Time Spent Monitoring Stocks: day trading
requires constant monitoring of stocks throughout the day to capitalize
on intraday volatility. But, Long term trading can be carried out
effectively using a weekly monitoring system. This approach is most
often far less stressful than watching prices constantly on a daily
basis. Moreover, long term investment strategy helps you to
concentrate more on your job/profession.
Advantage #6: Tax Effect: In India, short term capital gains (The
profit you make by buying shares and selling it off anytime within a
year) is taxable at 15% and there are no exemptions to it. Long term
capital gains (The profit you make by buying shares and selling it off
after a year) are totally tax free
Advantage #7:Oppurtunity to average down: Suppose you invest in
a blue chip like reliance at Rs.1000 and for some reason the stock
falls unexpectedly to Rs 850. That gives you an opportunity to buy
more shares and bring the average cost down. This can bring
dramatic increase in profits in the long term.
Advantage #8: Opportunity to make huge returns: Long term
investments, if done after careful study of fundamentals, would give
opportunity to create huge wealth over a period of [Link] like
Warren Buffet has followed this strategy to create wealth.
Overall, 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. When you invest for a short term,
you miss out all these advantages.

Ethical Stock Investing

ETHICAL INVESTING
Ethical investing or socially responsible investing is also known as
sustainable, socially conscious investing – an investment strategy
which seeks to maximize both financial return and social good.
Some investors feel that there are no standards which can be created
for ethical investing since each individual has their own set of values
and morals. If no standards are created, however, then even the most
harmful investments can be called “ethical” by some. Anyone who tries
to invest responsibly faces the ethical investment dilemma. This
dilemma really revolves around two simple questions. They are: ‘What
is or is not ethical?’ and’Who decides?’
Fortunately, there are several basic values that most people share:
Avoid Causing Illness, Disease & Death
Avoid Destroying or Damaging the Environment
Avoid Treating Honest People with Disrespect etc..
So, arms makers, polluters, tobacco companies, pesticides
manufacturers, companies with poor management record such as
Enron and satyam, oil companies are some examples of businesses
which are generally excluded.
In 2010, the OIC announced the initiation of a stock index that
complies with Islamic law’s ban on alcohol, tobacco and gambling.
The Dow Jones Islamic Market World Index is another example.
Another important trend is strict mechanical criteria for inclusion and
exclusion to prevent market manipulation. Ethical indices have a
particular interest in mechanical criteria, seeking to avoid accusations
of ideological bias in selection, and have pioneered techniques for
inclusion and exclusion of stocks based on complex criteria. Another
means of mechanical selection is mark-to-future methods that exploit
scenarios produced by multiple analysts weighted according to
probability, to determine which stocks have become too risky to hold in
the index of concern.
Critics of such initiatives argue that many firms satisfy mechanical
“ethical criteria”, e.g. regarding board composition or hiring practices,
but fail to perform ethically with respect to shareholders, e.g. Enron.
Indeed, the seeming “seal of approval” of an ethical index may put
investors more at ease, enabling scams. One response to these
criticisms is that trust in the corporate management, index criteria,
fund or index manager, and securities regulator, can never be replaced
by mechanical means, so “market transparency” and “disclosure” are
the only long-term-effective paths to fair markets.
ETHICAL INVESTING ENTERS INDIA
There is growing market demand for Socially Responsible Investment
(SRI) and more investors are willing to invest over the longer term in
the organisations that contribute positively to sustainable
development, public benefit and environmental [Link] Amro
launched India’s first SRI fund (called ABN Amro Sustainable
Development Fund).
Global index provider Dow Jones indexes and Dharma Investments, a
private investment company, in Jan, 2008 announced the launch of
Dow Jones Dharma index for measuring the performance of
companies selected according to the value systems and principles of
Dharmic religions, especially Hinduism and Buddhism. This index has
been put together by Wallstreet. Stocks will be screened on industry,
environmental and corporate governance parameters before being
included in the Dharma indexes. The index constituents would be
reviewed on a quarterly basis.
CONCLUSION
Ethical investing depends on an investor’s views; some may choose to
eliminate certain industries entirely or to over-allocate to industries that
meet the individual’s ethical guidelines. A good way to start with an
ethical investing policy is to write down the areas you want to avoid as
well as where you want to see your money invested. From there you
can come up with an asset allocation plan and begin researching
individual securities.

Indirect way to invest in stocks –Mutual funds.

What is it?

The term itself gives some hint about its nature. “Mutual” means
combined and “Funds” means money. So, mutual funds are the
collective investment contributed by many investors and managed by
professional individual or company (your fund manager). The fund
manager invests this combined money in stocks, bonds, short-term
money market instruments, and/or other securities

What’s the advantage?

You do not have to constantly keep an aye on the stock market.
The fund manager will invest the funds wisely and in profitable
companies.
The funds are invested in various companies and that too by the
professionals. So, you are not keeping all your money in one
pocket. This minimizes the risk of huge loss investment loss.
Even your Rs 5000 invested is diversified.
You can plan and invest systematically. (That can be done in
share markets to, but SIP process in mutual funds works well)
Unlike companies, mutual funds will not close down. Rather they
would be merged into another successful fund
Normally the NAVs do not show a significant rise or crash

Any Disadvantages?

You don’t have a say in deciding where your money is invested.

The fund manager decides for you and he may be wrong, thus
causing a loss
You don’t own shares directly, so you are not eligible for any
rights due to the owner.
Dividend is optional and if chosen will affect the value of your
investment by the amount of dividend declared

Scheme philosophy
Whenever a mutual fund scheme is launched there is a specific
mandate (philosophy of investing) based on which investing is done by
that mutual fund. This mandate outlines the debt-equity mix and the
type of instruments that the fund would [Link] example, the
prospectus of a mutual fund will always mention the stock universe
that fund invests in viz, large cap, mid cap, small cap, sector funds
etc.. or it will have a ‘theme’ for example – ‘energy opportunities fund’
or ‘emerging leaders fund’ etc.. From the name itself,you could get a
basic idea of where your money will be invested. Since Mutual funds
offer a whole bouquet of products , you must first decide on the types
of funds that would suit your needs. Only then should you start
selecting the best funds within those categories.

NAV and it’s importance.

Net Asset Value, or NAV, is the sum total of the market value of all the
shares held in the portfolio including cash, less the liabilities, divided
by the total number of units outstanding. Thus, NAV of a mutual fund
unit is nothing but the ‘book value.’
The NAV of the fund has no impact on the returns it will deliver in the
future.
For example – Let’s assume you plan to invest in an index fund
and you have two choices - Fund A is a new fund with an NAV of
Rs. 10, which will mimic the Nifty and a Fund B, which is an
existing Nifty index fund with an NAV of Rs. 200.
Suppose you invest Rs. 10,000 in Fund A and Rs. 10,000 in
Fund B. You will get 1000 units of Fund A and 50 units of Fund
B. After 1 year, if the Nifty has appreciated by 25%, it means that
both funds would have also appreciated by 25%, as they are a
replica of the Nifty.
So after 1 year, the NAV of Fund A would become Rs. 12.50 and
that of Fund B Rs. 250. But what is the value of your two
investments? Fund A would now be Rs. 12,500 (1000 units * Rs.
12.50/unit) and Fund B also would be Rs. 12,500 (50 units * Rs.
 250/unit).
The bottom line is that don’t bother about the NAV of a mutual fund, as
you might do for the price of a share.
Conclusion
As with any investment, there are risks involved in buying mutual
funds. These investment vehicles can experience market fluctuations
and sometimes provide returns below the overall market. You may
consider investing in those companies belonging to the top
performing mutual fund companies. This gives you some security that
the company is able to increase your capital investment. To know if the
company is performing well you can ask for feedbacks, past
performances etc.

The Only 2 ways to buy stocks – Primary

markets & Secondary markets.

Hi there,
So far what I have discussed is about share markets or secondary
markets. I haven’t talked about primary markets in detail. That’s a
basic topic which I should have discussed earlier. So let’s catch up
with the topic.
If you recall our story on shares, in scene 3, the couple raises 52 lacs
by selling 40% of their shares to the public,When they did that, they
tapped money from the primary market. Basically the primary market
is the place where the shares are issued for the first time.

So, there’s only two ways you can buy a stock.

1. Through stock markets – those gigantic auction houses where
millions of shares are exchanged. ( Also called secondary
 market)
2. IPO’s or initial public offers ( Also called primary market)
WHAT’S THE DIFFERENCE?
Companies raise money for expansion through initial public offers. As
the name suggests, IPO’s are fresh issue of shares to the public. The
money you pay by subscribing shares goes to the company for its
expansion [Link] when a company is getting listed for the first time
at the stock exchange and issues shares – this process is undertaken
at the primary [Link] companies, who have already issued
shares, ,may require additional money for further expansion. If they
wish, they can tap if from the primary market . Such share issues will
be called ‘follow on issues’.
When you buy shares in the secondary market ( stock markets) , the
money which you pay goes to the seller of the shares and not to the
[Link] when we speak about investing or trading at the
stock market we mean trading at the secondary stock market. It is the
secondary market where we can invest and trade in the stocks to get
the profit from our stock market investment.
ISSUE OF SHARES: Face value vs Premium.
When a company launches an IPO to the public, it can offer those
shares at ‘face value’ or at a ‘Premium’.
Shares carry a fixed rate, as declared in the legal documents of the
company. It’s also called ‘par value’. For example, a company may
issue 10 lakhs shares of Rs 10 each at par.
Over and above the fixed rate, a company can issue shares at a
premium from its subscribers if the management is able to justify the
reason for such premium. For example, a company may issue 10 lakh
shares of Rs 10 each at a premium of Rs 50. So the total cost of one
share becomes Rs 60.
WHY NOT AT DISCOUNT?
Yes, theoretically speaking, shares can be issued at a discount also.
Practically, nobody does that. Shares are either issued at par or at a
premium.
IT’s NO EASY PROCESS
To successfully complete the share issue process, a company will
have to appoint a lot of intermediaries like –
Lead managers who would take care of all the paper work with
SEBI and other regulatory authorities, with the stock exchanges,
bankers, Underwriters, allotment of shares.. in short, everything
from A to Z
Bankers to the issue who would ensure the collection of funds
from the public.
Registrars to the issue who would scrutinize the applications,
reject the disqualified ones and allot the shares to eligible
allotees , transfer those shares to their demat accounts and
refund the amount to unsuccessful applicants.
Underwriters who would ‘undertake’ to buy the shares that are
not taken up by the public so that the IPO is complete.
PRICING OF SHARE ISSUES.
Shares issued through an IPO can be priced in two ways. First method
is straight forward – The company can decide the price at which it will
offer it’s shares.
The second method is – The Company, in consultation with the lead
managers, would fix a ‘price band’ for the issue. The price band is
nothing but a range. For example If the issue document says that the
shares are issued in a price band of Rs 50 to Rs 75. It means, that the
investors willing to subscribe the shares are free to bid for any price
between that range. The lower end of the band is called the ‘floor
price’ and the upper end of the band is called the ‘cap’.
The highest price at which there are maximum numbers of subscribers
is taken as the issue price. All bids at or above this price are valid bids
and considered for allotment.
INVESTORS WHO CAN INVEST IN AN IPO
The total issue of shares is divided into three parts for three categories
of investors. These categories are:
Retail investors – For You, me, residents, NRIs and Hindu
undivided families, whose share application size is less than Rs
1 lakh, 35% of the issue is kept aside.
Qualified institutional bidders: For mutual funds, banks,
insurance companies, foreign institutional investors etc 50% of
the issue is kept aside.
Non-institutional bidders – individuals, companies, NRI’s, HUFs,
societies, trusts whose share application size is more than 1
lakh, the balance 15% is given.

Stock Market timings.

INDIAN MARKETS
Trading on the Indian equities segment takes place on all weekdays.
There is No trading on Saturday, Sunday and Published Indian Stock
Market Holidays declared by the Indian Stock Exchange in advance.
The Market Opens at: 09:15 hours and Closes at: 15:30 hours
Pre open trade session will be from 09:00 ~ 09:15 hours
Pre-open trade session is a 15 minute trade session from 9:00AM to
9:15AM on the 50 stocks of NIFTY index .
Only 50 stocks of the NIFTY index can be traded during this time on
both NSE and BSE. Normal trading for all other stocks will start at
9:15AM till 3:30PM.
WHY PRE MARKET SESSION?
In case a major event or announcement comes overnight before
market opens, such events are likely to bring heavy volatility on the
next day when the market opens. Special events include merger and
acquisition announcements, open offers, delistings, debt-
restructurings, credit-rating downgrades etc which may have a deep
impact on investors wealth. In order to stabilize this, pre open call
auction is conducted to discover the right price and to reduce volatility.
BREAK-UP OF 15 MINUTES
The 15 minutes of pre open session is broken into 8 + 4 + 3.
The first 8 minutes: During this session investors can place/ modify
/cancel orders on the basis of which the exchanges would determine
the rates at which trading would happen. Orders are not accepted
after this initial 8 minutes.
Limit orders will get priority over market orders at the time of execution
of trades .All orders shall be disclosed in full quantity, i.e. orders where
revealed quantity function is enabled, will not be allowed during the
pre-open session
In the next four minutes, orders are matched, executable price is
discovered and trades are confirmed. The next 3 minutes is just a
buffer period for transmission from pre-market session to normal
market session.
PRICE DISCOVERY
The equilibrium price shall be the price at which the maximum volume
is executable. That is, the price at which there are maximum number
of buy orders and sell orders.
In case of more than one price meets the said criteria, the equilibrium
price shall be the price at which there is minimum order imbalance
quantity (unmatched qty).
Further, in case more than one price has same minimum order
imbalance quantity, the equilibrium price shall be the price closest to
previous day’s closing price. In case the previous day’s closing price is
the mid-value of a pair of prices which are closest to it, then the
previous day’s closing price itself shall be taken as the equilibrium
price. In case of corporate action, previous day’s closing price shall be
the adjustable closing price or the base price.
If the price is not discovered in pre-open session then the orders
entered in the pre-open session will be shifted to the order book
of the normal market following time priority. The price of the first
trade in the normal market shall be the opening price.
Price band of 20% shall be applicable on the securities during
pre-open session.
In case the index breaches the prescribed threshold limit upon
the closure of pre-open session, the procedure as prescribed in
SEBI Circular Ref. [Link]/Policy/Cir-37 /2001 dated June
28, 2001 shall be applicable from the time continuous normal
market opens.
what the circular says is about circuit limits. In case of 20%
movement in the index, trading will be halted for reminder of the
day.
There is also a 15 minute video on this topic by Dr. Sayee Srinivasan ,
Head Product Strategy, at BSE.
REGIONAL STOCK MARKETS
Apart from the BSE and NSE, there are 21 regional exchanges which
open at normal hours 9:15 to 15:30 hrs.
WORLD MARKET TIMINGS
Apart from this, global trends in stocks also affect the Indian market
when it opens. Here’s a list of opening time of stock markets around
the world.
WORLD STOCK MARKET TIME ACCORDING TO IST.
Shanghai stock exchange – Opens at 7.30 Am
Hong Kong stock exchange - Opens at 7.55 Am
Tokyo stock exchange - Opens at 5.50 Am
South Korea – Opens at 5.50 Am
NYSE, New York – Opens at 8.30 Pm
NASDAQ – Opens at 8.30 Pm
BOVESPA , Brazil – Opens at 7 Pm
Bogota, Columbia – Opens at 7 Pm
Dow Jones – Opens at 7.30 Pm
INTRODUCTION TO FINANCIAL
STATEMENTS
Understanding Annual reports.

What is an annual report?

An annual report is a summary of all that’s happened in the business
in a financial year – growth in revenues, new contracts, new
milestones, changes in management team, new appointments of key
personnel’s, future plans etc. It is prepared by the management and
distributed to the shareholders, promoters, government authorities,
general public and to anybody who’s interested in the affairs of the
company. Most annual reports are in the form of a book. It runs into
many pages starting from a chairman’s message to future plans and
prospects. An annual report is presented in the annual general
meeting.
What is a financial year? – A financial year is a period of twelve
months or less ending on 31 march in India. It could be any other
st

date-for example, for most of the European countries, financial year

ends on 31 December.
st

What does an annual report contain?

Typically an annual report would kick off with the letter to the
shareholders from the Chief Executive Officer. It will also contain a list
with contact numbers of all the key board members, auditors,
company secretary etc
Then, in the next pages, detailed financial reports like balance sheet,
income statement, supporting schedules, a general report on
company’s operations, an independent auditor’s report etc are given. It
will also contain details regarding the share holding pattern of the
company, along with historical share prices – highs and lows, a lot of
pictures and graphs, displaying in visual form all the milestones and
achievements the company has made.
You will have to read his report with a shrewd mind because,
generally, an annual report may amplify the positive aspects of the
business and give less attention to the negative aspects. The
chairman’s report may indirectly contain apologies for targets missed.
The best way to read the annual report is to read it in comparison with
the previous one. When you connect the present report with the
previous ones you’ll straight away get an idea about what targets have
been missed during the year. That way, you’ll also get the first
impression about the management’s performance.
It may take some expertise and patience to read and understand an
annual report thoroughly. As an investor, it will be very beneficial for
you to go through these reports since; it will give you more insights
into that company’s operations.

Contents of an annual report:

You should be able to find the following informations from an annual
report:
Letter from the CEO
Summary of the operations-milestones, achievements, prospects.
Past Annual summary of all financial figures.
Management discussion and analysis of the performance of the
company
The director’s report.
The balance sheet
The income statement
Auditor’s report
Subsidiaries, brands, addresses, registered office, head quarters etc..
Names of directors
Stock price history
Conclusion
Annual reports are a collection of important informations that may be
vital for the investor. Our next article would tell you on how best to read
them and what to look for.

How to read an Annual report.

An annual report, as mentioned in the last article, contains a wealth of

information on any event that has a material impact on the company.
We also said that you will have to read it carefully in order to dig out
those negative remarks since; it will be generally written in a positive
tone. The ‘positive tone’ in which it is presented is not meant to
deceive the shareholders or the general public in any way. But, that’s
the way it is presented – amplifying the positive facts and muting the
negative aspects. This piece of advice should be there in the back of
your mind while going through annual reports. The form, layout,
pictures, graphs and color of the annual report are of less importance.
What’s to be collected is the content – those figures, ratios, notes and
other bits and pieces of information that you’ll be able to gather. If you
know how to put everything together and fish out meaningful
information, you’re bang on target.
Must reads in an annual report.
You do not have to read the report cover to cover. That’s not practical
also. The first few pages are colorful and it presents a non technical
overview of the company’s objective and how well it is meeting them.
The front section will probably also tell you about the company’s
strategies, products and competitive positioning. The chairman’s
statement or message to shareholders will also be included here.
The back portion of the annual report is usually filled with financial
information about the company. The real meat of an annual report is in
the financial statements and ‘notes to accounts’ found in this portion.
The balance sheet, income statements along with auditor’s comments
and notes to accounts are must reads. Apart from these, the Director’s
address gives an overview of your company’s operational and
segment-wise performance, key initiatives undertaken during the year,
achievements and a financial snapshot.
The Director’s report will give an overview of the initiatives taken
during the year, other achievements, awards and a snapshot of
whatever milestones the company could achieve in the past one year.
Many items of expenditure or income may be disclosed in the financial
statements in abstract figures for which break up will be given in the
schedules. There will be a long list of schedules accompanying the
balance sheet and income statements.
The management will also discuss in detail about the industry, factors
affecting the company’s prospects, impact of policy changes by the
management or the government, strengths, opportunities, threats,
competitors and how well the company tackles all this.
Other bits and pieces.
A detailed study of the notes to financial statements, allow you to go
beyond the numbers to understand some of the assumptions and
accounting policies that underlie them. For this purpose, we must refer
to the notes to accounts, given as an appendix to the balance-sheet
and profit and loss account.
Remuneration given to directors and other managerial personnel,
dealing with sister concerns of the company etc may also find place in
the notes to accounts.
Notes can be divided into two parts. The first part describes the basis
of accounting and presentation. It briefs you on estimates used and
where foreign exchange earnings are involved, the basis of
conversion. Some of the key points of information contained in the
notes include the position of cash and cash equivalents, collateral
given to various lending institutions and investments in sister
concerns.
The second part provides information on the assets and liabilities
position. Here, related party transactions that show company’s
dealings with group companies and associates, are key sources of
information.
For manufacturing concerns, the production figures assume
significance. The production figures compared with installed capacity
could give you an idea of the efficiency at which the company is
operating .This information is particularly pertinent if the company is
planning further expansion
For newly listed companies, the utilization of the IPO proceeds are
disclosed in the annual report.
Since financial statements are prepared by “matching principle” an
analysis of the cash flow statement will show the actual flow of cash.
So, next time you get an annual report, look beyond numbers. The
financials are just one part of it. To get the bigger picture, consider
reading and analyzing the above mentioned points.

Introduction to financial statements

From the last two articles we know that financial statements are part of
a broad report call annual report. Now we proceed to understand what
financial statements are. Law requires corporate entities to keep
correct financial records of all the transactions. This is because; the
company does business with the money of the public (shareholders).In
order make sure that these funds are utilized properly, law makes it
mandatory for companies to keep systematic record of all financial
transactions. From these financial records, the annual profit or loss
from the business is ascertained by an independent qualified auditor.
This audited statement forms part of the annual report.
FIRST THINGS FIRST
The very first point you have to understand is that apart from annual
financial statements, these are also prepared on monthly , quarterly
and half yearly basis so that the management has absolute control
over what’s happening and they are up-to-date with the financial
position of the business. Quarterly statements will be published every
three months, half yearly statements after the end of six months of
operation and the final statement for the whole year will be published
after twelve months of business. Out of these, the full year official
audited statements (or annual financial statements) are the most
important ones since, as said above, it presents the grand summary of
business done in a year and it’s is also checked and certified by an
independent financial auditor.
This doesn’t mean that quarterly and half yearly statements have no
importance to the investor. They are important too. Since Quarterly /
half yearly statements provide a summary of what has happened in
the last 3/6 months, these figures are used by analysts to judge
whether the company’s performance is up to the mark as expected.
Analysts may also make projected or estimated figures using these
statements and predict about the probable performance of the
company.
Another important use of these quarterly statements is that it is
possible to compare the performance from quarter to quarter. Such
comparisons may reveal certain important aspects of the business- for
example, the seasonal nature of the business. A company’s ability to
hit the estimates expected by the investors every quarter also affects
the market price of its shares. For example – If the quarterly financial
result of a company exceeds investor’s expectations, you can witness
a jump in its share price. So all these statements has its own
importance.
A WORD OF CAUTION: as said above, analyzing quarterly or half
yearly statements are good. However, it doesn’t not mean that you can
rely on it totally. That’s because, it’s possible that a company that has
shown promising results in the first quarter may face difficulties going
forward. Uncertainty is a big factor in business. Predictions of all the
market experts and brokers can go wrong. Why should we say about
brokers? Those CEOs themselves can go wrong in certain cases.
now that you’ve got an idea about financial statements in general, our
next article will explain the components of financial statements in
detail.

The components of financial statements

THE COMPONENTS OF FINANCIAL STATEMENTS

In the last article we said that financial statemenst are prepared on
monthly / quarterly /half yearly and annual basis. Now, irrespective of
the time period, financial statements ( or ‘financials’ as it is called in
common parlance) basically consists of three parts:
Income statement or Profit and Loss account
Balance Sheet
 Cash flow statement
Most of the figures shown in the annual financial statements will be in
a summarized form since – for example the total of all the assets like
machinery, buildings, plant, tools, vehicles, computers etc will be
shown in the balance sheet as ‘fixed assets’. If you want to know about
the details of fixed assets, you may have to refer to the schedule of
fixed assets attached with the balance sheet. A big company may
have many more schedules like the one mentioned above.

Apart from schedules, accounting rules allow accountants to calculate

certain figures based on certain assumptions – for example the
company may have given a lot of goods on credit and based on past
experiences, the accountant may write off certain percentage of
debtors (amounts receivable from credit sales) as irrecoverable. Such
assumptions made while preparing financial statements will be
separately disclosed in a statement called ‘notes to accounts’.
Apart from this, the independent auditor may also have his opinion
about the correctness of the assumptions made and about the truth
and fairness of the figures disclosed in the financial statements. He
discloses his opinion and comments in a report called the audit report.
So apart from the 3 components that comprise financial statements,
the following three statements also form part of it as a sub category-
they are-
Schedules to accounts ( Part of balance sheet and income
statements)
Notes to accounts. ( Accountant’s disclosure about the
assumptions made)
Audit report (Independent auditor’s comments and opinion)
So there are three components and three sub-components for any
financial statement. Now we will explain in brief what those 3
statements are about.
INCOME STATEMENT
The income statement summarizes a company’s sales (Also called
revenues or turnover) and expenses. The final net figure is either profit
(if total of revenues exceed Expenses) or loss ( if expenses exceed
revenues).The ‘profit’ or ‘loss’ shown in this statement is essentially an
‘estimate’( we will tell you why, later ! ) For example – if a company
reports of having made a profit of Rs 300 Crore, it doesn’t mean that it
has Rs 300 Crore in it’s bank account.
BALANCE SHEET
A balance sheet summarizes a company’s assets, liabilities
and shareholders’ equity at a specific point in time. These three
balance sheet segments give investors an idea as to what the
company owns and owes, as well as the amount invested by the
shareholders.
CASH FLOW STATEMENT
‘Profit’ and ‘cash’ are not the same. A statement that shows ‘actual
cash’ coming in and how the same has been used is called the cash
flow statement. It deals with liquidity. Being profitable does not
necessarily mean being liquid. A company can fail because of a
shortage of cash, even while profitable. So to analyse the economic
realities, cash flow statements are prepared.
CONCLUSION
Financial statements provide financial statistics of past events; but
they are not forward looking. They don’t provide key non-
financial information like quality of revenues, types of customers and
risk factors. Certain qualitative elements are not considered in
the financial statements terms like the quality and reputation of the
management team and employees because they are incapable of
being measured in monetary terms. The figures provided
in financial statements can’t be attributed to future since future
earnings depend on many more factors like local and global market
conditions, inflation etc. Limitations apart, these are the numbers
which an investor depends. The assumption is that ,a company which
has given excellent numbers in the past is capable of delivering
improved results in the future also.

The Income statement : Basics

MANY NAMES OF INCOME STATEMENT

we know that the income statement shows revenues, expenses and
profit for a period of time, such as month, quarter or year. Accountants
call these statements by different names –
1 Profit and loss account or just ‘P & L’
2 Income statement
3 Trading and profit and loss account
4 Statement of income/revenues
5 Statement of operations
6 Operating results statement
7 Statement of operating results
8 Statement of earnings
9 Earnings statement
10 P & L statement
11 Statement of financial performance..etc

WHAT’S IN A NAME?

We cannot say that it’s the accountants call to put any name he likes.
These statements assume different names according to the nature of
business of the company. For example a company that has no trading
activity ( buying and selling of goods) or a company involved in service
oriented industry, will not have a trading and profit and loss account
simply because, there is no trading activity involved. So a company
like Infosys will have an income statement or a statement of revenues
or a profit and loss account and a company like Reliance will have a
trading and profit and loss account.
In any case, the income statement displays the profit made. However,
in the case of companies involved in trading, it makes two types of
profits called -
Gross profit and
Net profit.
Gross profit is the profit made from sales before deducting running
expenses. The only item deducted from sales is the purchase cost of
goods that was sold. The purpose of tracking gross profit is to know
the actual trading margin in the business. It’s important for companies
to see that the percentage of gross profit never falls.
Net profit is what the company makes after deducting all types of
expenses. So, if the net profit falls, that means that somewhere the
cost of operating the business has increased.
In the case of companies not involved in trading, the Gross profit
element will be missing in the income statement. Only the net profit
will be shown. In fact, there is no gross profit for them – since their
business do not involve buying something for a lesser price and selling
it at a margin.
So, income statement will be prepared according to the nature of
business and an appropriate name will be given that matches with the
nature of [Link] the case of a trading company, the income
statement will show the gross profit and net profit separately.
MANY FEATURES OF INCOME STATEMENT

That’s not all. The income statement has many more features. Here’s
a point wise collection will help you to understand the income
statement better.
The format can be vertical or horizontal: Generally, the income
statement is drawn in a vertical or horizontal format. In which
ever way it’s drawn, the first item in it would be ‘revenues’ or
‘sales’. This sales figure appearing on top of the statement is
also called ‘top line’ of the business. (Hope you’ve heard of
analysts taking about the increase/decrease in ‘topline’ of the
company). In vertical format, each and every expense is
deducted from the revenue figure and finally the net profit is
arrived at. This net profit is also called ‘bottom line’ in financial
lingo since it appears as the last item in the income statement. In
the horizontal format, the sales or revenues are shown on the
right side and categorized expenses are shown on the left side
and the difference between the two will be shown on
the right side ( loss) or left side ( profit).Charitable organizations /
clubs / non profit making voluntary organizations / association of
persons that exist for the welfare of the society etc- may not have
an income statement or revenue statement since they do not
exist for making revenues. However, these organizations do have
money flowing in the form of contributions. Hence, they prepare
a statement called ‘receipts and payment account’ and the
resultant surplus money will be termed as ‘excess of revenue
over expenditure’.Which ever way it’s presented, the basic idea of
a revenue statement is to arrive at the profit. The form is not
important.
The time period – you cannot draw a revenue statement unless
you decide about the time period for which it is drawn. For
example – you can find the revenues, deduct all the expenses
and arrive at the net profit for a year, for six months, for a quarter,
for a month or even for a week. The time period has to be
decided. Corporates prepare revenue statement for all quarters
and of course, the official annual report.
Projected and estimated statements: Accountants also
prepare ‘projected financial statements’ which shows the
expected revenues and expenses in the coming years if the
current trend continues. Accounting projections may be made for
5 or even 10 years forward depending on the use intended.
Estimated financial statements are sometimes prepared to know
the expected profits for the current year if the current trend
continues. Projections are basically estimates.
Stand alone and consolidated statements : Big companies (For
example – Tata group) which has many subsidiary companies
under it’s control may publish ‘consolidated financial
statements’ to show the consolidated figures from all it’s
businesses. Such business conglomerates will also have stand
alone statements for each of their firms.
Provisional and audited statements: In India, The companies Act
and the Income tax Act requires companies to get their financial
statements audited by professional accountants. A financial
statement that’s not audited is called ‘provisional financial
statements’ and the one that’s audited is called audited
statements. What’s important for an investor is to look at the
audited financial statements. Audited financial statements are
included in the annual report and that is the final –official- legal –
profit and loss statement of the company. The audited financial
 statements will be made available to the share holders of the
company. The audited statements of all the companies listed in
the stock exchange are available in the stock exchange’s website
or various financial sites and newspapers.
CONCLUSION
The income statement is one of the three statements that a stock
market investor should be familiar with. What’s important for an
investor is to have a look at the audited financial statements.
Projections, estimates or provisional statements are made for different
purposes and involves a lot of assumptions.
Even the actual financial statement we are talking about is not free
from assumptions and estimates. To understand how income
statements are made , we need to look at an important concept in
accounting- called the ‘matching concept’.

The Income statement : Understanding the

“matching principle”.

Matching principle is one of the fundamental accounting principles

followed by accountants worldwide. To understand matching principle,
we will look at two business transactions first -
Transaction 1-

You run a whole sale super market. There is a 20% profit in every sale
you make. There are many retailers who buy in bulk, mostly on credit.
One such customer buys goods worth 5 lakhs on credit, on March 31
(last day of the financial year). Definitely, you have made a sale.
Goods have gone from your go down and the stock reports will show
goods worth 5 lakhs dispatched. Fine. But, on the other hand, the
customer has not paid anything and hence the 5 lakhs sale will not
bring in a penny to your bank account. There is also a probability that
the customer can delay or default in his payments. In such a scenario,
can we consider this as a sale in this financial year? If this is recorded
as a sale, your revenue statement will show an additional 1 lakh as
profit for which you are supposed to pay income tax. Whereas in
reality, you have not got a penny.

Transaction 2 –

On the very same day (March 31 ) salary for the month is to be paid.
st

There is a total of Rs 50,000 to be paid. It is an expense to be

deducted from the profits of that accounting year. But, since salary is
always paid on the 5 of every month,the amount remains in your
th

bank. Nothing has been paid. Should we add this as an expense of

this year? If this is recorded as an expense, your expense will increase
but at the same time you have not paid a penny from your bank
account.
What’s the right decision?

In the first case, it is a sale and the transaction should be recorded.

That’s because, if we look closely, we will understand that the profit
has been already made although there is a delay in realizing the
money. This sale was made due to the effort of your employees in the
month of March. Hence, the second transaction should also be
recorded in this financial year. The salary of 50,000 payable in March
is an expense (payment delayed because due date is on 5th) against
the profit of Rs 1 lakh made ( receipt delayed due to the credit policy of
the company) . You actual profit is Rs 50,000, for which you have to
pay tax.

If we do not record both these transactions this year, there are two
side effects- for the year ending march 31 , your records will show no
sale or profit but at the same time, your stock records will show an
outflow of goods worth 5 lakhs. Next month, even if you do not make a
single sale and close down your business, your accounts will still show
a receipt of Rs 5 lakhs and an expense of Rs 50,000. If this carries on,
your accounts will finally become a jungle of complications.

So, Accountants don’t mind if the customer has actually paid the cash
or not. They don’t mind if an expense like salary is actually paid in
cash or not. If it pertains to a particular period, they record it in that
period itself. In the balance sheet ( where all receivables (assets)and
payables (liabilities) of the company are recorded for the year) the
accountant will show Rs 5 lakhs as an asset (cash) receivable and the
unpaid salary as a liability to be payable.
Now the picture becomes clear for anyone who goes through the
revenue statement and balance sheet. The company has made a sale
of 5 lakhs ( will be shown as revenue from sales in the income
statement) against which 20% is the profit. So the balance 80% is the
purchase cost which will be first deducted from Rs 5 lakhs to arrive at
Rs 1 lakh as gross profit. But as they can see in the balance sheet, the
entire 5 lakhs is pending to be received. An expense of 50,000 will be
shown against this profit. At the same time, the balance sheet will
show the expense as a liability payable. Subject to this, the company
has made a profit of 50,000 for the year.
Why do accountants do like that?
The reason lies in a concept called ‘matching principle’. Matching
principle says – that appropriate costs should be matched to the sales
for the period represented in the income statement. Knowledge of this
concept is necessary to understand how accountants arrive at the
profit of a business.
Let’s take another example. My business performs consulting service
for a client and has billed Rs 50,000 in December 2010 and he pays
my bill 3months later on April 2011. I do not have Rs 50,000 as my
income because when I perform the service, I also incur some
expenses in the form of salary, printing, electricity etc… Let’s assume
that my expenses are Rs 15,000 in total. My profit for the year 2010 is
Rs 35,000 and I have to pay tax for that amount- irrespective of the
fact that my client has paid me Rs 50,000 in April 2011!!

This might seem to be strange for Newbies. Think and you’ll

understand. If I don’t ‘match’ my expenses of 2010 to ‘revenues’ of
2010, my financial statements would never show the right picture in
any year. It will show a loss of Rs 15,000 in 2010 and a profit of Rs
50,000 in 2011. Although I know the reason, nobody looking at my
financial statement would be able to understand why I incurred a loss
in one year and a huge profit in the next year.
The above is case a very simplified example. Imagine what would be
the result when you have huge volume of bills and number branches
all over India? Even I may not understand what has caused too much
volatility.
The above discussion brings us to some realities-
The ‘sales’ or ‘revenues’ or ‘operating income’ you see in the
income statement is the value of goods sold or services
rendered in a particular year. For example – sale revenue of Rs
300 Crores means that the company has actually ‘sold’ or
‘rendered services’ worth Rs 300 Crores. It doesn’t mean that
the company has received 300 Crores in their bank account.
 Some of the customers may have paid a portion of it.
The profit shown in the financial statements is based on the
above sales figure of Rs. 300 Crores after deducting the
expenses incurred. Let’s assume that the expenses (salary etc.)
incurred by the company to generate Rs 300 Crores is Rs 140
Crores. The company has made a profit of Rs 160 Crores ‘in
papers’. But in reality, since their clients have paid the whole
amount, the profit that’s displayed at the end of the revenue
statement is basically an estimate. ( we said that earlier in our
post components of financial statements that profit is an
estimate). The customers have not paid yet, so the profit shown
in the statements does not reflect real money. So, a company
can be very profitable and still run out of cash!!
Later, the profit shown in papers will turn into real cash when the
customers start paying.
Let’s see one more application of the matching principle – If the
company buys a truck in 2010 that it plans to use for 5 years, the
full cost of the truck will not be shown as expense in 2010 itself.
That’s because, the company is availing the benefit of the truck
for the next 5 years and hence, the cost of the truck has to be
spread over the next 5 years and should be deducted from the
sale proceeds of these 5 years equally.
The profit and loss account, in fact, tries to measure whether the
products or services that a company provides are profitable
when each and every expense (whether paid or not) is
considered. It has nothing to do with the company’s actual cash
inflow and outflow.

CONCLUSION
That’s matching principle for you. Now we proceed to discuss about
the components of income statement. There are basically only 5
components in an income statement. These are 1. sales 2. Direct
expenses 3. Gross profit 4. Indirect expenses 5. Net profit. If there are
only 5 components, then why does an income statement look very
complicated with lots of figures in it? We’ll try to understand all that in
our next lesson.

The Income statement: Understanding the

components.

THE 5 COMPONENTS
Towards the end of the last post we wrote that the income statement
has only 5 components, they are–
Sales ( or revenue or income )
Direct cost
Gross profit (or it could be gross loss)
Indirect cost
Net profit (or it could be net loss)
So the question that remained to be answered was – Why does the
income statement looks complicated if there are only 5 components?
We will try to find the answer in this post. Before we explain that, we
need to remember that –
Sales – direct costs = gross profit
Gross profit – indirect costs = net profit.
So, amoung the five elements, gross profit and net profit are single
figures and will be displayed as such in the revenue statement. That
leaves us with three figures – sales, direct cost and indirect [Link]
Sales figure should be less complicated when compared to direct and
indirect costs. These statements look complicated due to the complex
nature of businesses done by big business houses.
For example a company like reliance has income from various sources
like oil production business, oil refining and marketing business,
petrochemicals [Link] different segments may be separately
shown in their revenue statement and hence, the first item in their
revenue statement –‘sales’ would show four different figures and also
the grand total of the four segments. When these figures are shown
separately, it looks complicated. Such separate disclosure is essential
for the reader to understand the proportion of income from different
products. Separate disclosure can also be made based on
geographical locations or any other viable separator. There will not be
separate disclosure for credit sales and cash sales. (Recall the
matching principle)

COSTS AND EXPENSES

There are two types of expenses.
(1) Directly related to the sale and
(2) Indirect expenses.
All expenses direct or indirect will be deducted from the revenues. By
‘directly related’ we mean that such costs are normally directly
proportional to the volume of sales. Direct costs are also known as
“costs of sales” or “cost of goods sold”. This figure will be shown
separately in the income statement as a deduction from the ‘Total
revenues’ or ‘total sales’ figure.
The resultant figure after deduction is termed as ‘gross profit’. From
the gross profit that the company has made, it needs to meet all its
operational expenses like advertisement, salary to staff, rent
[Link] expenses , which are not directly proportional to the sales
are called indirect expenses. They are also known as ‘overheads’ or
operating expenses.
Both direct costs and indirect cost also follow the matching principle
and hence, those figures may not represent money actually paid.
CASH AND NON-CASH EXPENSES

At this point it is important for you to understand two more terms which
are required to understand the profit and loss statement completely.
They are: (1) cash expense and (2) non cash expense. Cash expense
are expenses which are payable in cash. Non cash expenses are
expenses for which there is no outflow of cash, but it will still be
recorded as an expense. That’s because as far as an accountant is
concerned the term expense has wider meaning and includes outflow
of cash or outflow of other valuable assets or decreases in economic
benefits or depletions of assets
Regardless of whether an expense is cash or non-cash in nature, it
will be shown as deduction from the gross profit in an income
statement. So if asset like machinery is used in business, the
proportionate cost of machinery will be deducted as expense.
Technically it’s called depreciation. It’s an expense. Precisely, it’s a
non cash expense since there is no cash outflow.
Expenses – is it good or bad?
If a revenue statement shows too much expenses which affects the
profitability of the company, that’s a bad sign. It’s important for the
management to find out areas where they can save costs and
expenses so that it improves the company’s profitability. Any such
steps (for example spotting unnecessary down time in a
manufacturing process) taken by a company is a positive sign.
We now know that expenses can be classified – as direct and indirect
or as cash and non cash expense. Expenses can also be classified in
many other ways –for example it can be classified on the basis of
controllability –as controllable and un controllable expense or based
on variability- as fixed and variable expenses.
In a revenue statement, instead of showing all the expenses as one
figure, accountants would show it in maximum detail as possible so
that the users, especially investors, can get further insights into the
way in which the company is operating.
Now we hope you have understood why an income statement looks
complicated at the beginning. It’s because, additional details are
provided for clarity and transparency. At the end, any income
statement can be trimmed down to just those five elements.

The Income statement: Profits

So far we know that sales less all type of expenses results in profit.
We know a little bit more – we know that sales less direct expenses
results in Gross profit and Gross profit less indirect expenses
( including taxes ) results in net profit. In this lesson we will introduce
two more variations of net profit – the PBIT , PBT and PAT. ( Profit
before interest and tax , Profit before tax and profit after tax)
Gross profit
Companies need to generate a healthy gross profit to cover up indirect
expenses, taxes, financing cost (all indirect costs) and net profit. But
how much is ‘healthy’? That varies from industry to industry and from
company to company. To analyse a company’s gross profit , you need
to do two things :
1. Compare the Gross profit ratio with competitors in the industry and
2. Compare the Gross profit ratio with the past 5 year’s ratio.
Comparison with the peers will give you an idea about how
competitive the company is and by comparing the last 5 years’ ratio
will tell you whether the company is headed up or down.
Operating profit or EBIT

Gross profit minus operating expenses results in operating profit. This

operating profit is also know by another name – EBIT. I.e., earnings
before interest and tax (Pronounced as EE-bit). Some companies may
write the same as PBIT (Profit before Interest and taxes). What has
not been deducted is interest and taxes. Why? Because operating
profit is the profit a business earns from the business it is in- from
operations. Interest expense depend on whether the company has
taken a bank loan or not and taxes don’t’ really have anything to do
with how well you are running the company. The EBIT will be
displayed in the income statement of any company.
EBT-or Earnings before taxes.
…Or profit before taxes (PBT). The term implies operating profit after
deducting interest expense.
PAT/EAT.
Now let’s get to the bottom line: Net profit. (Also called Profit after tax
(PAT) / or Earnings after tax (EAT)]. PAT is what is left over after
everything is subtracted- direct expenses, indirect expenses, interest
and taxes. When the analyst says “the company’s bottom line has
shown considerable growth” what he means to say is that the
company’s PAT has gone up. Some of the key ratios used to
fundamentally analyse a company such as Earning Per share and
Price earnings ratio are based on this PAT.
To analyse a company’s PAT, you need to the same routine as you did
in Gross profit analysis:
1 Compare the PBT ratio with competitors in the industry and
2 Compare the PBT ratio with the past 5 year’s ratio.
Comparison with the peers will give you an idea about how
competitive the company is and by comparing the last 5 years’ ratio
will tell you whether the company is headed up or down.
EBDITA-
Before we close this section we need to look at one more important
version of profit called EBDITA or Earnings before depreciation,
interest, taxes and amortisation.( Amortization is something we
haven’t explained. For the time being understand that it’s non cash
expenditure.) Some people think that EBDITA is a better measure of a
company’s operating efficiency because it ignores non cash charges
such as depreciation.
How to calculate these ratios have been given in the “Fundamental
analysis” section. For you as an investor , it’s enough that you take out
the EBDITA, PAT and PBIT figures. A comparison of these figures with
the peers a for the past 5 years would give you a first hand impression
about the company.

The income statement : Difference between

earnings and revenues

let’s catch up with the terms ‘Earnings’ and ‘Revenues’- two totally
different terms which may baffle a naive financial analyser.
EARNINGS
Earnings means – Profits. It’s that simple.
Now, in business, there are different names for it. The most popular
being “bottom Line” and “net income”. It’s similar to the term “net pay”
or “net income” or “net earnings” or “net salary” or “take home pay” on
your pay slips. Just like your take home pay, earnings are the “take
home pay” of a business. It represents how much money the company
has left over, if any, after it’s paid the costs of doing business —
payroll, raw materials, taxes, interest on loans, etc. Earnings are
arguably the ultimate measure of growth of a business. Analysts want
to find companies that are growing their earnings because this is what
they keep after they’ve paid their bills. That’s why “earnings results”
reports each quarter are eagerly awaited by stock investors.
REVENUES
Revenues means – The total amount of money a company receives
from sale of goods and services (i.e. receipts BEFORE deducting all
expenses). It’s also called “top-line” or “Total sales” or “gross income”.
It’s similar to the term “gross pay” or “gross earnings” on your salary
slip. If you take an income statement, revenues or sales will be
displayed on the left hand side of the statement ( Horizontal format) or
on top of the statement ( vertical format). When you deduct all the
expenses from revenues the resultant figure is called earnings.
Arguably, top-line growth is more important, but also a more
misleading figure than bottom-line growth. It’s more important in the
sense that any earnings growth is going to have to come from
revenues. But it’s misleading because on its own it doesn’t tell you
what the company is actually making in profits. (Since the numbers
don’t reflect what the business has to pay out in expenses).
FORMS OF EARNINGS
We discussed earlier about earnings. It’s a company’s “profit.” The real
issue is what goes into that income number. There are many flavors:
EBT is earnings before taxes, EBIT is earnings before interest and
taxes, EBDIT is earnings before depreciation ,interest and taxes, EAT
is earnings after taxes and EBDITA means earnings before interest,
taxes, depreciation and amortization. In other words, incomes before
those costs have been subtracted.
MEASUREMENT OF EARNINGS -EPS
EPS is earnings per share, or the part of the company’s profit that is
attributed to each individual share of stock. EPS is a good indicator of
a company’s profitability, and is a very important ratio to look at while
evaluating a certain stock.
HOW IS IT CALCULATED?
The formula for EPS is below.
(Net income – Dividends on Preferred Stock) / (Average Outstanding
Shares)
In Beginner’s lessons- Fundamental analysis we have given the
formula (Net income – Dividends on Preferred Stock) / Outstanding
Shares).You may wonder why “average outstanding shares” is used
as denominator instead of outstanding shares . The reason is that
EPS is reported over a certain period of time, and the number of
outstanding shares will likely fluctuate in that period, so you can get a
more accurate result by using the average number of outstanding
shares.
WHY IS IT IMPORTANT?
EPS is considered by most investors to be the single most important
ratio to use when evaluating a stock. However, some aspects of EPS
can be misleading when comparing two different companies. For
example, one company could use twice as much capital to generate
the same amount of profit as another, but it is obviously not utilizing its
capital as efficiently as the other company. However, these numbers
are not reflected in the EPS, so it is important to remember that EPS
alone doesn’t tell the whole story.
POINTS TO NOTE
When you analyse a company for it’s EPS, keep these points in mind:
You should always compare earnings growth relative to previous
 years / quarters. A steady increase in earnings per share is a
good indicator of genuine growth and reduces the possibility that
the company just had one great quarter which might not be
sustained in the future.
Current quarterly earnings per share – Earnings must be up at
least 10-20%.
Annual earnings per share – These figures should show
meaningful growth for the last five years.
With that we complete our discussion on the difference between
earnings and revenues. I said that quarterly earnings results
influence stock prices. But Why? Why do results for a single
quarter cause so much mayhem?

The Income statement :Understanding

Depreciation

Depreciation
One of the things that analysts and investors frequently look for while
analyzing a company is the amount of depreciation written as expense
in the profit and loss account. It is a term frequently used in finance
that describes the loss of value over time. Depreciation is an expense;
hence less of this expense would mean higher profits! Similarly, a
steep rise in the depreciation would result in the company’s earnings
falling below the expected levels, however profitable their operations
are.
Depreciation is calculated as Cost – (minus) estimated residual value /
Life of the asset. A change in any one of these measures — cost,
residual value or life — will result in a change in the amount charged
as depreciation.
There are also two methods of calculating depreciation – straight line
method and written down value method. – a change in the
depreciation policy can also bring in huge difference in the profits
either positively or negatively.
As an investor you need not dig deep into this topic. What you need to
understand is the following points:
Depreciation is an expense
It is a non cash expense. That is, there is no outflow of cash from
the company.
The choices that a company makes in deciding how to amortize
and depreciate — and by what amounts — will affect its overall
appearance of financial health. The amounts will play probably a
large part in determining the figures on the company’s balance
sheet. They will also affect the profit figures on the income
statement. These two documents are enormously important in
determining everything from shareholder/investor returns to
credit worthiness.
An increase in depreciation also means that the company has
acquired new assets. High growth oriented companies, which are
on an expansion spree may acquire lot of assets in the form of
machinery and other fixed assets. So, to that extent it’s also a
positive sign.
A fall in profits due to increased depreciation expense cannot be
taken as a negative sign if the increase depreciation figure is due
to acquisition of fixed assets
However, if the depreciation figures show material change due to
factors like charging different depreciation rates or due to
changes in the method of calculating depreciation etc… You may
better be careful.
 Since depreciation is an expense that depends on lot of factors,
investors consider the Profit Before Deprecation and Taxes for
valuation purposes.
Amortization and depletion are other expenses similar to
depreciation that’s non cash in nature.
Amortization is a process that is exactly same as depreciation,
for an intangible asset. We said in our earlier chapters that the
business may have tangible assets like machinery or intangible
assets like patents and goodwill. When tangible assets are
written off at a specific rate, its called depreciation and when
intangible assets are written off, it’s called amortization.
Depletion refers to the allocation of the cost of natural resources
over time. For example, an oil well has a finite life before all of
the oil is pumped out. Therefore, the oil well’s setup
costs are spread out over the predicted life of the oil well.
Being non cash expense, these three items decreases the
earnings figures of the company but helps in increasing the cash
flow of the company.
It can also have significant effects on tax burden. The less a
company claims as depreciation/amortization, the more
profitable the company seems and therefore the more it will be
taxed. Choosing higher depreciation amounts can provide short-
term tax relief.
Where to look
The best place to find information on all this is the schedules to the
balance sheet and notes to accounts in the company’s annual report
or quarterly results. The schedule on ‘Significant Accounting Policies’
will give the method and rates of depreciation, along with other
accounting treatment specifically followed by the company. The notes
to accounts explain the accounting treatment to give us an idea of how
the depreciation of that particular year has been arrived at.

The income statement : Revenues – an important

figure.

Sales or revenue is the value of all the products or services a

company sold to it’s customers during a given period of time. Profits of
the company are based largely on the volume of this figure.
Why this figure is important.
More revenues means more profits. An increase in profits year on will
have a positive impact in the stock price. So companies are always
eager to show increased revenues in the profit and loss account. And,
the ‘sales’ figure is one of the easiest figure to manipulate.
How do companies manipulate sales?
Method 1. Sales to related parties – The Company may sell its
products to another company which may be owned by a director
or any one who has substantial influence in the company.
Method 2. Record fraudulent sales using fake bills. For example
– It was discovered that Mr. Raju of satyam computers created
as many as 7,561 fake invoices during the period from April 2003
to December 2008.
Method 3. Very Flexible terms for payment for the buyer – by
providing such a facility the company may boost up the revenues
temporarily, but in the long run such arrangements pose an
increased risk of the payment never being realized!
Method 4. Including one time revenues like income from sale of
fixed assets like unwanted machinery or scraped assets or even
loan amount received in the sales figure and thus boosting the
 figure and profits.
Method 5. Companies can adjust reported net earnings simply
by changing accounting policies. These tend to be quite complex
and difficult to understand, but the details are going to be found
in the footnotes. For example, a company may change the way it
values inventory, which in turn could have a big effect on
calculation of the cost of goods sold and gross profit.
Method 6. Converting reserve profits to income. This may also
be difficult to understand for a newbie. Reserves are profits
earned in the past years, kept aside for future expansion
activities. Companies carrying large balance in reserves can
manipulate current year outcome by simply reclassifying all or
part of the reserve balance to income.
Well, i am not here to list out fraudulent practices…. that list goes on
and on from least complex ones to complicated accounting tricks. The
question is how to analyse a company’s quality of revenues.
HERE’S YOUR SIX POINT CHECKLIST.
How can a company continue to earn profits year after year? By
selling more and more every year. So, the first question to be
answered is – Does the company have a history of increasing
revenues every year?
Now the second question to be answered is – Are the Revenues
increasing at par or above the other competitors in the industry?
Does the company have a unique product-line that will sell fast?
You have to invest in companies whose products and business
model you understand.
Does the company have a unique branded product to sell?
Branded products are easy to sell and if consumers love the
brand, they do not mind paying a premium for its products &
services. For example – Maruti. Moreover, a company with a
brand value can easily diversity into other sectors and instantly
become successful – For example Titan. They have diversified
successfully into the eye wear and diamond jewelry sectors.
Take the current assets section in the balance sheet. The
amount of unrealized sale from customers will be given under the
head “accounts receivables” or “sundry debtors”. Check if the
receivables are showing a sudden jump. Co-relate with the
revenue figure and see that the revenues and receivables are
growing at the same pace. For example – if you see the
revenues growing moderately but receivables showing a sudden
jump, that’s a red flag! You need to be careful. You have to look
for company’s disclosures regarding related party transactions,
sale to sister concerns , change in the assessment of customer’s
ability to pay , extended payment terms offered to any particular
client etc..
Calculate the price /sales ratio. Calculating the price/sales ratio
is a simple matter of performing the maths. Let’s assume that the
company we are using as an example had revenue of 300 million
rupees over the last four quarters. If we take the current market
capitalization of 150 million rupees and divide it by the revenue
of 300 million rupees, we arrive at a P/S ratio of 0.5. As with the
P/E ratio, the lower this ratio is, the better the odds that this will
prove to be a good investment.
Balance sheet : what is it?

Balance sheet is a statement that shows what a business owns

and owes AT a particular point of time. (Remember, the income
statement shows revenues and related expenses FOR a period
 of time , usually a year).
ALL COMPANIES are statutorily required to come out with a final
statement of accounts every year. The final statement of
accounts consist of the balance-sheet, the profit and loss (P&L)
account, supporting schedules, the auditor’s report, a statement
of accounting policies and additional notes on account. The
balance-sheet and P&L account are designed to give a bird’s eye
view of the state of affairs of a company.
Schedule VI of the Companies Act details the format and typical
contents of the balance-sheet and P&L account. Companies are
given the option to have their statements in either the `horizontal’
or `vertical’ format. Most companies follow the latter.
Companies are also given the freedom to have the figures
published in thousands, lakhs or Crores of rupees depending
upon the scale and magnitude of operations.
A typical vertical balance-sheet’s design is like this- The
company gets it’s sources of funds – from shares issues, loans
borrowed etc.. and applies the funds to run the business in fixed
assets, investments, stock etc..
Logically, at any point of time, the total of sources of funds would
be equal to the total of application of funds.
But law in India (Companies ACT) requires companies to
disclose more facts about the deployment of funds and not just a
summary. So, a typical balance sheet is accompanied by
schedules, notes, bifurcations, tables, disclosures.. and hence,
the whole things looks complicated at the beginning for a
newbie.
Balance sheet is also called ‘statement of financial position’
Conclusion
The balance sheet of a company reflects it’s financial position at a
particular point of time. It shows what the company owns and owes
after doing business for a year. So, analysis of balance sheet of a
company becomes vital for an investor. To do that, you need to know
what are the components of the balance sheet . More about that in our
next lesson.

Balance sheet components: Assets

The hardest thing about the balance sheet is deciphering the

vocabulary on it. Once you learn what a few things mean, the sheet is
much easier to read. Before you can understand the individual
accounts in each section, it is important to understand the three main
sections on the balance sheet.
Section 1 – Assets – (these may be again classified in the
balance sheet as fixed assets and current assets). But for the
time being, let’s see what assets are- Assets are what the
company owns. Example – land, buildings, factories, machinery,
vehicles, computers, furniture, cash, bank balance in company’s
account etc.. , it also includes receivable amounts from
customers, tax authorities, government and other entities.
A company can also have fixed deposits in banks. That’s not all ,
it can have deposits for various purposes like rent deposit,
advance given to suppliers etc , it can invest in shares, mutual
funds and bonds.. these amounts also form part of the
company’s assets.
A company may also hold finished goods which are meant for
sale. In some cases , work may be in progress. For example
–,Late’s take a car factory. As on the balance sheet date, the
 company will have finished cars ready for sale as well as partly
finished cars. These are collectively called ‘inventories’. The
value of ‘finished goods’ (Fully made cars) and ‘work-in –
progress’ (partly made cars) forms part of the assets of the
company.
Prepaid assets are another category of asset that may be seen
in a balance sheet. In the course of every day operations,
businesses will have to pay for goods or services before they
actually receive the product. For example rent may have to be
paid in advance for a year. Sometimes companies may decide to
prepay taxes, salaries, utility bills, or the interest on their debt.
These would all be pooled together and put on the balance sheet
under the heading ‘pre paid expenses’ or ‘pre paid assets’.By
their very nature, Prepaid Expenses are a small part of the
balance sheet. They are relatively unimportant in your analysis
and shouldn’t be given too much attention.
There’s one more class of assets – intangible asset – ie, assets
which appear in the balance sheet in the form of a ‘value’ but
which cannot be seen , touched or felt. These include copy
rights, trademarks , intellectual property, patents goodwill etc..
So that’s it for the first component in the balance sheet – Assets. Add
them all up and you get the total assets owned by the company.
Simple.
ASSET VALUE : MORE OF ESTIMATES AND ASSUMPTIONS
One important point to take note here is that, the value of most of the
asset components discussed above as shown in the balance sheet is
derived based on certain estimates and assumptions. For example –
Property, plant and machinery, computers , furniture and fittings and
all those equipments that the company use to operate business are
accounted in the balance sheet at the purchase price in year one and
in the subsequent years , a fixed rate of depreciation is charged on it
and the balance is shown as the value. But in reality, nobody knows
how much the company’s real estate or equipment might be worth in
the open market. The fact that companies must rely on purchase price
to value their assets can create some anomalies. Let’s discuss some
examples here:
you started a company 25 years back and bought land For 25
lakhs. The land could be worth 5 or 6 crores today – but it will
still be shown at 25 lakhs in the balance sheet. Since land does
not wear out, depreciation is not charged on land each year.
In the case of machinery and other fixed assets, depreciation is
charged at a fixed rate by the accountants. So , when you buy
machinery worth 25 lakhs, it’s shown in the balance sheet after
charging a depreciation of say, 10% or 15%. Two years down,
this machinery may not have a reliazable value at all due to
various reasons – for example technological obsolescence but,
may still appear in the balance sheet at cost (25 lakhs) less
depreciation charged (say at 15% for two years) at 18.06 lakhs.
A company may have intangible assets ( goodwill, intellectual
property, customer base , strategic strength, brand image etc..).
These are assets which exists but you cannot touch or spend.
Most of these assets are ‘created’ over time and are not found on
the balance sheet of the company unless an acquiring company
pays for them and records them as goodwill.
Your company launched a major advertising [Link] the
work is done in January and the cost comes to around 25 lakhs.
The accountants may now decide that the benefit from this ad
campaign will benefit the company for 2 years . So they will
record an expense of 12.50 lakhs in the first year and show the
balance 12.50 lakhs as ‘prepaid asset’. The value of 12.50 lakhs
 prepaid asset is actually an estimate since the company may
receive the benefit of ad campaign for several years or the ad
may not click at all !
Balance sheet components: Liabilities and
Equity.

We said earlier that the balance sheet shows what the company owns
and owes. What the company owns are called assets and we have
seen the various types of assets that a company holds. Now what the
company ‘owes’ is categorized into two – (1) Liabilities and (2) equity.
So in another way, the total of what the company ‘owes’ shows how
the company found money to buy the assets !!. Let’s dig into the topic:
Section 2- Equity and Liabilities. What the company owes is
classified into Equity and Liabilities. Fine. But what’s the
difference between the two? The difference is – Equity is that
part of funds that the company raised by issuing shares. It also
includes that amount the profits that has been made in all the
past years and kept accumulated without paying it to the share
holders.
So, you and I, who gives money to the company by subscribing
to it’s IPO forms the ‘Equity’. To that extend, we are the owner’s
of the company. The equity ownership that we get can be sold in
the secondary market if there are takers for it. That organized
place where we sell equity ownership is called the stock market.
Liabilities are outside borrowings, usually listed on the balance
sheet from the shortest term to the longest term, so the very
layout tells you something about what’s due to be paid and when.
Anything a company owes to people or businesses other than its
 owners is considered a liability. There are two types of liabilities –
Current liabilities and long term liabilities. In general, if a liability
must be paid within a year, it is considered current. This includes
bills, money you owe to your vendors and suppliers, employee
payroll and short-term loans. A long-term liability is any debt that
extends beyond one year, such as a mortgage loan or a term
loan availed by the company to purchase machinery.
Apart from long term and short term liabilities there’s one more
category called ‘contingent liability’. Contingent liabilities are
estimated payments that the company may have to make if a
future event takes place. For instance, suppose the excise
authorities have imposed a heavy levy on the company, which
has been disputed by the company on some justifiable grounds,
but the authorities have gone on appeal against the company, it
is a contingent liability. In the normal course, the company does
not expect the liability to crystallize, but if the court verdict
ultimately goes against the company, it will have to meet the
liability. This is a contingent liability.
Contingent liabilities are not ‘actual liabilities’ and hence will not
be displayed in the balance sheet figures. It will be shown as a
‘note’ below the balance [Link]’s why ‘notes to balance
sheet’ assume lot of importance to an analyst.
So, logically, Equity (+) liabilities should be equal to Total assets. This
will be true at any point of time. How and why it will always happen is
something an accounting student should be learning , not you. Since
your aim is to study and analyse the balance sheet to make
investment decisions, a through knowledge of the frame work given in
this session should be sufficient.
Cash flow statement. – An introduction.

CASH FLOW STATEMENTS.

The Cash flow statement is the final component of a company’s
annual report. It throws light on the cash generating ability of a
company. The statement records the actual movements in cash in an
accounting period. All cash received (inflows) by the company, and
spent (outflows) by the company will be shown in this statement.
Cash flow statements may be a little bit difficult to understand than
balance sheets and income statements.
WHAT DOES IT SHOW?
If you recall our article on matching principle, you’d have understood
that the expenses and revenues shown in the income statement are
subject to lot of adjustment. Accountants do not consider the actual
payment or receipt of cash and instead, follows the matching concept.
hence, it would be impossible for anyone who analyses the company’s
financial statement to know the exact inflow and outflow of cash. for
this, we need the help of a cash flow statement.
CFS ( Cash flow statements ) shows the liquidity and solvency
position of a company. It throws light on the ability of the company to
generate cash from its core operations, and where from it sources
funds for expansion. The CFS discloses the actual movement of cash.
Hence, it is also a useful tool to gauge a company’s ability to
effectively manage cash. For example, while profit figures may not
help a bank to analyse the loan repaying capacity of the company, an
analysis of the cash flows will provide information on the funds
available for the same.
CLASSIFICATION OF CASH FLOWS.
Cash flows are classified under three heads — operating, financing
and investing activities. The first two sections show the two ways the
company can get cash. Operations means “making” money by selling
goods and services; Financing means “raising” money by issuing
stocks and bonds. The third section shows how the company is
spending cash, Investing in its future growth. If you’re interested in the
stock of this company, you’d like to see that they can pay for the
“investing” figure out of the “operations” figure, without having to turn
to “financing”. (Financing causes problems: issuing new stocks will
lower the value of each individual share; issuing bonds commits them
to making interest payments which will punish future earnings)
Actual cash flows differ from profits. A company may be low on cash
but reported good earnings and vice-versa. The CFS explains the
reason for this divergence. Consider this case. A company that has
sold its goods on credit (shown as sundry debtors in balance sheet )
may take time or have trouble realizing the cash. This may elongate
the company’s working capital cycle and force it to resort to other
funding options to keep the production cycle moving. Similarly, a
company may have produced goods but piled them up as inventory
without quickly converting them into revenues.
Here the cost of holding such inventory instead of converting it into
cash would affect operations. Both these may also be indicators of a
slowing demand (in case of inventory build up) or higher risk of
debtors becoming bad. Thus, a study of operating cash flows may be
a key indicator of a company’s health or provide cues for any
impending trouble in its business or financial position.
In our next two lessons, we try to understand cash flow statements
from the investor’s point of view and will also give tips to analyse cash.
We will also look at how to analyse cash flow without actually looking
at a cash flow statement which is a bit complicated to read.
Understanding Cash flow statements

“Profit is an estimate. Cash is a fact.”

Cash flow statement-That’s last of the three types of financial
statements.
I hope the very first sentence in this article has given you an idea
about cash flows. The cash flow statement reports the “actual solid
cash” generated and used during the time interval specified in its
heading, unlike profit and loss statement which gives an estimate
based on certain rules and assumptions, after deducting certain
expenses like deprecation which does not require any cash outflow.
The whole idea of cash flow statement is to show you from where the
company got it’s cash – whether it’s from it’s business operations or by
sale of assets or issue of shares and how it used up those funds. This
data is important because business needs cash like a car needs fuel.
If there is no regular generation of cash from the day-to-day
operations, the business will need to resort to debt and share issues
to survive.

THREE SECTIONS OF A CASH FLOW STATEMENT.

A Cash flow statement split into three sections. It shows separately the
cash flow from operating, investing and financing activities of the
business.
Operating cash flow is cash received or paid by a company in the
course of its regular business during a specific time period.
Operating cash flow items will usually have a correspondence to
items in the company’s income statement.A strong positive cash
flow from operations is a good sign of the company’s health
Investing cash flows are cash received or paid out by the
 company associated with investment items. These can be
investments in publicly traded securities, investments in other
companies or investments in assets such as property or
factories. Oftentimes, investing cash flows will not have a
corresponding item on a company’s income statement but the
changes should show up on a company’s balance [Link]
changes in cash flow form changes in equipment, assets, or
investments are revealed here. Cash goes out to buy new
equipment. Also cash comes into the company when an asset is
sold or divested.
Financing cash flows shows money received or paid out by the
company associated with its capitalization. These items can be
related to debt payments or new debt. Dividend payments would
show up here. Stock buybacks or the issuance of new stock
would also show up here. Most of these items would be unlikely
to show up on a company’s income statement (although interest
payments would) but would show up on the balance [Link]
financing section shows how borrowing money affects the
company’s cash flow.
WHAT DOES THE CASH FLOW TELL US?
It’s three sections gives us an idea about the ‘quality of income’ that
the company is generating. The cash flow statement may appear to be
a complicated statement for a young investor, but a careful study along
with the following tips would help him better understand it and enable
him to take better investing decisions.
Operating section
The statement gives you details of cash from operating activities.
Consistent cash generation that’s greater than the net income of
the company can be considered to be of a “high quality”. But If
the cash from operating activities is less than net income, you
may want to check why the reported net income is not turning
into cash.
When a company spends more than it receives, it is said to have
a ‘negative’ cash flow. Negative cash flows are often viewed as
indicators of financial ill health by investors.
To get a feel for whether a company is playing games with its
earnings, compare net income on the income statement with
”cash from operating activities,” which represents how much
cash a company’s operations generate or consume. ”Generally,
the closer a ratio of those two numbers is to one, the higher-
quality the earnings.
If a statement consistently shows more inflows than outflows, it is
an indication that it can increase its dividend payments,
repurchase its stocks reduce its debt or acquire another firm. All
these are signs of a firm that is in good standing and is
considered to be of good value.
If the firm consistently reports growth on its income statement,
but has negative cash flow from operating activities, it may be
lacking the ability to translate its growth into cash. These firms
are more likely to face liquidity problems, or even default on their
short term liabilities. A company that keeps Increasing it’s
earnings and at the same time, suffers from negative cash flow is
a red flag.
Compare the rates at which net income and operating cash are
growing. If the two normally move in lockstep but cash now lags,
that’s a caution signal for you.
Negative cash flow from operations isn’t always bad. Because of
the high costs of growing a business, it’s normal for fast-growing
companies to spend more cash than they generate. Typically,
such companies may rely on bank borrowings or share issues to
raise funds for expansion. In other words, they run a surplus in
”financing” cash flows.
Cash outflows towards customers for refunds may indicate that
the customers are not happy with the company’s products and
services.
Investing section
Review the investing section of the cash flow statement. This
section reveals the changes in cash due to equipment, assets or
company investments. For example, cash goes out when new
equipment is bought and cash comes into the company when an
asset is sold.
The cash flow from investing activities also indicates a firm’s
ability to invest in non-current assets. If the company generates
enough cash to invest continually in property, plant and
equipment as well as other fixed assets, it is an indication that
the firm aims at replacing technologically obsolete equipment to
keep up with the latest trends.
Any substantial increase in investing section of cash flow may
also hint at possible attempt to take control of another company
for diversification of business. Increase in fixed assets indicates
capital expansion and future growth.
Financing section
The cash flow from financing activities should be carefully
evaluated when interpreting cash flow statements. Investors
should compare current debt financing with past periods to
determine if the firm has reduced its debt over the years.
While analysing financing activities, Issuance of common stocks
at attractive prices (high stock price above book value) may
indicate that the brand image and product of company is good.
Issuance of preferred stock is not a good sign as it hints that the
 company is having problems in selling common stock. If
company is resorting to debt financial then it is important for
investors to analyze the debt equity ratio of company. Reduction
of long term debts is desirable.
CONCLUSION
Cash flow is an important measurement and is best understood when
you compare the results of a company to its peers and to the market. It
is important because it focuses on actual operations and eliminates
one-time expenses and non-cash charges.
Remember- Cash is king !

More about cash flows.

If there is one investor who watches the flow of cash closely- that’s Mr.
Warren Buffet, one of the world’s richest stock market investor. There’s
lot of books and videos explaining his method of investing, the way he
analyses a company and about his investing philosophy. But if you
watch closely, what buffet does is quite fundamental –
He targets long term investment appreciation
He invests in businesses he understands
He takes a closer look on cash flow.

WHY SO MUCH STRESS ON CASH?

Cash is different!
When you look at a company’s balance sheet – you’re looking at what
the company owns and owes recordically.
The problem is that , assets like land are recorded at purchase price
( Now, land would be worth more than the purchase price) and assets
like buildings and machinery are recorded at cost less a fixed
depreciation rate as prescribed in law ( actual depreciation may be
more or less than the depreciation charged).
Similarly, debtors may not be fully recoverable. The figure is shown on
the assumption that those are fully recoverable.
So, in short what you see in the balance sheet is the value of the
assets and liabilities as decided by certain rules, assumptions and
estimates. This is not the actual picture.
Same is the case with profit and loss account. The profit and loss
accounts is made up with lots of estimates, accrual accounting
method, non cash expenses etc..This distorts the actual picture of the
company.
But, when you look at the cash flow statement, you’re indirectly looking
at the bank account of the company. Buffet has been looking at cash
all along.
PROFITS AND CASH ARE DIFFERENT.
Profits are not the same as cash. Cash may come in from different
sources for a business. It can come in from banks in the form of loans
or from investors. If you understood what you read in our ‘matching
concept’ you would remember that :-
Revenues are booked at sale, expenses are ‘matched’ to
revenue and capital expenditures don’t count against profits.
In other words, revenues are recorded when ever the company
deliver a product or service irrespective of whether the customer
has paid for it or not, the expenses are ‘matched to revenues’
implying that it does not represent the actual cash going out and
capital expenditures ( or expense incurred to purchase a fixed
asset like machinery ) is never recorded as an expense in the
profit and loss account but, an amount technically called
depreciation is charged against revenue.
Hence -
A COMPANY CAN REPORT PROFITS (and still be left out with no
cash!!)

Yes! We’ll illustrate how. For this exercise, let us go back to the
imaginary company we created in our third chapter- ‘say-it-with-
flowers’. The company now buys flowers from farmers at 30 days
credit and delivers it to customers on 60 days credit. That means, it
needs to pay it’s suppliers at the end of 30 days and it collects the sale
proceeds from customers only at the end of 60 days. For every sale , it
makes a profit of 40% from which it needs to meet it monthly
expenses of 10 lakhs. Presently it has a bank balance of 130 lakhs.
In January, it records a sale of 200 lakhs. So, the profit made is
40% – that is 80 lakhs before expenses according to books. The
accountant would look at his records and say that it has made a
profit of 70 lakhs (200 – 120 -10). But, in reality it has not
collected a penny since it’s customers pay at the end of 60 days.
But at the end of the month, it has to pay it’s suppliers 120 lakhs
and a monthly expense of 10 lakhs. So it takes out the 130 lakhs
from bank, pays 120 lakhs to suppliers and 10 lakhs for monthly
expenses. Now, the profit according to income statement is 70
lakhs, but in reality, bank balance is ‘0’.
How did we find out that the bank balance is ‘0’? We looked at how the
cash flowed.
In February, say-it-with-flowers records a sale of 320 lakhs and
makes a profit of 40% – 128 lakhs. Deducting the monthly
expenses due, the accountant would show from his income
statement that it has made a profit of 118 lakhs in February and
a total profit of 188 lakhs (70 in Jan + 118 in Feb.) But, reality is
– the company has received Rs 200 lakhs from sale made in
January (customers pay after 60 days ) , it pays off 192 lakhs to
 it’s suppliers for flowers supplied in February , and is left out with
just 8 lakhs in bank account. It has to borrow 2 lakhs from
somebody to pay off the monthly expenses!!
So- If we look at the company’s income statement as given by the
accountant, we’d find that sales and profits are growing. If we look at
the cash flow, we’d understand that in reality, the company is in cash
crunch.
A COMPANY CAN REPORT LOSS (and still have plenty of cash!!)

Now, let’s look at an imaginary company called “Dee’s fried chicken”.

Since the company sells fried chicken, it has a 100% cash based
business. It get’s chicken from suppliers at 60 days credit. Customers
pay upfront and buy chicken fry. There’s no credit. However, monthly
expenses are 90 lakhs- on the higher side due to high standards to be
maintained. For sake of comparing, this company also makes 40%
profits on sales and starts it’s business in January with 130 lakhs in
bank account.
In January, it records a sale of 200 lakhs. So, the profit made is
40% – that is 80 lakhs before expenses according to books. The
accountant would look at his records and say that it has suffered
a loss of 10 lakhs (200 – 120 -90). But, in reality it has to pay
only 90 lakhs at the end of the month, it need not pay it’s
suppliers 120 lakhs since supply is at 60 days credit. The
company has 240 lakhs (130 lakhs previous balance + 110 lakhs
in January) in bank, after monthly expenses. Now, according to
income statement the company is in loss, but in reality, bank
balance is 240 lakhs.
In February, ‘Dee’s fried chicken’ records a sale of 320 lakhs and
makes a profit of 40% – 128 lakhs. Deducting the monthly
expenses due, the accountant would show from his income
 statement that it has made a profit of 38 lakhs in February and a
total profit of 28 lakhs (-10 in Jan + 38 in Feb.) But, reality is –
the company already has 240 lakhs in bank , it gets another 320
lakhs , pays off 120 lakhs to it’s suppliers for chicken supplied in
January , pays monthly expense of 90 lakhs in February and has
a balance of 350 lakhs in bank account !!
So- If we look at the company’s income statement as given by the
accountant, we’d find that sales and profits are not upto the mark. If
we look at the cash flow, we’d understand that in reality, the company
is cash rich.
Understanding this difference between profits and cash is the key to
increasing your analytical ability. It opens a whole new perspective
from which you would start looking at companies
THE LINK BETWEEN PROFITS & CASH – Cash flow statement.
The most interesting fact about cash flows is that you can analyse it by
looking at the income statement and two balance sheets. This is not a
very complicated process; but it’s easy to get confused in the process
if you don’t understand the whole thing clearly. Here’s a step by step
guide to analyse cash.
Look at every change from one balance sheet to the next
Determine whether the change has resulted in an actual outflow
or inflow of cash.
Add / deduct the amount from the net income as per current
income statement.
More specifically –
Start with profits
Non cash expenses: Add back all non cash expenses like
depreciation.

Assets
 Accounts receivable: If it has increased deduct from profits; if it
has decreased add back to the profits.
Inventory / closing stock: If it has increased deduct from profits; if
it has decreased add back to the profits.
Any other asset: If it has increased deduct from profits; if it has
decreased add back to the profits.
Liabilities
Accounts payable: If it has increased add back to profits; if it has
decreased deduct from the profits.
Loans and debts: If it has increased add back to profits; if it has
decreased deduct from the profits.
Any other liabilities: If it has increased add back to profits; if it
has decreased deduct from the profits.
Others
Dividends paid: deduct the payment from net profit

CONCLUSION:

Cash flow is the key to picking highly profitable companies. The

analysis would help you to get insights into a company’s actual
financial health.
Introduction to financial
ratios
Financial ratios are used to evaluate a company- Its Financial
Strength, Management effectiveness, Efficiency and Profitability.
Ratios look at the fundamental financial aspects of the company. It
gives you an idea about –
The current financial position of the company
where the company ranks among its peers and if it is properly
priced by the market as reflected in its stock’s price
Overall, it helps you to decide if a particular company is worth
getting involved with.
Since, ratios look at companies from the fundamental level; ratio
analysis is also called fundamental analysis. Many investors use
fundamental analysis alone or in combination with other tools to
evaluate stocks for investment purposes. The ultimate goal is to
determine the current worth and, more importantly, how the market
values the stock.
There are at least 12 financial ratios you should understand to
evaluate a company.
This article focuses on the key tools of fundamental analysis and what
they tell you. Even if you don’t plan to do in-depth fundamental
analysis yourself, it will help you follow stocks more closely if you
understand the key ratios and terms.
It is enough that you understand all these ratios, its meaning,
components and relevance. Most of the ratios need not be computed
since these form part of the financial statements. All these ratios are
available in the internet from various financial websites and
magazines.
My favorite site for picking up ratios
To get all the non financial and financial datas of Indian companies,
List of key ratios :
1 Earnings per share or EPS
2 Price to Earnings Ratio – P/E
3 Market capitalization
4 Price to Sales – P/S
5 Price to Book – P/B
6 Dividend Payout Ratio
7 Dividend Yield
8 Book value
9 Return on Equity
10 Interest coverage ratio
11 Current and quick ratios
12 PEG ratio

Understanding Earnings Per

Share (or EPS)
Earnings means profits. Before you buy a share , this is the first figure
that you need to check. An increase in earnings every year is a sign
that the company in question is prima facie a good candidate for
further analysis. Increasing earnings generally leads to a higher stock
price. Most of the high earning companies also pay regular dividend to
its shareholders. Analyzing Earnings is the first most important step
for investors because they give an indication of the company’s
expected future dividends and its potential for growth and capital
appreciation. The other names by which earnings are called are –
Profits , Income etc.. ( But not ‘Revenues’. That’s a totally different
term !)
THE BASICS.
Earnings simply are the company’s profit – how much money did it
make in any given [Link] does a company calculate earnings ?
It’s by deducting the ‘cost of sales’ , ‘operating expenses’ and ‘taxes’
from it’s total sales revenues. The term ‘cost of sales’ is nothing but
the total amount incurred of raw materials, labour and other expenses
incurred in producing a product for sale. The term ‘operating
expenses’ means the cost incurred for operating the business such as
salary to staff, legal expenses, advertisement etc.. and taxes are those
payments made to the government on the income that’s generated.
POSITIVE EARNINGS.
Investors expect established companies like Infosys to declare high
earnings. If they report lower earnings for a quarter, the stock price
would immediately tumble. New or Young companies, on the other
hand, may go for years with negative earnings and still enjoy the favor
of the market if investors believe in the future of the company.
Companies are required to declare it’s earnings figures every quarter.
In India, A financial year starts from 1st of April and ends on the
subsequent march 31st. So the quarters are as follows-
Quarter 1 -1st April to 30th June. Earnings for the quarter will be
declared in July
Quarter 2 – 1st July to 30th Sept. Earnings for the quarter will be
declared in Oct.
Quarter 3 – 1st Oct to 31st Dec . Earnings for the quarter will be
declared in Jan.
Quarter 4 – 1st Jan to 31st Mar . Earnings for the quarter will be
declared in April.
Companies also declare half yearly results clubbing two quarters.
Investors, based on the given facts, try to figure out the expected
earnings of the company. This expectation of the investors is what is
actually reflected in the share price movements. So, in addition to the
actual earnings, the expectation of earnings also play an important
part in stock prices . Companies that fail to meet the expectations of
the investors gets beaten by the market. Earnings (or growth towards
positive earnings) tell you how healthy a company is.
EARNINGS PER SHARE.
The basic measurement of earnings is “earnings per share” or EPS.
This measurement divides the earnings by the number of outstanding
shares. For example, if a company earned Rs 150 Crores in the third
quarter and had 75 Crore shares outstanding, the EPS would be Rs 2
(150 / 75).
WHY EPS?
The reason you reduce earnings to a per share basis is to compare it
with another company. For example – Two companies A and B has
earned a profit of 150 crores [Link] one would you prefer? Both
seems to be ok with you. Right? However, if I say that company A has
75 Crore shares outstanding and company B has 100 crore shares
outstanding, which one would you prefer? Your answer lies in the EPS
figure.
Company A has an EPS of 2 ( 150/75) whereas company B has an
EPS of just 1.5 (150/100). So you prefer the company A that pays you
more profit per share.
It’s importants to note here that the EPS is helpful in comparing one
company to another, assuming they are competing companies of the
same category ( large cap or small cap etc..) in the same industry, but
it doesn’t tell you whether it’s a good stock to buy or what the market
thinks of it.
EARNINGS PERIOD.
As said earlier, companies report earnings every quarter. April-June is
Quarter 1 generally termed as ‘Q1’, July –Sept is quarter 2 or ‘Q2’and
so forth. Generally , the quarter results come out by the mid of the
subsequent quarter. The market always approaches the earnings
reporting day with [Link] day can be a time of some volatility,
either up or down for particular stocks and/or sectors.
TYPES OF EPS
The numerator and denominator in an EPS equation can change
depending on how you define “earnings” and “shares outstanding”.
Let’s try to crack the numerator (Earnings) first.
There are three types of Earnings numbers:
Trailing earnings – last year end earnings figure.
Current earnings – current year’s number- part actuals,part
projections based on the current performance.
Forward Earnings – future numbers which are pure estimates.
EPS calculated with the last year end actual earnings figure is called
“trailing EPS”. trailing EPS is the actual EPS figure.
When Current earning estimates are used to compute EPS , it’s called
the “Current EPS” and when Future earnings figures are used, it’s
called “forward EPS”.
Now, Let’s see the denominator part. (ie Shares outstanding)
Shares outstanding can be classified as either Basic or fully diluted
Basic EPS is calculated using the number of shares that have
been issued and held by investors. These are the shares that are
currently in the market and can be traded.
Basic Earnings per share (Basic EPS) tells an investor how
much of the company’s profit belongs to each share of stock.
The number calculated this way excludes any possible dilution
stemming from outstanding dilutive securities, such as options,
warrants, convertible bonds, or convertible preferred stock. Diluted
EPS reflects the potential dilution from such dilutive securities. The
companies that don’t have any dilutive securities, or the companies
that report net losses, report only Basic EPS.
In short, EPS computed can be Trailing EPS (Diluted or basic) or
Forward EPS (Diluted or basic).
Know it
Earnings means Profits. The term should not be confused with
‘Revenues’ which is a totally different term
Companies report earnings every quarter i.e April-June (quarter
1 or Q1) Jul-sept (Q2) so on..
The stock market approaches each earnings report with caution.
Markets will react positively on a company that declares positive
earnings growth. The reverse is also true.
The basic measurement of earnings is EPS
EPS computed can be Trailing EPS (Diluted or basic) or Forward
EPS (Diluted or basic).

Price to Earnings ratio or P/E

ratio
Hi there ..
In the last post I discussed about earnings and earnings per share.
You learnt that Earnings per share is useful to compare two or more
companies of the same category and industry. In this article we will
look into a more important ratio called the P/E ratio. That’s the Price /
Earnings ratio more commonly called the P/E ratio. The P/E Ratio is a
widely used ratio for valuing shares prices. It also know
by different term such as P/E multiple, earnings ratio , Price earnings
ratio, P/E ratio etc..
WHAT IS IT?

The ‘P’ in the formula stands for the market price of the [Link] “E”
in the formula stands for the Earnings per share. If you see a stock
trading at 50 per share on the market, and that stock had an EPS
(earning per share) of 2.50, then according to this formula, the P/E
Ratio of this stock is 20.
HOW TO CALCULATE P/E
The P/E looks at the relationship between the stock price and the
company’s earnings. You calculate the P/E by taking the share price
and dividing it by the company’s EPS as shown in the above example.
WHAT DOES THE P/E TELL YOU ?
The P/E gives you an idea of what the market is willing to pay for a
share of company’s earnings. The higher the P/E the more the market
is willing to pay for the company’s earnings. Some investors read a
high P/E as an overpriced stock and that may be the case, however it
can also indicate the market has high hopes for this stock’s future and
has bid up the price.
Conversely, a low P/E may indicate a “vote of no confidence” by the
market or it could mean this is a sleeper that the market has
overlooked. Known as value stocks, many investors made their
fortunes spotting these “sleepers” before the rest of the market
discovered their true worth.
WHAT IS THE RIGHT P/E?
There is no correct answer to this question, because part of the
answer depends on your willingness to pay for earnings. The more
you are willing to pay, which means you believe the company has
good long term prospects over and above its current position, the
higher the “right” P/E is for that particular stock in your decision-
making process. Another investor may not see the same value and
think your “right” P/E is all wrong.
MORE TIPS ON P/E
If a stock has a P/E of 15, that means the market is willing to pay
15 times its earnings for the stock. For this reason, P/E is
sometimes referred to as a multiple. In the above example, the
stock has a multiple of 15. Also denoted as 15x .
Companies with good growth potential will have a higher P/E
because investors are willing to pay a premium for future profits.
High-risk companies will typically have low P/Es, which means
the market is not willing to pay a high price for risk.
IS THE P/E FORMULA PERFECT TO VALUE STOCKS?
Unfortunately, P/E alone cannot be used as a single measure to value
stocks. The reason is that an individual company’s earnings figure
can be skewed by accounting abnormalities which may temporarily
inflate or deflate the actual earnings. A low P/E does not necessarily
mean a stock is cheap and l a high P/E doesn’t mean a stock is
expensive! You have to compare apples to apples. You have to put a
stock’s P/E ratio into the proper [Link] you cannot make a buy or
sell decision strictly on P/E, but it can be used to get greater insights
into a sector or stock price.
Different industries have different P/E ratio ranges that are
considered normal. For example in the recent years of IT boom,
information technology companies had high P/E
ratios compared to other sectors.
P/E ratios are available are available sector wise. This helps in
 finding out which sectors are more expensive at a particular point
of [Link] know when a sector is overpriced, the average P/E
ratio of all of the companies in the industry is compared to the
historical average. If the average climbs far above the historical
average, you get the hint that the sector as a whole is overpriced.
You can use the P/E ratio to compare the prices of companies in
the same sector. For example, if company A and company B are
both selling for 50 per share, one might be far more expensive
than the other depending upon the underlying profits and growth
rates of each [Link]’s about P/E ratio.

More about P/E

Hi there,
Let’s catch up with P/E ratio in detail. Before that, here’s a re-cap of
what P/E is all about.
WHAT IS P/E RATIO?
Price to Earnings ratio is jargon used by investors and analysts.
P/E is one of the most commonly used valuation methods in the
world of investment.
It is used to measure how cheap or expensive a stock is.
It has the ability to explain long-term return potential of a stock.
P/E is ‘market price of the share’ divided by ‘earnings per share’.
It is the amount of rupees the market is willing to pay for one
rupee of the company’s earnings or to put it in another way, it is
the number of times the share of a company is priced in the
stock market compared with its earnings.
The inverse of this ratio is known as the earnings yield.
The commonly used time-frame to calculate price-earnings
multiple is the trailing 12-month period.

DETERMINANTS OF P/E RATIO

The P/E multiple of a company is determined by many factors

but the key determinants are (a) Expected Growth Rate (b)
Current and Future Risk and (c) Current and Future investment
needs.
(a) Expected Growth Rate -Companies with a higher expected
growth rate in business normally trade at a higher P/E multiple,
as the earnings are expected to be more attractive in future.
When the estimated EPS is higher, the forward P/E is lower
compared with the current P/E. So, when the market gets this
information, the share price goes up as then investors would be
willing to pay a higher price for the stock. Therefore, companies
with higher growth rates trade at higher P/E multiples.
(b) Current and Future Risk -Companies perceived as risky
usually trade at lower multiples, as the market expects
fluctuations in their operating results.
For instance, companies with higher operating leverage (higher
proportion of fixed costs to total costs) and higher financial
leverage (higher debt/equity ratio) are perceived to be riskier, by
the market.
(c) Current and Future investment needs-P/E ratio is also
affected by the reinvestment needs/requirements of a company.
For example, a company with higher reinvestment needs is
perceived as riskier, as it would then require the company to
borrow more funds. This may lead to a higher financial leverage
or earnings dilution for existing shareholders depending on the
method adopted to raise funds.
TYPES OF P/E

Trailing P/E Ratio – Current market price divided by its last year
EPS.
Forward P/E Ratio – Current market price divided by its
estimated next year [Link] ONE TO USE?While these two
are the most commonly used P/E ratios — as both are based on
actual earnings and hence the most accurate — it is forward PE
that holds more relevance to investors when evaluating a
company.

PRACTICAL TIPS WHILE USING P/E

Tip [Link] that the P/E multiple comes down drastically due to
the steep increase in the forecast EPS; the opposite holds true
for a steep decline in the forecast e EPS number. All the variants
of P/E are based on the same numerator (i.e. market price per
share) but use different denominators (i.e. earnings per share-
historical, trailing, forward and future). You can also consider
taking the 6 -12 months median market price of the share for
computing the price to earnings multiples.
Tip [Link] investors tend to adopt a low PE as a rulebook for an
investment. While a low PE multiple is desirable, it would be
inappropriate to adopt this ratio as a stock-picking tool across
industries. Technology stocks tend to quote at trailing 12-month
PE multiples between 30 and 40 compared to basic industry
stocks that usually have single-digit PE multiples. As such,
investors would be better off adopting this tool for peer
comparisons within the same sector.
Tip [Link] tool bypasses investment opportunities in companies
that are making losses and are on the verge of a turnaround. So
 that’s another area to be careful about while analysing
companies.
Tip [Link] moderate price-earnings multiple as a filter, an
investor would also miss out on companies with substantial
growth prospects.
Tip 5. Companies that are just out of the red would be off the
radar as they tend to command high PE multiples. Take the case
of an investor who had adopted this tool in September 2003.
SAIL, which traded at Rs 40, would not have been on his radar
then as it quoted at about 60 times its trailing 12-month
(standalone) earnings. Within a span of three-and-quarter years,
the stock doubled to about Rs 80 (commanding an earnings
multiple of 8).
Tip [Link] by a low PE would also filter out most stocks in the
retail, media and technology space and leaving only those in the
basic industries. A good number of stocks with a low PE are
those perceived to have little opportunity for earnings growth or
are highly [Link], while the PE multiple is the most
commonly used valuation metric, it cannot be the only one you
use to decide on an investment
Have a nice Day !

Measurement of size- market

capitalization
Now Let us forget about ratios and concentrate on another important
[Link].
If I tell you the price of two companies – say, company A Rs 150 and
company B Rs 75. would you be able to tell me which is the bigger
one? Is it company A? No. why? because, you cannot guess the size
of the company by looking at it’s share price.
So, the question is how to measure the [Link] answer lies in finding
out something called “Market capitalization” of that company.
Market capitalization or market Cap is calculated by multiplying the
current stock price by the number of outstanding shares. This number
gives you the total value of the company or stated another way, what it
would cost to buy the whole company on the open market.
For Example: A stock trading at Rs 55 with 100,000 outstanding
shares would have a market cap of Rs 5.5 lakhs.
Since the per-share price keeps changing and since each company
has a different number of outstanding shares, the market capitalization
of a company keeps changing everyday.
Here’s an example: lets’s take tw companies – A ltd and B ltd
A Ltd’s Stock price: Rs 50 Outstanding shares: 50 Lakhs
So , Market cap works out to : Rs 50 x 50,00,000 = Rs 2500,00,000
B Ltd’s Stock price: Rs 10 Outstanding shares: 3 Crores
So Market cap works out to : Rs 10 x 300,000,000 = Rs 30000,00,000
This is how you should look at these two companies for evaluation
purposes. Their per-share prices tell you nothing by themselves. This
is exactly why Reliance industries with a share price of Rs 1100 is a
bigger company than say, MRF Ltd whose share price is around Rs
7500.
Having said that, let us look into how the companies are classified
according to its market capitalization.
LARGE CAP
There is no standard definition of Large Cap and it varies from
institution to institution. But as a general rule, in India, if a company
has a market capitalization of more than Rs. 5000 Crores, it is
considered as a Large Cap.
A Large Cap company is normally a dominating player in its industry,
and has a stable growth rate.
It should be noted that almost all the Large Cap companies from India
would be considered as Mid Cap or Small Cap companies in a global
scenario, as globally, companies are usually classified as Large Cap if
their market cap is more than $10 Billion (roughly Rs. 39,000 Crores).
MID CAP
If a company has a market capitalization of between Rs. 1000 Crores
and Rs. 5000 Crores, it is considered as a Mid Cap
A Mid Cap company is normally an emerging player in its industry.
Such a company has a potential to grow fast and become a leader
(a Large Cap) in the future.
Mid cap companies can show very high growth rates (in percentage
terms), because they have a small base – since their size is small,
even a small incremental increase in revenue / profits can be a big
figure when expressed in terms of percentage.
SMALL CAP
If a company has a market capitalization of less than Rs. 1000 Crores,
it is considered as a Small Cap
A Small Cap company is normally a company that is just starting out in
its industry, and has moderate to very high growth rate. Such a
company has a potential to grow fast and become a Mid Cap in the
future.
CONCLUSION
Focus on the market cap to get a picture of the company’s value in the
market place. Per share price may not give you the actual picture
about the company’s size .
More about Market-caps.
Hi there,
Market capitalisation or “market cap” is a simple indicator of the value
placed on a company by the market at today’s prices. The
computation of market capitalization and its meaning has been
explained in beginners lessons 3:Market Capitalization. Now let’s get
into more details on market-cap. Stocks are classified into large, mid
or small cap, based on their overall market cap. Indices such as the
BSE Sensex and the CNX Nifty represent a basket of large-cap
stocks.
However, What was a small-cap stock a few years earlier may
graduate to a large-cap status, as the company ramps up in size and
gains greater recognition from the market.

WHERE SHOULD YOU INVEST?

Well, that’s a difficult question to answer since much would depend on

an investor’s attitude, age, financial capacity, investing aims and his
ability to take risks. What I can do is to give you some pointers as to
what you can expect by investing in these different caps.
WHAT TO EXPECT FROM LARGE CAPS.
[Link] growth: Large-cap stocks usually represent well-known
companies with a sizeable scale of operations; they often carry the
potential for steady growth in line with the economy.
[Link] volatility: Earnings of Large cap companies will seldom grow
in leaps and bounds, but may exhibit fewer surprises from quarter-to-
quarter or year-to-year, as they are tracked by a veritable army of
analysts!
[Link] of FII’s: Foreign institutional investors seeking to dip their
toes into the Indian markets often make their first investments in large-
cap stocks. If you are the conservative type, and would like to buy and
hold for the long term, you should probably pick your investments from
the basket of large-cap stocks.
[Link] of the pack:Large-caps are usually the first to lead any
market recovery, while mid- and small-cap stocks tend to join in later.
[Link] par performance in bullish market: Large-cap stocks will
usually perform well than mid and small caps during bullish periods.
[Link]:large cap companies generally have the history of paying
out regular [Link] and mid-cap companies may not pay
regular dividend since they keep investing the surplus in more
ambitious projects.
WHAT TO EXPECT FROM MID CAPS AND SMALL CAPS.
[Link] growth :Mid- and small-cap stocks usually represent
companies that are in nascent businesses or those that are lower in
the pecking order, within a sector, in terms of revenues or market
share.
[Link] volatility: Earnings of mid-cap and small-cap companies will
grow in leaps and bounds and they may come up with surprises from
quarter-to-quarter or year-to-year, resulting in high variation in stock
prices.
[Link]-baggers hide here: If you are hoping to find multi-baggers,
you must invest in mid- and small-cap stocks.
[Link] returns and high risk: Midcaps offer potential for higher
returns because of their ability to register earnings growth at a faster
pace. At the same time , you should be aware that they often carry
higher risks than large caps. Their earnings could suffer bigger blips
because of vulnerability to a downturn in the business.
[Link] liquidity: Small and mid-cap stocks are often not traded as
actively as large caps, dwindling volumes could magnify the decline in
prices of such stocks in the event of a market meltdown. It is,
therefore, important to put your choice through a liquidity filter (check
for the stock’s historical trading volumes over a couple of years) before
investing in mid- or small-cap stocks.
[Link] to fall in a market crash: If you are booking profits on your
portfolio because you expect a big correction, your mid- and small-cap
stocks should probably go first, as they would be most vulnerable to
any meltdown in prices.
[Link] par performance during uncertainty: Mid- and small-cap
stocks will usually under-perform large caps during periods of high
uncertainty.
[Link] preferred stocks during uncertainity:Global events
impacting FII flows , political upheavals or financial instability often
prompt a “flight to safety” which results in liquidity fleeing mid- and
small-cap stocks into the tried-and-tested large-caps.
TIPS FOR BALANCED APPROACH
If you now have a grip on how large-, mid- and small-cap stocks
behave, here are a few additional pointers on investing based on
market cap:
Tip #1:Maintain a balance: Maintaining a balance between large-,
mid- and small-cap stocks in your portfolio is as important as
spreading your investments across different sectors and businesses.
Typically, you should have 60 % of your money invested in large caps,
30% in mid caps and 10% in small caps.
Tip #2:Never stick to a single cap: Making investments only in small
and mid-cap stocks could make for high volatility while sticking only
with the large-caps could deliver modest results.
Tip#3:Analyse your risk tolerance capacity: Decide on your
allocations to each group based on your appetite for risk and to
adhere to this, irrespective of market conditions.
Tip#4:Do your home work: shift your allocations between large-,
mid- and small-cap stocks based on market conditions. That would
give you maximum results. But practicing such a strategy is not for
beginners. It can be quite difficult and may require timing skills and
analytical abilities.
Have a nice Day !

Understanding price to
sales ratio
Hi there ,
We learned about P/E ratio in our earlier section. P/E ratio is useful for
evaluating companies with adequate earnings. But in some cases,
especially in the case of promising start up companies, earnings of the
company may not be anything much to talk about. The reason could
be high amounts spent for further expansion. In such cases, instead of
P/E , P/S would be used. That is, we try to figure out what the market
is willing to pay for a share of company’s sales. The higher the P/S the
more the market is willing to pay for the company’s sales generated.
HOW IS IT CALCULATED?
Price to sales ratio relates market value of the company to it’s annual
sales. You calculate the P/S by dividing the market cap of the stock by
the total revenues of the company.
You can also calculate the P/S by dividing the current stock price by
the sales per share.
P/S = Market Cap / Revenues
P/S is an alternative method to look at companies where P/E doesn’t
work. For example – Price to sales are useful to value retailing
companies.
ADVANTAGES AND DISADVANTAGES
Earnings is basically an accountant’s estimate of the profits
made by a company. earnings can differ according to the
accounting method used and the assumptions that has gone into
computing it. So, a shrewd accountant can very easily
manipulate the earnings figure of a company to please the share
holders. But, sales figures are not subject to such
high manipulation.
The flip side is that, eventually, any company should come up
with profits. A business may have higher sales but a lower profit
margin than a competitor, indicating that it’s not operating
efficiently. what’s the benefit if a company generates crores and
crores of sales but ultimately falls short when it comes to earning
profits? Ultimately , earnings is what drives the stock price up.
So, P/S is a tool that should be used very carefully in certain
special circumstances. For example – we need to take a decision
between two similar retailing companies. Both the companies are
identical in all respects- EPS, Debt (borrowings) etc. You can use
P/S to evaluate which company generates more volume of sales
with the borrowed money. so, if leverage ( technical jargon for
borrowings) is similar across companies , P/S may become
useful for the investor to make decisions.
P/S can also be used to spot high growth companies of tomorrow
which may not be reflected with P/E analysis. Companies with
high potential for growth generally have low earnings due to
heavy investments made in the initial [Link] you assume that
 the future of the company is bright, P/S may be the measure you
need to confirm that.
CONTRADICTION BETWEEN P/E AND P/S

Generally, P/E of a company and P/S move in the same direction.

There could be situations where P/E of a company contradicts with the
P/S ratio. For example , If a company has a low P/E but a high P/S, it
can be a signal that there were some one-time gains.

Understanding price to
book ratio
PRICE TO BOOK RATIO
Hi there,
before I begin my discussion on Price to book, a quick recap of some
important terms. Book value’ is a concept we discussed at earlier
[Link] Book Value is simply the company’s assets minus its
liabilities. That is the actual worth of the company. But if you want to
acquire that company, you need to buy every single share at the
current market price and that value (ie market price per share x total
shares) is called market capitalization.
i hope you remember those two terms – book value and market
capitalization or market value.
PRICE TO BOOK RATIO
Price to book ratio is computed as follows -
Market capitalization / Book value OR
Market price per share / Book value per share.
Market price of the share and book values for any listed company are
available straight from financial web sites. So there is no need to
compute [Link] let’s try to understand the ratio and it’s significance.
The P/B gives you an idea of what the market is willing to pay for a
share of company’s book [Link] higher the P/B the more the
market is willing to pay for the company’s book assets. Some
investors read a high P/B as an overpriced stock.
P/B ratios should be used with caution. A low price to book ratio can
mean the following-
1 That the stock is selling at a discount to its book value. That
gives you a perfect buying opportunity.
2 Something is fundamentally wrong with the company.
3 That the book value of assets is over stated in the company’s
balance sheet
MORE ON P/B
Since market price is compared with book values, a distortion in
the book value of assets of the company affects this ratio. For
example, a company might have acquired land 10 years back.
The value shown in the balance sheet would be the price paid at
the time of acquisition, 10 years back. Naturally, the asset price
would have shot up several Crores, but the same will not be
reflected in the balance sheet. The price to book ratio of this
company may look expensive, but in reality , it may be an
undervalued stock.
Companies like software firms, which rely on intellectual property
may have very high price to book ratios. They are not capital
intensive and hence invest little in solid assets. Their assets are
the intellectuals they have and hence P/B are not suitable for
valuing such stocks.
Assets heavy companies like infrastructure, financial institutions,
banks, manufacturing companies can be better valued with this
 ratio.
The ROE and P/B are inter connected. A company with a higher
ROE will have a higher P/B and vice versa.

Understanding Dividend pay

out & retention
DIVIDEND PAYOUT & RETENTION RATIOS
Hi there,
In this article, We look at two ratios that are connected with dividend
payments. They are 1. the dividend payout ratio and 2. the retention
ratio.
The dividend payout ratio measures the portion of profits that’s
distributed as dividends. The Dividend Payout Ratio is calculated by
dividing the annual dividends per share by the Earnings Per Share. So
the formula is:
Dividends Per Share / EPS or
Alternatively, you can divide the dividend by net income to arrive at the
same figure.
For example, If the company’s earnings per share is Rs 3 and it pays
Rs 1 as dividend, the dividend payout ratio is 33%. That is, (Rs 1/ Rs
3) x 100
The next question is whether this 33% s good or bad. You may have to
analyse the dividend history and the dividends declared by its peers to
form an opinion.
Generally companies that pay higher dividends are large cap or so
called ‘mature companies’ that doesn’t have big expansion plans
anymore. A company that has massive expansion plans retains the
profits with them and will not pay out much dividends.
RETENTION RATIO
Retention ratio is the exact opposite of dividend payout ratio. Retention
ratio becomes important to spot growth companies.
The retention ratio shows how much is kept by the company from the
profits made. It is assumed in analysis that whatever amount the
company retains, will be reinvested for growth in the company. So, it
follows that, a company that retains a large portion of its income, is
planning to expand its business. Generally, high retention ratios are
seen in young and growing companies.
So, the formula for retention ratio is
Net income – dividends / Net income.
Alternatively you can deduct the dividend pay out ratio from 100 to get
the retention ratio. A high retention ratio is a sign that the company is
in a massive expansion mode.
A company that looks to sustain growth without any external financing
would resort to increase the retention ratio.

Understanding Dividend yield

& Earnings yield.
DIVIDEND YIELD.
Hi there,
Dividend yield is another ratio that’s connected with dividend
payments. The yield ratio is particularly useful for investors who are
looking to cash in on the dividends paid by a company.
Dividend yield and dividend pay out ratios are different. If dividend
payout ratio was the percentage of profit that was paid out as
dividends, dividend yield ratio shows how much divided you received
for the money you spend on your investment. Yield is a measure to
calculate the percentage of return on an investment. With dividend
yield, it becomes easier for you to compare between companies that
pay high dividends.
The formula for calculating the Dividend Yield is by taking the annual
dividend per share and divide by the stock’s price. So, the equation is-
Annual dividend per share / the stock’s price.
For example: Two companies- A and B pay an annual dividend of Rs
15 per share. The share price of company A is Rs 100 and the price of
company B is 150. Which stock gives better return?
Company A , because it gives an yield of 15% for every Rs 100
invested in it whereas company B gives an yield of just 10%
( 15/150)
The Dividend Yield Trap
We talked about dividend yield ‘s positive factors. However, Dividend
yield can lead you into a trap if you’re not careful.
The trap is the denominator figure. The dividend payout is divided by
the share’s price. Since the share price keeps changing, the ratio will
keep changing accordingly. So, if there is a sudden fall in a stock’s
price, the dividend yield ratio will show a higher figure. That’s one pint
to be careful.
EARNINGS YIELD.
As I said before, yield is a measure to calculate the percentage of
return on an investment. Earnings yield is another ratio that’s similar to
dividend yield. Earnings yield ratio shows how much earnings you
received for the money you spend on your investment.
This ratio becomes useful where the dividend payments are low.
Earnings yield is calculated as follows:
 Earnings per share / market price per share or E/P
That means, earnings yield is the exact opposite of P/E ratio. The
convenience of earnings yield is that since it measures the return you
received for the money you spend on your investment, it’s makes it
easier for you to compare the company’s return against alternative
investment options such as bonds or fixed deposits. So, practically it’s
more useful than a P/E.
The only problem for E/P is that ‘earnings’ are not properly defined.
Benjamin Graham, the father of value investing, has recommended
investors to buy a stock that has a P/E ratio equal or lower than the
sum of the earnings yield plus the growth rate. That is , an investor
should buy a share only id it’s P/E is less than the earnings yield +
growth rate.
P/E Ratio < Earnings Yield + Growth Rate
For example, let’s say you want to invest in shares of a company that
has 7% earnings yield and was growing at 7%. You check he balance
sheet and find that the company’s fundamentals are good.
Considering the history of the company, quality of the management
and order book for the future, you expected the company to accelerate
it’s growth from now on. In this case, if you could buy the shares at a
price-to-earnings ratio of 14 or less, you would have a reasonable
chance for very satisfactory returns (7% earnings yield + 7% growth
rate = 14 P/E ratio maximum).
However, it would be very difficult to get such investing opportunities
where the P/E equals the earnings yield plus growth rate. It’s a very
conservative filter. I am sure that 95% of the stocks you scan would
get rejected on this basis alone. (And, that’s why it’s such a safe
measure to valuate investments)
Understanding ROE & ROCE.
RETURN ON EQUITY (ROE)
‘Equity’ means shareholder’s funds.
Share holder’s funds in a company includes the equity capital they
invested + their share of earnings retained by the company for further
expansion.
Hence, return on equity means, the return generated by using
shareholder’s capital.
How does a company generate return from it’s capital? It’s by investing
in assets which are capable of producing returns. So, Return on Equity
(ROE) is a measure of how efficiently a company uses its assets to
produce earnings. ROE is the speed at which the company might grow
without sorting to additional fund raising.
The formula for computing return on equity is:
Earnings / shareholders equity
AVERAGE ROE
Instead of taking the ROE figure of just one year and forming an
opinion on that basis, it’s better to study the financial history of the
company and find the average ROE of 5 or more years. This would
give you a reasonable assurance about the rate of return that the
company is capable of generating.
An average ROE of 15% -20% is the preferred range for a company
that’s growing at a steady pace.
THREE COMPONENTS OF ROE
The ROE is not a simple equation as you saw above. Let’s try to split
and expand the equation and try to find what boosts the ROE of a
company and why. Let’s check the expanded formula.
 ROE= (Earnings / Sales) x (Sales / Assets) x (Assets /
Shareholder’s equity)
If you notice the equation carefully, you’ll take note that ‘sales’ and
‘assets’ are both the numerator and denominator and hence they get
nullified. When we break the equation in this manner, the three
components of ROE is revealed. They are;
Earnings or profits
Assets
Leverage
Earnings or profits:
Profits, in simple terms, are the money left after all the expenses is
met. So the first part of the equation – (earnings / sales) shows the
profit margin that’s generated by the company from its sales. A low
profit margin can mean many things including:
Inefficient pricing policy
Inefficient cost control ( hence a drop in profits)
Unprofitable product ( hence it eats into the profits generated by
other products of the company)
Cut throat competition ( hence, the company is forced to sell at a
low margin)
A high profit margin, on the other hand, may mean that the company is
enjoying a monopoly in its field. It also indicates that the company has
a product or product range that has some brand image and quality
and hence it’s possible for them to sell their products at a higher
margin. Such companies are also capable of eliminating competition
from new entrants by lowering the prices temporarily or by enhancing
the quality of the product without enhancing the price.
Assets:
The second part of the equation is sales / assets. So that measures
the sales generated from per rupee of assets invested by the
company. It’s also called asset turnover ratio.
The asset turnover ratio of a company throws light into an important
aspect. How much assets does the company need to generate the
required volume of sales? If the company is capable of generating
sales by investing heavily in assets, it could mean that the company is
capital intensive in nature. The capital intensive nature of the company
affects the ROE of the company negatively.
Leverage or debt:
The last part of the equation is assets / shareholder’s equity. It is
basically a measure of leverage. Leverage is nothing but the amount
of debt funds used by the company to sustain business. If the ratio is
less, it shows that the company has resorted more to debt funds. If the
ratio is 1 it shows that the company has built all the revenue producing
assets from shareholders funds.
if a company raises funds through to do business through borrowing
rather than issuing stock it will reduce its shareholder’s equity. A lower
equity means that you’re dividing earnings by a smaller number, so
the ROE is artificially higher.
So, higher the debt, higher the ROE.
So, earnings, assets turnover and debt are the three factors that boost
the ROE of a company. Hence,
ROE = Net margin x asset turnover x financial leverage.
In general, It’s important to screen companies for a higher earnings,
higher assets turnover and a lower debt.
SECTION 2

RETURN ON CAPITAL EMPLOYED (ROCE)

ROCE is different from ROE we discussed above. ROCE is the ability
of the company to earn return from ‘all the capital’ it employs. The term
‘All the capital’ means that it includes debt funds like loans and
preference capital as well.
The equation for computing ROCE is:
Return (before interest and Tax) / capital employed.
Debt funds are included in the denominator; logically the numerator
should be the earnings before deducting the interest paid on debts.
For a company to remain in business over the long term, it’s important
to generate an ROCE which is higher than its ‘cost of capital’. ‘Cost of
capital’ is nothing but the compensation that the company should pay
to each category capital contributors. That is, for using debt it has to
pay interest, for preferred capital it has to pay a fixed return and for
ordinary equity holders it has to pay what the equity holders expect –
something above the risk free return rate and average return they
expect from any other stock investment.
Since the proportion of equity, preferred capital and loan funds would
be different, the weighted average of all is taken as the cost of capital
of a company.
The higher the ROCE, the better it is.
So that’s about ROE and ROCE.

Understanding interest
coverage ratio
INTEREST COVERAGE RATIO
This ratio relates the fixed interest charges to the income earned by
the business. It indicates whether the business has earned sufficient
profits to pay periodically the interest charges. It is calculated by using
the following formula.
 Interest Coverage Ratio = Net Profit before Interest and
Tax /Fixed Interest Charges
What it shows is:
1. The amount of interest expense the company bears in a current
year due to loan funds and its impact on profitability.
2. The profit of the company in terms of ‘number of times’ the interest
obligation. This information would show the financial strength of the
company. A company which merely manages to generate the required
income to pay interest obligations is prone to severe liquidity crisis.
3. An interest coverage ratio of less than 1 is an indication that the
company is not generating enough cash to pay its interest obligations.
4 . Any improvement in interest coverage ratio is a good sign. On the
same lines, any decrease in the interest coverage ratio of the
company is a red flag.
WHAT KNID OF DEBTS ARE TO BE INCULDED?
All kind of Debts of a company- long term, short term, bank loans,
bonds, debentures, notes payable.. In fact, any form of debt for which
there is an obligation on the part of the company to pay interest should
form part of this calculation.
ICR- A part of debt ratios.
The ICR is in fact, the smallest form of debt ratios. The big brother is
debt ratio which measures the total debts against the total assets. The
equation is:
Total debt / Total assets.
The debt ratio gives us the big picture about the company’s debts and
the proportion it bears to the total assets.
There is also one more ratio called the debt equity ratio which
measures the amount of debt in relation to the total equity share
capital. Debt equity ratio is calculated as follows:
Debt / equity
A high debt equity ratio shows that the company has larger amount of
debts and hence the risk of running into financial difficulties is much
more.

Evaluate debt-Understanding
Current and quick ratios
MEASUREMENT OF DEBT
There are several measurements you can use to gauge whether a
company may be carrying too much debt. Both come off the balance
sheet if you want to do the math yourself or you can find the ratios on
several online services.
We need two definitions before we move on:
CURRENT LIABILITIES AND CURRENT ASSETS
Current Liabilities are bills that will come due in the next 12 months.
These include the company’s normal operating expenses such as
salaries, utilities, and so on. Long-term debt, such as mortgages
would not be included, however that portion of payments due in the
next 12 months would be included.
Current Assets are marketable securities, cash and other assets that
can be easily converted to cash within 12 months. Land and real
estate do not fall into this category because it often takes longer than
a year to sell property.
The term ‘debt’ includes short term liabilities, such as accounts
payable, creditors for expenses and taxes [Link] are short
term liabilities generated on aren’t really considered as “debts”.
Basically, these kind operational liabilities would be there for all
companies.
QUICK RATIO
The first ratio is the Quick Ratio. This ratio gives you an idea how
easily the company can pay its current obligations – that is those bills
due in the next 12 months.
The Quick Ratio is cash, marketable securities and accounts
receivable divided by current liabilities (those due in the next 12
months). However, not all Current Assets are included in this ratio –
excluded are doubtful accounts receivables and inventory. Basically,
you are saying if all income stopped tomorrow and the company sold
off its readily convertible assets, could it meet its current obligations?
A Quick Ratio of 1.00 means the company has just enough current
assets to cover current obligations. Something higher than 1.00
indicates there are more current assets than current obligations.
It is important to compare companies with others in the same sector
because different industries operate with ratios that may vary from one
sector to another. Some industries such as utilities, for example carry
much more debt than other industries and should only be compared to
other utilities.
So, quick ratio is :
Current assets – doubtful debtors and inventory / Current
liabilities.
It’s also called ‘acid test ratio’ since it takes into account only those
assets of the company that can be converted to cash immediately.
That’s why even doubtful debtors or debtors which may delay payment
are excluded.
CURRENT RATIO
The second ratio is the Current Ratio. The Current Ratio is very similar
to the Quick Ratio, but broadens the comparison to include all Current
Liabilities and all Current Assets. It measures the same financial
strength as the Quick Ratio that is a company’s ability to meet its
short-term obligations.
Some analysts like the Current Ratio better because it is more “real
world” in that a company would convert every available asset to stay
afloat if needed. The Current Ratio measures that better than the
Quick Ratio.
Current ratio is computed as follows:
Current assets / Current liabilities.
Like the Quick Ratio, a current ration of minimum 1.00 or better is
good, and you should always compare companies in the same sector.
CASH RATIO
Talking about liquidity ratios, there is another ratio commonly
described in academic texts called cash ratio which measures the
liquid cash in hand against the current liabilities of the company. cash
ratio is computed by the equation-
Cash balance as shown in balance sheet / current liabilities
From the investor’s pint of view, only the current ratio is
relevant, because nobody is interested in the very short term liquidity
measurements of the company. In the very short term, stock
movements are more influenced by the demand, supply and
sentiments of the market participants. However, It would be nice to
know whether the company is sitting on huge cash reserves or not.
CONCLUSION
These three ratios, which you can find on any Web site that offer
quotes, tell you a great deal, about how a company may or may not
weather tough times. Low numbers in these ratios should be a red
flag when you are evaluating a stock.

Understanding PEG ratio

PEG RATIO
Popularized by the legendary Peter Lynch, It’s a ratio that will help
you look at future earnings growth You calculate the PEG by taking
the P/E and dividing it by the projected growth in earnings.
PEG = (P/E) / (projected growth in earnings)
For example, a stock with a P/E of 20 and projected earning growth
next year of 10% would have a PEG of 20 / 10 = 2.
WHAT DOES IT SHOW?
Consider this situation; you have a stock with a low P/E. Since the
stock is has a low P/E, you start do wonder why the stock has a low
P/E. Is it that the stock market does not like the stock? Or is it that the
stock market has overlooked a stock that is actually fundamentally
very strong and of good value?
To find the answer, PEG ratio would help. Now, if the PEG ratio is big
(or close to the P/E ratio), you can understand that this is probably
because the “projected growth earnings” are low. This is the kind of
stock that the stock market thinks is of not much value.
On the other hand, if the PEG ratio is small (or very small as
compared to the P/E ratio, then you know that it is a valuable stock)
you know that the projected earnings must be high. You know that this
is the kind of fundamentally strong stock that the market has
overlooked for some reason.
WHAT IS THE RIGHT PEG?
There are no hard and fast rules regarding the right PEG ratio.
Normally, A PEG Ratio of 2 or below is considered excellent. A PEG
Ratio of 2 to 3 is considered OK. A PEG Ratio above 3 usually means
that the company’s stock is over priced.
Technically speaking
If PEG ratio=1, it means that the share at today’s prices is fairly
valued.
If PEG ratio>1, it indicates that the share is possibly over-valued.
PEG ratio<1, it indicates that the share is possibly under-valued.
PROBLEMS WITH PEG.
The first problem is the P/E itself. Which P/E should be used for this?
Is it the trailing P/E or the forward P/E? What ever P/E you may use,
the ‘E’ factor in P/E is a number not fully trusted by analysts due to
the estimates that go with it.
Second, difficult part is the estimation of growth rate figures. Flaws in
estimating both these figures would affect the results obtained by the
PEG analysis.
What Peter Lynch has said in his one up on wall street is that “the P/E
ratio of any company that’s fairly priced will equal its growth rate”.
Therefore, according to him, a properly priced company will have a
PEG of 1. But what if the growth rate is 0? So, the ratio doesn’t work
well for all stocks . It works for a stock with normal rate of growth and
earnings.
CONCLUSION.
The two most important numbers that investment analysts look at
when evaluating a stock are the P/E ratio and the PEG ratio. The PEG
is a valuable tool for investors to use. It reveals whether the high price
of a stock is justified based on whether earnings will grow enough to
continue to drive the stock higher.
Technical Analysis 1.

Technicals vs Fundamentals.

“Before you invest, investigate.” William Arthur Ward (1921-1994)

author, educator
Two schools of thought.
Technical analysis and fundamental analysis are the two main schools
of thought in the financial markets. Technical analysis looks at the
price movement of a stock using chart and uses this data to predict its
future price movements. Fundamental analysis, on the other hand,
looks at various economic factors like Balance sheets, income
statements, ratios etc and tries to figure out companies worth investing
in. Our section on financial ratios and value investing intends to cover
fundamentals.
An investor who follows the fundamentals tries to find the ‘actual value’
of a company and invests when the market price is lower than the
actual value. Technical investor believes that all the fundamentals
factors are accounted for in the current stock price and hence there is
no need to further investigate into the fundamentals. Hence, they look
out for the trends using price charts and volume analysis. Basics of
technical analysis are covered in our technical analysis sections.
Who is right?
A common dilemma facing anyone who invests in the stock market is
whether one should buy shares based on the fundamentals of the
company, or one should follow the momentum of stocks as indicated
by technical analysis.
Fundamentals are very important. Without fundamentals the markets
would not move. Fundamental analysis focuses on understanding the
underlying enterprise – which involves analysing a company’s financial
statements, management competence, market share, competitors…
etc – and then valuing its shares based on an estimate of the future
cash flows it could generate. i.e. Fundamental analysis uses historical
and current data to estimate future stock returns and takes into
consideration economic data releases, events such as political
elections as well as individual company announcements that causes
the prices to move up and down or stay the same.
Technical analysis focuses exclusively on the study of market action.
Technical analyst assumes that all of this information is already
included into a stock’s price, so all a trader has to do is find out trends
in share price movements and volumes to make speculative decisions.
Technical analysis studies prices and volume by utilizing charts
whereas fundamental analysis is more concerned about whether the
company is a sound enterprise to invest in.
What should you do?
If your intention is to invest for a long period, say 5 years or
more, value or growth or GARP investing strategy would work
perfectly for you. All these strategies use fundamental analysis
as its base.
If your intention is to make as much profit as possible from your
investments over a short period of time, say 1 year, then you
need an investment strategy that takes into account both the
fundamental soundness of a business as well as the expected
movement of the shares of the company over the near term.
Fundamental analysis would help you to spot companies that are
doing well and technical movement of its share price would help
 you to predict the movement of shares over the near future.
If your intention is to invest for a very short period, better rely on
the technicals of fundamentally good companies. When you look
at the markets through technical eyes, you can quickly spot
changes in direction that aren’t obvious in fundamental terms.
The more longer the time frame, the more you rely on
fundamentals.

Stock investing strategy-Fundamental investing

FUNDAMENTAL INVESTING
As mentioned in the earlier posts, fundamental investing is all about
investigating the financial health of the company and its competitive
advantages. The financial health is judged by analysing the earnings
growth, revenues, debts, quality of management, profitability ratios,
cash flow etc..Apart from company specific data, they would also
study the macro economic factors that affect the company. Once the
financial position of the business is satisfactory, the fundamental
analyst would do a process called valuation and based on the results
he would proceed to fix a value for the company’s share. This value
would be taken as the benchmark for judging whether the stock is
undervalued or not. Fundamental analysts believe that when the
overall markets decline, fundamentally good stocks also decline below
what it’s actually worth giving rise to investment opportunities.

THE PROS AND CONS OF FUNDEMENTAL INVESTING

Fundamental analysis is good for long-term investors – ie, those who
are willing to wait patiently for their funds to grow. This time taken to
grow itself is its greatest disadvantage. Its difficult for most of the
investors to keep holding on to investments especially when the
markets are crashing.
We said it’s difficult- not impossible! A thorough grasp of fundamental
analysis can ensure that we stay calm and composed during market
volatility.
Fundamental analysis may offer excellent insights, but it can be
extraordinarily time- consuming. Analysing a company fundamentally
may take a lot of time. So, quick decisions may not be possible. This
delay in forming opinions may result in missing favorable chances to
buy stocks.
This method’s ability to increase your odds of success for a selected
security is greater than other methods. The relationships between
financial figures are tested by sound mathematical and statistical
methods. Hard and fast financial ratios are laid down by analysts to
find how sound a company is. Those that fail the ratio tests are
discarded, while those that pass are perceived as being credible.
There is no room for personal predilection or bias. Hence, when you
pick a fundamentally good share, your chance of success in investing
is also greater.
The usage of mathematical and statistical methods in fundamental
analysis also means that considerable amount of data is required to
test the significance of variables. Such data are often not easy to
acquire. Fundamental analysis also requires a considerable amount of
human labor – time and energy.
Great investors like Warren Buffett and John Neff are champions of
fundamental analysis. Fundamental analysis can help uncover
companies with valuable assets, a strong balance sheet, stable
earnings, and staying power.
One of the most obvious, but less tangible, rewards of fundamental
analysis is the development of a thorough understanding of the
business. After such painstaking research and analysis, an investor
will be familiar with the key revenue and profit drivers behind a
company. The advantage is that, the investor from there on, would be
in a position to quickly grasp the impact of laws, rules and regulations,
business agreements and changing business scenario on the share
price of the company.
FUNDEMENTAL ANALYSIS – APPROACHES.
There are basically two approaches to fundamental analysis.
Top-down approach:
Bottoms up approach.
In Top-down approach, an analyst investigates both international and
national economic indicators, such as GDP growth rates, energy
prices, inflation and interest rates. The search for the best security
then trickles down to the analysis of total sales, price levels and
foreign competition in a sector in order to identify the best business in
the sector.
In the second approach, an analyst starts the search with specific
businesses, irrespective of their industry/region.
In short, fundamental analysis is all about analyzing the company to
the roots.
Stock investing strategy: Technical investing

TECHNICAL INVESTING
Technical investing is the exact opposite of fundamental investing. The
word ‘technical’ is used because, this school of stock analysis believes
that all the fundamental factors that affect a company would be
reflected in the share price at any point of time. The price movement is
purely technical and has nothing to do with the fundamentals of the
company. If this assumption hold true, then there is no need to
analyse the stocks fundamentally. So, what remains to be analysed is
the demand and supply levels of the stock. For this, a technical
analyst has something called ‘price charts’ in which the daily price
movement of the stock along with the volume is recorded. This school
believes that emotions, reactions, and psychology of individuals
regarding economic events and news influence the demand and
supply of stocks and in turn, it is that demand and supply forces that
keep the market ticking.

Apart from charts, technical analyst employs a lot of tools like

Fibonacci numbers, moving average crossover divergence (MACD),
Williams %R, stochastic oscillators, momentum, directional movement,
on-balance volume (OBV), relative strength index (RSI), and moving
averages.
EFFICIENT MARKET THEORY.
Technical investors fundamentally believe in the efficient market
theory: It believes that all information on the markets, economy and on
individual stocks are known and are priced into the securities, and that
securities are fairly valued at all times.
The advantage of this system is that it’s easy to understand and use.
Unlike fundamental analysis which requires a detailed understanding
of financial and accounting terms, technical analysis focuses on trends
– graphically depicted on charts and graphs. It’s easy to understand
those graphs. It’s easy to find whether a stock is moving up, down, or
sideways. Technical indicators can sometimes point to the beginning /
end of a trend before it shows up in the market.
We believe that technical indicators can be used by short term
investors because; in that case, what matters are the trend and the
volume of activity. Both these are reflected more accurately on
technical charts.

Stock investing strategy- Value investing

In a nut shell….
In ‘Value’ investing approach, Investment decisions are made based
on the basis of valuation of a share. That is, the ‘Actual value’ of the
share is found out by certain calculations and the figure you get is
compared with the current market trading price. If the particular share
is undervalued it signals a good investing opportunity and if the share
in question is overvalued, it is better to stay off from investing in that
share. Whenever a share is undervalued by the market, analysts call
them ‘value shares’. This is the strategy of investing is followed by
masters such as warren buffet. Value investing is discussed in detail in
a separate chapter.
Where did value investing come from?
Value investing was started by a man named Benjamin Graham.
(1894 -1976). He was Warren Buffet’s mentor and author of some
great investing books. He is considered to be the father of Value
Investing.
What’s the concept all about?
Investors that follow this strategy believe that there are two values to a
stock. The current market price (which is influenced by market forces
and investor sentiments) and the ‘actual’ or ‘fair price’ (called intrinsic
value). Value Investors actively look out for shares of companies that
they believe have been undervalued by the market – that is the current
market price below the intrinsic value.
But why should a company’s share price be less or more than
what it is really worth?

The answer is – The market overreacts to good and bad news,

causing sharp movements in prices that do not correspond with
fundamentals of the company. This results in stock price movements
that do not correspond with the company’s long-term fundamentals.
The result is an opportunity for Value Investors to profit by buying
when the share price is low.
What does a Value Investor look for in a stock?

The Value Investor looks for stocks with strong fundamentals –

including earnings, dividends, book value, and cash flow – that are
selling at a bargain price, given their quality. The Value Investor seeks
companies that seem to be incorrectly valued (i.e. undervalued) by the
market and therefore has the potential to increase in share price when
the market corrects its error in valuation.
Value investors collect certain Financial and Non-financial datas about
the company, and by using those data, they derive at a conclusion as
to whether the share price is undervalued or not. Typically, they look at
stocks with high dividend yields, high book value or low price-to-
earnings multiple or a mixture of all three. It basically fundamental
analysis.
Value – the defensive strategy.
Value investors focus on the inherent strengths/weaknesses of
individual companies and as such market gyrations and macro-level
changes do not matter to them. The ‘margin of safety’ approach
ensures that the downside risk to investment is limited. However, value
investing should be applied with caution. Everything that appears
cheap may not be a good bargain.
Is a low priced share a value share?
Value Investing doesn’t mean just buying shares in a company where
the price is declining. It’s important to distinguish the difference
between a value company and a company that simply has a declining
price. A sudden drop in the share price of the company does not mean
that the share is selling at a bargain. The drop in price could be a
result of the market responding to a fundamental problem in the
company.
What are the sources to find value shares?
The best method is to do your own research. Those who do not have
time may try to locate them from the indexes or from 52 week lows list.
You may also validate shares of Industries that have recently fallen on
hard times, or are currently facing market overreaction to a piece of
news affecting the industry in the short term and try to spot one.
When can I find value shares?
Anytime. You have to keep analysing selected companies one by one.
But it’s hard to find value bargains in a bullish market. Value investors
go on an investing spree when the markets are down. They stay away
from the market when everyone’s in and they enter the market when
everyone’s washed out.
Why is this approach not used by everyone?
Only very long term investors can use the value investing approach.
The reasons are –
The length of time that may be required to find a target
Once invested, an investor should probably hold for years to
come. This means that an investor needs to have enough capital
to not be forced to sell a holding for other reasons
 An investor who follows and operates this method needs to have
considerable patience. Waiting on the sidelines for a long time
(probably many years) or holding on to an investment for a long
time (sometimes a decade!) before proving your skill is not an
easy trait to display
Value investment is a method of analysis that is very logical and
rational and therefore rather seductive to potential investors. But
the extreme dedication required to actually practice it makes it a
method that is only really used by professionals.
Are value stocks the best way to ensure capital preservation in
equities?
By their very nature as deeply discounted “on sale” securities, value
stocks are safer than most other equities. If you pick the wrong stock,
you don’t lose as much as other investors because the stock is already
scraping bottom.
At times, the fall in a stock’s price may be on account of impending
events such as a change in industry dynamics that are not captured in
its current financials. Investors who buy such a stock thinking it to be a
value pick may end up with a dud.
What are the Pros and cons of value investing?

Pros: Less risky approach.

“Hot” stock tips, hype, and mass hysteria do not affect the
decisions of a value investor.
Produces steady, consistent gains that regularly outperform the
Market Index
Cons: On the negative side, the potential returns for value
investing are smaller than those of growth investing.
Stock investing strategy – Growth investing

In a nut shell….

Growth investors, invest in companies that exhibit signs of above-

average growth. They don’t mind if the share price is expensive in
comparison to its actual value. ‘Signs of above-average Growth’ is
what growth investors try to spot. These signs gets revealed when you
study the fundamentals. This is the exact opposite of ‘value investing’
approach. In a nutshell, the difference between ‘value’ investing and
‘growth’ investing lies in the methodology adopted by the investors.
While the value investor looks for undervalued shares, the growth
investor looks for shares with higher growth potential.
What exactly is ‘growth’?

Benjamin Graham defined a growth share as a share in a company

“that has done better than average in the past, and is expected to do
so in the future.” Any company whose business generates significant
positive cash flows or earnings, which increase at significantly faster
rates than the overall economy, can be categorised under ‘growth’. A
growth company tends to have very profitable reinvestment
opportunities for its own retained earnings. Thus, it typically pays little
to no dividends to stockholders, opting instead to plow most or all of its
profits back into its expanding business. Software companies are
examples of growth oriented companies.

What’s the concept all about?

Investors who follow this strategy look for companies that exhibit huge
growth in terms of revenues and profits. Typically, this set of investors
looks for those in sunrise sectors (those in the early stages of growth)
hoping to find the next Microsoft. A growth investor may look into the
past year’s data to recognize the past growth rates and based on his
studies about the industry’s potential and company’s prospects; try to
estimate the future growth of the company. Investors look to spot a
company that grows at minimum 15% annually. If a stock cannot
realistically double in five years, it’s probably not a growth stock. That’s
the general consensus. This may seem like an overly high, unrealistic
standard, but remember that with a growth rate of 10%, a stock’s price
would double in seven years. So the rate growth investors are seeking
is 15% per annum, which yields a doubling in price in five years.
What does a Growth Investor look for in a stock?

Low dividend yields, high price-to-earnings ratio or high sales-to-

market capitalisation ratio or a mix of all. For identifying stocks with
high potential, growth investors look at key variables such as rate of
growth in per share earnings over the last five-10 years, expected
growth in earnings over the next five years or so, operating and net
profit margins and business efficiency. A growth investor would target
a company that’s growing at 15%-40% year on.
On a macro level, factors such as the stage in business cycle in which
the industry operates, its relative attractiveness, and the positioning of
the company in the competition matrix form part of the investment
analysis. They then look at the current price and determine if it reflects
the growth potential of the company’s business.

Growth – the risky strategy.

As growth investing often involves taking exposure to companies that
trade at high valuation levels, the downside risk is relatively high.
Sometimes, owing to their unproven business models, these
companies could be sensitive to changes in market movements and
business cycles.
Is a sky rocketing share a growth share?

Not necessarily. Share prices can move up due to various reasons

including fraudulent practices. High price is never a criteria for spoting
a growth share. What matters is the rate of growth in the past years
and the future prospects of the industry in which the company is in.
What are the sources to find Growth shares?

The best method is to do your own research. Most growth stocks can
be spotted in the small cap and mid cap indexes. It is the growth rate
that finally makes them large caps. Try to spot new companies that
come up with innovative ideas – for example in medical Pharma
industry. Watch companies that have grown from small cap to mid
caps. Watch companies that breach all time high levels. Investigate
why the prices sky rocketed. You may also validate shares of
Industries that are currently facing market overreaction to a piece of
news affecting the industry in the short term and try to spot one.
Is this approach popular?

Yes. If warren buffet is popular for his value investing strategies, Peter
lynch is one of the greatest growth investors. Both he strategies are
being used by investors according to market conditions worldwide.
What are the Pros and cons of Growth investing?
Pros:The biggest advantage of this approach is Potential for
 incredible returns in a short period of time
Cons:On the negative side, these shares carry the potential for
huge losses.
Market downturns hit growth stocks far harder than value stocks.
Failure to relate the stock price to the company value leads to
purchasing overvalued stocks
Hot stock tips, rumors, hype, and market hysteria are not reliable
sources of information to act upon

Which is better? Value or growth?

Both has its pros and cons as mentioned in our lessons. In value
investing, the investor has to ensure correct stock valuation as well as
the right time of entry – both being equally vital as he would not like to
get too early into a stock.
In growth investing, it is essential for the investor to identify
businesses that face little threat of erosion so that earnings growth of
those companies is not impacted. Growth investors are generally in for
short time frame compared to value investors. In general, value stocks
tend to hold up better during stock market downturns.
An investor having a high-risk appetite is more likely to choose a
growth strategy. While a defensive investor would choose to take the
value investing route.

Stock investing strategy- GARP

GARP investing was popularized by legendary Fidelity manager Peter

Lynch. Growth at Reasonable Price (GARP) is a combination of both
growth and value investing. While a growth strategy is more focused
on a company’s earnings growth and value investing seeks companies
having their prices below their intrinsic value, growth at reasonable
price as a strategy, hunts for stocks that have both a growth potential
and are also trading at a reasonable price. A typical GARP investor
seeks to invest in companies that have had a positive performance
over the past few years, and also have positive projections for the
upcoming years.
What Is an Ideal GARP Stock?

In fact, the ideal GARP style stock would be one with above average
growth potential in earnings and revenue for the future, greater than its
peers in its industry group, but would also happen to be trading at a
value or lower price than its fundamental analysis valuation target.
A GARP investor would buy stocks that are priced lower (but not as
low as possible) than their fundamental analysis target but that also
have good future prospects of growth in cash flow, revenue, earnings
per share and so on. In other words, a GARP investor tries to find
stocks that will rise in value for two specific reasons:
Stock is priced under valuation target: One, if a stock is priced
under its fundamental analysis valuation target, then over time,
the stock should rise to that consensus target of what it is
intrinsically worth, or its intrinsic value.
Stock has above average earnings potential: Second, if the stock
has above average potential for earnings or revenue growth in
the future, then the price of the stock should rise as the company
grows in value, makes more sales, and increases its revenue
and earnings per share in the future.
PEG and ROE ratio- The benchmarks for a GARP investor.
A solid benchmark to spot a GARP stock is PEG ratio or
price/earnings growth ratio. The PEG shows the ratio between a
company’s P/E ratio (valuation) and its expected earnings growth rate
over the next several years. A GARP investor would seek out stocks
that have a PEG of 1 or less, which shows that P/E ratios are in line
with expected earnings growth. This helps to uncover stocks that are
trading at reasonable prices.
Another ratio that’s relevant for a GARP investor is the Return on
Equity percentage. Finding companies that have a consistently high
ROE generally shows that you are dealing with good management
and a strong business.
GARP is all about finding rapidly growing companies that are available
for low PE multiples. If an investor gets it right, this strategy could yield
multi baggers in due course of time because of two factors. One, the
growth of the company and its per share earnings would increase over
a period. Two, because it shows sustained growth over many years, its
price to earnings ratio would get re-rated.
Advantage GARP.
A GARP investor will have a hybrid investment style that allows
for some of the principles of a value investor and some of the
principles of a growth investor-Truly the best of both worlds.
In value investing, one might miss a potentially good quality
stock trading at reasonable valuations; one is more likely to spot
the opportunity under the GARP style of investing.
Owing to the strategy employed by GARP, an investor is more
likely to see his returns to be more stable than those of either a
pure growth or value investor.
In a bull trend, it is the growth investor who will stand to benefit
the most, followed by GARP and value investor.
In a bear run, the growth stocks will see big falls in their value
 than the GARP or value stocks.
Thus irrespective of the market movements, the GARP investor
would strike the golden mean. His investments would yield
reasonable returns
Conclusion.
GARP is a balanced approach to investing. It tends to combine the
positives of value and growth strategies. A GARP investor wants a
stock that’s not priced too high or too low, but one that is slightly priced
lower that perhaps it should be and that also has good prospects for
future growth– but not so much that the stock is overpriced or the
future projections are too high.

Stock investing strategy- Index investing

INDEX INVESTING
You know what a stock index is. Sensex, Nifty etc are stock indices.
Index investing is all about having the same combination of shares in
the same ratio as the target index so that it replicates the index itself.
A change in holdings happens only when a company enters or leaves
the index.
The biggest attraction of this strategy is that it is a humble approach.
Thousands of companies are listed in the stock exchange. If you were
to start analysing the fundamental aspects of each and every
company or even a selected group of companies, it would be a
daunting task. Quite difficult even for experienced investors. Research
and analysis takes a lot of time and hard work. In such a scenario,
Index investing works as a much easier way to invest in stocks. It
provides the opportunity to invest in a diversified portfolio which would
give you some decent returns. This strategy will not beat the market
returns, but makes sure that you do get at least the returns offered by
the market. It’s essentially a passive form of investing.

WHAT’S THE ADVANTAGE?

A stock, to be included in the index has to pass through various quality
filters set by the securities exchange board. So when you invest in an
index, the quality of stocks is almost assured. Your money goes into
investing in some of the largest companies in the economy.
The liquidity factor is high. All segments of investors trade in the index
in cash or in the derivatives segment and hence there is no lack of
liquidity.
And, of course, you need worry about the timing of your entry. It’s easy
to track an index. All you need to know is about the macro economic
factors and enter when the index has hit a reasonable low.
However, there are some negative sides also. For example, the best
performing stock may not the one that’s included in the index. So you
miss the opportunity of not investing in a high performance company.
When you compute the opportunity cost, it might be on the higher
side.
A second disadvantage is that, within the index, certain large
corporations dominate. A group of 3 or 4 companies may have a
combined weight of more than 40% of the index. For example ITC,
Reliance, Infosys, HDFC and ICICI bank constitute approximately 40%
of the Sensex. So, if these 5 companies don’t perform, the index
strategy will suffer.
WHERE TO START?
You need not make long list of stocks that are included in the index,
find out the percentage of weight and then invest your money in the
same ratio of the index which you are going to follow. That’s not the
idea behind index investing.
Index investing works in a different way. It works through the mutual
funds route. There are many index mutual funds in the market and one
can subscribe to any one of them to follow this strategy.
For example The Franklin India NSE Nifty tracks and invests in the
nifty stocks, the Kotak Sensex ETF tracks the Sensex stocks. There
are many more index funds in the market. The combination of stocks
in the index decides where the fund would be invested by the fund
manager and hence the index fund manager’s job is only to adjust the
funds according to changes in the Index. The NAV (Net asset value) of
a well managed Index scheme should be directly proportional to the
index they follow. If not, it means that there is some sort of tracking or
fund managing errors.
So, if you do not have the time or patience to analyse stocks but want
to participate in the growth of the markets, index investing is for you.
You are assured of approximately the same returns of an index.
Stock investing strategy-Momentum investing

What is it?
Simply put, it assumes that prices tend to trend in one direction, even
if there is no fundamental reason for it to do so. It works similar to a
roller coaster ride, when a roller coaster falls down a steep slope it
tends to build up momentum, so it can do things like spinning around
in loops without actually having to use any mechanical help. The
momentum alone is able to push the cart.
Stocks move in a similar way, some good fundamental news can push
the stocks up and start an upward trend. The pure momentum of that
trend can push the stock higher and higher, well above what the true
value of the stock actually is.
Successful traders such as Nicholas Darvas (who turned $10,000 into
$2,000,000 in 18 months), Jessie Livermore and Ed Seykota (Who
has made an average of 60% over a 10 year period) all made their
amazing gains following this strategy of momentum.

Why Does momentum investing Work?

The reason why momentum strategy works is that no one wants to be
left out. When a stock starts trending up, investors and mutual fund
managers fear that they are going to miss the next big move so they
start jumping in. This pushes the stock even higher and so on.

Is it practical for you?

Momentum investing relies on technical data rather than
fundamentals. Momentum investing can work, but it is may not be
practical for all investors. When you purchase a stock that is rising or
sell a stock that is falling, you will be reacting to older news than the
professionals at the head of momentum investing funds. They will get
out and leave you and other unlucky folks holding the bag. If you do
manage to time it right, you will still have to be more conscious of the
fees from turnover and how much they will eat up your returns.
Conclusion
Momentum investing is not necessarily for everyone, but it can often
lead to impressive returns if done properly.

Stock investing strategy-CAN SLIM

Hi there,
CAN SLIM is a stock investing strategy developed by William O’Neil.
O’Neil reportedly has made millions by consistently using this
approach. Given below is my explanation of the method. I have kept
things simple as possible.

WHAT IS CAN SLIM?

CAN SLIM is a stock picking strategy that combines both technical

analysis and fundamental analysis. CAN SLIM is an acronym. Each
letter stands for a quality that a potential stock should pass. It trys to
identify stocks that are likely to rise in price and have a high potential
for profits. It’s basically a growth investing strategy, works well in bull
markets. Basically the technique boils down to the following three
steps-
Follow the overall market trend, buy when it is going up
Search within the best industry groups and narrow to the top
stocks within each group fundamentally and technically.
Control your asset allocation and buy the best stocks when they
break out. Use a 7% to 8% stop loss.
THE 10 STEPS.
T0 pick a stock using CANSLIM method, there are 10 calculations to
be made. Those are:
(1) EPS growth last quarter vs. a year ago.
(2) EPS growth prior quarter vs. a year ago.
(3) Sales growth last quarter vs. a year ago.
(4) Annual EPS growth rate of 3 years
(5) Long term EPS growth estimate.
(6) Annual cash flow per share vs actual earnings per share.
(7) Price as a percentage of 52 week high.
(8) 52 week relative strength percentile.
(9) Number of Institutional share holders.
(10) NET institutional share purchased.
Those stocks which meets the criteria as mentioned below using the
above 10 figures are considered to be potential candidates for
investment according to this method.
HOW TO PERFORM CAN SLIM STOCK SCREENING.

C = Current Quarter Earnings

There are 3 figures to be used in this section. Those are the first 3
figures as mentioned in the list above. All three are connected with
earnings and revenues.
Earnings should be up by 18-20% over the same quarter 1 year
ago. And, there must be positive earnings in this quarter –
excluding special one time events. It is important to compare with
the same quarter a year ago. For example- this year’s second
quarter to last year’s second quarter. The reason for doing this is
that many firms have seasonal patterns to their earnings.
As already said, remember to exclude one time events which
may distort the actual trend in earnings and make the company
performance look better or worse.
Look for increasing RATE of growth in quarterly EPS (consider
selling stock if it has a slowing growth rate for 2 quarters in a
row).
Same quarter sales growth greater than 25% (or at least
accelerating over the last 3 quarters)
Earnings growth rate from quarter 1 year ago compared to latest
quarter should be higher than similar quarter 1 year earlier.
A = Annual Earnings
There are 3 figures to be used in this section. Figures 4 , 5 and 6 are
connected with annual earnings of a company. The benchmarks are:
Annual EPS must increase in each of last 3 years
The method also recommends an annual growth rate of 25%
 over last 3 years for a [Link] earnings estimate for
next year should be higher than actual earnings of current year.
ROE of 17% or better preferred.
Look for annual cash flow per share greater than the actual
earnings per share by atleast 20%.
N = New Products, New Management, New Highs
The next two sections are basically qualitative analysis section. Those
stocks which have passed the ‘C’ and ‘A’ are further checked for the
following qualities:
Stock should be within 10% of 52 week high price.( figure 7)
Stocks that hit new highs on big volume worth looking at.
Stocks that hit new high after undergoing a period of price
correction and consolidation are interesting candidates.
Look out for companies with a major new product or service or
new management which is positive for the industry.
S = Supply and Demand
Stocks with a good percentage of ownership by top management
are good.
Companies that announce stock buy back plans are good.
Look for companies with a lower debt-to-equity ratio or
companies lowering the debt to equity ratio over the last few
years. It implies that the company generates enough cash to pay
off part of it’s debts every year.
When choosing between two stocks, stocks with a reasonable
number of shares outstanding will in all probability out perform
older large capitalization stocks.
L = Leader or Laggard
Figure number 8 from the above list is used here.
Buy among the best 2 or 3 stocks in a group.
Relative Strength of 80% or better. I.e. the price performance for
 a given time and their percentage ranking among all stocks.
Buy among best 10-15 groups out of nearly 200.
I = Institutional Sponsorship
Figures 9 and 10 are to be used here-
Numbers of shares purchased by institutions should be greater
than or equal to the number of share sold by institutions over the
last quarter
Look for companies that have at least 10 institutional investors
invested in it.
Look for stocks with increasing number of institutional investors.
Always be careful not to consider stocks with a very large single
institutional ownership.
M = Market Direction
Do NOT fight the trend. Determine if you are in a BULL or a
BEAR market.
Understand the general market averages every day.
Try to be 25% in cash when market peaks and begins major
reversal.
Heavy volume without significant price movement MAY signal a
top.
Follow market leaders for clues on strength.
Divergence of key averages/indexes point to weaker/narrow
market movement.
Now, the Final rule – do NOT buy breakouts in a BEAR market.
CONCLUSION
A stock that meets all the requirements as mentioned above is an
ideal candidate for investing. That’s CAN SLIM for you.

Stock investing strategy: Contrarian Investing.

Following a strategy of going against the current views of the majority
investors is called contrarian investing. Why do such investors take a
contrary view? Because, they believe that certain consensus among
investors can lead to wide mispricing in securities markets.
For example: A wide spread negative news or rumours about a stock
may send the prices of that stock crashing. These investors try to spot
such stocks and invest in it resulting in above average returns.

CONTRARIAN -THE BOLD APPROACH

A true contrarian is neither bullish nor bearish on securities. A
contrarian investor takes a bold approach. The goal of a contrarian
investor is to profit from the mis-pricing that an irrational market
creates. Something similar to value investing. The only difference here
is that, this approach relies more on market sentiments and investor
behaviour. Contrarian investing has more opportunities in markets
which are emerging out of a bear phase. Typically, in such markets
many stocks, which have a strong growth potential, quote at attractive
valuations primarily because investors widely extrapolate news flow
and performance of the recent past.

MISPRICED STOCKS

Contrarian investing works because of the psychology of market

participants. During the beginning of a trend, buyers are cautious, and
the more seasoned players are the primary participants. As the trend
gains traction, more and more investors become aware of it, deploying
more capital to take advantage of the market’s strength. Then at the
end of the trend, when everyone who’s interested in buying into the
trend already had — with no more available capital to sustain the
already inflated prices, it’s incredibly easy for a panic to make stock
prices tumble down.
A perfect example of this was the 2008 market crash. The trend
started and it continued till all those who were interested in buying into
the trend has put in their money. Then, Stocks sold off hard, all the
seasoned players made money and the crowd was left with stocks
purchased at higher prices. The prices of stocks tumbled and the
crowd, unable to hold on, sold their stocks suffering heavy financial
loss. At this point, the smart guys step in again and then, dramatically
the stock regains much of that lost ground in 2010. This was a classic
case of the crowd dramatically shifting sentiment. Those who thought
opposite to what the crowd thought would have definitely made lot of
money.

DOES IT WORK IN INDIAN MARKETS?

Emotions play a huge part in Indian stock markets. Right from

horoscopes to palm reading and tarot cards, there’s lot of ‘shastras’
that Indians rely on to take financial decisions. Otherwise, the stock
market wouldn’t have crossed 21000 in January 2008, tumble to 7600
points in October 2008 and then again cross 21000 in November
2010. More than earnings data, sentiments played a major role in this
huge fluctuation.
According to Mr. Ved Prakash of Tata mutual fund, “The strategy of
contrarian investing works in most markets. Contrarian investing
focuses on looking at companies with a long-term potential who are
out of favour either because they are misunderstood or because their
short-term expected performance is below market expectations or
there is short-term negative news flow which is clouding the otherwise
strong potential of the business”.
So, where emotions or expectations are high, contrarian approach
works well. The crowd will always be caught on the wrong side when
the market turns upside down.
SPOTTING THE TURNING POINTS

So, then, if turning points are where the crowd is wrong, the biggest
challenge is spotting them. You can spot turning points through
fundamentals or technicals or by studying the general economic
indicators.
1. Valuation
The theory behind valuation is simple. Buy when stocks look
fundamentally cheap. Sell when the stock is expensive. Valuation,
however, is not an easy process. It requires a strong understanding of
fundamental analysis; it also requires its practitioner to attempt to
make an objective decision about a subjective topic like “value.”
2. Technical Analysis

Another option for contrarians is to use technical analysis to spot

reversals. Momentum, trend breaks, volumes, RSI all come into play
here.
3. Quantitative and Economic Indicators

The last method skips looking directly at a security’s price and looks at
broader economic indicators such as volatility index to spot
turnarounds.
CONCLUSION.
Tracking these indicators- not any one of them –but all of them
together, may help you to take a contrary position before the market
starts to correct itself. Successful contrarians realize that turning
points are key. So next time, I hope this little advice would help you to
avoid getting trapped in a market crash and at the same time help you
to spot turnarounds and profit from it.
Technical Analysis-2

MEANING
Technical analysis is a completely different approach to stock market
investing- it doesn’t try to find the intrinsic value of a company or try
to find whether a share is mis-priced or undervalued. A technical
analyst is interested only in the price movements in the market. So, it
all about analyzing the demand and supply or a price volume analysis.
TECHS VS FUNDAS
Technical analysis is a study of supply and demand in a market to
determine what direction, or trend, will continue in the future. Investors
who follow fundamentals try to spot shares that has the potential to
increase in value, while investors who follow technical analysis buy
assets they believe they can sell to somebody else at a greater price.
Although technical analysis and fundamental analysis are seen by
many as polar opposites – many market participants have experienced
great success by combining the two. There are distinct advantages for
both the schools of thought. it’s better to be versed with the pros and
cons of both and take advantage of both the schools.
The purpose of mentioning technical trading tools here is to help you
understand the relevance of technical terms used by experts in the
stock recommendations. Technical analysis requires special charting
software to accumulate data and convert it into information. Generally,
online trading software offered by leading brokers has options to do
technical analysis.
CHARTS -WORKING TOOLS OF A TECHNICAL ANALYST.
A technical analyst works with the help of ‘charts’. A chart is nothing
but a graphical representation of the current price movement of a
stock. There are various forms and styles of charts and it represents
graphically almost anything and everything that takes place in the
stock market.
BASIC ASSUMPTIONS
Technical analysis is based on three assumptions:
MARKETS DISCOUNTS EVERYTHING.
Technical analysis assumes that, at any given time, a stock’s price
reflects everything that has or could affect the company –
including fundamental factors. Technical analysts believe that the
company’s fundamentals, along with broader economic factors
and market psychology, are all priced into the stock, removing the
need to actually consider these factors separately. This only leaves the
analysis of price movement, which technical theory views as a product
of the supply and demand for a particular stock in the market.
PRICE MOVES IN TRENDS
In technical analysis, price movements are believed to follow trends.
This means that after a trend has been established, the future price
movement is more likely to be in the same direction unless something
happens to change the supply -demand balance. Such changes will
take time and are usually detectable in the action of the market itself.
Most technical trading strategies are based on this assumption.
HISTORY TENDS TO REPEAT ITSELF
Another important idea in technical analysis is that history tends to
repeat itself, mainly in terms of price movement. The repetitive nature
of price movements is attributed to market psychology; in other words,
market participants tend to provide a consistent reaction to similar
market stimuli over time. Technical analysis uses chart patterns to
analyze market movements and understand trends. Although many of
these charts have been used for more than 100 years, they are still
believed to be relevant because they illustrate patterns in price
movements that often repeat themselves.
Types of Charts

We said in the first section that Charts are the working tools of the
technical analyst and they have been developed in various forms and
styles to represent graphically almost anything and everything that
takes place in the stock market.
There are three main types of charts that are used to analyse price
movements. They are – the line chart, the bar chart and the
candlestick chart.
LINE CHART
Line chart is the simplest of the three charts. A simple line chart draws
a line from one closing price to the next closing price. When strung
together with a line, it reveals the general price movement of a share
over a period of time.
BAR CHARTS
The most basic tool of technical analysis is the bar chart. This chart
displays basic market price data over a defined period of time. Daily
bar charts note the open, high, low and closing price of an asset.
Rising vertically, the bar marks the high and the low of a given time
period, with the starting price marked by a horizontal line, or tick, to
the left and the ending or closing price marked by a tick to the right.
Structure of a bar chart

CANDLESTICK CHART
Another type of chart used in technical analysis is the candlestick
chart, so called because the main component of the chart
representing prices looks like a candlestick, with a thick ‘body’ and
usually a line extending above and below it, called the upper
shadow and lower shadow, respectively. The top of the upper shadow
represents the high price, while the bottom of the lower shadow
represents the low price. Patterns are formed both by the body and
the shadows. Candlestick patterns are most useful over short periods
of time, and mostly have significance at the top of an uptrend or the
bottom of a downtrend, when the patterns most often signify a reversal
of the trend.
While the candlestick chart shows basically the same information as
the bar chart, certain patterns are more apparent in the candlestick
chart. The candlestick chart emphasizes opening and closing prices.
The top and bottom of the real body represents the opening and
closing prices. Whether the top represents the opening or closing price
depends on the color of the real body—if it is white/ blue/green, then
the top represents the close; black / red or some other dark color,
indicates that the top was the opening price. The length of the real
body shows the difference between the opening and closing prices.
Obviously, white/green/blue real bodies indicate bullishness, while
black/red real bodies indicate bearishness, and their pattern is easily
observable in a candlestick chart.
Structure of a candlestick chart

CONCLUSION
What we know so far is about the types of charts. While line charts are
the simplest form of charts, candlesticks are more advanced and they
reveal stories not detected with other charts. Whether you use a line
chart or candlestick chart, you need to draw trend lines to find out
direction of the stock prices. More about that in the next section- trend
lines.
Trendlines

TREND
‘Trend’ in technical analysis means direction. It is one of the most
important concepts in technical analysis. After plotting the stock prices
on a chart, a line is drawn through the price movement to identify the
direction of price. It’s called ‘trendline’ and it could slope either
downwards or upwards.
A principle of technical analysis is that once a trend has been formed,
it will remain intact until it’s broken. When there is little movement up
or down it’s a ‘sideways’ or ‘horizontal trend’ .If you observe financial
magazines or channels you might recall experts saying about
‘sideways movement’ in stocks A sideways trend is actually not a
trend on its own, but a lack of a well-defined trend in either direction.
In any case, the market can move only in these three ways: up, down
or nowhere.

LENGTH OR TIME FRAME OF A TREND

Trend lines can move in a same direction for any length of time until
something major happens in the market that brings a change in the
demand -supply balance and hence a change in price direction. A
trend of any direction can be classified as a long-term trend,
intermediate trend or a short-term trend depending on the time frame
we are talking about.
In terms of the stock market, a major trend (long term trend) is
generally categorized as one lasting longer than a year. An
intermediate trend is considered to last between one and three months
and a near-term trend is anything less than a month.
A long-term trend may be composed of several intermediate trends,
which often move against the direction of the major trend. If the major
trend is upward and there is a downward correction in price movement
followed by a continuation of the uptrend, the correction is considered
to be an intermediate trend. The short-term trends are components of
both major and intermediate trends. See the graph below:
As explained earlier, a long term trend is one which lasts for a year or
more .So in order to analyze the long term direction of a stock you
need to take the stock chart of a year or more. Similarly to analyze a
medium term trend you need to check the graph for a 6 month period
or so. Short term trend can be analyzed by taking the graph for a short
period ,say 10 or 30 days . In short, a stock chart should be
constructed to best reflect the type of trend being analyzed.
DRAWING A TREND LINE
Drawing trend lines are the basics of technical analysis. The
explanation on how to draw may be confusing to a learner, but in
actual practice it’s no big deal. In an uptrend analysis, draw a line
from the lowest low, up and to the highest minor low point preceding
the highest high, so that the line does not pass though prices between
the two low points. This when completed will be an ‘upward trend line’
similarly , To draw a downward trend line , draw a line from the
highest high, down and to the lowest minor high point preceding the
lowest low, so that the line does not pass though prices between the
two low points .
You may also refer to the figure given above. The blue line starts from
the lowest low and up to the ‘highest minor low’ point preceding the
highest high and the downward trend line represented by the red line
starts from the highest high and down to the lowest minor high point
preceding the lowest low point.
That’s about trend lines. Drawing trendlines is just the beginning. To
move further, you need to learn something called ‘support and
resistance levels’ more about that in our next section.

Support and Resistance

Hi there,
As i said in my last section, the next major concept is that of ‘support’
and ‘resistance’. These are two terms that are used very frequently by
stock analysts.
To put in very simple terms -Support is the price level below which a
stock is not expected to fall. Resistance, on the other hand, is the price
level which a stock is not expected to surpass.
You also need to go thru the next topic on ‘volume’ to fully understand
the concept of support and resistance.
SUPPORT AND RESISTANCE
Support is the price level at which demand is thought to be strong
enough to prevent the price from declining further. The logic is that,
when the price declines, there will be more demand for the particular
share. By the time the price reaches a particular level (called support
level), it is believed that demand will overcome supply and prevent the
price from falling below support
Resistance is just the opposite of ‘support’. A Resistance is the price
level at which selling is thought to be strong enough to prevent the
price from rising further. The logic behind the theory is that , as the
price advances , sellers become more inclined to sell and buyers
become less inclined to buy. By the time the price reaches a particular
level (called the resistance level) it is believed that supply will
overcome demand and prevent the price from rising above resistance.
In the book “Trading for a Living,” Dr. Alex Elder gives a simple, but
effective image of support and resistance – “A ball hits the floor and
bounces. It drops after it hits the ceiling. Support and resistance is like
a floor and a ceiling, with prices sandwiched between them.” When a
stock’s price has fallen to a level where demand at that price increases
and buyers begin to buy, this creates a “floor” or support level. When a
stock’s price rises to a level where demand decreases and owners
begin to sell to lock in their profits, this creates the “ceiling” or
resistance level.
Shown below is a typical share price movement on a chart. The two
lines drawn horizontally are called trendlines. The red arrows illustrate
‘resistance’ or ‘ceiling’. As you can observe, the price fails to pass
above that particular level. Similarly the blue arrows illustrate ‘support’
level or ‘floor’ beyond which the price fails to fall.

HOW TO RECOGNIZE SUPPORT AND RESISTANCE.

You can identify support and resistance levels by studying a chart.
(See the chart above) Look for a series of low points where a stock
falls to this level, but then falls no further. This is a support level. When
you find that a stock rises to a certain high, but no higher, you have
found a resistance level.
The more times that a stock bounces off support and falls back from
resistance, the stronger these support and resistance levels become.
It creates a self-fulfilling prophecy. The more often it happens, the
more likely it is to happen again. The more those historical patterns
repeat themselves, the more traders “know,” and the more confident
they become in forecasting the future behavior of the stock.
ROUND NUMBERS
One type of universal support and resistance that tends to be seen
across a large number of securities is round numbers. Round
numbers like 10, 20, 35, 50, 100 and 1,000 tend be important in
support and resistance levels because they often represent the major
psychological turning points at which many traders will make buy or
sell decisions.
Buyers will often purchase large amounts of stock once the price
starts to fall toward a major round number such as Rs 50, which
makes it more difficult for shares to fall below the level. On the other
hand, sellers start to sell off a stock as it moves toward a round
number peak, making it difficult to move past this upper level as well. It
is the increased buying and selling pressure at these levels that makes
them important points of support and resistance and, in many cases,
major psychological points as well.
THE IMPORTANCE OF SUPPORT AND RESISTANCE
Support and resistance analysis is an important part of trends
because it can be used to make trading decisions and identify when a
trend is reversing. For example, if a trader identifies an important level
of resistance that has been tested several times but never broken, he
or she may decide to take profits as the share price moves toward this
point because it is unlikely that it will move past this level.
THE PSYCHOLOGY BEHIND SUPPORT AND RESISTANCE
To understand the psychology behind support and resistance, we
need to first categorize market participants. Market participants can
typically be classified into:
1) The longs -traders who have a ‘BUY’ position and stand to profit if
prices increase.
2) The shorts -traders who have a ‘SELL’ and stand to profit if prices
decrease.
3) Traders who got out of their previous positions prematurely.
4) Traders who are undecided on which side of the market to be on
and are looking for entry points either on the short side or the long
side.
Assuming now, that prices start advancing from a support area, the
longs who bought around this area would have regretted not buying
more. So, every time prices come back to the support area, they
would likely decide to buy more.
Traders on the short side however, would have likely realized that they
are on the wrong side of the market and they would be hoping for
prices to come back to the support area where they entered their short
positions so that they can get out and at least break even.
The traders who had previously got out of their long positions at the
support area would likely be annoyed at themselves for getting out too
early and would thus be looking for a chance to get into a position
again at or around the support area.
The traders who were previously undecided on which side they
wanted to be on would likely decide to want to enter the market on the
long side after observing the advance in prices. As such, they would
be looking to enter whenever there is a good buying opportunity, which
is at or around the support area.
These traders now all have the same resolve to buy should a good
opportunity present itself and should prices decline to the support
area, there would be buying taking place by all four groups which
would result in prices being pushed up.
ROLE REVERSAL
Once a resistance or support level is broken, its role is reversed. If the
price falls below a support level, that level may become resistance. If
the price rises above a resistance level, it may often become support.
As the price moves past a level of support or resistance, it is believed
that supply and demand has shifted, causing the breached level to
reverse its role. For a true reversal to occur, however, it is important
that the price make a strong move through either the support or
resistance.
In almost every case, a stock will have both a level of support and a
level of resistance and will trade in this range as it bounces between
these levels.
NUMERICAL WAY TO CALCULATE SUPPORT AND RESISTANCE
There are many ways to calculate levels of support and resistance
(Pivot point method, Moving averages, Fibonacci numbers etc). One of
the most common is to use a series of formulas to calculate “pivot
points”, described herein
Calculate the pivot point as follows, using the previous day’s high, low,
and close:
Pivot or P = (High + Low + Close) / 3
Calculate the first support point (S1) = (P x 2) – H
Calculate the second support point (S2) = P – (High – Low)
Calculate the first resistance point (R1) = (P x 2) – Low
Calculate the second resistance point( R2) = P + (High – Low)
Adjusted Pivots
Many traders adjust their value for P as follows:
O = Today’s Opening Price
P = O + (H + L + C) / 4 (where H, L & C are from the previous
day’s stock details)
Pivot points are short-term indicators, and ultimately it is the trader’s
responsibility to use them wisely, in conjunction with other confirming
indicators. Pivot points keep changing everyday since it’s based on
daily data.
That’s about support and resistance. in the next section, we will
discuss about the importance of ‘volume’ in technical analysis.
Importance of Volume in Technical Analysis

VOLUME
Volume is simply the total number of buyers and sellers exchanging
shares over a given period of time, usually a day. Higher the volume,
more active the share. The data regarding volume of a share will be
readily available on your online trading screen. Most financial sites
carry data about volume.
For example if the Stocks volume for the day was 1,500,000 shares
that means 1,500,000 shares were sold by someone and bought by
someone on that day.
Volume as such may not be an attractive piece of information. But try
to combine the volume data with support and resistance levels – you‘ll
get the real picture.
For example – Say stock A ltd broke a ‘resistance level’ and went up
further. Also since it broke through a critical level we would expect it to
go up even more in the near future.
Now, let us also consider the volume traded on that day – say 3 lakh
shares were exchanged. On a normal day 1o lakh shares are
traded. That means, Volume was way below average for that day. So,
all the big investors were not trading. They could come in the very
next day and decide they are bearish on the stock. They sell and
cause a panic. So the stock goes down the next day.
This is the importance of ‘volume’. Most traders will not buy a stock
when it breaks a critical level unless volume is high. The reverse is
also true. If a stock goes down with little volume it could mean the
same thing. The majority of investors were not trading. When they
come back they could see this stock and decide it is too low. So
they buy it and the price goes up.
In short, Volume is a critical factor in technical analysis. Any support
and resistance level is not valid unless it is backed by adequate
volume. Volume should move with the trend. If prices are moving in an
upward trend, volume should increase (and vice versa). If the previous
relationship between volume and price movements starts to
deteriorate, it is usually a sign of weakness in the trend. For example,
if the stock is in an uptrend but the up trading days are marked with
lower volume, it is a sign that the trend is starting to lose its legs and
may soon end.
TIPS ON VOLUME ANALYSIS
Investors must always look at price patterns in conjunction with
their associated volume pattern, never alone. A stock may
appear to go up but the volume pattern must confirm that
analysis
Careful analysis of the volume of selling that occurred above
current resistance will help you estimate how long a stock will
stall at that level
Well-above-normal volume is essential when separating a true
from a false breakout above resistance.
If a stock is truly in a healthy uptrend, then volume should rise as
prices rise. If this is the case, then the volume indicates that
buyers are chasing the stock. This increases the probability that
the uptrend will continue.
Hope you are now clear about volume and it’s importance.
A study of chart patterns

One of the basic assumptions of technical analysis is that- history

repeats itself, mainly in terms of price movement. Chart patterns are
graphical representations of historical price movements of stocks. So,
when you analyse those price movements on chart , it reveals certain
repeating patterns .It shows where the prices have been, where the
buyers and seller lurk and often times the trading psychology at work
in the market. If human emotions drive buying and selling behavior,
then careful analysis of the chart patterns can help to determine where
such emotions may next surface. Chart patterns depict trading
psychology in motion.
However it should be remembered that identifying chart patterns and
their subsequent signals is not an exact science. While there is a
general idea and components to every chart pattern, in our opinion,
the price movement does not necessarily correspond to the pattern
suggested by the chart.
TYPES OF CHART PATTERNS
There are two basic types of patterns – continuing patterns and
reversal patterns.
A continuing pattern indicates that the prior trend will continue onward
upon the pattern’s completion. A reversal pattern signals that a prior
trend will reverse on completion of the pattern. The main patterns are
discussed below.
Types of continuing Patterns
Flag, Pennant
Triangles- Symmetrical Triangle , Ascending Triangle and
Descending Triangle
Cup with Handle
Types of reversal patterns
Double Top and Double Bottom
Head and Shoulders and Inverse Head and Shoulders.
Falling Wedge and Rising Wedge
 Rounding Bottom
Triple Top and Triple Bottom
In the next few pages we’ll look in detail about each of the above
patterns.

Continuing patterns 1 : Flag & Pennant

A continuing pattern indicates that the prior trend will continue onward
upon the pattern’s completion.
The Flag and pennant are two short-term continuation chart patterns
that are formed when there is a sharp price movement followed by
a generally sideways consolidation. The price then moves sharply
either upwards or downwards but generally in the same direction as
the move that started the trend. By using the term ‘Flag’ it doesn’t
mean that the trend formation would look exactly like a flag. The basic
characteristic of a flag pattern is that it will have two trend lines sloping
generally in the opposite direction of the initial price movement The
buy or sell signal is formed once the price breaks through the support
or resistance level, with the trend continuing in the prior direction. This
breakthrough should be backed by heavier volume to improve the
signal of the chart pattern.
EXAMPLE

You may notice the following –

There are two trendlines drawn, both sloping downwards e in the
opposite direction of the initial price movement. Through the trend
lines you see certain price level beyond which the stock prices neither
fall nor rise. These points are support and resistance levels in the flag
pattern. Once the price breaks out of the resistance level, the stock
prices continues to move in the initial direction ie upwards.
PENNANT
The pennant is slightly different from the flag pattern. Here the two
trendlines converge towards each other and the direction of the
pennant is not important as in the case of flag.
EXAMPLE

The attributes of the flag and pennant are similar and it can be
summarized as follows:
SHARP PRICE MOVEMENT
It all starts from a prior trend. There should be evidence of a prior
trend – either upwards or downwards. Such a price movement should
be backed by heavy [Link] moves may also contain gaps (we’ll
discuss the theory of gaps later). Such a move usually halts or pauses
temporarily causing sideways movement for sometime, resulting in a
flag or pennant formation.
DURATION
The sideways movement (flag/pennant) can last from 1 to 12 weeks.
There is some debate on the timeframe and some consider 8 weeks to
be pushing the limits for a reliable pattern. Ideally, these patterns will
form between 1 and 4 weeks. Once a flag becomes more than 12
weeks old, it would be classified as a rectangle. A pennant more than
12 weeks old would turn into a symmetrical triangle. The reliability of
patterns that fall between 8 and 12 weeks is therefore debatable.
BREAKING THE FLAG/PENNANT
For a bullish flag or pennant, a break above resistance signals that the
previous advance has resumed. For a bearish flag or pennant, a break
below support signals that the previous decline has resumed.
HEAVY VOLUME
Volume is the key. Volume should be heavy during the advance or
decline that forms the flagpole. Heavy volume provides legitimacy for
the sudden and sharp move that creates the flagpole. An expansion of
volume on the resistance (support) break lends credibility to the
validity of the formation and the likelihood of continuation.
We’ll take up triangles in our next section.

Continuing patterns 2 : Triangles

Whenever there is a convergence of two trend lines – flat, ascending

or descending – with the price of the security moving between the two
trendlines, it takes shape of a triangle. A triangle formation can be any
of the following types : Symmetrical Triangle , Ascending Triangle and
Descending Triangle. All the three are continuing patterns, meaning
that it signals a period of consolidation in a trend followed by a
resumption of the prior trend.
Symmetrical triangle formation: it is formed by the convergence of a
descending resistance line and an ascending support line. The two
trendlines in the formation of this triangle should have a similar slope
converging at a point known as the apex. The price of the security will
bounce between these trendlines, towards the apex, and typically
breakout in the direction of the prior trend. that is , if preceded by a
downward trend, the focus should be on a break below the ascending
support line. If preceded by an upward trend, look for a break above
the descending resistance line. As the symmetrical triangle extends
and the trading range contracts, volume should start to diminish. This
refers to the tightening consolidation before the breakout. The
symmetrical triangle can extend for a few weeks or many months. If
the pattern is less than 3 weeks, it is usually considered a pennant.
Typically, the time duration is about 3 months. Symmetrical triangle is
a ‘neutral’ formation. The future direction of the breakout can only be
determined after the break has occurred. Attempting to guess the
direction of the breakout can be dangerous. Even though a
continuation pattern is supposed to breakout in the direction of the
long-term trend, this is not always the case .A break in the opposite
direction of the prior trend should signal the formation of a new trend.
Example :

Ascending Triangle: The ascending triangle is a bullish pattern,

which gives an indication that the price of the security is headed
higher upon completion. The pattern is formed by two trendlines: a flat
trendline being a point of resistance and an ascending trendline acting
as a price support. The ascending triangle indicates that the sellers
are now less interested in the stock and the buyers volume is
increasing. Once the demand increases, the price naturally will tend to
go up and break the resistance levels and resume the upward trend.

Descending Triangle: Descending triangle is just the opposite of

ascending triangle. If an ascending triangle was a bullish pattern, a
descending triangle is a bearish pattern .In a descending triangle
formation, the two trendlines drawn will show a flat support line and a
downward-sloping resistance line. Indicating that the prices will fall
further. As the pattern develops, volume usually contracts. When the
downside break occurs, there would ideally be an expansion of
volume for confirmation. Volume confirmation is important.

Continuing patterns 3 : Cup with handle

As its name implies, there are two parts to the pattern: The cup and
the handle. A cup-and-handle pattern resembles the shape of a tea
cup on a chart. This is a bullish continuation pattern where the upward
trend has paused, and traded down, but will continue in an upward
direction upon the completion of the pattern. The ‘cup’ is a bowl-
shaped consolidation and the ‘handle’ is a short pullback followed by a
breakout. There should be a substantial increase in volume on the
breakout above the handle’s resistance. The stronger the volume on
the upward breakout, the clearer the sign that the upward trend will
continue. The Shape of the cup itself is also important: it should be a
nicely rounded formation, similar to a semi-circle.
Example of a Cup with handle:

Reversal Patterns 1 : Double

tops and double bottoms
by J Victor on December 14th, 2010

Introduction
Reversal implies a ‘change in direction’. Thus, reversal patterns are
chart formations that tend to reverse the direction of the trend. These
patterns can be spotted on the daily, weekly or monthly charts. The
Existence of a prior trend is the most important prerequisites in
analyzing trend reversal patterns. Many a time, a pattern that appears
on the chart resembles a reversal pattern. However, if there were no
major prior trends before the occurrence of this pattern, it becomes
suspect. If on the other hand, one finds that a downward reversal
pattern is being formed on the chart when the market has appreciated
considerably, that reversal pattern is of significance and should be
studied carefully. The second point to be studied carefully is the
volume. Volume can provide insights in trend reversals. It should be
used as a corroborative evidence of a trend, not as primary evidence.
Volume can also be used to confirm price changes. When a trend
starts, and there is no pick up in volume activity, that may mean that
the trend is weak and does not have commitment. Volume precedes
the price. If there is a pick up in volume, then that may mean that a
change in price may be approaching. The direction of the movement
during this increase in volume can be indicative of the upcoming
action. In the following sessions we explain some important reversal
patterns
Double tops and double bottoms:
Double top and double bottom formations are also called ‘M’ and ‘W’
patterns. A double top is simply two peaks. The pattern forms when
the share price makes a run up to a particular level, then drops back
from that level, then make a second run at that level, and then finally
drop back off again resulting in a ‘M’ shaped formation. It is a reversal
pattern. For confirmation that a double top has actually formed and
that a reversal in the uptrend is at hand, a common strategy is to look
for declining volume going into the second peak and rising volume on
a break below the bottom of the trough which has formed between the
two peaks (support).Here too, volume plays an important part.
Example of Double top:

Double Bottom
This is the opposite chart pattern of the double top as it signals a
reversal of the downtrend into an uptrend. The pattern forms when the
share price makes a run down to a particular level, then trades up
from that level then makes a second run down to at or near the same
level as the first bottom, and then finally trades back up again,
resulting in a ’W’ shaped formation. For confirmation that a double
bottom has formed and that a reversal in the downtrend is at hand , a
common strategy is to look for declining volume going into the second
trough and rising volume on the break of the peak which has formed
between the two troughs (resistance).
Example of double Bottom:

Reversal Patterns 2 : Head and Shoulders

The head-and-shoulders pattern is one of the most popular and

reliable chart patterns in technical analysis. And as one might imagine
from the name, the pattern looks like a head with two shoulders. A
Head and Shoulders pattern forms when one peak, followed by a
higher peak, which is then followed by a lower peak, and finally a
break below the support level established by the two troughs formed
by the pattern. The head-and-shoulders is a signal that a share price
is set to fall..
As the Head and Shoulders pattern unfolds, volume plays an
important role in confirmation. Ideally, but not always, volume during
the advance of the left shoulder should be higher than during the
advance of the head. This decrease in volume and the new high of the
head, together, serve as a warning sign. The next warning sign comes
when volume increases on the decline from the peak of the head.
Final confirmation comes when volume further increases during the
decline of the right shoulder
Inverse Head and shoulders Pattern:
The second version, the inverse head and shoulders, signals that a
share price is set to rise and usually forms during a downward trend.
As the name indicates, it is a mirror image of the head and shoulders
pattern signaling that the price is set to raise .Needless to say, volume
plays an important role here too. Without the proper expansion of
volume, the validity of any breakout becomes suspect.
Head and Shoulder

Inverse Head and Shoulder

Reversal Patterns 3 : The Wedges

The wedge pattern is more like a symmetrical triangle pattern, the only
difference is that it has converging trendlines which slat in either
upwards or downward direction. There are two main types of wedges
– falling and rising. A falling wedge slopes downward-it is a bullish
pattern. In a falling wedge, the upper (or resistance) trendline will have
a sharper slope than the support level in the wedge construction. The
lower (or support) trendline will be clearly flatter as you can see in the
figure given below. The stock prices tend to move between the
resistance and support lines formed with a downward bias. The price
movement in the wedge should at minimum test both the support
trendline and the resistance trendline twice during the life of the
wedge. The more times it tests each level, especially on the resistance
end, the higher quality the wedge pattern is thought to be. The buy
signal is formed when the price breaks through the upper resistance
line. This breakout move should be on heavier volume, but due to the
longer-term nature of this pattern, it’s important that the price has
successive closes above the resistance line.
Example of falling wedge:

Conversely, a rising wedge is a bearish pattern. A rising wedge slopes

upward. The upper (or resistance) trendline will have a flatter slope
than the support level in the wedge construction. The lower (or
support) trendline will clearly slop sharp as you can see in the figure
given below. The stock prices tend to move between the resistance
and support lines formed with a upward bias. The price movement in
the wedge should at minimum test both the support trendline and the
resistance trendline twice during the life of the wedge. The more times
it tests each level, especially on the support end, the higher quality the
wedge pattern is thought to be.
Example of a Rising wedge:

Reversal Patterns 4 : Rounding Bottom

The rounding bottom is a long-term reversal pattern that signals a shift

from a downtrend to an uptrend. The pattern resembles the cup and
handle pattern but, without the handle. Volume is one of the most
important confirming measures for this pattern where volume should
be high at the initial peak (or start of the pattern) and weaken as the
price movement heads toward the low. As the price moves away from
the low to the price level set by the initial peak, volume should be
rising. The way in which the price moves from peak to low and from
low to second peak may cause some confusion as the long-term
nature of the pattern can display several different price movements.
The price movement does not necessarily move in a straight line but
will often have many ups and downs. What is important is the general
direction of the stock price.
Example of a rounding bottom pattern:

Reversal Patterns 5 : Triple tops and Triple

bottoms

Triple top is a bearish reversal pattern formed when a share price that
is trending upward tests a similar level of resistance three times
without breaking through. When the stock fails to move past the
resistance level three times, it is assumed that the stock price would
come down. This pattern is difficult to spot in the earlier stages of
formation. In the triple-top formation, each test of resistance at the
upper end should be marked with declining volume at each successive
peak. And again, when the price breaks below the support level, it
should be accompanied by high volume.
Example of triple top pattern:

Triple bottom is a bullish reversal pattern formed when a share price

that is coming down tests a similar level of support three times without
breaking through. When the stock fails to move past the support level
three times, it is assumed that the stock price would resume the up
trend. In this pattern, volume plays a role similar to the triple top,
declining at each trough as it tests the support level, which is a sign of
diminishing selling pressure. Again, volume should be high on a
breakout above the resistance level on the completion of the pattern.
Example of triple bottom pattern:

Summary of Chart Patterns

Here’s the summary of what we have discussed so far:
Charts
Chart analysis is the technique of using patterns formed on a
chart to get an idea about the price movement of a share.
There are two types of chart patterns: reversal and continuation.
A continuation pattern suggests that the prior trend will continue
upon completion of the pattern.
A reversal pattern suggests that the prior trend will reverse upon
completion of the pattern.
Flag and Pennants:
Flags and pennants are continuation patterns formed after a
sharp price movement. The move consolidates, forming a flag
shape or pennant share, and suggests another strong move in
the same direction of the prior move upon completion.
Triangles:
There are three main types of triangle
patterns – symmetrical, descending and ascending, which are
constructed by converging trendlines.
A symmetrical triangle, which is formed when two similarly
sloped trendlines converge, typically suggests a continuation of
the prior trend.
A descending triangle, which is formed when a downward
sloping trendline converges towards a horizontal support line,
suggests a downward trend after completion of the pattern.
An ascending triangle, which is formed when an upward sloping
trendline converges towards a horizontal resistance line,
suggests an uptrend after completion of the pattern.
Cup with handle:
 A cup-and-handle pattern is a bullish continuation pattern that
suggests a continuation of the prior uptrend.
Double tops and Double bottoms:
A double top is a bearish reversal pattern, which suggests that
the preceding up trend will reverse after confirmation of the
pattern.
A double bottom is a bullish reversal pattern, which suggests that
the prior downtrend will reverse.
Head and shoulders:
A head-and-shoulder suggests a reversal in the prior uptrend.
An inverse head and shoulders suggests a reversal in the
prior downtrend
Wedges:
A wedge chart pattern suggests a reversal in the prior trend
when the price action moves outside of the converging trend
lines in the opposite direction of the prior trend.
Rounding Bottom:
A rounding bottom is a long-term reversal pattern that signals a
shift from a downward trend to an upward trend
Triple tops and triple bottom:
A triple top is a reversal pattern formed when a security attempts
to move past a level of resistance three times and fails. Upon
failure of the third attempt the trend is thought to reverse and
move in a downward trend.
A triple bottom is a reversal pattern formed when a security
attempts to move below an area of support three times but fails
to do so. Upon failure of the third attempt below resistance the
trend is thought to reverse and move upward.
Theory of Price Gaps
What is a ‘Gap’ in technical analysis?
A gap is an area on a price chart in which there were no trades. It is
easy to see gaps if you take candle stick charts. Let us try to
understand gaps in another way. The fluctuations in stock prices are
coherent in nature. That means that the price rises or falls gradually.
Thus, in rising scrip, if on one day the low was Rs 100 and the high
was Rs 135, on the next day the low would be Rs 130 and the high Rs
140. Here, the low for the next day falls within the high-low range of
the previous day. But suppose for the second day, the low was Rs 145
and the high Rs 150. Then, the low for the next day has fallen above
the previous day High-Low range, or it was higher than the previous
day’s high. So, when one draws bar charts showing High-Lows every
day, there would be a discontinuity, termed as a ‘Gap’ in technical
theory. An interesting feature of Price gaps is that it gets filled within a
short amount of time. That is, the price would come back to fill the
price gap of Rs 140 – Rs145, where there was no trade in the
previous days.
In simple terms-a gap occurs when the current bar opens above the
high or below the low of the previous bar. On a price chart, a space
appears between the bars indicating the gap.
Types of price gaps
Gaps can be subdivided into four basic categories:
Common Gaps
Breakaway Gaps
Runaway Gaps and
Exhaustion Gaps.
Common gaps:
Common gaps are ‘common’ and ‘uneventful’. If a Gap is formed when
the markets are moving in a narrow range, it is called a Common Gap.
Breakaway Gaps:
A “breakaway” gap ends a consolidation pattern and happens as
prices break out. Often, they would be accompanied by huge volumes.
Break-out Gaps are generally not filled for a long time, i.e. in the case
of an uptrend, the price does not fall back to wipe off the gains. They
may be filled as and when the prices retrace after a substantial up
move. If the breakout happens to be a downtrend, the prices may not
rise soon to wipe off the loss.
Runaway Gaps:
Runaway gaps are best described as gaps that are caused by
increased interest in the stock. For runaway gaps to the upside, it
usually represents traders who did not get in during the initial move of
the up trend and while waiting for a retracement in price, decided it
was not going to happen. Increased buying interest happens all of a
sudden, and the price gaps above the previous day’s close. This type
of runaway gap represents an almost panic state in traders. Also, a
good uptrend can have runaway gaps caused by significant news
events that cause new interest in the stock. Runaway gaps can also
happen in downtrends. This usually represents increased liquidation of
that stock by traders and buyers who are standing on the sidelines.
These can become very serious as those who are holding onto the
stock will eventually panic and sell – but sell to whom? The price has
to continue to drop and gap down to find buyers. So, in either case,
runaway gaps form as a result of panic trading.
Exhaustion Gap:
An “exhaustion” gap occurs at the end of a price move. If there have
been two or more gaps before it, then this kind of gap should be
regarded very skeptically. A genuine “exhaustion” gap is filled within a
few days to a week. It is generally not easy to distinguish between the
Runaway and Exhaustion Gaps. Experience in reading charts will help
in due course. The best clue available is that Exhaustion Gaps are not
the first Gaps in the chart, i.e. they follow the Runaway Gaps and
usually occur when the runaway Gap is nearing completion.
Exhaustion Gaps do not indicate whether the trend will reverse, they
only call for a halt in the price movement.
This completes our discussion on gaps. I hope it has filled in some
gaps in your trading knowledge. Here are some additional hints :-
A gap has relevance only to a daily or short term trader.
On spotting a gap in a daily chart, immediately question yourself
as to which of the four kinds of gaps it is.
Generally, short-term trades should be in the direction of the gap.
The larger the gap and the stronger the volume, the more likely it
is prices will continue to trend in that direction.
A “breakaway” gap provides an immediate buy point, particularly
when it is confirmed by heavy volume.
The third upside gap raises the possibility of an “exhaustion” gap.
Traders should look for the gap to be filled in approximately one
trading week. If the gap is filled and selling pressure persists,
then that issue should be shorted. If the gap is the third one to
the downside, then traders should be alert for a buy signal.
Gaps are powerful signals to make profits if used intelligently.
They should not be acted on in isolation. View the gap within the
context of the other technical results.
Introduction to technical
indicators
What is a technical indicator?
In stock market analysis, a technical indicator is nothing but a tool that
provides an indication about the condition or direction of the economy.
Indicators take the form of calculations based on the price and the
volume of a security and measures factors such as volatility and
momentum. They are also used as a basis for trading as they can
form buy-and-sell signals. Indicators provide an extremely useful
source of additional information.
Technical analysis is broken into two main categories:-
1 Chart patterns (discussed in technical analysis part 1)
2 Indicators and oscillators ( discussed below)
What does it offer?
Some technical indicators, such as moving averages are derived from
simple formulas and the mechanics are relatively easy to understand.
Others, such as stochastic, have complex formulas and require more
study to fully understand and appreciate. Regardless of the complexity
of the formula, technical indicators can provide unique perspective on
the strength and direction of the underlying price action.
Types of indicators:
There are basically two types of indicators based on what they show
users:
1 Leading indicators
2 Lagging indicators.
Leading indicators, as their name implies, are designed to ‘lead’ price
movements. That is-the indicators move first and price action follows.
Some of the more popular leading indicators are commodity channel
index, Momentum, relative strength index, stochastic oscillators and
Williams %R.
The advantage of using leading indicators is that the signals act as
warning against a potential strength or weakness. Leading indicators
are more ‘sensitive’ to price fluctuations.
Lagging indicators as their name implies, follow the price action and
are commonly referred to as trend-following indicators. It has less
predictive qualities. The usefulness of lagging indicators tends to be
lower during non-trending periods but highly useful during trending
periods. This is due to the fact that lagging indicators tend to focus
more on the ‘trend’ and produce fewer buy-and-sell signals. This
allows the trader to capture more of the trend instead of being forced
out of their position based on the volatile or sensitive nature of the
leading indicators. Moving averages and Bollinger bands are
examples of lagging indicators.
Where to find these indicators?
Most of the common indicators and oscillators are available readily on
your online trading platform screen.
Know it:
Always remember- Technical Indicators are sources of additional
information.
The purpose of indicators is to ‘indicate’. This may sound very
straightforward, but sometimes investors ignore the price action
of a security and focus solely on an indicator. Indicators filter
price action with formulas. As such, they are derivatives and not
direct reflections of the price action. This should be taken into
 consideration when applying analysis. Any analysis of an
indicator should be taken with the price action in mind. What is
the indicator saying about the price action of a security? Is the
price action getting stronger? Weaker?
Indicators should be studied in context of other technical analysis
tools. An indicator may show a buy signal but the chart pattern
and fundamentals may be weak.
There are two types of indicators – leading (one that leads the
price change) and lagging indicators(one that follows the price
action)

How does a technical

indicator work ?

How does a technical indicator work?

Technical indicators are derived from technical charts – which are
graphical or pictorial representations of the market activity in terms of
upward or downward movements in stock prices over a period of time.
Mathematically, a technical chart is a plot of a set of price data (on the
vertical axis) as a function of time (on the horizontal axis). The price
data can include a stock’s opening price, closing price, day’s high or
low price, average price, or a combination of these. The plotted data
points on the chart can show as individual points or as small bars.
When all the data points on the chart are joined, a wave-like pattern is
obtained. This pattern is then subjected to technical analysis by
experts, who apply standard mathematical formulae to these price
movements in order to arrive at technical indicators, from which they
can predict the future market price of a stock or its market trend
(upward/downward movement).
Types of signals- Crossovers and
Divergence
The indicators show the signals in one of the two ways- through
‘crossovers’ or ‘divergence’. ‘Crossover’ indicators are constructed with
an upper limit and a lower limit. When the limits set are breached, it
signals that the trend in the indicator is shifting and that this trend shift
will lead to a certain movement in the price of the underlying security.
Divergence means the direction of the price trend and the direction of
the indicator trend moves in the opposite direction. This signals that
the direction of the price trend may be weakening as the underlying
momentum is changing. Divergence is a key concept. Divergences
can serve as a warning that the trend is about to change.
There are two types of divergences: positive and negative. In its most
basic form, a positive divergence occurs when the indicator advances
and the underlying security declines. A negative divergence occurs
when an indicator declines and the underlying security advances.
The concepts of ‘crossovers’ and ‘Divergence’ would become clear to
you once you learn more about indicators and oscillators.
How do technical indicators help the
investor/trader?
If you have watched the stock market action on a computer screen,
you would have noticed that stock prices keep fluctuating almost every
second and it is impossible to make head or tail of the pattern if all the
price movements are planted on a chart. So, to smooth out the data,
technical analysts plot any one of the high/low/open/close/average
prices on the charts. This also helps in understanding the movements
of an extremely volatile stock and then predicting its future price
movement. Technical indicators also help an investor in the following.
1 They determine support and resistance levels. Even an amateur
technical chartist can determine important technical levels, which
when breached will take a stock’s price lower (support levels) or
higher (resistance levels).
2 Some indicators can help determine the future price of a share.
3 Technical indicators help in establishing trends (upward or
downward), which are critical for both traders and investors.
4 Technical indicators always alert a technical analyst of any major
price action/volatility is about to occur in a stock’s price. Even
you will be able to interpret the alerts once you are through all
the sections featured in this topic.
Next we need to look at something called ‘oscillators’. more about that
in our next lesson.

Oscillators

What are oscillators?

Oscillators are technical indicators that measure a stock’s momentum
as it oscillates between an overbought and an oversold zone and then
give a buy/sell signal. Oscillators have recently caught the fancy of
most traders. Oscillators give out ‘crossover’ model signals to indicate
a change in trend.
Oscillators are typically plotted in two ways.
1 Banded oscillators: Plotted within a range between 0 and 100,
 in this method, the zone between 0 and 30 is considered the
‘oversold’ zone while the zone between 70 and 100 is considered
‘overbought’. When the oscillator reaches an extreme value in
any end, either up or down, the implication is that price has
moved too fast and too far. This would warn investor to be ready
to face a sudden reversal or a period of consolidation or
sideways movement. Investors should typically buy when
oscillators feature in the lower end of the range and sell when the
oscillator line reaches the upper end of the range.
2 Centered oscillators: The other way to plot oscillators is on
either side of a zero line and the oscillator moves between
positive and negative values. Called ‘centered oscillators’, they
fluctuate above and below a central point or line. These
oscillators are good for identifying the strength or weakness, or
direction, of momentum behind a security’s move. In its purest
form, momentum is positive (bullish) when a centred oscillator is
trading above its center line and negative (bearish) when the
oscillator is trading below its centre line. MACD (discussed later)
is an example of a centered oscillator that fluctuates above and
below zero.
What are ‘oversold’ and ‘overbought’
conditions?
Oversold is a condition where it appears that a stock has
declined to the point where the selling is over and buyers will
likely step in and push the stock higher.
Over bought is a condition where it appears that a stock has
reached a price peak and is now likely to turn down.
However, overbought is not meant to act as a sell signal, and
oversold is not meant to act as a buy signal. Overbought and
 oversold situations serve as an alert that conditions are reaching
extreme levels and close attention should be paid to the price
action and other indicators.
An example of relative strength index (RSI) , one of the most
commonly used oscillators is given below.

The blue line on the picture above is the stock’s RSI which moves
within a band of 30 -70. When ever the RSI breaches the 30 mark it
signals an oversold situation and the stock bounces back. The zone
above 70 is considered as overbought. Note that the stock price has
shown a drop in price after it breaches the upper limit of the band at
70.
A few words of caution
Too Many indicators and oscillators!
The best technical indicators are those that have in the past been
tried, tested and proven successful. Nowadays, every other technical
analyst develops a new technical indicator or oscillator regularly. There
are hundreds of oscillators available. In fact, you ‘will be confused as
to which one would give you good signals. Our advice to you is to
follow the tried and tested indicators. Also, keep in mind the following
points:
Do not attempt to master all technical indicators and oscillators.
Just pick up knowledge in about three of them.
Do not analyse stock’s price by applying just one indicator – use
about 2 or 3 complementary indicators, as using just one
indicator may give you a false signal. Using 2–3 indicators can
confirm the signals given by one indicator, but if you get a
different signal from another complementary indicator then you
must not rush into the trade.
 Take your time to study. With time you will develop the art of
judging profitable trades using technical indicators. Do not expect
to morph into an expert on day one and carry out trades based
on a knee-jerk assessment. First put your new found knowledge
to test and begin trading only if you’re proven correct most of the
time.

Types of
indicators/Oscillators
Before moving on to the next lesson, here’s the summary of the last
three lessons:
Technical indicators are tools that provide an indication about the
condition or direction of the stock market. These indicators are
generally used as additional information before one takes a decision to
buy or sell a share. They provide unique perspective on the strength
and direction of the market. Oscillators are a type of technical
indicator. Most of the indicators work on the principle of averages.
For technical indicators, there is a trade-off between sensitivity and
consistency. In an ideal world, we want an indicator that is sensitive to
price movements, gives early signals and has few false signals
(whipsaws).
Sensitiveness of an indicator/oscillator to price movements in the
market would depend on the time interval for which the indicator is
constructed. For example a 5 day RSI would be more sensitive than a
14 day RSI. The 5 period RSI would have more overbought and
oversold readings. It is up to each investor to select a time frame that
suits his or her trading style and objectives. The shorter the period
selected, the more sensitive the indicator becomes.
If we increase the sensitivity by reducing the number of periods, an
indicator will provide early signals, but the number of false signals will
increase. If we decrease sensitivity by increasing the number of
periods, then the number of false signals will decrease, but the signals
will lag and this will skew the risk reward ratio.
From here on, for ease of understanding, we will discuss the
prominent types of technical indicators/oscillators from the point of
view of what exactly it measures. Whether it is leading or lagging and
whether it’s signals are crossovers or not would be discussed at
appropriate places.
Prominent indicators/oscillators.
Indicators that show the trend
Moving average
MACD (Moving average convergence/ divergence)
Average directional index.
Indicators that show momentum
RSI (relative strength index)
Stochastic oscillator
Williams %R
Indicators that measures volatility
Average true range
Bollinger bands
Before moving further, I would also like to explain in brief about the
difference between trend, momentum and volatility.
Momentum- It measures the degree of acceleration in a stock price. It
is a short term measurement. In other words, Momentum measures
the speed of price change and provides a leading indicator of changes
in trend. When momentum slows, this is taken to mean that there
might be a change in direction. Momentum is significant because it
signals the strength of price trends
Trend – A trend can be defined as the general direction in which the
market is moving in. A trend can be either upwards (bullish trend) or
downwards (bearish trend) or sideways (lack of direction).
Volatility – The relative rate at which the price of a stock moves up
and down If the price of a stock moves up and down rapidly over short
time periods, it has high volatility. If the price almost never changes, it
has low volatility. In other words, Volatility refers to the amount
of uncertainty about the swings in price of a stock. A higher volatility
means that a stock’s value can potentially be spread out over a larger
range of values. This means that the price of the security can change
dramatically over a short time period in either direction. A lower
volatility means that a security’s value does not fluctuate dramatically,
but changes in value at a steady pace over a period of time.

Understanding Moving
average

An average that moves!

As its name implies, a moving average is an average that moves. They
do not predict price direction, but rather show the current direction with
a lag. Moving averages are based on past prices, which mean they will
lag behind current prices. It will be presented in graphical form on your
online stock trading terminal. Moving averages form the building
blocks for many other technical indicators and overlays, such
as Bollinger bands and MACD (explained later in this section). Most
analysts use the 50 day, 100 day and the 200 day moving averages.
The 200-day moving average is the important moving average.
Example: To begin calculating a 200-day moving average of Infosys,
the closing prices of Infosys over the last 200 days would be added
together, and then divided by 200. That provides the average price at
which Infosys was sold over the last 200 days. That point would be
marked on the chart today. To make the average move, each
subsequent day the same process is repeated, and the new point is
added to the chart. After a few weeks you have the 200-day moving
average moving along the chart where its relationship to Infosys’s
price each day can be seen. Note that in calculating the moving
average each day, the oldest of the 200 closes is dropped and the new
day’s close is added (Only the prices over the most recent 200 days
are added together and divided by 200 each day).
So, the 200-day moving average is simply a share’s average closing
price over the last 200 days. The 200-day moving average is
perceived to be the dividing line between a stock that is technically
healthy and one that is not. Furthermore, the percentage of stocks
above their 200-day moving average helps determine the overall
health of the market. Many market traders also use moving averages
to determine profitable entry and exit points into specific securities.

Purpose of moving averages:

Primary function of a moving average is to identify trends
and reversals, measure the strength of an asset’s momentum and
determine potential areas where an asset will find support or
resistance.
Moving averages are easier to see and analyse on a chart. There are
different types of moving averages-simple moving average (explained
above) and exponential moving average. The Exponential Moving
Average differs from a Simple Moving Average both by calculation
method and in the way that prices are weighted. The Exponential
Moving Average (shortened to the initials EMA) is effectively
a weighted moving average. With the EMA, the weighting is such that
the recent days’ prices are given more weight than older prices. The
theory behind this is that more recent prices are considered to be
more important than older prices, particularly as a long-term simple
average (for example a 200 day) places equal weight on price data
that is over 6 months old and could be thought of as slightly out-of-
date.
A moving average can be a great risk management tool because of its
ability to identify strategic areas to stop losses.
What is the right moving average?
Moving averages come in various forms, but their underlying purpose
remains the same: to help technical traders track the trend of financial
assets by smoothing out the day-to-day price fluctuations. There is
nothing called ‘right moving average’. A 50-day moving average should
be right for the intermediate term and 150 or 200-day moving average
should work well for a long term investor.

Understanding MACD

Developed by Gerald Appel in the late seventies, Moving Average

Convergence-Divergence (MACD) is one of the simplest and most
effective indicators available.
The two components of MACD.
The MACD indicator is comprised of two exponential moving averages
(EMA), covering two different time periods, which help to measure
momentum in the security. The two exponential moving averages are
the 12 period EMA and the 26 period EMA. The MACD is the
difference between these two moving averages. A 9-day EMA of
MACD is plotted along side to act as a ‘signal line’ to identify turns in
the indicator. MACD is all about the convergence and divergence of
the above said two moving averages.
Histogram
Another aspect to the MACD indicator that is often found on charts is
the MACD histogram. Thomas Aspray added a histogram to the
MACD in 1986. The MACD-Histogram represents the difference
between MACD and its 9-day EMA, the signal line. The histogram is
positive when MACD is above its 9-day EMA and negative when
MACD is below its 9-day EMA.
What’s said above would be clearer if you follow the MACD signal
given below. The idea behind this momentum indicator is to measure
short-term momentum compared to long-term momentum to help
determine the future direction of the asset. Note that the red line is the
9 day average of the MACD (and not of the stock price).

MACD signal is available on any standard online trading screen. Your

online trading screen will have the option to select the MACD signal
from the choices of technical indicators. The exact location of this
operation varies between trading screens, but will almost always be
titled “technicals” ,”indicators,” “studies,” “oscillators” or “analysis.” It
may be a button on the chart, an option available by right-clicking on a
chart or a menu above the chart. MACD signal will be displayed below
the stock price chart.
It generates three meaningful signals for the investor: They are
1 Crossover signal 1- MACD line crosses the signal line.
2 Crossover signal 2- MACD Line crosses the line ‘Zero’(center
line)
3 Divergence signal- MACD line ( or histogram) and the price of
the stock (as seen on the price graph) diverge (i.e. moves in the
opposite direction)

Understanding Average
Directional Index (ADX)
Introduction:
Average directional index evaluates the strength of the current trend,
be it up or down. The ADX is an oscillator that fluctuates between 0
and 100. The indicator does not grade the trend as bullish or bearish,
but merely assesses the strength of the current trend. A reading above
40 indicates that the trend is strong and a reading below 20 indicates
that the trend is weak. An extremely strong trend is indicated by
readings above 50.
What does it measure?
ADX does not indicate trend direction, only trend strength. It is a
lagging indicator; that is, a trend must have established itself before
the ADX will generate a signal that a trend is underway.
ADX can also be used to identify potential changes in a market from
trending to non-trending. When ADX begins to strengthen from below
20 and moves above 20, it is a sign that the trading range is ending
and a trend is developing.
The ADX indicator does not provide buy or sell signals for investors. It
does, however, give you some perspective on where the stock is in the
trend. Low readings and you have a trading range or the beginning of
a trend. Extremely high readings tell you that the trend will likely come
to an end.
Overall, what is important to understand is that this indicator measures
strong or weak trends. This can be either a strong uptrend or a strong
downtrend. It does not tell you if the trend is up or down, it just tell you
how strong the current trend is.
Construction of ADX.
We will not go into the formulas for the Indicator here. However what
we need to know is that:
ADX is derived from two other indicators
The first one is called the positive directional indicator(sometimes
written +DI) and the second indicator is called the negative
directional indicator(-DI)
The +DI Line shows how strong or weak the uptrend in the
market is.
The -DI line shows how strong or weak the downtrend in the
market is.
ADX is the average of the above two lines and hence, it shows
the strength of the current movement.
On screen, the ADX appears below the stock price chart. The
+DI (normally a green line) and –DI lines (red line) would
accompany the ADX (Black line). So you see three lines as
shown in the figure below.

More tips:
 When the ADX starts rising from a low level it signals the
beginning of a trend.
The trend is confirmed when the ADX has risen above the 20-25
value and the +DMI line has crossed the –DMI line (in case of an
uptrend).
The ADX signal generally does not move above 60 or 70. ADX
above these levels are considered to be ‘over bought’ levels.
When the ADX has reached an overbought level and starts
consolidating it can signal the end of the current trend.
The decline of the ADX signals the consolidation or indecision of
the market.
When the ADX drops below 10, the current trend is virtually
dead. Be ready for the beginning of a new trend – bullish or
bearish. Don’t assume that since your current position has given
you an ADX reading of 10 (or lower) implying that your trend is
over and that the subsequent ADX move above 20 will take you
in the opposite direction. That’s a terribly wrong assumption.
An ADX reading above 20 implies the “beginning” of a new trend;
whereas; a rise above 25 implies a “trending” market; even a
bearish market. So, know this – it is possible to have a reading of
35 and the market can be falling like a rock. An upward moving
ADX does not specify market direction – only market trend. This
is a very important point to note.
That completes our lesson on ADX. More about indicators in our next
lesson.

Understanding RSI (Relative

strength Index)
Introduction
The name “Relative Strength Index” is slightly misleading as the
Relative Strength Index does not compare the relative strength of two
securities, but rather the internal strength of a single security. Relative
Strength Index (RSI) is a very popular momentum indicator.
What does it measure?
RSI measures the speed and change of price movements. RSI
oscillates between zero and 100. When the RSI line moves higher, it is
understood that price is enjoying increased strength and as the RSI
line moves lower, it is understood that the price is suffering from a lack
of strength. However, technical analysts believe that a value of 30 or
below indicates an oversold condition and that a value of 70 or above
indicates an over bought condition.
When Wilder introduced the Relative Strength Index in 1978, he
recommended using a 14-day Relative Strength Index. Since then,
the 9-day and 25-day Relative Strength Indexes have also gained
popularity. The most popular is the 14 day RSI. Shown below is an
example of how the RSI would be displayed below your stock prices
chart

Tips for Using the RSI Indicator

As with all technical indicators, RSI is a way of measuring odds –
it’s not a full-blown, fool-proof ‘system’ to gauge price trends. It is
usually best used in conduction with other indicators.
Though considered an oscillator, the relative strength index has
 qualities of momentum indicators, and can be used in that
capacity. For instance, some investors interpret a cross of the 50
level (the mid-point of the scale) as a signal of momentum –
bullish or bearish – in itself.
If the stock has been trending up, but the relative strength
indicator starts to trend down, there is a divergence and you
would prepare to enter a bearish trade (down direction). It’s the
vice versa for bullish trades.
Once the stock becomes overbought (RSI reaches the point 70)
or oversold (RSI at 30), or has price divergence you should
always wait for some type of confirmation that a price reversal
has indeed occurred.
RSI should not be used in isolation. It must be used in
combination with other indicators to help build a clear picture.
The RSI oscillator should not be confused with another trading
tool – unfortunately called – the ‘Relative strength’. The other tool
compares a stock’s or index’s performance to other stocks or
indices in a group, and ranks that stock or index, assigning a
‘relative strength’ score. The other tool is powerful too, but is
unrelated to the RSI indicator discussed here.
RSI is a versatile momentum oscillator that has stood the test of time.
Hope you have got information about RSI and how it can be used to
take decisions.

Understanding Stochastic
oscillators.
Stochastic indicator:
The Stochastic oscillator is a technical indicator that shows the
momentum. It is designed to oscillate between 0 and 100. Low levels
mark oversold markets, and high levels mark overbought markets.
Overbought means prices are too high, ready to turn down. Oversold
means prices are too low, ready to turn up. Technical analysts believe
that a value of 20 or below indicates an oversold condition and that a
value of 80 or above indicates an over bought condition. This indicator
was popularized by George lane decades ago and is now included in
most software packages.
What does it measure?
The Stochastic oscillator measures the capacity of bulls to close prices
near the top of the recent trading range and the capacity of bears to
close them near the bottom. Bulls may push prices higher during the
day, or bears may push them lower, but the stochastic oscillator
measures their performance at closing time—the crucial money-
counting time in the markets. If bulls lift prices during the day but
cannot close them near the high of the recent range, the stochastic
oscillator turns down, identifying weakness and giving a sell signal. If
bears push prices down during the day but cannot close them near the
lows, the stochastic oscillator turns up, identifying strength and giving
a buy signal. An example of how Stochastics appears below the stock
price chart is shown below:

Fast & Slow Stochastics:

There are 2 main types of setting, the Fast Stochastic and the Slow
stochastic.
Fast Stochastics: use shorter Time Periods, and Shorter Averages –
this creates more fluctuations but conversely also more false alarms
Slow Stochastics: use longer time periods and longer average
periods – this creates a smoother flow and gives the ability to see
trends clearer, the drawback is the Indicator lags price and is less
responsive.
How is the indicator plotted?
The term stochastic refers to the location of a current price in relation
to its price range over a period of time. The stochastic is plotted as two
lines %K, a fast line normally represented by a blue line and %D, a
slow line, normally red. These two lines have the following
characteristics:
The default setting for the Stochastic Oscillator is 14 periods, which
can be days, weeks, months or an intraday time frame. The %K line is
basically a representation of where the market has closed for each
period in relation to the trading range for the 14 periods used in the
indicator.
The %D line is a 5 period moving average of %K.
Sounds very complicated, isn’t it? Don’t worry. You don’t need to learn
about how combustion engine works to drive a car. What you need to
do is to follow these simple rules.
Rule 1- Use the stochastic oscillator just like RSI to identify
overbought and oversold levels in the market. When the lines that
make up the indicator are above 80, it represents a market that is
potentially overbought and when they are below 20, it represents a
market that is potentially oversold. The developer of the indicator
George Lane recommended waiting for the %K line to trade back
below or above the 80 or 20 lines as this gives a better signal that the
momentum in the market is reversing.
Rule 2- Watch for a crossover of the %K line and the %D line. When
%D is below the 20 mark and the faster %K line crosses the slower
%D line, it is a sign that the market may be heading up and when %D
is above the 80 mark and the %K line crosses below the %D line this
is a sign that the market may be heading down.
Rule 3- The third rule is to watch for divergences where the Stochastic
trends in the opposite direction of price. As with the RSI this is an
indication that the momentum in the market is waning and a reversal
may be in the making. For further confirmation many traders will wait
for the cross below the 80 or above the 20 line before entering a trade
on divergence.
Rule 4- Never rely solely on Stochastics or any other technical
indicator for that matter. Always use technical indicators as additional
tools. Stochastics uses the Price Open, High, Low and Close for the
period, so it can be used well in conjunction with RSI, which uses only
Close Price as the input.
That completes our lesson on Stochastics. The nicest thing about the
stochastic is that it can keep up with fast moving, volatile or even
trading range markets.

Understanding Williams %R
Williams %R is a simple momentum oscillator explained by Larry
Williams for the first time in [Link] shows the relationship of the close
relative to the high-low range over a set period of time.
Typically, Williams %R is calculated using 14 periods and can be used
on intraday, daily, weekly or monthly data. The time frame and number
of periods will likely vary according to desired sensitivity and the
characteristics of the individual security. The scale ranges from 0 to
-100 with readings from 0 to -20 considered overbought, and readings
from -80 to -100 considered oversold.
This momentum indicator is, in fact , the inverse of the Fast Stochastic
Oscillator. The default setting for Williams %R, as said above, is 14
periods, which can be days, weeks, months or an intraday timeframe.
A 14-period %R would use the most recent close, the highest high
over the last 14 periods and the lowest low over the last 14 periods.
The indicator would appear below the price chart on your trading
screen. An example of how Williams %R would look is given below.

Reading W %R signals.
Here’s a collection of pointers you should be following in order to
interpret William %R signals correctly.
Williams %R moves between 0 and -100, which makes -50 the
midpoint. A Williams %R cross above -50 signals that prices are
trading in the upper half of their high-low range for the given look-
back period. Conversely, a cross below -50 means prices are
trading in the bottom half of the given look-back period
Low readings (below -80) indicate that price is near its low for the
given time period. High readings (above -20) indicate that price is
near its high for the given time period.
Williams %R makes it easy to identify overbought and oversold
levels. Readings from 0 to -20 considered overbought, and
readings from -80 to -100 considered oversold. However, It is
important to remember that overbought does not necessarily
imply time to sell, and oversold does not necessarily imply time
to buy. A security can be in a downtrend, become oversold and
remain oversold as the price continues to trend lower. Once a
security becomes overbought or oversold, traders should wait for
a signal that a price reversal has occurred
%R can be used to gauge the six month trend for a security. 125-
 day %R covers around 6 months. Prices are above their 6-month
average when %R is above -50, which is consistent with an
uptrend. Readings below -50 are consistent with a downtrend. In
this regard, %R can be used to help define the bigger trend (six
months).
Like all technical indicators, it is important to use the Williams
%R in conjunction with other technical analysis tools.

Understanding Average True

Range.
The Average True Range (ATR) is an indicator that measures volatility.
A stock’s ‘range’ is the difference between the high and low price on
any given day. It reveals information about how volatile a stock is.
Large ranges indicate high volatility and small ranges indicate low
volatility.
Average true range is built on this principle of ‘range’. To understand
ATR, you must first try the concept of ‘true range’.
What is True range?
True Range is the greatest of the following three values:
[Link] difference in price between today’s high and today’s low of a
stock.
[Link] difference in price between yesterday’s close to today’s high.
[Link] difference in price between yesterdays close to today’s low.
True range is always a positive number (negative numbers from the
calculation above are to be ignored).
Average true range is simply an average of the true range- usually 14-
days. Calculating the Average True Range Indicator is slightly
complex, though it is possible with a spreadsheet. Fortunately, most of
the trading screens provide the average true range indicator as a part
of their service.
Care should be taken to use sufficient periods in the averaging
process in order to obtain a suitable sample size, i.e. an average true
range using only 3 days would not provide a large enough sample to
give you an accurate indication of the true range of the security’s price
movement. A more useful period to use for the average true range
would be 14.
What does ATR indicate?
The value returned by the average true range is simply an indication
as to how much a stock has moved either up or down on average over
the defined period. High values indicate that prices are changing a
large amount during the day. Low values indicate that prices are
staying relatively constant.
The ATR (Average True Range) indicator also helps to determine the
average size of the daily trading range. In other words, it tells how
volatile the market is and how much does it move from one point to
another during the trading day.
ATR is not a leading indicator – means it does not send signals about
market direction or duration, but it gauges one of the most important
market parameter – price volatility.
The logic behind ATR is that – over the last several days on average, if
the stock price has moved ‘X’ points, we could safely assume that
unless some shocking market news comes along, this range will
remain relatively consistent.
In short, ATR indicator is a tool for short term [Link] it shows
the average price range of a share, traders also use it to place stop
loss orders.

Understanding Bollinger
Bands.
What are they?
Introduced by John Bollinger in the 1980s, Bollinger Bands are a pair
of trading bands representing an upper and lower trading range for a
particular market price. A stock is expected to trade within this upper
and lower limit as each band or line represents the predictable range
on either side of the moving average. Generally, 80-85% of the price
action happens within these bands. All trading softwares will have
options to display Bollinger bands.
Bollinger Bands consist of a set of three lines drawn in relation to
securities prices. The middle line is a measure of the intermediate-
term trend, usually a simple moving average that serves as the base
for the upper band and lower band. The interval between the upper
and lower bands and the middle band is determined by volatility. The
purpose of Bollinger Bands is to provide a relative definition of high
and low. By definition, prices are high at the upper band and low at the
lower band.
Why use them?
Finds support and resistance levels: The upper band usually
indicates a resistance level while the lower band usually indicates a
support level. If you take a close look at any Bollinger band, you will
find that the price usually bounce off the Bollinger band whenever it
touches the upper or lower band. With this observation, you can use
the upper and lower bands as support and resistance when planning
your trade.
Helps to find where to Enter and Exit: Bollinger Bands can be very
useful trading tools, particularly in determining when to enter and exit
a market position. For example: entering a market position when the
price is midway between the bands with no apparent trend, is not a
good idea. Generally when a price touches one band, it switches
direction and moves the whole way across to the price level on the
opposing band. If a price breaks out of the trading bands, then
generally the directional trend prevails and the bands will widen
accordingly.
Gauges volatility: The Bollinger Band is an indicator that helps you to
measure the volatility of the market. It can tell you the current situation
of the market by using its upper and lower band. Whenever the market
has low volatility, the bands will be narrow and whenever the market
has high volatility, the bands will be wide.
Shows Breakouts—one of the lesser known uses of Bollinger bands
is the prediction for breakouts or gaps. As the bands squeeze a share
price, the price range grows very narrow. Some trading systems
identify that this is a prime time for the price to breakout of this range.
Usually a large price gap is the result. The difficulty is to know the
direction of the price breakout.
Stock Market Strategies-
Can you measure management effectiveness?

Hi there,
The success or failure of an organisation depends on how effective
the management is. The management team of a company is
responsible for propelling the future growth in the right direction. It also
responsible for administering and controlling the business activities
and accounting for the results. An ineffective management at the top
results in failure of the company. Such is the importance of
management.
So, one has to measure the effectiveness of the management before
purchasing a stock. It’s all about finding answer to one single
question- Are they doing the right thing?
How do you go about finding answer to that question? To be more
specific, how would you assess whether the management utilizing the
available resources in the best possible way? How well is the
company being run relative to others in its sector and the market as a
whole? The answer lies in finding three important ratios -
.Return on assets
Return on investment ( ROCE)
Return on equity ( ROE)
ROE and ROCE was discussed in the earlier sections, so I don’t want
to repeat the whole thing here. What remains to be explained is return
on assets.
RETURN ON ASSETS
Return on assets is calculated by taking the net income and dividing it
by the total assets.
ROA = Net Income / Total assets
ROA is a very effective tool . For example – If the total assets of
Company as per the balance sheet is Rs 10 million and if it has
earned a net income of Rs 20 million , the ROA would be 2 (20 / 10) .
It means, for every Rs 1 in assets, the company has made a profit of
Rs 2. So , higher the ratio, the better it is.
This ratio should be only used to compare companies in the same
industry. The reason for this is that companies in some industries are
more asset-insensitive i.e. they need expensive plant and equipment
to generate income compared to others. Their ROA will naturally be
lower than the ROA of companies which are low asset intensive – like
IT service industry.
A single period ROA of a company will not tell you the whole story. You
have to check the ROA for the past years and check if it’s showing an
increasing trend. An increasing trend of ROA indicates that the
profitability of the company is improving.
By measuring the management’s effectiveness, you will be able to
make reasonable comparison between the company and its peers
from the same industry or sector.
Before I close, here’s some more thoughts about using ROE, ROCE
and ROA.
In order to make a clear view of the company’s management
effectiveness use all the three ratios mentioned.
With ROE you get an idea about how the management is using
the money given by the shareholders.
ROCE would reveal how the management is utilizing the total
capital employed, which includes loans and other debt funds.
ROA is a totally different take. It measures the number of times
 earnings generated using the assets of the company.
The basic balance sheet equation is assets = liabilities + Equity.
So, if there were no liabilities in a company’s balance sheet , the
ROA and ROE would be same. In other words, If the ROA and
ROE of a company are different, the reason is the presence of
liabilities or loan funds in the balance sheet.
If a company has loan funds, ROE would be more than the
ROA. How? A company buys more assets by taking loans, but
since equity = assets – liabilities, a company decreases its equity
by increasing debt. So, when debt increases, equity shrinks, and
since equity is the ROE’s denominator, ROE, gets a boost.
Hance the presence of debt in a company’s balance sheet
boosts the ROE in relation to ROA.
Using price and volume to find market trends.

Hi there,
In this section i’m going to talk about two vital pieces of information
that you have to keep a close watch. They are ‘price’ and ‘volume’.
Both these figures are important and it gives a quick idea about the
direction of the stock price.
WHAT DOES IT TELL?
Volume – tells you whether there are buyers or sellers for this
stock in the market.
Price – tells you which direction.
RELATION BETWEEN PRICE AND VOLUME.
If the number of shares traded is high and the prices are also moving
higher- that’s a positive signal. You are probably looking at a large
group of people investing heavily in that stock. On the other hand, If
the number of shares traded is high and the prices are coming down –
that’s something to be careful about. You are probably looking at
investors backing out from that stock.
Several combinations of price and volumes are possible. Let’s look at
the most common scenarios:
A price advance with steady increasing volume
This indicates continuing upward momentum. As the price is climbing,
more and more buyers are getting attracted until the stock gets into a
stage of euphoria that usually indicates the end of the price advance.
A slowing pace of buying with decreasing volume
Slow pace in buying also means that there are not many sellers for the
stock, which is a good sign. It also indicates that the price is almost at
it’s peek and a further up move is unlikely immediately. Since the
sellers are in short, the stock might move higher after a pause.
A relatively big volume increase during the price advance with
lower volume on the pullback.
This indicates a continuing uptrend. The lower volume during the
pullback indicates that there are not enough sellers in the market to
drive the stock down.
Big buying volume without the price going higher
This indicates distribution, which means resistance. A big seller is
likely in the market. There is no way to tell yet if the buyers will win this
battle and are able to drive the price higher, or if they will give up and
the stock eventually reverses.
A slow and steady movement upward with consistent volume
This indicates continuing upward momentum. There might be a buyer
in the market who is steadily buying shares while trying to not attract
too much attention.
CONCLUSION
Tracking on price and volume for a few days will give you an idea
about general direction of the market and with some expertise, you
can spot the warning signs that a change in direction/trend is coming.
That’s about price and volumes.
Bonus shares – A positive sign.

WHAT ARE THEY?

Bonus shares are issued in a certain proportion to the existing
holders. A 2 for 1 bonus would mean you get two additional shares —
free of cost — for the one share you hold in the [Link] you hold
100 shares of a company and a 2:1 bonus offer is declared, you get
200 shares free. That means your total holding of shares in that
company will now be 300 instead of 100 at no cost to you.
WHO BEARS THE COST IF IT’S FREE FOR ME?
You are right. There is no free [Link] shares are issued by
cashing in on the free reserves (accumulated profits) of the
company.A company builds up its reserves by retaining part of its
profit over the years (the part that is not paid out as dividend). After a
while, these free reserves increase, and the company wanting to issue
bonus shares converts part of the reserves into [Link] you do not
pay; and the company’s profits are not impacted.
WHAT ARE THE EFFECTS OF A BONUS ISSUE?
Bonus shares do not directly affect a company’s performance. Bonus
issue has following major effects.
1. Share capital gets increased according to the bonus issue ratio.
2. Liquidity in the stock increases.
3. Effective Earnings per share, Book Value and other per share
values stand reduced.
4. Markets take the action usually as a favorable act.
5. Accumulated profits get reduced.
6. A bonus issue is taken as a sign of the good health of the company.
WILL THE SHARE PRICE CHANGE AFTER BONUS ISSUE?
A bonus issue adds to the total number of shares in the [Link] a
company had 10 million shares. Now, with a bonus issue of 2:1, there
will be 20 million shares issues. So now, there will be 30 million
[Link] is referred to as a dilution in [Link] the earnings of
the company will have to be divided by that many more shares.
(Earnings Per Share = Net Profit/ Number of Shares)Since the
profits remain the same but the number of shares has increased, the
EPS will [Link],When EPS declines, the stock price
should also decrease proportionately. But, in reality, it may not
happen.
That’s because:
i. The stock is now more liquid. Now that there are so many more
shares, it is easier to buy and sell.
ii. A bonus issue is a signal that the company is in a position to
service its larger equity. What it means is that the management would
not have given these shares if it was not confident of being able to
increase its profits and distribute dividends on all these shares in the
future.
THE RECORD DATE.
When a bonus issue is announced, the company also announces a
record date for the issue. The record date is the date on which the
bonus takes effect, and shareholders on that date are entitled to the
bonus.
After the announcement of the bonus but before the record date, the
shares are referred to as cum-bonus. After the record date, when the
bonus has been given effect, the shares become ex-bonus.
HOW BONUS SHARES CREATES ENORMOUS WEALTH
Bonus shares, in the long run would create enormous wealth for the
investor. For example, a Rs 10,000 invested in Wipro in 1980 would
have grown into several Crores as shown below:-
In 1980 You buy 100 shares @ Rs 100 per share in your name . In
1981 company declared 1:1 bonus = you have 200 shares
In 1985 company declared 1:1 bonus = you have 400 shares. In 1986
company split the share to Rs. 10 = you have 4,000 shares
In 1987 company declared 1:1 bonus = you have 8,000 shares. In
1989 company declared 1:1 bonus = you have 16,000 shares
In 1992 company declared 1:1 bonus = you have 32,000 shares In
1995 company declared 1:1 bonus = you have 64,000 shares
In 1997 company declared 2:1 bonus = you have 1,92,000 shares. In
1999 company split the share to Rs. 2 = you have 9,60,000 shares
In 2004 company declared 2:1 bonus = you have 28,80,000 shares. In
2005 company declared 1:1 bonus = you have 57,60,000 shares
In 2010 company declared 2:3 bonus=you have 96,00,000 shares.
Share price of Wipro is Rs 428.00 in July 2010
The value of 57,60,000 shares in 2010 – 406.60 Crores.
CONCLUSION
Declaring Bonus shares is a sign that companies are increasing their
profitability. If you look back, many companies have announced issues
of bonus shares to their shareholders by capitalizing their free
reserves . Shareholders have benefited tremendously, even after
accounting the inevitable reduction in share prices section-bonus,
since the floating stock of shares increases. So keep an eye on bonus
history when you decide to buy a stock-It may be a good indicator that
the company is healthy.

Using Beta to gauge volatility.

If your heart has a high beta level, invest in a stock that has low beta!
Hi there ,
Beta is a measure of a stock’s price volatility in relation to the rest of
the market. In other words beta is a measure of risk. The ‘rest of the
market’ would be represented by any broad index that represents the
market. Hence, in India, the broad based index could be the Sensex or
the nifty.
Understanding beta is simple.
Stocks that have a beta greater than 1 have greater price
volatility than the overall market and are more risky.
Stocks with a beta of 1 fluctuate in price at the same rate as the
market.
Stocks with a beta of less than 1 have less price volatility than
the market and are less [Link], if the market goes up 20%,a
stock with beta 1 goes up 20%. If the Market is down 10%, the
stock comes down 10%. This is, of course, calculated over a
period of months and does not necessarily hold true on a daily
basis.
NOT ONLY FOR INDIVIDUAL STOCKS..
Not only for individual stocks, beta measure can also be computed for
the entire industry. That would compare the volatility that industry
relative to the market.
If you know the industry beta, it would be possible for you compare a
stock relative to the industry and the market.
For example, if you know that the beta for information technology
stocks was 1.5 and you found a company in that industry with a beta
of 0.7, this would tell you that the company is not only less volatile
than the market as a whole, but extremely stable compared to its
industry.
Beta can be constructed for your individual portfolio also. Beta of a
portfolio should be the weighted average betas of securities
comprising the portfolio.
Beta measures of a stock is useful in finding the cost of equity using
the CAPM method. I ‘ll explain more on that when we discuss about
cost of equity in our valuation section.
WHERE TO FIND ?
All financial information web-sites like moneycontrol have information
about a stock’s beta.
PROBLEMS WITH BETA.
While the ‘beta’ may seem to be a good measure of risk, there are
some problems with relying on beta scores alone for determining the
risk of an investment.
Beta is computed with historical data.
Beta suggests a stock’s price volatility relative to the whole market, but
that volatility can be upward as well as downward movement. In a bull
market, the stock that outperforms all will have beta that’s greater
than 1.
HOW TO USE BETA.
Beta is useful for short term decision making. In short term decisions,
price volatility is important. Since beta measures exactly that, it useful
for that class of investors.
In a rising market, it’s good to have high beta stocks and in a falling
market it’s better to stick to low beta shares.
Later when I talk about risk premium, we will find more applications of
beta. For the time being, remember beta as a simple and very
valuable tool to gauge volatility.
Is a stock buyback scheme a good sign?

Hi there,

Stock buy back offers or stock repurchase offers are generally

understood to be a good sign. This is one indirect way for cash rich
companies to maximise the wealth of its shareholders.
LET’S TAKE A CLOSER LOOK
The idea behind share buy back is simple. The company uses its cash
to repurchase it’s shares from the open market. Since the company
cannot act as its own shareholder, the repurchases shares are
absorbed by the company and the number of shares outstanding is
reduced thereby increasing the EPS. So buy backs result in increase
in shareholders value.
Another reason why a company would resort to share buy backs is to
improve its financial ratios – For example, buybacks reduce the cash
component on the balance sheet. Since cash is an asset, it effectively
reduces the total assets of the company. Since ROA is calculated as
return / total assets, any reduction in the total assets figure will
improve the ROA figure. Similarly, re purchase results in a reduction in
the number of shares outstanding. Since ROE is calculated as return /
number of shares, any reduction in the number of shares will improve
the ROE figure. So, if the company is buying back its shares with the
sole intention of improving its rations like ROE and ROA, that’s not a
good sign.
Another problem stock buybacks seek to cure is the dilution (too much
stock on the open market) caused by stock option plans. When stock
options are exercised the number of outstanding shares increase. This
makes the company’s ratios look weaker – the opposite of what
repurchasing does.
The buyback offers however, reduces the book value of the company.
( see the example below)

Advantages to the Investor

Buying back stock means that the company earnings are now
split among fewer shares, meaning higher earnings per share
(EPS). Theoretically, higher earnings per share should command
a higher stock price which is great!
Improving EPS also means that the P/E of the company is
reduced. A lower P/E, higher EPS, ROA and ROE are regarded
as positive signals by investors.
Buying back stock uses up excess cash which otherwise remain
idle. Buying back stock allows a company to pass on extra cash
to shareholders without raising the dividend. If the cash is
temporary in nature it may prove more beneficial to pass on
value to shareholders through buybacks rather than raising the
dividend.
Example:
Lets take the financial figures of company xy ltd-
Before buyback
The total assets of the company are 5000 lakhs and the total
liabilities are 3000 lakhs. Hence, book value would be (assets –
liabilities) = 2000 lakhs.
Assuming that the company has 1o lakh shares outstanding, the
book value per share would be (2000/10) = 200 per share.
If the earnings of the company for the year was Rs 250 lakhs,
the EPS of the company would be 25 ( 250 /10)
ROE would be 25/200 = 12.50 %
Let us assume that the shares of the company are trading at Rs 250
now and the company proposes to buy back 25% of its shares from
the market.

Section Buy back

The company would need 625 lakhs to buy 25% shares @ Rs
250
The company takes cash worth 625 lakhs and buys back the
[Link] assets of the company now get reduced by Rs 625 to
Rs 4375 lakhs.
The number of shares outstanding is reduced by 2.5 lakh shares
to 7.5 lakhs
New book value would be Rs 1375 lakhs (Rs 4375 lakhs – 3000
lakhs ) therefore, book value per share = 183.33 per share
EPS = improved from 25 to 33.33 (250 / 7.5)
ROE increased from 12.50% to 18 % ( 33.33 / 183.33)
As you can see, figures like price earnings ratio, earnings per share,
return on assets, return on equity and others can be pumped up by a
stock buyback program. So even if nothing has fundamentally
changed about the company, the ratios will give a better picture after
buyback. . All weaknesses in the business model before the stock
buyback will still be there after the buyback.
CONCLUSION
Stock buy backs may not be a positive sign [Link] not buy a stock
as soon as a stock buy back is announced, expecting a rise in prices.
Always look behind the scenes and find out the real picture behind the
buy back.
Using Advance / Decline to spot market trends
ADVANCE/DECLINE NUMBERS
Hi there,
Stock exchanges around the world give out the number of shares that
‘advanced’ or ‘declined’ in a trading day from the last close.
For example, the exchange may inform that out of the 7000 stocks,
4500 stocks advanced while 2000 stocks declined. The balance 500
stocks remained ‘unchanged’.
A/D RATIO
The advance/decline ratio is calculated by dividing the number of
advancing stocks by the number of declining stocks.
Values higher than 1 show that more issues are presently
advancing than declining.
Values between 0 and 1 indicate that more issues are currently
declining in price.
HOW DOES THIS HELP?
Stock market indexes are very tricky. For example, it is possible for the
Sensex to report a gain at the end of the day in spite of many stocks
falling, if a couple of heavyweight stocks in the index do well. In such
cases, stock indices may not give you that actual picture of what’s
happening. To get the real picture, you need the number of shares that
advanced and declined out of the total number of shares listed. If too
many stocks have advanced it gives us an indication that we are in a
bull market.
Another way you can use the advance/decline numbers is in watching
trading during the day to spot trends or false trends. For example, if a
major index is up significantly, but you find that there is no
corresponding increase in advance numbers. So, that increase could
be a bubble in a major stock that’s going to burst.
INDEX OR NUMBERS?
If the broad based index conflict with the advance/decline numbers,
you have to go with the numbers (and not with the index) to determine
what the market really did in terms of direction.
One of the major limitations of the advance/decline numbers is they
don’t tell you anything about the size of the advances or declines. It
just tells the numbers. It doesn’t tell whether advances were up a
Rupee or a 100?
CONCLUSION
Advance/decline is a very simple and effective indicator. It gives you
an indication of how the overall market is doing and can add a level of
information to indexes for a better understanding of they mean.

Keep an eye on the factors that cause volatility in

stock markets

What moves the stock market?

Hi there,
That question has many answers. Economic factors like GDP and
earnings reports, political factors like government policies and political
unrest, commodity prices like price of crude oil and gold, social issues
like war and terrorism, acts of God such as earth quakes and flood
may cause the market to change direction or speed up or slow down
its momentum.
Most common of them are listed below.
Inflation, Interest rates & Earnings
High Speculative activity
Demand and supply
Oil/Energy Prices ,War/terrorism , Crime/fraud
Serious domestic political unrest
 Uncertainty
Inflation, interest rates & Earnings
To put it in simple terms, Inflation is a sustained increase in the
general level of prices for goods and services. There may be a lot of
reasons for this. It is measured as an annual percentage increase. As
inflation rises, every Rupee in your wallet buys a smaller percentage
of a good or service. People living off a fixed-income, such as retirees
and salaried class see a decline in their purchasing power and,
consequently, their standard of living. Uncertainty about economic
future makes corporations / consumers spend their money cautiously.
This hurts economic output in the Long run
As inflation increases, Reserve bank increases the interest rates to
reduce the money supply and slow inflation down: When interest rates
are high, people find it expensive to borrow, and therefore there is less
money floating around. When interest rates are high; people require
higher returns on stocks. Its not so easy to just increase earnings for a
stock, so its price has to adjust downward.
For example : Consider a stock that sells at Rs 100 with earnings of
Rs 12, a 12% return. When Fixed deposits pay 8%, an investor may
be willing to buy this stock for the extra 4% return. However, if interest
rates were to rise, to say 12%, who would pay for this 12% return,
when they could get 12% risk-free by Fixed deposits ? Therefore, the
stock may drop to Rs 75. With earnings of Rs 12, this now generates a
16% return and is once again at a price where an investor might be
willing to take the risk on this stock for the extra 4%.
Mismatch between actual earnings and expected earnings of the
corporates may cause the stock markets to fluctuate. That’s because,
when the corporates report week results than expected, the investors
react by selling of their holdings in that stock resulting in a huge drop
in stock prices. The opposite is also true. If corporates come up with
better than expected earnings results, more an more investors would
invest in those stocks resulting in a surge in stock price.
Speculators and investors
Anyone who owns shares are generally referred to as ‘investors’.
However, not everyone is an investor in share market. There is one
category of buyers who do not follow the fundamentals – Speculators.
Excessive use derivative instruments like options and futures to
speculate may drive stock prices to extreme levels defying all logic.
Speculators are largely responsible in creating heavy volatility in the
stock markets. Since they buy securities based on momentum, it leads
to stocks becoming dramatically overvalued when everyone is
interested and unjustifiably undervalued when the craze ends.
Demand and supply
The very basic economic theory of demand and supply holds good in
stock markets too. When there are more shares available than
demand, each of those shares is worth less. The opposite is true
when there is more demand than shares available.
Oil prices/fraud /scams and other factors affecting stock markets
There are many other factor like hike in Oil prices (resulting in
commodities and services getting dearer) war and terrorism (Example:
The sept 11 attack and the uncertainty it created in stock markets
around the world) Fraud / scams (Example :- Satyam’s case) serious
political unrests which results in certain commodity prices moving up
( or revenues of a particular country decreases) which might result in
stock prices crashing down.
CONCLUSION
If you have decided to become active in share markets, it’s important
to know what moves the stock market. Events like those mentioned
above create golden opportunities to buy shares of good companies at
throw away prices.
Balancing your investments.

Hi there,
Remember the topic on market capitalization? Market capitalization is
how we measure the total worth of a company. It is the way you
categorise companies by size. A simple way of thinking of it is – how
much you would pay to buy all the shares of that company available in
the market. The term ‘cap’ is the short form of capitalization. General
break down by size of companies are:
LARGE CAPS
There is no standard definition of Large Cap and it varies from
institution to institution. But as a general rule, if a company has a
market capitalization of more than Rs. 5000 Crores, it is considered as
a Large Cap. A Large Cap company is normally a dominating player in
its industry, and has a stable growth rate. It should be noted that
almost all the Large Cap companies from India would be considered
as Mid Cap or Small Cap companies in a global scenario, as globally,
companies are usually classified as Large Cap if their market cap is
more than $10 Billion (roughly Rs. 39,000 Crores).
MID CAPS
If a company has a market capitalization of between Rs. 1000 Crores
and Rs. 5000 Crores, it is considered as a Mid Cap.A Mid
Cap company is normally an emerging player in its industry. Such a
company has a potential to grow fast and become a leader (a Large
Cap) in the future. Mid -cap companies can show very high growth
rates (in percentage terms), because they have a small base – since
their size is small, even a small incremental increase in revenue /
profits can be a big figure when expressed in terms of percentage.
SMALL CAPS
If a company has a market capitalization of less than Rs. 1000 Crores,
it is considered as a Small Cap. A Small Cap company is normally a
company that is just starting out in its industry, and has moderate to
very high growth rate. Such a company has a potential to grow fast
and become a Mid Cap in the future. If you invest in the small cap
markets expect volatility and failure. It is always risky to invest in these
kinds of shares. But this doesn’t mean that you should stay off from
small caps. Small caps should form part of your portfolio in a limited
manner.
See the BSE list of Mid caps and small caps :
Mid-caps – click here
Small caps - click here
REMEMBER…
A company’s survival is not guaranteed by size; however, it helps
to be a fairly large fish if you are going to swim in the big pond.
Small companies or small –caps are risky investments, but can
pay big rewards.
You should not have too much exposure to small-caps if you are
the risk-averse types. Mid-caps and small caps rise faster than
large-caps in bull markets, but also fall as rapidly.
Large-cap companies are typically more stable with larger, more
diversified revenues and have steady predictable earnings. That
is not to say that many a large cap has not melted down.
Mid-caps tend to have some of the stability of the large caps but
also some of the high-growth prospects of the small caps. Mid
caps also have institutional ownership but to a lesser extent than
large caps do.
You should invest your money in a mix of large-caps, mid-caps
 and small-caps. Large caps would bring stability(steady growth)
over long term, mid caps would bring in the acceleration (fast
growth) and small caps would bring the excitement( risky
investments, but may pay big rewards)
A 60% exposure to large-caps , 30% in mid-caps and 10 % in
small caps would be a balanced investment strategy, however,
what is the right mix depends on an individual’s risk tolerance
capacity
Investors may note that the total amount to be invested in
equities would ideally be 90-your age. The balance should be
invested in debt funds
Shareholding pattern – it tells you a lot.

Hi there,
Reviewing the shareholding pattern and the change in shareholding
pattern could be useful to the investors. It shows how shares of a
company are split among the entities that make up its owners.
The Shareholding structure is declared every quarter
BASIC RULES.
As a rule of thumb, higher promoter’s stake is perceived as
positive and a lower equity stake could mean low confidence of
promoters in their own company. Rise in promoter stake is
considered positive because promoters will commit additional
fund only when they are optimistic about future growth of their
company.
Similarly a higher FIIs stake is considered as positive and a
lower FII participation could mean low confidence of FIIs in the
company. Rise in FII stake is considered positive as they will
 commit funds only when they are totally optimistic and confident
about the future prospects of the company.

Too high or too low of promoters stake or FII holding is not

favorable.
WHO CAN HOLD SHARES IN A COMPANY?
Share Holding can be done by any investor right from a person to a
corporation to a FII. When an entity or a person buys a large chunk of
share in another company, their intention may be to get control in:-
The decision making power of the company
Election of the Board of Directors of the company
Controlling the management of the company
PATTERN.

Data regarding the share holding pattern is available in the stock

exchange’s website, all financial websites as well as in the company’s
website and annual reports. Share holding pattern of a company
generally involves:-
Promoters’ Holding – Promoters may include domestic and
foreign promoters. Promoters are the entities that floated the
company, and to a large extent have seats on the Board of
Directors or the management.
Persons acting in concert with the Promoters. Relatives of the
promoters who hold shares fall under this class and are termed
as the promoter group.
Holding of the Non-Promoters – these include institutional
investors like Banks, Financial Institutions, Insurance
Companies, Mutual Funds , Foreign Institutional Investors and
others like private Corporate bodies, Trusts, Foreign
Companies , you and me ..
PROMOTERS AND FIIs – The two categories of shareholders to
watch.
While analysing the shareholding pattern of the company, the two
important categories to be watched are the promoter’s stake and the
FIIs stake in that company. An increase in promoter stake does not
always constitute a sign of confidence. It is also necessary to see
whether fresh funds have come in. If fresh fund have been invested,
where will they be invested. Answers to these questions would help
investors to determine whether jump in promoter stake is beneficial to
the company. However, an increase in FIIs stake is a good sign – It
shows that they are bullish on the stock. At the same time, the flip side
of huge FII holding is that the stock price will be subject to huge price
volatility when they off load the stake.

HOW TO ANALYSE

Analysing the holdings of various categories of investors would give

you insights into the pattern of control in the company.
Here’s a collection of tips for you –

Rise or fall in promoters holding is to be studied by looking at two

aspects. First what is purpose of promoters in raising or reducing
their equity stakes and second, the methods promoters have
adopted to increase or reduce their ownership.
If the promoters are increasing their stake to pay off debts and
strengthen their balance sheet. This is certainly positive for the
shareholders.
Companies that have gone for share buy back also see rise in
promoter’s stake. The core objective of a buyback is to create
wealth, but it also increases promoter’s equity stake at no
additional cost. A rise in promoter’s stake due to merges or
buyback means little for investors in real terms.
Promoters of companies that have opted for rights issue are
forced to step in and bail out the unsubscribed portion just in
case the rights are undersubscribed. Here, there will be an
unintentional rise in promoter’s stake. Shareholders declining to
subscribe to rights issue and promoters chipping to rescue the
issue do not qualify to be positive development.
A decline in promoter holding should also be analyzed in detail.
Decline in promoter holding can be due to various factors such
as issuing fresh share towards employee stock option, or it could
be due to offloading/issuing of fresh shares to strategic/financial
partners. These changes should be carefully studied.
Promoters offloading their holdings in the open market are a
warning signal. Some dubious companies announce positive
development periodically; promoters keep on offloading equity
stake at the same time. It is well laid-out trap for investors.
If you see promoters increasing their stakes in successive
quarters, you know that the financial performance is going to be
good and the stock prices would possibly be higher. However, it’s
unusual to see promoters’ holding increase on a regular basis.
They usually step in to buy after a sharp market decline to shore
up their holdings.
A very high promoter holding is not a good sign. A diversified
holding and a good presence of institutional investors indicates
that promoters have little room to make and carry out random
decisions that benefit them without gauging how it would affect
earnings and other shareholders.
Very low stake of promoters is perceived as diminishing
confidence of promoters. This results in rampant sell off which
 results in loss for investors.
FII holdings in stocks are used as indicators in stock selections;
stocks with high FII holdings are largely favored. However, such
stocks could take a hit should the FIIs decide to sell their stake.
Retail investors may perceive such selling off to be a lack of faith
in the stock by the FII.
Holding by mutual funds and insurance companies is an
indicator on how favored a stock is. Multiple funds holding the
stock could be a sign of growth potential. Therefore, such high
institutional holding may mean your investment is a tad safer
since that company may then be more professionally run.
While looking at the shareholding pattern, figures for a single
period is also unlikely to tell you much. Compare holding patterns
with those of the previous quarters to check how holdings have
changed.
Along with holding patterns, companies also disclose the entities
— other than the promoters — that hold more than 1 per cent in
the share capital. Companies are also required to declare the
promoters’ shares that have been pledged as debt collateral.
So next time you analyse a company, don’t forget to have a look at the
shareholding pattern for the present period and the previous quarter or
two. It might just give you a surprise insight about the company’s
management.
Is it possible to predict Markets accurately?

If I have noticed anything over these 60 years on Wall Street, it is that

people do not succeed in forecasting what’s going to happen to the
stock market. – Benjamin Graham
Hi there,
First of all, in my opinion, it’s not possible to accurately predict Market
movements. Making buy or sell decisions by predicting market
movements is a strategy called ‘Market timing’. It’s one of the most
controversial topics in stock markets. The viability of the strategy is
something that’s debated for years now.

There are brokers and analysts who claim that they can predict exact
market movements. I’ve tested their services once and that was a
disaster. Apart from that, there is no first hand experience to write
about . But, I know many people who have availed paid services of
these so called market forecasters. Nobody so far, has given me a
100% positive feed back.
The second point I would like to mention here is that no two investors
are alike. Risk bearing capacity, expected returns, investment horizon,
investment objectives etc are different for every investor. What’s good
for one may not be good for another. So there’s no meaning in those
calls ‘to buy’ or ‘to sell’ a particular stock which is not based on
individual preferences.
So, now, the first question is – then, what do we see in these
newspapers and websites about the future of the markets? Well, you
have to take those comments in the right context. Chartists and
analysts comment on the general trend of the market, they are never
stock specific. At best, they may specify certain sectors that may be
positively or negatively impacted by the economic events that are
going around nationally and internationally. It’s up to the investors to
do some homework and try to find whether those factors need to be
considered in their investment decisions.
Secondly, what about those stock specific buy calls or sell calls that
appear in newspapers and television channels? What they give out is
their opinion based on historic data and future prospects. Whether that
particular stock is suitable for you to invest is something you have to
evaluate based on your investment objectives.
There maybe big investment houses or big investors out there who
have systems and experience to predict the market and make a killing.
If they have, well, they are not going to disclose that to anyone. Even
Mr. Warren buffet has never written a book on how he makes
investment decisions. For the common investor, the option is to use
publicly known information from their brokers or analysts or try some
paid softwares or develop own systems, which yield excess returns.
Market report generally combines technical as well as fundamental
data. Common investors should have at least basic understanding
about these. The Internet is the ultimate library, hosting hours and
hours of reading materials in every subject imaginable. And, the
subject of investments is no different. Several free resources offer
beginners strategies for investing and basic definitions of the
terminology used. It’s important to prepare yourself by reading these
materials before you try to read and understand a market analysis
report.
HAVE YOU DEFINED YOUR INVESTMENT OBJECTIVES?
In one sentence, any investment objective would be – In 20xx I need
to create an income/wealth of Rs xx xx xx . The objective should be to
get ‘optimum returns’ and not ‘maximum returns’. Getting maximum
returns would mean that you have to take maximum risk. So the basic
objective, in my opinion , should be to optimize return on investment.
How? The first step should be to do a SWOT analysis of your self and
find out where you stand right now.
Strengths – would be a list of what you own –Gold, property, parental
wealth , cash , alternative sources of income, Knowledge, Support,
money management skills, facilities and the platform available for
investing.
Weaknesses – would be a list out what you lack – Risk tolerance
capacity, money management skills, lack of alternative income source,
still living in a rented house…
Opportunities – considering the investment capital you have, try to find
suitable opportunities. For example if you think you can invest only a
small sum, there no point in looking at real estate or solid gold. SIP’s
or gold ETF’s could be a better way to start.
Threats – Inflation risk, interest rate risk, peer group pressures etc…
By listing out your strengths and weaknesses, you will be in a position
to evaluate yourself first. Once you have done that, those market
analysis and investment recommendations may make sense.
have a nice day !!

3 silly mistakes a beginner

should avoid.
Hi there,
After interacting with some beginners, I found 3 very silly mistakes
that’s so common. So, i thought i should write about that in this
section, with the help of an example.
– You buy shares in company ‘x’ of IT sector. The shares move up and
you get a decent profit. From that moment, you are tempted to look
more deals like that., preferably from the IT sector- since you get a
feeling the IT sector is a sure bet !
Not only that, in the process of trying to find such deals, you tend to
overlook other investment opportunities that come your way – a new
mutual fund offer or a low rate in gold ETF or an opportunity to lock in
a debt fund that’s available at a higher rate of interest.
 This is the first point – as long as your investment remains in a
few stocks or markets, you may be missing on other
opportunities. It’s important to have an overall view of the
economy and financial markets regularly- and not just stock
market [Link] tend to concentrate on stocks alone and
in the process, they forget to take note of what’s going around in
the financial world. For example – in 2010-11, it was gold that out
performed all other asset classes. Those who had an overall
knowledge about financial markets would have invested a part of
their funds in gold.

Continuing the above example – let us assume that the buy price of
that IT stock was Rs 150 and you sold it for Rs 225 in one month,
thereby making a gross profit of Rs 75 per share. You made a killing
on that stock. Every time that stock drops to Rs 150, even if it’s a year
or two later, you’ll be tempted to buy that stock based on the previous
experience. That ‘Rs 150’ remains in your memory as a sweet spot to
buy. You tend to forget the fact that financial fundamentals of the
company might have changed by then.
So, that’s my second point – financial fundamentals of a
company keep changing. That’s the reason why result
announcements create such hype in the stock markets. It’s
important to keep track of the fundamentals of the company
every quarter. Do not buy a share just because it came back to
the previous levels. This time, may be, there’s some problem with
the fundamentals.
Let’s continue our story – after valuating some IT companies including
the stock you previously owned, you have now short listed 2
companies – one trades at Rs 200 and the other trades at Rs 600. A
common belief of beginners is that Rs 200 stock is 3 times cheaper
than a Rs 600 stock. That’s wrong. For example, the company that
trades at Rs 200 may have 6 million shares while the other one that
trades at Rs 600 may have only 2 million shares. So the market
capitalization of the two companies is the same. So the solution to this
is in finding out the P/E of the stocks. The price of the stock is divided
by the earnings per share and that tells you which company is more
expensive. A stock that has a P/E of 20 is definitely priced lower than
a stock that has a P/E of say, 65.
That brings us to our 3 point – price per share is not the criteria
rd

to decide whether a stock is cheap or expensive. You need the

P/E of the stocks.
From my interaction with freshers, these are 3 of the most common
mistakes that they commit.
What are Demat accounts?
WHAT IS A DEMAT ACCOUNT?
Demat refers to a dematerialized account.
Demat is very similar to your savings bank account. You have to
open an account with a bank if you want to save your money, make
cheque payments etc. Similarly, you open a demat account if you
want to buy or sell stocks. So it is just like a bank account where
actual money is replaced by shares.
A ‘dematerialised’ account holds shares in electronic form, saving
you the bother of holding shares in paper form. Possessing a demat
account is now a prerequisite for stock market investments.
so, while your bank account keeps your money safe and transfers it
from account to account according to your instructions without
bothering you , your demat account keeps your shares safe and
transfers it to the next owner when you sell it.
WHO PROVIDES THE SERVICE?
Demat services are provided by banks, financial institutions and
stock broking houses. The broking houses in such cases also act
as DPs (depository participants) intermediating between the
depositories — CDSL or NSDL and the investor. To open a demat
account, you have to make an application to a DP and submit
required documents. Once you have a demat account to your name,
you can open a trading account with a broker of your choice.
The shares bought and sold by you will be reflected in your demat
account. Any previously held physical share can also be
dematerialised and transferred to the [Link] DP, at regular
intervals, would provide you with an account statement showing the
balance of shares in your demat account and transactions during a
period.
In short, to start trading in shares you have to open two accounts-
1. A trading account -with the broker and
2.A de-mat account – Either you choose a bank/financial institution
or a stock broker who could provide you the DP services.
CHARGES
The fees charged for DP services differ across the industry. Though
the rates change, the charges normally go under the following
heads:
[Link] opening fee
[Link] maintenance fee
[Link] fee
Besides the above, depository participants also charge service tax
as applicable.
DOCUMENTS REQUIRED
For opening a demat account one needs to provide a set of
documents to the agent. They are:
[Link] completed account opening form and passport size photos;
2.A copy of PAN card as proof of identity;
[Link] cheque/Copy of the bank passbook
4.A copy of passport/voter ID/ ration card as a proof of address
[Link] of the DP-investor agreement.
On giving the above papers, the agent would complete the other
formalities with the depository and facilitate opening of the account.
You would then be given a unique account number (BO ID-
Beneficiary Owner Identity), which would serve as a reference
number for all further transactions.
A set of delivery instruction (DI) slips will be give to you from the DP.
This is almost similar to he cheque book you get when you open
your bank account. A DI slip has to be filled and sent to the DP on
every delivery (sale of shares) you make. DI slip is an instruction to
the DP to debit your account and credit the broker’s account with
the specific stock.
Take note that the DI instruction has to reach the DP the very next
day after the sale, failing which the securities won’t reach the broker
and hence the exchange. This could result in auction of the security.
When you open a demat account with your stockbroker, you also
sign and deliver a standing instruction for delivery of stocks that you
[Link], the broker handles the delivery system and you need
not worry about all this.
CONCLUSION
With that, we end our discussion about De-mat accounts.

What is a trading account?

As said in the previous section, Your Demat account is merely an
account which keeps track of which shares or equities you have
bought and you currently hold in your portfolio. So there is not much
to do as far as ‘operating’ demat account is concerned.
TRADING ACCOUNT
Some of the beginners do not understand relationship between
Share Trading account and Demat Account. This short section will
explain the relationship between Demat account, trading Account
and your Bank Account. We will also see how many trading or
Demat account you can have in total.
Trading account is an interface between your Bank account
and your Demat account. To buy shares, the first step is to
transfer money from your bank account to trading account. For
example , if you want to buy 100 shares at Rs 50 , you have to
transfer Rs 5000 from your bank account to the trading
account.
The shares that you buy will be stored in the demat account.
When you sell, your trading account takes back the shares
from your Demat account and Sells them in Stock Market and
get back the money.
If you want your money back into your bank account, you have
 to give a request online to the broker to transfer it to Bank
account. The money gets credited in your bank account in 2 or
3 working days.
Just as every person is allowed to open as many savings
account as he likes, there are no restrictions of the number of
Demat Accounts a person can have. You can have any
number of demat accounts.
SELECTING A DEMAT AND TRADING ACCOUNT
The key criteria for selecting these accounts are:
1. Your purpose/usage. In short, how frequently are you going to
buy/sell and is it intraday or delivery based. You may have to
choose the Broker whose charges are lowest according to your
transaction style.
2. Look at a complete solution and not just one individual product
like a demat account. After all, the money in the savings account
will be linked to your trading account for buying/selling shares and
the trading account will be linked to your demat account for storing
the shares. Suppose you have a Savings account with Bank A, and
the trading account with Broker B and Broker B trading account
does not have a partnering arrangement with Bank A, you will be
forced to open a new savings account with a bank which has
partnering arrangement with broker B. Usually, most non-bank
brokerages have tie-ups with the popular banks for savings bank
accounts and demat accounts, but brokerages in a banking group
company may have only the same bank as its partner.
3. Think long term. In case you have got yourself a demat account
and you have existing shares in it and you want to move to another
demat account, transfer of shares is chargeable. Brokers may
charge based on number of shares or amount worth or anything.
Please find out what this amount is, in case you are ever tired of
bad service and you want to change the demat account. These
transfer rates are never mentioned anywhere.
4. Technology. Some online stock brokers do a great job in making
sure that their clients can always access their accounts, and in turn
buy and sell as quickly as possible. But on the other side of things,
not all brokers run this smoothly. Due to excess demands on the
system, some brokers have a slower load time than others. In fact,
this can lead to the server becoming bogged down. This is not
common as it once was, but still this can happen.
5. Service. With the demand increasing on discount stock brokers, it
is common for errors to occur from time to time. Hopefully this never
happens to you, but you never know what the future holds. If you
notice a mistake on your account, it is important that you contact the
customer support team right away. This will help to ensure that you
get the issue worked out before it causes a snowball effect on your
account. In most cases, the broker you are working with will be
apologetic for the mistake, and will do whatever it takes to get the
issue resolved within a matter of minutes. Also, Gauge the level of
personal service that a stockbroker provides as a final step in the
selection process. Every investor should be assigned a specific
broker or representative to contact at any time.
CONCLUSION
Hope you are now clear about demat and trading accounts and
about how to choose an [Link] around for your broker is
a good idea.

Who is a stock broker?

STOCK BROKER -EXPLAINED
A stockbroker is an individual / organization who are specially given
license to participate in the securities market on behalf of clients.
The stockbroker has the role of an agent. When the Stockbroker
acts as agent for the buyers and sellers of securities, a commission
is charged for this service.
As an agent the stock broker is merely performing a service for the
investor. This means that the broker will buy for the buyer and sell
for the seller, each time making sure that the best price is obtained
for the client.
An investor should regard the stockbroker as one who provides
valuable service and information to assist in making the correct
investment decision. They are adequately qualified to provide
answers to a number of questions that the investor might need
answers to and to assist in participating in the regional market.
Are they governed by any Rules and Regulations?
Of course, yes. Stock brokers are governed by SEBI Act, 1992,
Securities Contracts (Regulation) Act, 1956, Securities and
Exchange Board of India [SEBI (Stock brokers and Sub brokers)
Rules and Regulations, 1992], Rules, Regulations and Bye laws of
stock exchange of which he is a member as well as various
directives of SEBI and stock exchange issued from time to
time. Every stock broker is required to be a member of a stock
exchange as well as registered with SEBI. Examine the SEBI
registration number and other relevant details can be found out from
the registration certificate issued by SEBI.
How do I know whether a broker is registered or not?
Every broker displays registration details on their website and on all
the official documents. You can confirm the registration details on
SEBI website. The SEBI website provides the details of all
registered brokers. A broker’s registration number begins with the
letters “INB” and that of a sub broker with the letters “INS”.
What are the documents to be signed with stock broker?
Before start of trading with a stock broker, you are required to
furnish your details such as name, address, proof of address, etc.
and execute a broker client agreement. You are also entitled to a
document called ‘Risk Disclosure Document’, which would give you
a fair idea about the risks associated with securities market. You
need to go through all these documents carefully.
SUB BROKERS
According to the BSE website – “Sub-broker” means any person not
being a member of a Stock Exchange who acts on behalf of a
member-broker as an agent or otherwise for assisting the investors
in buying, selling or dealing in securities through such member-
brokers.
All Sub-brokers are required to obtain a Certificate of Registration
from SEBI without which they are not permitted to deal in securities.
SEBI has directed that no broker shall deal with a person who is
acting as a sub-broker unless he is registered with SEBI and it shall
be the responsibility of the member-broker to ensure that his clients
are not acting in the capacity of a sub-broker unless they are
registered with SEBI as a sub-broker.
It is mandatory for member-brokers to enter into an agreement with
all the sub-brokers. The agreement lays down the rights and
responsibilities of member-brokers as well as sub-brokers.
STOCK BROKERS IN INDIA.
There are a number of broking houses all over India. Many of them
have International presence too. Following are some of the leading
Stock Broking firms in India.
IndiaInfoline
ICICIdirect
Share khan
India bulls
Geojit Securities
HDFC
Reliance Money
Religare
Angel Broking
Investors have to check the broker’s terms and conditions and
decide about opening a trading account. Only Govt. tax rates like,
security transaction tax, stamp duty and service tax are uniform
other charges like brokerage for delivery trades, intraday trades,
minimum transaction charge, statement charges, DP charges,
annual maintenance charges etc., may vary from one broker to
another.

How to choose a Stock

broker?

hi there,
In this section, i would like to talk about some tips on choosing a
broker.
Stock Brokers are registered members of stock exchange. Nobody
except the stock brokers can directly buy and sell shares in Stock
Market. An investor must contact a stock broker to trade [Link]
availing the service, the broker charges a fee called brokerage. It is
generally a percentage of the value traded.
India has two big stock exchanges (Bombay Stock Exchange – BSE
and National Stock Exchange – NSE) and few small exchanges like
the Cochin Stock exchange. Investor can trade stocks in any of the
stock exchange in India .
The best and practical way to choose a broker is to get referrals.
You can find out from other people about the broker they use and
why they have selected them, it is better to choose someone whom
you have heard good things about.
Here are a few more tips from my experience:-
THE ‘BIGGEST’ MAY NOT BE THE RIGHT ONE.
Some brokers are more geared for frequent traders and
professionals. There are others that are geared more for beginners.
For most novice investors, it is much better to go with beginner-
friendly brokers. High professional stock brokers will have a long list
of high flying investors. While they’ll be busy attending their high
profile investors, you a may not get the personal attention and
advice that a newbie needs.
BROKERAGE
Most of them, I’ve seen, select a broker who offers to charge fewer
commissions on trade. But, that’s not the criteria by which you
select a broker. A broker should understand your preferences, your
likes, your dislikes, your favored asset classes, your risk profile and
they should be capable of giving you personalized tips based on
that information. A stockbroker has to work with your goals in mind.
Now, this doesn’t mean that you should totally ignore the
commission part. You should definitely negotiate. Commissions
charged should be reasonable.
DOES YOUR BROKER COMPEL YOU TO BUY STOCKS?
Stockbrokers are service providers. They are in business to make
you wealthy. Some stockbrokers feel that their business is to buy
and sell stocks. For them, money making is just incidental.
Whatever a stockbroker says to you, always remember you are the
client. It is your money and you make the final decisions. If you feel
uncomfortable about any investment proposition, tell your broker
and they will respect your decision. If they go ahead and go against
you, or compel you to buy shares of their choice, then you definitely
have the wrong stockbroker.
TEST YOUR BROKER’S KNOWLEDGE
Ask ‘market tips’ to any broker and he’ll immediately give a list of 5
or 6 ‘hot stocks’. Whenever you get such tips ask yourself – “Why is
this tip worthy of my hard earned money?” A good stockbroker will
make decisions based on your profile and then choose a stock.
They should be able to explain to you in simple terms why they think
that stock is a good choice for you. A broker will have to explain
what the fundamentals are, about its market capitalization and PE,
about its valuation and future prospects, about the degree of risk
and the profit potential. The broker’s product knowledge is critical. If
they cannot explain their actions, drop them.
BE WITH THE KING !
Check if the broker has any specialty or is a jack-of-all-trades. If a
broker has special focus and strength and this agrees with your
investment goals and aspiration, you will gain more working with
him.
RESEARCH REPORTS
Some broking houses publish excellent research reports exclusively
for it’s [Link] your prospective broker to give copies of
earlier research reports and see if the opinions expressed in those
reports have some degree of accuracy. These research reports are
useful guides to get useful insights.
SERVICE
Be sure to get opinion from investors about the quality of service
that the broker provides.
that’s some tips from my side..

The Broker’s role in

investing.
Hi there,
What should be the broker’s role in your investing decisions?
It would be better if you can limit your broker’s role to executing your
orders .This is not to undermine their importance. But, i feel that’s
where it should end. Because, your broker makes money through
brokerage targets achieved through securities transactions. He
does not make any money from setting up a long-term financial plan
for you. Since a fee is charged whenever you buy or sell,the more
you keep buying and selling – the more he makes money.
Knowingly or otherwise, the broker/relationship managers will be
more interested in generating the target brokerage. This is the
reality. Your broker may NOT be required to act in your best interest
and you may be receiving dangerous advice that could cost you a
fortune.
Why? –Because, brokers don’t have fiduciary responsibility.
Most people using stock recommendations from brokers expect the
broker to recommend appropriate investments so that it improves
their portfolio’s performance. Underlying these expectations is the
understanding that they will act in the best interest. The legal term
for ‘acting in your best interest’ is called fiduciary responsibility. For
instance, if you set up a trust for your child and name a trustee to
oversee that trust, the trustee has a fiduciary responsibility to act in
your child’s best interest. If they don’t, they can be taken to court
and be held liable for their actions. A common misconception
among investors is that their stockbroker has this fiduciary
responsibility. They don’t. That’s why following their advice can be
dangerous.
Want more proof? – read the fine prints.
How did you start your de-mat account? You just placed 32 odd
signatures on that 60 page booklet. Isn’t it? Did you read that whole
thing? Most probably- No. If you go through those paragraphs, you
will realise that –You are solely responsible for all investment
decisions and trades even if you have accepted the broker’s call.
Who gives you market tips? Your broker or analyst?
Here’s the reality- Most of the time, the guy who gives you market
tips is the employer of the broker. They are given general ‘market
tips’ every morning by the main broker which they blindly tell to all
their customers- without considering the risk tolerance capacity,
age, equity or profile of the customer. That’s the exact reason why
there are more losers in the market. This is not to say that
researches done by brokers are not good, but those are general
advices.
Understand the difference between a broker and an analyst.
At this point, it is also very important to understand the difference in
role between a broker and a stock market analyst. An analyst
literally analyzes the stock market, and predicts what it will or will
not do, or how specific stocks will perform. A stock broker is only
there to follow your instructions to either buy or sell stock and not to
analyze stocks. Broker’s target is to earn their money from
commissions on sales. So when brokers themselves double up as
investment advisors– there is some danger in it.
CONCLUSION
Being with the right broker is critical. It can mean making money for
yourself with your trades, or end up you making money for the
broker. Ideally, brokerage should assume importance only when
they threaten to eat up a significant chunk of your profits. This would
be a problem more relevant to day traders than the long-term
investors, who, in comparison, might trade occasionally. High-
volume traders can consider negotiating their commissions with
brokers. Alternately, such traders can also consider flat fee broking
products, which charge fixed brokerage for a specified period,
irrespective of the frequency or value of transactions. This ensures
a limited trading cost even as traders enjoy the broker’s services
and advice. A good investor should be more concerned about the
quality of tips and advices he takes, rather than negotiating on
brokerages.
So, If you are seeking advice on balancing your portfolio, then you
need to look for an investment advisor (sometimes called a financial
planner), who will charge a fee for drawing up a total financial plan
for you. The financial planner may work out a strategy to manage
your securities holdings in harmony with your total financial plan.
Investment advisors- An
introduction.
Hi there,
As an investment professional, I can confirm that most members of
the public have roughly zero investment skill. This is not meant to
be derogatory, just realistic. However, most members of the public
also seem to think that investment is or should be ‘easy’ and as a
skill has very little value added. If only it were so.
The reality is that most people have limited financial skills because
these things take effort, study and thought. In our time away from
an occupation, we want to relax, not analyse annual reports. But to
be successful, we need to see a lot of annual reports before we find
the one we really like. This is a real chore.
The ability to trade online through laptops and mobile phones has
made share market even more available to investors and it has
definitely expanded the number of trades being made, which
brokers and stock exchanges around the world must be grateful for;
but all of these facilities has not made us better investors. As long
as the investor does not have the required skills to flourish, he
needs an investment advisor that offers research and guidance.
Should an investor with very limited funds be investing in the
markets? If yes, what should his approach be? What should be the
approach of an investor who has a huge chunk of money to invest?
Should he hedge his investments in the derivatives market? If an
investment is made that proves to be shockingly poor, and loses
eighty or ninety percent of the money invested, it was a bad deal ,
right? If an advisor had pointed out just how risky the deal was,
might the investment funds have been saved? Would that have
been money better spent than saved? If an extra thirty or fifty
rupees spent on advice from an investment advisor could have
saved one thousand, might that not be an acceptable price to pay?
The above thoughts clearly bring into focus the need of an
investment advisor.
More about investment advisors and portfolio management in our
next section.

What is a portfolio? What’s

portfolio management?

PORTFOLIO
Simply put-
If you own more than one asset as investment, you have an
investment [Link] example you may have 30% of your wealth
invested in equities, 30% in debt funds, 20% in gold and the
balance in cash- that’s a portfolio of investments.
In the context of shares, you have a portfolio of shares, when you
own and manage a group of different [Link] example if you own
stocks of Infosys , HLL , Cipla, Tata motors and DLF – what you
have is a portfolio of equity investments in diversified sectors.
All investments carry risk. You cannot put all your money in
one asset class . For example , you have 1 million with you
and you decide to put the whole money into equities. What
would be your fate if the stock crashes? or if you have
invested in fixed income deposits that gives you 8% interest for
a long term . The average inflation rate stays at 8% . Do you
think you’ve made a penny ?
So, putting all your money in one basket in not a good idea
 because it exposes you to great risks. The solution to reduce
risk is to do the opposite- put all your money in different
baskets- so that even if one fails , you get a return from other
which may compensate the loss in other. The more you
diversify, the less risky your portfolio becomes. This is one of
the basic principles in investments.
So, the main characteristic of a serious investment portfolio is
diversity. It should show a spread of investments to minimize
risk.
WHO IS A PORTFOLIO MANAGER?
A portfolio manager is that person who, with his skill and expertise,
looks after your investments and manages them for you. PM’s
(Portfolio managers) make decisions about investment mix and
policy, matching investments to objectives, asset allocation for
individuals and institutions, and balancing risk against performance.
Are they known by any other names?
Yes. They are also called money managers, investment advisors,
financial advisors, financial consultants, investment consultants,
financial planers etc.. after all, what’s in a name? What matters is
what something is, not what it is called. However, there are two
types of portfolio managers- discretionary PM and non-discretionary
PM.
What’s the difference?
The discretionary PM individually and independently manages the
funds of each client in accordance with the needs of the client. So
they make the buy-sell decisions without referring to the account
owner (client) for every transaction. The manager, however, must
operate within the agreed upon limits to achieve the client’s stated
investment objectives. Non discretionary PM manages the fund in
accordance with the directions of the client.
Is there an agreement between you and PM?
Yes. The portfolio manager, before taking up an assignment of
management of funds on behalf of the client, enters into an
agreement in writing with the client clearly defining the relationship
and setting out their mutual rights, obligations and liabilities relating
to the management of funds containing details as specified in
schedule IV of the SEBI (portfolio managers) Regulations, 1993.
IS THERE A MINIMUM INVESTMENT?
Yes. The PM is required to accept fund or securities having a
minimum worth of 5 lakhs rupees from the client while opening the
account for the purpose of rendering portfolio management services
to the client.
How much can a PM charge from you?
The SEBI (portfolio managers) regulations, 1993, have not
prescribed any scale of fee to be charged by the portfolio manager
to his clients. However, the regulations provide that they can charge
a fee as per the agreement wit the client for rendering their
services. The fee so charged may be a fixed amount or a return
based fee or a combination of both. The PM shall take specific
permission from the client for charging such fees.
Can a PM invest in derivatives (futures and options)
for his client?
Yes. However, leveraging of portfolio is not permitted in respect of
investment in derivatives. The total exposure of the client’s portfolio
derivatives should not exceed his portfolio funds placed with the
PM.
What are the disclosure requirements of PM to their clients?
The PM provides to the client the disclosure document at least 2
days prior to entering into an agreement with the client. The
disclosure document contains the quantum and manner of payment
of fees payable by the client for each activity for which service is
rendered by the PM directly or indirectly, portfolio risks, complete
disclosures in respect of transactions with related parties as per the
standards issued by the ICAI in this regard, the performance of the
PM and the audited financial statements for the last 3 years.
Is premature withdrawal of Funds/securities by an investor
allowed?
The funds or securities can be withdrawn or taken back by the client
before the maturity of the contract. However, the terms of the
premature withdrawal would be as per the agreement between the
client and the portfolio manager.
Can a Portfolio Manager impose a lock-in on the investor?
Portfolio managers cannot impose a lock-in on the investment of
their clients. However, a portfolio manager can charge exit fees from
the client for early exit, as laid down in the agreement.
CAN A PM OFFER GUARANTEED RETURNS?
Portfolio manager cannot offer/ promise indicative or guaranteed
returns to clients.
Where can an investor look out for information on portfolio
managers?
Investors can log on to the website of SEBI [Link] for
information on SEBI regulations and circulars pertaining to portfolio
managers. Addresses of the registered portfolio managers are also
available on the website.
How can the investors redress their complaints?
Investors would find in the Disclosure Document the name, address
and telephone number of the investor relation officer of the portfolio
manager who attends to the investor queries and complaints. The
grievance redressal and dispute mechanism is also mentioned in
the Disclosure Document. Investors can approach SEBI for
redressal of their complaints. On receipt of complaints, SEBI takes
up the matter with the concerned portfolio manager and follows up
with them.
Investors may send their complaints to: Office of Investor
Assistance and Education, Securities and Exchange Board of India,
SEBI Bhavan Plot No. C4-A, ‘G’ Block, Bandra-Kurla Complex,
Bandra (E), Mumbai – 400 05
That completes portfolio and portfolio managers. Our next section
will detail about the qualities that you should look for in a PM and
how to go about selecting a PM.

How to select a Portfolio

Manager?

Hi there,
As said in the previous section,The portfolio manager manages the
portfolio on behalf of the client by investing the money in shares and
other securities.
You can invest fresh money in Portfolio Management Scheme and
the portfolio manager will build a portfolio by deploying that money.
Also you can transfer your existing share portfolio to the Portfolio
Management Scheme provider. In that case, the portfolio manager
will revamp your share portfolio in sync with his investment
philosophy and strategy.
Once the Portfolio Management Scheme account is opened, you
will be provided with an online access to your portfolio. You can look
at where the portfolio manager is investing your money. Also you
will be able to generate reports like Portfolio Transaction List,
Investment Summary, Performance Analysis, Portfolio Statement
and Quarterly capital gain report. As a result, Portfolio Management
Scheme relieves you as an investor from all the administrative
hassles of investments.
Portfolio Management Scheme Vs Direct Stock Market
investment:
You can directly invest in stock market. Then what is the benefit of
investing in the stock market through a Portfolio Management
Scheme. Investing in share market demands time, knowledge, right
mindset, and continuous periodical monitoring. It is really difficult for
an individual investor to meet all these demands. But a Portfolio
Management Scheme meets these demands at ease. The Portfolio
Management Scheme will be managed by a professional expert. It
saves a lot of time and effort of the individual investors like you.
Hence it is advisable to outsource the stock market investment to a
sound Portfolio Management Scheme operator instead of managing
it on your own.
Guidelines in choosing the right PM
There are all kinds of money managers: good, bad, mediocre,
and cheats. Clearly, it’s not worth paying for anything less than
the best manager you can find.
Look for PMs that are truly unbiased and independent.
Advisory companies that have asset management companies
as stakeholders may be biased towards their products.
Choose an advisory company that offers a holistic approach to
investments. There are companies that require their advisors
to understand the client’s needs through financial planning
before recommending solutions.
Regular communication in the form of newsletters, portfolio
updates, investment alerts, etc, is a must and this indicates
that the company hasn’t forgotten you after you’ve given it
business.
Look for a company whose representatives are ready to
explain product benefits in a jargon-free language, and help
you decide what is best for you.
Above all, do cross check to ensure that the company you
choose to put your trust in has a clean record. The company
should be established and should have a good reputation in
the market.
Disadvantages:
The most obvious disadvantage of portfolio management is that the
fund manager may make bad investment choices or follow an
unsound theory in managing the portfolio. The fees associated with
portfolio management are also high. It’s generally a percentage of
the annual value of investments. Those who are considering
investing in portfolio managers should evaluate carefully. Data from
recent decades demonstrates that the majority of portfolio
managers failed to perform to expectations.
CONCLUSION
Trusting a portfolio management advisor is difficult and risky . There
are many known cases of churning, where the consultant shifts
investment from one fund to another. Some investors restrict this
practice by limiting the commission to the consultant depending on
his performance; however, if there is a loss, it wouldn’t matter much
to them.

How much should you pay

for the right portfolio
manager?
Hi there,
The rationale for entrusting one’s wealth and savings to a fund
manager is simple - Majority of us have zero investment skills. The
only ‘safe’ investment that we all know is ‘fixed deposits’. so we nee
someone who can create wealth for us- a professional- who’s
knows the investment game well.
Now, let’s assume that you’ve found one. Now, how much should
you pay for the right fund manager? Are there any regulations for it?
How can you make sure that he would perform? Imagine an
electrician not doing the work for which he is paid and also causing
damage to your electrical [Link] would you feel?
Here are some guidelines-
Portfolio managers have been asked by SEBI that profits of their
schemes be computed only on the ‘high water-mark’ principle. This
means the portfolio managers can only charge fee (or share profit)
based on the highest value that the portfolio has reached over the
life of the investment.
For example, if a portfolio of Rs 10 lakh appreciates to Rs 12 lakh in
the first year, a performance fee or profit sharing will be payable on
Rs 2 lakh. In the next year if the portfolio value falls to Rs 11 lakh,
no performance fee will accrue. If the portfolio value goes up to Rs
13 lakh in the third year, the fee can be charged only on Rs 1 lakh
(Rs 13 lakh-Rs 12 lakh). For the fourth year, the ‘high water-mark’
will become Rs 13 lakh.
The regulator has thus ensured that portfolio managers do not
charge for loss recovery. However, the ‘high water-mark principle’
will apply only to discretionary and non-discretionary services and
not for advisory services.
The market regulator has also prescribed a standardized format of
declaring fees and charge. Providers of portfolio management
services are now expected to provide details of fees and charges
under three scenarios — 20 per cent profit, no profit/no loss and 20
per cent loss — to all clients. This format enables a client to
compute the indicative gain or loss on the funds he would be
investing for a year.
ASSOCIATED COSTS
Annual management fees and profit sharing:
PMS typically works on a 20/2 thumb rule. You pay 2 per cent
annual management fees, on top of which you share 20 per cent of
profits you make beyond a “Hurdle Rate”. The Hurdle rate is defined
at the outset of your agreement terms and till such time this return is
obtained by you, you don’t have to share any profit with the service
provider. Until then, you share profits on the basis of “Watermark”
concept mentioned above.
Brokerage
Apart from these, you also incur the cost of brokerage for each
transaction. Brokerage can vary from 0.25 per cent to 0.50 per cent
of transaction value. Many PMS’ also take an upfront fee, which is
typically about 2 per cent.
Evaluate cost very carefully. Get a clear understanding of how often
stocks will be churned in your portfolio as a high level of churn will
mean significant cost on brokerage. This will reduce your overall
returns. PMS providers have to mandatorily give at least a six-
monthly statement but many of them report more frequently. It’s
better to get regular updates so that you can track your returns and
take corrective actions if required. Some portfolio managers also
provide online access to your portfolio.
Exit clause
And finally, look at the exit clauses. PMS’ may charge a fee if you
exit a plan before a certain time period. This will be an important
consideration if you think you may need the money in case of
exigencies.
PMS BY STOCK BROKING FIRMS
Some of the leading brokerage firms in India are also offering PMS
to clients without any lock in terms and conditions. They charge an
annual fund management fee, payable quarterly . There is also a
minimum investment of 5 or 10 lakhs depending on the broker’s
terms and conditions.

Investing in Indian stock

markets- A guide for NRI’s
For most NRI’s the difficult part about knowing how to go about
investing in Indian stock markets is-finding one place where they
can get all the required information. There’s isn’t much complicated
process involved in opening a share investment account in India.
There are only 3 steps involved:-
Step 1 : Get your PAN Card
Step 2 : Open an NRE/NRO account.
Step 3 : Open demat/trading account.
Step 1: Pan Card
PAN – stands for ‘Permanent Account Number’ and it is just an
identification number like your ‘Social Security Number’ in the
United States or ‘Social Insurance Number’ in Canada. The PAN
card will have your photograph, date of birth and signature on
[Link] is mandatory for everyone who wishes to invest in Indian
stock market.
Step 2: NRE/NRO Account.
NRE stands for Non Resident External Account and NRO stands for
Non Resident Ordinary account.
How to decide whether you need NRE or NRO account?
Here are some pointers:
Decide whether you want to repatriate (take back your
profits/principal from share markets) to your country. If you
want to take back the amount then, you should open NRE
(Non Resident External) Account and if you do not want to
repatriate, open NRO (Non Resident Ordinary) Account.
Please remember that as an NRI you can’t operate normal
resident savings bank account i.e. all existing resident bank
accounts should be converted to NRO accounts once a
person becomes NRI. NRO accounts are generally opened by
the NRI’s to deposit previous or existing income earned in
India in Rupees.
 So, if you have money flowing in from abroad alone, what you
need is an NRE account. But, if you have some source of
income in India too, you need to open an NRO account.
Step 3- Open Demat/trading account.
Final step would be to open a demat account- an account to
maintain your online purchase and sale of shares. Demat and
trading account can be opened with any registered broker. That’s it.
Once your trading and demat accounts are open, you can invest in
Indian share markets. The entire process of transferring funds and
buying/ selling can be done online .
General documents required to open a share investment
account:
Self attested Copy of Passport & Visa
Self attested Copy of Indian Address proof & Overseas
Address proof.
Self attested Copy of Pan Card
Passport size photos.
Bank statement for 3 months
A cancelled cheque and a cheque for initial investment.
Other important informations:
It is always better for an NRI to operate through a power of
attorney holder in India. There are many investors who do this
and it’s also a lot easier and faster.
NRI’s can invest in the Indian stock market under PIS
(Portfolio Investment Scheme) which is regulated by RBI.
Port folio Investment scheme is a Scheme is regulated by
Reserve Bank of India (RBI). RBI monitors the investments
made by non-residents so that it can keep a tab on money
flowing into India from outside the country.
NRI’s are not allowed to trade in the stock market on day to
day basis. i.e., you cannot buy and sell on the same day (Day
trades or intra day trades as it’s usually called). Day trades are
 akin to speculation. NRI’s are not allowed to speculate on a
day-to-day basis in the markets.
You can nominate only one bank account for your stock
trading.
NRIs can participate in the F & O segment (except currency
derivatives) out of INR funds held in India on non-repatriable
basis (NRO) subject to the limits prescribed by SEBI. An NRI,
who wishes to trade on the F&O segment of the exchange, is
required to apply for a custodial participant (CP) code.
Thereafter he can open a trading account and start trading in
derivatives. Position limits for NRIs shall be same as the client
level position limits specified by SEBI from time to time..
Individually any NRI or a PIO cannot invest more than 5%
stake in any Indian company.
NRE bank account- explained
NRE means Non Resident External rupee bank accounts.
Balances held in NRE accounts can be repatriated abroad
freely. This account is used for depositing money from abroad.
An NRE account keeps the money in Indian Rupee.
NRE account will let you convert your original foreign currency
investment into Indian Rupees for investment in India and then
convert it back to the foreign currency.
These accounts cannot be held jointly with residents. But,
Joint operation with other NRIs is permitted.
A Power of attorney can be granted to residents for operation
of accounts. Money once deposited in this account can only
be withdrawn for local payments including investments.
Interest on deposits in an NRE accounts is tax free in India.
The balance lying on the account does not attract wealth tax.
Any gifts given from the money lying in this account does not
attract gift tax.
Once you have the NRE account, you can invest funds to
 share market.
Those who already have NRE bank accounts should check
with their bankers to find out whether those are suitable for
stock investments. Not all NRE/NRO bank accounts are
suitable for investments.
Investors should make sure you read all the fine prints
regarding charges applicable.
NRI vs PIO
A Non-resident Indian (NRI) is a person who is a citizen of
India or a person of Indian origin, currently residing outside
India. To qualify for NRI status you must:
(1) Reside outside India for more than 182 days per year, and;
(2) Hold Indian citizenship, or;
(3) Be a Person of Indian Origin (PIO) as defined in the Foreign
Exchange Management Deposit Regulations of 2000
Condition no.1 is mandatory and condition 2 OR 3 should be
satisfied
A PIO (Person of Indian Origin) means a citizen of any country
other than Bangladesh or Pakistan, if-
1. He at any time held Indian passport or
2. He or either of his parents or any of his grand- parents was a
citizen of India or
3. The person is a spouse of an Indian citizen or a person referred
to in 1 or 2 above.
Conclusion
India’s economy is sizzling and is one of the fastest growing in the
world. It’s definitely a financial mistake if you don’t invest a part of
your hard earned money in India.

Going Online
GOING ONLINE
Traditionally stock trading was done through stock brokers,
personally or through telephones. Busy phone lines, miss
communication resulting in confusion and sometimes loss to the
investors created lot of practical problems in trading. Information
technology has helped stock brokers in solving these problems with
Online Stock Trading. Online stock trading sites offer investors
access to a variety of tools and research that just a few years ago
were only available through full service brokerage accounts. Online
stock trading is done through ‘terminal’ installed in your personal
computer. This online terminal is provided by the brokerage
house .so, you can trade in shares from the comfort of your home.

A good online stock terminal would offer you the following :

Fast trade execution with instant trade confirmation.
Live streaming quotes and price watch on any number of
stocks.
Intra day charts, updated live, tick-by-tick.
Live margin, position, marked to market profit & loss report.
Set any number of price alerts on any number of scrips.
Flexibility to customize screen layout and setting.
Facility to customize any number of portfolios & watch lists.
Facility to cancel all pending orders at one click.
Facility to square off all transactions at one click.
Top Gainers, Top Losers, Most Active, updated live.
Index information; index chart, index stock information live.
Market depth, i.e. Best 5 bids and offers, updated live for all
stocks.
Online access to both accounts and DP to check live updated
Order and Trade Book.
Facility to place after market orders.
Online fund transfer facility from your Bank account.
 Online intra-day technical calls.
Historical charts and technical analysis tools
THINGS TO DO BEFORE OPENING A TRADING ACCOUNT
Ask for Demo:Contact the broker who provide online trading
service and ask him to give you a demo of product.
Check if the broker trades in multiple stock exchanges.
Usually most of the Online Trading Websites trade in NSE and
BSE in India.
Check the integration of Brokerage account, Demat account
and Bank account.
Compare brokerages with other peer companies.
Standard document required to open an Online Trading Account
1 Proof of residence (Address proof-any one from the list)
Driving license
Voter’s ID
Passport
Photo credit card
Photo ration card
Utility Bill (Telephone, Electricity etc)
Bank Statement
2 Proof of identity(any one from the list )
Driving license
Voter’s ID
Passport
Photo ration card
PAN Card
3 Two photographs
4 Bank statement and two cheques-one cancelled and the other
for making initial investment.
ADVANTAGES OF ONLINE TRADING
Typically online trading requires the investors to pay lower
brokerage.
 In case of online trading there is no middle man involved.
In case of online trading there is no paper work involved.
Trading on a real time.
Investors can deal with different stock exchanges with single
online trading account.
Mutual funds and IPO’s can be bought and sold on line.

Understanding the online

trading software
Online trading is nothing but trading via the Internet with the help of
trading software provided by the broker. The trading platform may
be a source of great confusion to them. It is important that you get a
firm grip on the trading platform since it provides all the necessary
tools to do technical analysis. You can also transfer funds online
from your bank account to your share trading account with the click
of a button.
The advantages of using online trading are:
Fully automated trading process which is broker independent.
Access to advanced trading tools to perform technical analysis
Investors have direct control over their trading portfolio.
Ability to trade multiple markets and/or products (you can
trade in BSE/NSE)
Real-time market data.
Faster trade execution ( very crucial if you are a trader )
Easy to operate and manage account
No geographical limits.(whether you stay in New Zealand or
Dubai you can invest in Indian share market through online
trading platforms)
Our discussion is primarily based on the general features provided
by a good online trading platform. It’s important that you check the
quality and speed of the trading software provided to you by the
broker.
LOGIN ID AND PASSWORD:
Your online trading platform should be protected by a login id given
to you by the broker and a password of your choice. Password
should be changed frequently. Some software prompts you to
change your password every 15 days. Further, the facility to ‘lock’
the trading software to one computer would be an additional
security measure. With this facility, you will be able to login only
from one particular personal computer.
THE MARKET SCREEN:
For a beginner, the market screen might look like a jungle of
numbers. It’s nothing to be confused about.
Market screen is the most important window that will help you get
your trading done. This window gives a tabular representation of
the current market position for selected shares. Each share makes
up a row of data that contains the scrip name, its last traded price,
last traded quantity, best bid rate, best offer rate, total volume etc.
Market Watch window is highly configurable and you can decide
which columns are to be viewed and which not, whether you require
row or column separators, determine the size of all rows or each
column, the color used to display data etc. There are a host of
options available on a pop-up menu that can be accessed by right
clicking on the Market Watch window. All these windows will be
updated dynamically in real time and you need not ‘pull’ or refresh
any information. It’s all real time updated. In fact you are in live
market.
It will take only one day to understand the market screen. Market
Watch window is the prime controlling window from where you can
launch your trading actions. You buy or sell a share by clicking on
the specific share on the market screen.
INDICES DISPLAY
Trading screen should have indices displayed at a convenient
location on the screen.
It should display all popular Indices like Sensex and Nifty. The
indices display should be capable of being customized to show
other indices which you follow. An investor should keep track of the
market indices so as to get an overall picture of the market
sentiment.
REPORTS
Reports comprise of Order Book, Trade Book, Net Positions,
Margin, Exercise Book and Holdings. In any trading terminal, all
these reports are dynamically updated without the need to refresh
or pull information. From the Reports window you can ‘Modify’,
‘Cancel’, ‘Square Off’ or ‘Exercise’. The appropriate buttons will be
enabled/ disabled depending on which action can be taken based
on the currently selected row. You can save these reports to a file
either in text or CSV format.
CHARTS
A Good trading software will provide the following facilities to chart:
Streaming intraday tick-by-tick charts & historical data.
Ability to chart multiple companies and open unlimited charts.
Simultaneously.
Unique draw tools including trend line customization and
Fibonacci tools.
Different chart type options such as Line, Bar and Candlestick.
Lots of analysis options including indicators such as MACD,
RSI, Williams % R etc for price and volume panels. There are
at least 14 indicators that are useful to a trader.
Facility to save chart as JPEG file.
MARKET ANALYSER
Market analyser feature would provide top traded, top gainers and
top losers with % change, value and total quantity. It would also
provide the list of shares that have touched their 52 week High or 52
week low. It would also help to analyse all quotes and extract those
where quantity traded exceeds a given figure or transaction value
exceeds a given value. This helps you identify large trades and can
give you vital clues to where or in which scrip activity is currently
happening.

Online vs. Offline

Typically, an online trading account is linked to a depository
participant (DP) and bank account. Find out in which banks your
broker has a tie-up with. If you do not have an account in one of
those banks for trading, you may need to open one. Three-in-one
account is offered by some brokers, wherein all the three accounts
are opened with the same organization. This not only helps to
transfer money but also to redeem the sale proceeds when you sell
stocks from your portfolio. However, the two most important aspects
that determine the effectiveness of e-broking platform are the
trading software and customer service levels that the broker
provides.
If you are going to use internet to buy stocks- The first three steps
would be to-
Step 1. Understand how to place orders, modify and cancel them.
Step [Link] how to verify your ledger balance, get details of
transactions and, in general, learn to navigate through the software.
[Link] a grip of the nuances of transferring money online —
both to and from the trading account.
Demonstration of trading software.
You get a good demonstration of the trading software from your
relationship manager before you start trading.
Customer service
Since online trading reduces the human interaction you would
otherwise have had in an offline account, the customer service team
plays a key role in redressing any problem. Remember to enquire
about the customer service to existing clients to get an idea of the
competency of the team.
Phone trading option
Find out from your prospective brokers on how they usually handle
a `market meltdown’. This occurs when the market rises or falls
rapidly and the broker gets loaded with orders five-10 times the size
of normal orders. The internet is also not reliable all the time. Net
connections can get disconnected or disturbed due to several
reasons. In such cases, the broker should provide you with an
alternate means of placing orders. Most brokers offer what is called
phone trading to help their clients during such an untoward
exigency. However, these phone trading options are sometimes
charged.
Pre market / after market orders.
Find out if the broker will give you an option to place orders before
the market opens for the next day. Commonly called the “after
market orders”, you can use this option to place your order the
previous day itself when you foresee a busy day ahead.
Try to get details regarding the various trading products that are
offered by the brokers and find the one that suits your profile. While
some brokers offer a variety of trading products others offer only the
basic trading product.
Offline.
An offline account is the traditional broking account, wherein you
place orders with your dealer either by walking to the office or over
the phone. Traders and high net worth individuals with a need for
fast and professional execution of orders can consider such options.
Since the dealer plays a key role in this model, find out if your
dealer is good at execution of orders and is pro active in information
sharing. Remember the dealer’s experience in the market is also a
crucial factor. You might also want to negotiate on the trading
exposure and the fee that is charged. Unlike the online model,
offline brokers are more flexible with the exposure and the
brokerage charged.

Keep an eye on brokerage

costs.
Hi there,
The cost associated with buying and selling shares are very tricky.
Ask any relationship manager of a broking house about the
commission they charge and he would readily come up with this
answer- “.05% for intra day trades and .50% for delivery”. If you try
t0 walk away, he’ll come back with his second offer of “.04% for intra
day and .40% for delivery”. This can go down even to .01 for intra
day and .10% for delivery!
Tip: Although you may finally select a broker, make sure that
the brokerage applied on transactions is in line with the offer
he made initially. You need to check the brokerage applied by
your broker periodically.
Brokers charge an amount called ‘Annual maintenance
charges’ from your account. Check those charges. If they are
charging AMC every month, it eats into your invested fund.
The best option is to pay a lumpsum amount while joining and
get exempted from AMC being charged monthly. Generally,
Borkers charge a lumpsum of around Rs 500 – 750 for a life
time.

The effective rate of brokerage, however, is different from the above

percentages. Apart from brokerage there are other related costs
which these managers don’t talk about. Before getting further into
the topic we need to understand what the terms ‘intra day’ and
‘delivery’ mean. Let’s see-
Intra day - Intraday Trading, also known as Day Trading means you
buy a stock and sell that position before the end of that day’s
trading session thereby making a profit or loss for you. A buy
position and a sell position of same number of shares of a company
– All in one day’s trading session. Thus, intraday means trading in a
day. In intra day trading, brokerage is low in comparison to the
delivery.
Delivery- You do not square off your position in a day session.
Instead, you decide to hold the shares till the next trading session or
till 20 years or till your target is reached.

Now let’s talk about what those charges are. Since the topic is
about brokerage , i have also mentioned about the brokerages on
derivatives transaction.
RATES OF BROKERAGE
The net trading cost is computed as below:
Trading cost = Brokerage + STT + Stamp duty + other
charges
Now lets try to separate all the cost components-
Brokerage: It is calculated at the agreed percentage, on the total
cost of shares bought or sold. If you are charged .03% for intraday
and .30% on delivery, the basic brokerage figure would be as
follows-
Market price of the share x number of shares x .03% (intra
day)
Market price of the share x number of shares x .30% (delivery)
Securities transaction tax- It is imposed on the sale/purchase of
securities by investors and is charged on total turnover. It is charged
as follows:
Equity Delivery Transactions
Purchase: 0.125% of Turnover i.e. (Number of Shares * Price)
Sell: 0.125% of Turnover i.e. (Number of Shares * Price)
Equity Intra-day Transactions
Purchase: NIL
Sell: 0.025% of Turnover i.e. (Number of Shares * Price)
Future Transactions
Purchase: NIL
Sell: 0.017% of Turnover i.e. (Number of Lots * Lot Size *
Price)
Option Transactions
Purchase: NIL at the time of purchase of option. However the
purchaser has to pay 0.125% of the Settlement Price i.e.
(Number of Lots * Lot Size * Strike Price), in case of option
exercise
Sell: 0.017% of Premium
Transaction charges: There is a very slight difference in the rate of
transaction charges for NSE and the BSE.
Equity Delivery Transactions
Purchase: 0.0035% of turnover in NSE and 0.0034% of
Turnover in BSE
Sell: 0.0035% of turnover in NSE and 0.0034% of Turnover in
BSE
Equity Intra-day Transactions
Purchase: 0.0035% of Turnover in NSE and 0.0034% of
Turnover in BSE
Sell: 0.0035% of Turnover in NSE and 0.0034% of Turnover in
BSE
Future Transactions
Purchase: 0.002% of Turnover i.e. (Number of Lots * Lot Size
* Price)
 Sell: 0.002% of Turnover i.e. (Number of Lots * Lot Size *
Price)
Option Transactions
Purchase: 0.05% of Premium
Sell: 0.05% of Premium
SEBI turnover charges: For equity transaction, this remains NIL
but for derivative transactions, it is charged @ 0.0002% of total
turnover. The calculation would be as follows.
Equity Delivery Transactions
Purchase: NIL
Sell: NIL
Equity Intra-day Transactions
Purchase: NIL
Sell: NIL
Future Transactions
Purchase: 0.0002% of Turnover i.e. (Number of Lots * Lot Size
* Price)
Sell: 0.0002% of Turnover i.e. (Number of Lots * Lot Size *
Price)
Option Transactions
Purchase: 0.0002% of Premium
Sell: 0.0002% of Notional Value in case of exercise or
assignment

Stamp Duty

Equity Delivery Transactions

Purchase: 0.01% of Turnover. Turnover usually taken in
multiple of Rs 5000
Sell: 0.01% of Turnover. Turnover usually taken in multiple of
Rs 5000
Equity Intra-day Transactions
 Purchase: 0.002% of Turnover. Turnover usually taken in
multiple of Rs 5000
Sell: 0.002% of Turnover. Turnover usually taken in multiple of
Rs 5000
Future Transactions
Purchase: 0.002% of Turnover. Turnover usually taken in
multiple of Rs 5000
Sell: 0.002% of Turnover. Turnover usually taken in multiple of
Rs 5000
Option Transactions
Purchase: 0.002% of Premium
Sell: 0.002% of Notional Value in case of exercise or
assignment
Service Tax
Service Tax, Surcharge and Education Cess are applicable only on
Brokerage. No Service Tax, Surcharge and Education Cess are not
applicable on Securities Transaction Tax (STT) etc..Service tax is
levied at 10.30%.
EXAMPLE:
Now let’s assume that you purchased 10 ICICI bank’s share at Rs
868.00 through NSE. Assuming that the brokerage charged is .05%
for intra day and .50% for delivery, the total cost of the share (for
delivery) would be calculated as follows:
Basic brokerage:
Rs 868 x .50% = Rs 4.34
Security transaction charge = 868 x 10 x 0.125% =Rs 11
Transaction charge = Rs 0.32
SEBI turnover charges = NIL
Stamp duty = Rs 0.87
Service tax = 4.47
Total cost of 10 shares @ 868 = Rs 8740.06
When you buy shares, these figures will appear on your digital
contract note sent to you via mail. It’s important to keep a print out
of those digital contract notes in a file. Brokerages are very
important costs associated with stocks and you cannot afford to
ignore it. You have to be vigilant on the amount you are paying.
Periodic check of your ledger account is necessary.
The brokerage affects investors in different ways. For infrequent
traders, a higher brokerage would lengthen the amount of time
required to break even. If you are a high volume trader, a large
brokerage will eat into their overall return. Now, hope you’ve
understood the cost structure involved with stock transactions in
India.
Have a nice day !