wipro case study- How 100 shares of WIPRO grew to be ovet crores

Case Study: How 100 shares of WIPRO grew to be over Rs 3.28 crores in 27 years?

Case Study: How investment in 100 shares of WIPRO grew to be over Rs 3.28 crores in 27 years?

Indian stock market is filled with the examples of amazing stocks which has created enough wealth for its loyal shareholders to live a long happy life. Last week, we discussed one such stock- the case study of Infosys.

In this post, we are going to discuss the case study of WIPRO- an Indian information technology giant company owned by Azim Premji.

WIPRO Wealth Creation Story:

Assume you bought 100 shares of WIPRO in 1990. At that time, the face value of one stock of WIPRO was Rs 10. For simplicity, we are considering that you bought the stocks at the face value. Hence, your initial investment would have been Rs 1,000.

(Note: Stocks in the Indian stock market rarely trade below their face value. Most of the shares trade at a high premium compared to their face value. However, there has been a number of adjustment in the share price of the company since 1990 because of various bonuses and stock split. Therefore, just for simplicity, we are considering that you purchased the stock at the face value. Moreover, when you compare the appreciated value with the purchase price, you’ll understand that it wouldn’t have made much difference even if you had bought this stock at a little premium.)

Since 1990, WIPRO has given seven bonuses to its shareholders and one stock split (till 2017). Let’s also assume that you didn’t touch the stock after buying. This means that you didn’t sell any stock since the purchase and also avoided any profit booking.

Now, let us analyze the bonuses and stock split of WIPRO for past 27 years.

  • 1990: 100 shares
  • 1992: 200 shares (1:1 bonus on 12-08-1992)
  • 1995: 400 shares (1:1 bonus on 24-02-1995)
  • 1997: 1,200 shares (2:1 bonus on 20-10-1997)
  • 1999: 6,000 shares (5:1 split on 27-09-1999)
  • 2004: 18,000 shares (2:1 bonus on 25-06-2004)
  • 2005: 36,000 shares (1:1 bonus on 22-08-2005)
  • 2010: 60,000 shares (2:3 bonus on 15-06-2010)
  • 2017: 1,20,000 shares (1:1 bonus on 13-06-2017)

(Source: Money Control)

In short, 100 shares of WIPRO bought in 1990 would have turned out to be 1,20,000 share by 2017.

Also read: Stock split vs bonus share – Basics of stock market

Capital Appreciation:

Let’s find out the current worth of the 100 shares that you bought in 1990.

As of May 2018, the market price of one share of Wipro is Rs 273.75

Total Number of share= 1,20,000
Net Value = Rs 273.75 * 1,20,000 = Rs 3,28,50,000.

The net appreciated value would be worth over 3.28 crores.

Your small investment in the 100 shares of WIPRO in 1990 would have turned out to be worth over 3.28 crores in next 27 years.

Don’t forget the dividends…

In the last 27 years, WIPRO has given a decent annual dividend to its shareholders. However, here we are just considering the dividends for the last four years.

Annual dividend per share by WIPRO for last 4 years–

  • 2014: Rs 8.00
  • 2015: Rs 12.00
  • 2016: Rs 6.00
  • 2017: Rs 4.00

Annual dividend received by the shareholders can be calculated using this formula:

Annual dividend received= Dividend per share * Total Number of shares

Assuming that you bought 100 shares of WIPRO in 1990, here are the annual dividends that you would have received:

  • Dividends (2014) = Rs 8 * 60,000 = Rs 4,80,000
  • Dividends (2015) = Rs 12 * 60,000 = Rs 7,20,000
  • And Dividends (2016) = Rs 6 * 60,000 = Rs 3,60,000

Moreover, for the year 2017, the total number of shares in your portfolio would have turned out to be 1,20,000.

Dividends (2017) = Rs 4 * 1,20,000 = Rs 4,80,000

Overall, you would have received dividends worth Rs 4,80,000 in just an year by literally doing nothing.

New to stocks? Confused where to begin?  Here’s an amazing online course for beginners: ‘HOW TO PICK WINNING STOCKS?‘ This course is currently available at a discount. 

The best part…

Even if you don’t sell your stocks, you are holding a total of 1,20,000 shares in your portfolio and hence are eligible to get dividends on all those shares.

Moreover, dividends increase over time. If the company announces a bigger dividend next year, you will receive even a bigger passive income through dividends. In addition, if the company announces any bonuses in future, even your grandchildren lives can be considered as secured 🙂 (kidding!!).

Also read: How ‘Not’ to Kill The Goose That Lays the Golden Eggs?

Conclusion:

Time and again, the stock market has proved that the long-term investment is the real strategy to create huge wealth.

WIPRO is just an example. There are a number of companies in the Indian stock market which has given even a better return compared to WIPRO. For example- Eicher Motors, MRF, Symphony, Page Industries etc. Although it’s little difficult to hold a stock for such long-term and not to book any profit. However, if you are a conservative investor with good patience level, then you can definitely receive amazing returns from your investments.

In the end, here’s a quote by Warren Buffett:

“Our favorite holding period is forever.” 

Also read: How to Earn Rs 13,08,672 From Just One Stock?

May 31, 2018 Investment Basics, Stocks 2 comments
How to Earn Rs 13,08,672 From Just One Stock

How to Earn Rs 13,08,672 From Just One Stock?

How to Earn Rs 13,08,672 From Just One Stock?

Have you ever considered getting a deposit of Rs 13,08,672 per year in your bank account by doing nothing?

Yeah. It’s possible.

And in this post, we’ll discuss how a long-term investor can earn over Rs 13,08,672 per year just by purchasing good stocks at a decent price and holding it for a very long time horizon.

Infosys stocks

infosys

Infosys became public in February 1993 and started issuing its shares at Rs 95 per share.

Since then, this company has given seven bonuses and one stock split. In simple words, it means that if you had bought 100 shares of Infosys in 1993, today you would own 51,200 shares.

Now, let us analyze its bonuses & splits for the last 25 years:

1993: 100 shares
1994: 200 shares (1:1 bonus on 30/06/1994)
1997: 400 shares (1:1 bonus on 18/06/1997)
1999: 800 shares (1:1 bonus on 25/01/1999)
1999: 1,600 shares (2:1 split on 30/11/1999)
2004: 6,400 shares (3:1 bonus on 13/4/2004)
2006: 12,800 shares (1:1 bonus on 14/4/2006)
2014: 25,600 shares (1:1 bonus on 10/10/2014)
2015: 51,200 shares (1:1 bonus on 24/4/2015)

Also read: Stock split vs bonus share – Basics of stock market

Capital Appreciation

Suppose you purchased 100 shares in 1993.

Your initial investment would have cost you: 100 shares x Rs 95 = Rs 9,500.

Today, the market price of one share of Infosys is Rs 1,181.

Net Appreciated Worth = Rs 1,181 * 51,200 = Rs 6,04,77,200

Worth over Rs 6.04 Crores today.

Your small investment of Rs 9,500 would be worth over Rs 6.04 Crores in 25 years.

Also read: Why Warren Buffet Suggests- ‘Price Is What You Pay, Value Is What You Get’?

Don’t forget the Dividends…

In the last 25 years, Infosys has given decent dividends to its shareholders. For simplicity, let’s calculate the dividends earned for the last two years only.

For the last two years, here are the annual dividends are given by Infosys to its shareholders:

2016: Rs 24.26
2017: Rs 25.56

Assuming that you bought 100 shares of Infosys in 1993, it would have turned out to be 51,200 shares by now.

Now, let us calculate the annual dividends.

Dividend (2016) = Rs 24.26 * 51,200 = Rs 12,42,112

Dividend (2017) = Rs 25.56 * 51,200 = Rs 13,08,672

Dividends worth Rs 13,08,672 in just an year.

The best part:

Even if you do not sell your shares, you can enjoy the dividends for the rest of your life. Plus capital appreciation on your assets too…

Also read: How ‘Not’ to Kill The Goose That Lays the Golden Eggs?

Conclusion: Invest for the long-term

This is the best example to show you the power of holding good stocks for long term.

Besides Infosys, there are a number of good stocks in the Indian share market which has given even better returns to its shareholder for over decades.

Overall, you can create an amazing wealth if you focus on buying amazing stocks at a decent price and have the patience to hold it for the long term.

Value investing works- may be not in the short term, but definitely in the long-term.

(Source: Infosys Website, Annual Reports, Corporate Announcements, Moneycontrol)

New to stocks? Confused where to begin?  Here’s an amazing online course for beginners: ‘HOW TO PICK WINNING STOCKS?‘ This course is currently available at a discount. 

May 18, 2018 Investment Basics, Stocks 12 comments
Loss Aversion- How it can ruin your investments

Loss Aversion- How it Can Ruin Your Investments?

Loss Aversion: If I ask you to play a coin toss game with me where you’ll get Rs 1,000 if you win, however, you’ll have to give me Rs 1,000 if you lose, will you play the game?

It’s a fair game. Right? You have an equal chance to win Rs 1,000.

However, if you are like most of us, you won’t play this game.

What if I changed the rule a little? If you win, you’ll get Rs 1,200 and if you lose the amount to pay will be the same i.e. Rs 1,000. Will you play now?

No?… Okay. Last chance.

If you win, you’ll get Rs 1,500 and if you lose- pay just Rs 1,000. Should we start the game?

Still, No!!!

Also read: 3 Amazing Books to Read for a Successful Investing Mindset.

But Why?

For the majority of the population, until the amount that they could win is at least twice as large as the amount they could lose, they won’t play the game.

People prefer avoiding losses to acquiring equivalent gains. In technical terms, this is known as ‘loss aversion’. Here, the perceived value of the loss is considered more significant compared to the perceived value of gain even if the amount in both these cases is equivalent.

“Losses loom larger than gains.”

In the above example, loss aversion implies that the person who loses Rs 1,000 will lose more satisfaction than another person’s gain satisfaction from a win of Rs 1,000.

Psychologically, the pain of losing is about twice as powerful as the pleasure of gaining. (And maybe that’s why ‘penalties’ are sometimes more effective in motivating people than rewards).

A few examples of loss aversion in the stock market:

There are many examples in the stock market where we can notice the effect on loss aversion controlling the investing instincts of the investors. Few of the top ones are given below:

  • Investing in safe options like FD with a lower return (say 7.5%) even though better alternatives with higher yields (12-15%) are available like mutual funds.
  • Selling a good stock just because its price is higher than what you paid and to lock in quick profits.
  • Not willing to sell your loser stock below the buying price because you do not want to take a loss.

NOTE: Most mutual fund companies and fund managers know the concept of ‘risk-aversion’. That’s why, most of these funds have a tagline like – “Get a double return than your savings”, just to attract the customers. Even if that fund is not performing well compared to the market, many people will opt into those funds because of the tagline. Do not get trapped in wrong mutual funds.

Also read: 7 Types of Risk Involved in Stocks that You Should Know.

What is the cure for loss aversion?

Loss aversion is the default mode of most people, including investors. And unfortunately, this cannot be fixed quickly. Losing sucks and as humans, we don’t like it, and it results in many investing problems.

However, if you do not want to lose different opportunities to make money, then you need to get over this syndrome. There’s no hard and fast rule of how to get over loss aversion syndrome. Nonetheless, being aware might help a little.

Now that you know this syndrome take account of this factor whenever you’re making an investment decision. With time and practice, risk aversion syndrome can be controlled.

Also read: How ‘Not’ to Kill The Goose That Lays the Golden Eggs?

Conclusion:

Losses and gains are valued differently. People make their decisions based on the perceived value of the loss and gains. It’s human instincts, and most people behave similarly. Therefore, it’s okay if you also used to act the same.

However, now that you have learned this concept, you need to understand that loss aversion manifests itself as an unwillingness to take a loss. It’s tough to take a loss and sell your losing stock. However, it’s necessary to take control of your emotions. Do not let loss aversion rob yourself of the potential for a better future.

May 18, 2018 Investing Psychology, Investment Basics No comments yet
Why Do You Need to Start Creating Your Stock Watchlist Today

Why Do You Need to Start Creating Your Stock Watchlist Today?

Why do you need to start creating your stock watchlist today?

Have you ever been to a supermarket without any shopping list of the groceries that you want to buy?

If yes, then you can relate to the two most likely possible outcomes in such scenarios:

  1. You might miss few things that you wanted to purchase.
  2. Else, you might purchase few/many unnecessary products which you never intended to buy.

Also read: Why Warren Buffet Suggests- ‘Price Is What You Pay, Value Is What You Get’?

Both these scenarios are not favorable for a buyer.

For example, suppose there was a great discount on the products when you visited the supermarket. However, as you were not ready with the list, you missed a great opportunity to purchase many things that you wanted. Further, you don’t know when the same opportunity will return.

On the other hand, for the second scenario where you bought unnecessary products, then again its a waste of money. You could have invested that amount in something useful or could have bought something that you really wanted.

Overall, purchasing unnecessary products is not a good idea. As Warren Buffett used to say-

“If you buy things you do not need, soon you will have to sell things you need.”

The stock market is not very different from the supermarket. And similar to your groceries list, you need to make a stock list, if you don’t want to end up buying garbage stocks which you never intended to buy in the first place.

What is a stock watchlist?

A stock watchlist is a list of stocks which you have already studied (i.e. researched) and planning to invest in those stocks if a good opportunity arrives in future.

These are those stocks which you will buy if their market price falls within your purchase price range.

Also read: How ‘Not’ to Kill The Goose That Lays the Golden Eggs?

Why do you need to start creating your stock watchlist today?

Here are three best reasons why you need to start creating your stock watchlist today-

1. A stock watchlist will help you to avoid impulse buying:

Many times, you might see the market down or few stocks trading at a very cheap price. Here, most people will purchase stocks on impulse because they do not want to miss the opportunity. And because of this impulse buying, they end up with fundamentally weak stocks (most of the times) as they never got the time to study the stock properly. Having a stock watchlist can help you avoid impulse buying.

2. It will help you seize the opportunity when it presents:

If you already have a list of few amazing stocks that you are planning to buy and you found the stock prices within your purchase range in future, then you can seize the opportunity.

As you have researched that stock previously, all you needed was an opportunity. Remember, success occurs when opportunity meets preparation.

Also read: How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?

3. It can help you plan your future purchases:

There may come few situations when you won’t have enough cash/savings to purchase the stocks at that moment. In such case, you can keep those stocks in your watchlist so that you can buy them in future if a similar opportunity arrives.

Having a stock watchlist helps a lot in the scenarios like market fall or correction. In these scenarios, most people get confused what to purchase and what not to?

  • A quarter of the investing population is confused what to buy because they find most of the stocks at a discount price and ends up buying a number of not-so-good stocks.
  • Remaining are scared and starts researching the stocks from scratch. Generally, it takes a lot of time and hence, they miss this buying opportunity.

However, if you already have a watchlist of amazing stocks, then you can seize the best deals.

How to create your stock watchlist?

First of all, the best stocks to purchase are the ones that are in your portfolio.

You already have researched those companies and hence know you a lot regarding those stocks. You would have a good knowledge of the company’s product, competitive advantage, management, past-performance etc.

Also read: Why You Should Invest Inside Your- Circle of Competence?

However, you do not always need to stick to only those stocks. Its always good to have a list of better stocks in your watchlist. Besides, if you are willing to dedicate some time and efforts, you can always create an amazing watchlist on your own.

For beginners, I would recommend using excel sheets to create a stock watchlist. Here, you can create separate sheets of the stocks that you’re studying, stocks that you already studied & found attractive and lastly, the ones that you’re planning to research/study in future. This way, you can keep a separate track of stocks without much nuisance.

Anyways, you are always welcome to create your own strategy on how you’ll build your stock watchlist.

Many people prefer keeping the stocks details on their phone while there are few who still use the traditional way of writing the names of stock in their dairy.

I do not want to comment which way is best as it totally depends on personal preference. However, I thought it’s worth highlighting few simple ways to start creating your stock watchlist.

In addition, there are few free sources where you can create your stock watchlist –

  • Google sheet (My favorite)
  • Financial websites like Investing.com, Moneycontrol website, MarketWatch etc
  • Financial apps like Money Control app, ET market etc
  • Excel (simplest)

Also read: How to Track Your Stock Portfolio in Google Sheets?

Conclusion:

If you want to consistently make money from the stock market, you need to create your strategy and moreover stick to it. Avoiding impulse buying can be one such great strategy to not lose money in stocks.

Having a stock watchlist can help you a lot to avoid impulse purchases of stocks. Moreover, it would be even better, if you make a rule to purchase only those stocks that are either in your stock watchlist or already in your portfolio.

This will also help you to avoid sudden stock purchases based on tips/recommendations from friends/brokers/magazines or whatever the source.

If you are new to stocks and want to learn stock market investing from scratch, here’s an amazing online course: ‘HOW TO PICK WINNING STOCKS?‘ The course is currently available at a discount. 

Tags: stocks, start Creating Your Stock Watchlist, stock watchlist
May 14, 2018 Investment Basics No comments yet
Why Do Shares Fall on Good News

Why Do Shares Fall on Good News?

Why do shares fall on good news?

On 23 April 2018, HDFC bank announced its Q4 results for the year 2017-18. The net profit in the March quarter stood at Rs 4,799 crore, up 20% on a year-on-year basis (y-o-y).

Good news for the investors. Right?

And bam!! Next day the share price fell -1.03%.

Why did this happen? Why do shares fall on good news?

This is one of the most common questions asked by the stock market beginners.

In this post, we are going to discuss why do shares fall on good news? Why a good news may not always be a good news for the investors?

Let’s first understand the basics. Why stock price fluctuates?

We all know that stock market works on demand and supply. If the demand of a stock is greater than the supply, then its price will go up. On the other hand, if the supply is high and the demand is less then the share price will fall.

Further, the reason for increase/decrease in the demand or supply of a stock depends on a number of factors.

For example, negative news like bad earnings reports, failed products, resignation in top-level management, lawsuits etc can decrease the demand for the stock which will further lead to the decrease in its share price.

On contrary, positive news like increased earnings report, favorable government regulations, significant dividends, bonus etc can increase the demand for that stock and push the price high.

Besides, the reactions for some news might depend on the interpretation. For example, during mergers and acquisitions, the public need to figure out which company will get more benefits- Acquiring company or the target company. And the share price of that company will move accordingly.

Overall, the price movement seems simple, right?

However, the share price movement is not always that straightforward. There are many things happening underneath that you need to understand as they might the driving the prices.

Why do shares fall on good news?

Good news may not always be good for the shareholders. There can be a couple of situations when good news can be a bad news for the investors.

So, why do shares fall on good news? One of the simplest factors can be the phase of the economy. Whether the economy is in expansion phase or contraction phase right now?

For example, if the whole economy is going down- globally or locally, then it might be dragging the stock down in spite of the good news.

This can be easily understood, right?

Nevertheless, many a time market is good and the economy is doing perfectly. Still, the stock goes down after a good news. How to explain such scenarios?

Here, the reason for that stock to go down maybe stock specific (and might doesn’t have to do much with the economy).

Also read: Why do stock prices fluctuate?

Here are few reasons why stocks may fall on good news.

— When earnings report does not meet the expectations.

If you go to yahoo finance and enter a stock- you can find the estimates by the analysts. It’s inside the ‘analysis’ section.

maruti suzuki earnings expectations

Maruti suzuki growth expectations

Source: Yahoo finance

Here you can read the quarterly and yearly estimates by the analysts regarding the company’s earnings, revenue, growth etc.

There are a couple of more similar websites where you can find the estimates by the analysts.

Anyways, coming back to the original question- Why do shares fall on good news?

The stock price may fall if the company is not able to meet these expectations.

For example, if a company/management forecasted its next quarterly EPS to be Rs 40.

However, the analysts are expecting the EPS to be Rs 45.

Now, in next quarter, the actual earnings turn out to be Rs 42.5. Then it’s good, right? Better than what forecasted by the company.

However, here the price may fall as it doesn’t meet the public expectations.

Conversely, if a company posts loss in a quarter, but the loss is less than what expected by the public, then the share price may go up.

Here, whether the price will move up or down depends a lot on the actual report vs the estimates.

— Future expectations

The stock market is all about the future expectations. Current or past ‘good’ news is good for the investors but the comments about the future can easily scare them (no matter how good was the past).

For example, suppose you got your electricity bill today where the total bill turns out to be Rs 1400 (which is way less than the last month). Good, right?

However, you also received a notice that the ‘price per unit’ is going to significantly increase from next month.

Here the current news is good but the future is scary and hence instead of celebrating, you might be worried about the next month electricity bill.

In the same way, if a company announced a good result for the last quarter. However, in the same quarterly report/announcement, they also highlighted some issues which might affect the profitability of the company in upcoming months/years.

In such scenarios, instead of enjoying a good result for last quarter, the shareholders might take the news adversely and it may lead to a fall in the share price.

Also read: What is the Right Time to Exit a Stock?

— Missing parts

Sometimes the stock price of a company may even fell after a good news because of something announced/reported in the annual/quarterly report by the management/board of the directors of the company that you ‘missed’.

For example, the board of directors saying something negative/fearful regarding the future or some setbacks in the quarterly/annual report which you missed to read/notice.

Here, something is hidden underneath the big positive news that scares the people.

For example, if we go back to the original discussion that we started at the beginning of this article-

“HDFC bank announced its Q4 results for the year 2017-18 where the net profit in the March quarter stood at Rs4,799 crore, up 20% on a y-o-y basis. And the share price the share price fell -1.03%.”

If you read the report, you will find that although Q4 result was good, however, HDFC Bank’s unsecured loans have grown at a rapid pace, and the home loan segment hasn’t grown much. And these trends may cause some concern for the investor. That’s why HDFC Bank’s share price fell a little next day.

Read more here: HDFC Bank Q4 Profit Up 20%; Asset Quality Remains Stable- Bloomberg

In short, if the stock falls down on good news, there can be some part that you missed which might be scaring the people.

— Noise Traders:

With the boom in online trading, the noise trader has increased a lot over the last decade. They are those traders who sell on technicals i.e price trend and momentum.

Here, they simply copy what the others are doing. They do not analyze the fundamentals of the company but make their trades based on news/technicals.

For example- in scenarios of sell-offs in a stock due to whatever reason, these noise traders will sell their shares too and leave their position.

Many a time, noise traders drag the share price further down.

Also read: 7 Types of Risk Involved in Stocks that You Should Know.

Few addition reasons why shares fall on good news –

  • The market anticipates the results and prices already starts adjusting before the actual announcement. This simply means that before even the company announces its result, the market might be anticipating the outcome and hence, the prices might already by rising high before the announcement. As the prices keep rising since past few days/weeks, it might take a little rest/correction on the day on the result and the share price may fall a little.

  • Profit booking by the early investors: Many investors who might be holding the stock for a long time, may opt to book profit on the good news. This may further push the stock price down.

How should you react in such scenarios?

Fairly simple!!

If the stock is fundamentally strong, hold the stock despite the stock price going down. It won’t matter much in the long term if the company. Most of the great companies focus on their long-term goals. This means that few times, they might miss the short-term expectations.

Although, short-term concerns shouldn’t be ignored completely by the company or investors. However, if the company is overall performing good in the long run, then there’s no point of worry. In any business, there will be few setbacks in the short run.

Besides, do not get attached to the short-term expectations. Analysts will keep on making expectation every quarter. It’s their job and this is what they are paid for. If a company keeps on working for the short-term goals, it might never be able to focus on the long-term growth.

Overall, if the temporary setbacks are not going to affect the long-term profitability of the company, then ignore the short-term fluctuations and hold your stock ‘tightly’.

New to stocks? Want to learn how to select good stocks for long-term investment? Check out this amazing online course: HOW TO PICK WINNING PICKS? Enroll now and start your investing journey today.

TAGS: Why Do Shares Fall on Good News, how earnings affect stock price, Why Do Shares Fall on Good News on earnings
May 10, 2018 Essential Reading, Investment Basics No comments yet
What is an Economic MOAT and why it’s Worth Investigating

What is an Economic MOAT? And Why it’s Worth Investigating?

The Essential Guide to understanding What is an Economic MOAT: During the time of the Kings and Queens, the huge walls of the royal castles were protected by digging the earth around the castle and filling it with mud and water. This protective layer is called ‘moat’ and it helped the kingdom to survive in case any of their enemies attacked.

Due to the moat, these castles had an advantage (as a defense system) which their enemies were not able to break easily. And hence, many of the castles were able to survive for a long time. The same concept of ‘MOAT’ is also applicable in the stocks.

moat kings example

Similarly, many companies have created ‘invisible’ protection around themselves that gives them an advantage over their competitors and help them to keep their business profitable for a long time. In this post, we are going to discuss what is an economic moat and why is it worth investigating.

What is an Economic MOAT?

An economic moat can be defined as a competitive advantage for a company against its competitors or the companies in the same industry. It helps to create a closed market with a profitable business which is difficult for the competitors to copy.

The moat can be because of multiple reasons like brand value, business monopoly, intangible assets (patents and regulations), low production cost, high networking, technology, etc. The economic moat helps the company to sustain success for the long-term.

competitive advantage example example

Warren Buffett’s thoughts on Moat.

The concept of an economic moat is quite old. Benjamin Graham, the mentor of Warren Buffet and father of value investing, discussed the same in his book ‘The Intelligent Investor’.

Warren Buffett always looks for an economic moat in the company before making his investment decision. Here’s a quote by Warren Buffett from his company Berkshire’s 2000 annual meeting:

“So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way -it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses – or virtually all of our businesses — have pretty darned good moats.” – Warren Buffett (Berkshire’s 2000 annual meeting)

Further, here’s another thought of Warren Buffett on the concept of moat published in his annual letter to shareholders in 2007:

“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business ‘castle’ that is earning high returns.” -Warren Buffett (2007- letter to shareholders)

Also read: Top 10 Warren Buffett Quotes on Investing.

Five Popular Characteristics of big ‘MOAT’ Companies

There can be many types of sustainable competitive advantages for the companies depending on their industry, products and customers. Anyways, here are the five popular different characteristics of a company with a big moat :

1. Low Cost (Production advantage)

Many companies create an economic moat around themselves by developing a cheaper production cost compared to its competitors. As their production cost is low, they can make a good profit margin. The low production cost can be created because of different reasons like cheap raw material, low labor cost, highly-efficient plants, etc.

For example, ‘Maruti Alto’ has been the best-selling car in the ‘Hatch-back’ segment of the passenger vehicle for a very long time. This is because Maruti Suzuki has been able to build ‘Alto’ at a cheap price (with superior quality) for over 15 years according to the demand of the Indian audience.

2. Big Brand Value

There are a number of companies whose consumers get ‘used to’ the products and creates a habit for it. They become a fanatically loyal customer and either do not need or do not want to look for any other company for that product or services. A few companies with big brand value in India are Asian Paints, HDFC Bank etc.

coke brand value

3. Monopoly in Business

If any company is the single supplier or single service provider in an industry, then it can be considered as a business monopoly. There are no direct competitors for these companies and hence, they cover the whole market segment. For example- Coal India. Anyways, sooner or later a competitor will always appear if there’s too much profit potential in a company with very little competition.

Also read: Investment vs Speculation: What you need to know?

4. Switching Cost

If it costs time, energy, money, or efforts to switch from one product to another, then it is called a switching cost.  A company can also create an economic moat if the switching cost for the customers is too high. The products and services are not easily abandoned by the customers as they involve switching costs.

The best example of a company with switching costs as the economic moat is Microsoft Office (especially MS Excel). Although, the competitors may offer a better spreadsheet, however, the customers will prefer not to switch from Microsoft to others. This is because they will have to put additional efforts to learn a new spreadsheet, which might not be worth the costs.

5. Entry Barrier

There are few industries where the ‘entry-barrier’ acts as an economic moat for the company. These barriers can be because of multiple reasons like patents, brand recognition, a high cost of set-up, government licenses, etc.

For example, the telecommunication sector has an entry barrier because of the huge initial set-up cost. Similarly, a pharmaceutical company has an advantage over its competitors due to patented drugs, which will act a moat. No other pharmaceutical company can produce that patented drug. A few other industries with entry barriers are Oil and Gas, Airlines, the Cigarette industry, etc.

Also read: Understanding Barriers to Entry – Why they are Crucial!

Apart from the above five discussed types, a few other characteristics of big ‘moat’ companies are a high network, technological advantages, first-mover advantage, patents/trademark, etc.

Examples of Indian Companies with big MOAT.

Here are few Indian companies with a big moat, which give them a competitive advantage over their competitors:

  1. Hindustan Unilever (HUL): Consumer goods giant with brands like Surf Excel, Lux, Lifebuoy, Sun silk, ponds, Vaseline, Axe, Wheel, etc. HUL has got a big brand value in India.
  2. Maruti: Maruti has got a competitive advantage as low cost or production advantages that are not easily breachable by the competitors.
  3. ITC: Cigarettes (ITC Ltd sells 81 % of the cigarettes in India) and high regulations for other competitors by the government to enter this industry.
  4. TCS: High switching cost as clients cannot easily switch from TCS IT services to another
  5. Pidilite Industries: Big brand value in the adhesives manufacturing industry with brands like Fevicol, Fevikwik, Dr. Fixit, etc.
  6. Avenue Supermart (DMart): Low-cost production advantages that are not matched by competitors like Big Bazaar, Star Bazaar, etc.

New to stocks? Want to learn how to invest in Indian stock market from scratch? Then, here is an amazing online course: INVESTING IN STOCKS- THE COMPLETE COURSE FOR BEGINNERS. Enroll now and start your share market journey today.

Closing Thoughts

While investing in the long-term, always look for an economic ‘moat’ in the company. Not just it helps in longevity but it also increases the profitability of the company. Anyways, even companies with big ‘moat’ can lose their charm and market segment. For example, after coming of Baba Ramdeo’s ‘PATANJALI’ in the market, many of these big players like HUL, Colgate, Godrej etc have lost their market share.

However, having an economic ‘moat’ gives these companies a lot of advantages. And that’s why it’s really difficult for the ‘Yog-guru’ Baba Ramdeo to capture the market despite having a great product and an amazing marketing strategy.

That’s all. I hope this post on what is an Economic MOAT is useful to you. Please comment ‘below’ the names of other companies having big ‘moat’ which are not mentioned in this post. Happy Investing. Cheers!

Tags: What is an economic moat, what is moat, moat meaning, moat examples India, companies with moat, moat company India
May 5, 2018 Investment Basics 3 comments
Dividend Discount Model (DDM)

Stock Valuation: Dividend Discount Model (DDM)

Stock Valuation: Dividend Discount Model (DDM)

When you are investing for the long-term, it can be sensibly concluded that the only cash flow that you will receive from a publicly traded company will be the dividends, till you sell the stock.

Therefore, before investing it may be justifiable to calculate the dividends cash flow that you’ll receive while holding the stock. Dividend discount model (DDM) uses the same approach to find the worth of a stock.

In financial words, dividend discount model is a valuation method used to find the intrinsic value of a company by discounting the predicted dividends that the company will be giving (to its shareholders in future) to its present value.

Once, this value is calculated, it can be compared with the current market price of the stock to find whether the stock is overvalued or decently valued.

Don’t worry if you find this concept a little difficult to grasp right now. Read the post until the very end and this model will become crystal clear to you.

What is Dividend Discount Model (DDM)?

Dividend discount model aims to find the intrinsic value of a stock by estimating the expected value of the cash flow it generates in future through dividends. This valuation model is derived from the net present value (NPV) and time value of money (TVM) concept.

Dividend discount model uses this simple formula:

dividend discount model

Here,

P= value of stock
D= Dividend per share
r= Discount rate (also known as required rate of return or cost of equity)
g= expected dividend growth rate.

Assumptions: While calculating the value of a stock using dividend discount model, the two big assumptions made are future dividend payments and growth rate.

Limitations: Dividend discount model (DDM) does not work for companies that do not provide dividends.

Also read: Valuation Basics: What is the Time Value of Money (TVM)?

Calculations

A. Dividend growth rate (g):

The dividend growth rate (g) can be found using the company’s historical dividend growth.

Further, the dividend growth rate can also be calculated using return on equity (ROE) and retention rate values. Here’s a simple formula to calculate dividend growth rate:

Dividend growth rate = ROE * Retention rate

{Where, retention rate = (Net income – dividends)/ Net income = (1 – payout ratio) }

Therefore, Dividend growth rate = ROE * (1 – payout ratio)

ROE and payout ratio can be determined using company’s financial statements. An easier approach would be to refer financial websites like Money control, investing etc. You can find these values on most of the financial websites.

Also read: #19 Most Important Financial Ratios for Investors.

B. Discount rate or Rate of return (r):

In the dividend discount model, if you want to get an annual return of 10% for your investment, then you should consider the rate of return (r) as 0.10 or 10%.

Further, r can also be calculated using Capital asset pricing model (CAPM). Under this model, the discount rate is equal to the sum of risk-free rate and risk premium. The risk premium is calculated as the difference between the market rate of return and the risk-free rate of return, multiplied by the beta.

capm

For example, for a company, if the beta is 1.5, the risk-free rate is 3% and the market rate of return is 7%.

Risk premium= ((7% – 3%)x1.5) = 6%.

Discount rate, r= risk free rate + risk premium = 3% + 6%= 9%

TYPES OF DIVIDEND DISCOUNT MODELS 

Now that you have understood the basics of Dividend Discount Model, let us move forward and learn three types of Dividend Discount Models.

  1. Zero Growth Dividend Discount Model
  2. Constant Growth Dividend Discount Model 
  3. Variable Growth Dividend Discount Model

1. Zero Growth Dividend Discount Model

The Zero growth dividend discount model assumes that all the dividends that are paid by the company remain same forever (until infinity).

Therefore, here the dividend growth rate (g) is zero.

As dividend is constant throughout the company life
The dividend is first year= dividend in second year = dividend in the third year…
Div1= Div2= Div3 = Div4 …. =Div

Here is the share value formula for the zero growth dividend discount model:

Or Value of stock (P) = Div /r

Let us understand this further with the help of an example.

Example 1: Assume company ABC gives a constant annual dividend of Rs 1 per share till perpetuity (lasting forever). The required rate of return on the stock is 5%. Then what should be the purchasing price of the stock of company ABC?

Here, Expected return/ required rate of return (r) = 5%

Dividend (Div) = Rs 1 = Constant

Value of stock (P) = Div/r =1/0.05 = Rs 20.

Therefore, the purchasing price of the stock ABC should be less than Rs 20 to get the required rate of return of 5% per annum.

Limitations of Zero growth dividend discount model:

As the company grows bigger, it is expected to increase company’s dividend per share. The dividend cannot be constant till perpetuity.

Also read: Why You Need to Learn- Porter’s Five Forces of Competitive Analysis?

2. Constant Growth Dividend Discount Model

This dividend discount model assumes that dividends grow at a fixed percentage annually. They are not variable and are constant throughout the life of the company. The most common model used in the constant growth dividend discount model is Gordon growth model (GGM)

Gordon Growth Model (GGM):

The Gordon growth model for DCF is quite simple and straightforward. Here are the three values required to calculate the share value of a company:

  • Div= Dividend at the zeroth year.
  • r = company’s cost of capital/ required rate of return
  • g=constant growth rate of dividends till perpetuity

Here, Div1= Dividend per share expected to be received at the end of first year = Div (1+g)

For the constant growth dividend discount model,

dividend discount model with constant growth

Note: If you want to learn how the derive the above formula, you can find it here.

Let us solve an example to find the share price of a company with Gordon growth model.

Example 2: Assume a company QPR has a constant dividend growth rate of 4% per annum for perpetuity. This year the company has given a dividend of Rs 5 per share. Further, the required rate of return for the company is 10% per annum. Then, what should be the purchase price for a share of company QPR?

Here,

  • Div= Dividend at zeroth year = Rs 5
  • r = required rate of return = 10%
  • g= constant growth rate of dividends till perpetuity= 4%

Div1= Dividend per share expected to be received at the end of first year = Div (1+g) = 5 (1+0.04) = Rs 5.2

Value of share (P) = Div1/ (r-g) = 5.2 / (0.1 -0.04) = 5.2/0.06 = Rs 86.67

Therefore, you should purchase the stock at a price below Rs 86.67 to get a required rate of return of 10% per annum.

Limitations of Gordon Growth Model:

Here are few genuine limitations to Gordon growth model while performing constant growth dividend discount model

  1. The constant growth rate for perpetuity is not valid for most of the companies. Moreover, Newer companies have fluctuating dividend growth rate in the initial years.
  2. The calculation is sensitive to the inputs. Even a small change in the input assumption can greatly alter expected value of the share.
  3. High growth problem. If the dividend growth rate becomes higher than the required rate of return i.e. g>r, then the value of the share price will become negative, which is not feasible.

Also read: SWOT Analysis for Stocks: A Simple Yet Effective Study Tool.

3. The multi-level/Variable Growth Dividend Discount Model:

The multi-level growth rate for dividends model may divide the growth rate into two or three phases (according to the assumption).

In the two-stage growth rate DDM Model, the dividends grow at a high rate initially followed by a lower constant rate for later years. (Also read: Supernormal dividend growth model)

Further, in the three-stage growth DDM Model, the first stage will be a fast initial phase, then a slower transition phase an then ultimately ends with a lower rate for the infinite period. For example- A company XYZ’s dividend may grow at 5% rate for the first 7 years, 3% rate for the next 4 years and finally 2% rate in perpetuity.

If you are interested to read more, here is an amazing source to learn the multi-level growth rate dividend discount model.

Limitation: 

The biggest drawback with the multi-level growth rate of dividend discount model is that’s it’s really difficult to assume the growth rate in small specific periods. There are a lot of uncertainties involved while making these assumptions when the growth is distributed at multiple levels.

Problems of forecasting value using DDM:

Here are few of the common limitations of forecasting share value using the dividend discount model:

  • Plenty of assumptions about the dividend growth and company’s future.
  • This valuation model is good only as far the assumptions are good.
  • Most of the inputs of DDM model keeps on changing and susceptible to error.
  • Not feasible for few categories of stocks like Growth stocks. These stocks pay little or no dividends but rather use the company profit in their growth. DDM might never find these stock suitable for investment no matter how good the stock is.

Also read: Efficient Market Hypothesis -The Only Theory That You Need to Read Today.

Conclusion:

Most of the analysts ignore dividend discount model while valuing the stock price because of its limitations as discussed above.

However, for few specific stocks (like stable dividend paying stocks), DDM remains a useful tool for evaluating stocks. Dividend discount model is a simple and straightforward method of stock valuation. It demonstrates how the stock value can be calculated by a simple approach of discounting future cash flows.

Anyways, I will highly recommend to never invest in a stock based on just DDM valuation. Use other financial tools like ROE, PE etc to cross-verify the conclusions before investing.

In the end, I would like to add that although DDM is criticised for the limited use, however, it has proved useful in the past. In addition, here is an amazing quote regarding valuation by one of the greatest investor of all time, Warren Buffett.

“It is better to be approximately right than precisely wrong.” -Warren Buffett

Also read: How to do the Relative Valuation of stocks?

May 1, 2018 Investment Basics, Valuations No comments yet
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