what is equity funds

What is an Equity Fund? Basics, Performance, Taxation & More!

“Mutual funds were created to make investing easy, so consumers wouldn’t have to be burdened with picking individual stocks.” – Scott Cook

An equity mutual fund is a variety of mutual fund where the portfolio management invests the cash collected from the investors in equities of listed companies. The portfolio of an equity oriented mutual fund consists of at least 65% investment in equities or equity related instruments.

(Quick note: An equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains.)

Equity funds can be either the traditional mutual fund variety or it can come in the form of ETF (Exchange Traded Funds).

The ETF trades in the stock exchange like an equity share, throughout the day. A traditional equity mutual fund, on the other hand, settles once in a day, where the buy and sell orders are netted after market hours for the computation of the Net Asset Value or NAV.

Different varieties of Equity Funds

Equity Funds can be classified into the following categories which are consisted of several sub-categories as follows:-

Based on market capitalization:

  • Large Cap Equity Funds: invest in companies having large market capitalization.
  • Mid Cap Equity Funds: invest in companies having medium market capitalization.
  • Small Cap Equity Funds: invest in companies having small market capitalization.
  • Micro Cap Equity Funds: invest companies having market capitalization less than that of companies with small market capitalization.

(Also read: Basics of Market Capitalization in Indian Stock Market.)

Based on the style of investment:-

  • Private Equity Funds: invest in companies that are not listed in any stock market.
  • Equity Income Funds: invest in equities of companies which pay a significant dividend.
  • Dividend Growth Funds: invest in equities of companies having a record of increasing dividends per share (DPS) at a rate much faster than the entire stock market.
  • Index Equity Funds: mimic an index like Nifty. (Also read: The Essential Guide to Index Fund Investing in India.)
  • Sector or Industry Specific Equity Funds: track specific areas of the economy of India like any industry or sector.

types of equity funds

Image source: sipfund.com

Equity Mutual Fund: How does it work?

how mutual funds work

Image source: Corporatefinanceinstitute.com

Mutual funds issue units to its investors according to the amount of money received from the latter by the former.

The assets of the mutual fund are known as a portfolio which is managed by the Asset Management Company or AMC through the qualified fund managers. The value of each unit of a mutual fund is called the Net Assets Value (NAV) of the mutual fund. As the stock prices keep continuously changes, the fluctuations in the value of the portfolio results in the fluctuation of the value of the units.

The AMC offers diverse products of mutual funds called schemes, structured in a way to suit the requirements of the unitholders. A portfolio statement, revenue account, and balance sheet are available for every scheme. (Also read: 23 Must-Know Mutual fund Terms for Investors.)

Calculation of NAV of Equity Mutual Funds

NAV of a fund is used as a parameter to judge the performance of the same. It is referred to the market value of the investments held by the scheme deducting liabilities and dividing the result by the number of units issued under the scheme.

Suppose, the market value of all investments held with respect to a mutual fund scheme is Rs. 100 lakh and 10 lakh units have been issued to the unitholders. In this case, the NAV per unit comes to Rs. 10.

NAV Mutual funds

Source: Moneycontrol

Which is the best way of investing in Equity Funds?

best ways to invest

Source: Clearfunds.com

The most effective way of investing in an Equity Mutual Fund scheme is through SIP or Systematic Investment Plan.

An investor usually invests monthly in a SIP. SIPs give the benefit of rupee-cost averaging. So when the markets go up, an investor ends up getting fewer units.

Again, when the markets are bullish, an investor is rewarded with more units in the same amount. Investing through SIP makes investing a regular habit for investors.

How to analyze the performance of an equity mutual fund?

  • Having a look at the cost of investment as reflected by the expense ratio and exit load.
  • Checking whether the turnover ratio of the underlying portfolio is not too high.
  • It is to be checked whether the investor’s investing strategy or philosophy matches with that of the fund manager.
  • The underlying portfolio should be broadly diversified so to gain the benefit of risk reduction.
  • Comparing the last few years’ returns of the fund under evaluation with that of its peers. Risk-adjusted returns should be the ideal basis for comparison.
  • Alpha and Beta of an equity fund should be given emphasis. Alpha measures the extra percentage of returns generated by the equity fund as compared with the benchmark returns. Beta gives the magnitude of risk of a fund i.e. the variability of returns of the fund about its expected return.
  • An equity fund managed by several fund managers for a long duration is preferred less as compared to one which is managed by the same person for the same period.
  • A prospective investor is required to check the quality of stocks in the portfolio as the latter drives the return of the fund in the future.

Note: New to investing and want to learn how to invest in mutual funds from scratch? Check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.

How to determine the taxation of equity funds in India?

For the financial year 2017-18, no long-term capital gain (for units held for 1 year or more) is charged for both Resident Indians and NRIs.

On the other hand, short-term capital gain (for units held less than 1 year) is charged @ 15%. The TDS rate applicable to the NRIs for the redemption of equity oriented funds is 15% and the same is applicable only for short-term capital gain.

The dividend received by an investor for an equity fund is completely tax-free in the hands of the former. As per the Finance Act 2018, the long-term capital gain of over Rs 1 lakh will attract tax @ 10% and no indexation benefit will be allowed. (Also read: Mutual Fund Taxation – How Mutual Fund Returns Are Taxed in India?)

Should one invest in Equity Mutual Funds?

mutual funds growth

Source: Amfiindia.com

If an investor wants to invest in equity funds, then he/she should decide on the basis of his/her risk appetite and horizon of investment. Investing in equity funds is meant for someone willing to invest for five years or more. These don’t suit someone willing to make money in the short term.

For an individual and HUF, ELSS sounds a great option for tax saving u/s 80C of the Income Tax Act, 1961. ELSS has a lock-in period of 3 years which relatively lower than other tax saving options like NSC, PPF, and ULIP. Having said this, ELSS also yields higher return as compared to any other investment eligible under the said section.

For a new investor willing to take exposure in the stock market, then large cap funds are highly recommended. Large-cap equity funds invest in the well-established corporate organizations giving stable long-term returns. Small-cap funds are suitable for young investors who are hungry for higher returns and are high-risk takers. Balanced funds represent one-third of debt instruments and the rest equity and are meant for those who are highly risk-averse.

For an investor who is willing to take calculated investment risks, the investment recommendation would be mid-cap equity funds. These funds invest in the shares of companies having diverse market capitalizations.

Also read:

indian stock market holidays 2019

Indian Stock Market Holidays 2019

The Indian stock market holidays 2019 has been announced by the stock exchanges. There’s going to be 15 holidays throughout the year (apart from regular holidays on Saturdays and Sundays).

Here are the trading holidays for Equity Segment, Equity Derivative Segment, and SLB Segment:

Indian Stock Market Holidays 2019

S. No Holidays Date Day
1 Mahashivratri March 04,2019 Monday
2 Holi March 21,2019 Thursday
3 Mahavir Jayanti April 17,2019 Wednesday
4 Good Friday April 19,2019 Friday
5 Maharashtra Day May 01,2019 Wednesday
6 Id-Ul-Fitr (Ramzan Id) June 05,2019 Wednesday
7 Bakri Id August 12,2019 Monday
8 Independence Day August 15,2019 Thursday
9 Ganesh Chaturthi September 02,2019 Monday
10 Muharram September 10,2019 Tuesday
11 Mahatma Gandhi Jayanti October 02,2019 Wednesday
12 Dussehra October 08,2019 Tuesday
13 Diwali Balipratipada October 28,2019 Monday
14 Gurunanak Jayanti November 12,2019 Tuesday
15 Christmas December 25,2019 Wednesday

(Source: BSE India)

Quick Note:

  1. Muhurat trading, the traditional trading on the day of Diwali, will be held on Sunday, October 27, 2019 (Diwali – Laxmi Pujan). The timings will be announced subsequently in the month of Diwali.
  2. The holidays falling on Saturday/Sunday are not listed above.
  3. The Exchange may alter/change any of the above holidays, for which a separate circular shall be issued in advance.

Also read: Stock Market Timings in India.

biggest mistake stock market

The Biggest Investing Mistake that 90% Beginners Make!

Suppose you bought two stocks- Stock A and Stock B. The buying price of both these stocks is the same, i.e. Rs 100.

After two years, you checked the returns from both these stocks and found that the current price of stock A has moved to Rs 180. On the other hand, the market price of company B has fallen to Rs 60. What would you do next?

Would you sell stock A and book a profit of 80%? Or Would you sell stock B to get rid of your losing stock?

scenario stocks

I will give the answer to this question in a few minutes. But first, let’s discuss another scenario in a similar context.

Let’s say, you have a garden where you’ve planted three vegetables- Ladyfinger, tomatoes, and Cabbage.

garden-min

Out of the three, Ladyfinger and tomatoes are doing exceptionally well. They are growing big and healthy. And that’s why you are able to make huge profits by selling them.

Anyhow, the third vegetable i.e. cabbage is just not doing well. It is not growing enough, no matter how much time, money and efforts you spend on planting those vegetables. It simply dies out without producing anything worthwhile to sell.

What’s the logical step here for you as the gardener?

Shouldn’t you get rid of the Cabbage which is not growing no matter how much efforts you put and focus more on growing the other two vegetables which are giving you awesome returns? After all, those two vegetables are the ones who are making you profits.

A similar concept should be applied in the stock market world.

Out of the two stocks- Stock A (which went up by 80%) and stock B (which fell down by 40%), it’s logical to hold the winning stock and get rid of the losing one.

Why do you want to sell Stock A to book a profit of just 80%, when it can get returns of 100%, 200%, 500% or even 1,000% in the future? If the company is fundamentally strong, selling its stocks just to book short-term profits doesn’t make much sense.

On the other hand, keeping the losing stock just to break even is also not a wise strategy. If you get rid of that stock and invest the same money in stronger companies, it can give you better returns. Holding the losers just to break even may lead you to loss of both time and money.

Here, the biggest lesson that every beginner should know is- “Hold your winners and cut your losers!!”.

But sadly, most people follow the totally opposite approach while investing. Even if the stock moves up by 30%, most beginners are eager to sell that stock, book profit and boast among their friends. 

The majority of the investing population would prefer to sell their winning stocks just for instant gratification of short-term profits. However, booking short-term profits should not be the goal of the investors if they want to build long-term wealth. After all, the consistent returns should always be preferred over a one-time profit.

The only reasons when you should sell your winning stocks is A) when the company’s fundamental changes and the stock is not as strong as when you originally invested, B) When you find a better stock to invest with bigger opportunity and C) when really need the money. For all the rest cases, you should stick with the stock.

Also read:

Besides, one more thing that most beginners ignore while booking short-term profits is taxes. When you sell your winning stock in short-term for booking profits, you are obliged to pay short-term capital gain (STCG) taxes of 15% on your profits.  Therefore, this portion of the profit is already gone to the government.

Nonetheless, you can easily avoid/delay this STCG gain tax by NOT selling your winning stocks and keeping it for the long term. After all, you only have to pay taxes when you book profits. Moreover, Long-term capital gain taxes are comparatively smaller (i.e. 10% of your gains). Therefore, by investing for long-term, you can save a few additional bucks.

Overall, whether you are investing in stocks, mutual funds or any other investment option, the first and biggest lesson is the same- “Cut your losers and hold your winners!”.

That’s all for this post. Happy Investing!!

wealth creators 2018 cover

Top 20 Wealth Creator (& Destroyer) Stocks of 2018

The calendar year 2018 was full of ups and downs for the Indian stock market investors. While Sensex made its all-time high in August 2018, the net return in this year is still just 4.90% (YTD). Sensex started with 33,812 points in January 2018 and as of December 2018, it is currently hovering around 35,470 points.

nifty 2018

On the other hand, if we look into the NSE benchmark index Nifty 50, it started at 10,435 points in January 2018 and currently trading at 10,663 points, with an overall return of merely 2.18% this year.

nifty 2018If we compare the returns on Nifty in 2018 with that of last year (2017- when it gave a return of around 28.6%), we can easily notice that the index has comparatively underperformed in 2018. Nonetheless, ups and downs are the characteristics of the market and the stock market investors should be not be haunted by it.

As the year 2018 is fastly approaching to its end, we performed a short analysis to find the winning and losing stocks of 2018. Here is a list of 20 large cap companies in India with a market capitalization greater than Rs 100 Billion, which either grew over +30% or fell over -35% within the year 2018.

If you are interested in large-cap companies, this list might give you a rough idea of the stocks that you missed or can add in your watchlist for the upcoming year.

Top 20 Wealth CREATORS of 2018

S. No Name Symbol Industry Last Price Market Cap 1-Yr Chg (%)
1 HEG HEGL Electronic Instr. & Controls 3675.35 155.86B 83.82
2 L&T Technology Services LTEH Construction Services 1687.05 171.74B 71.22
3 Larsen & Toubro Infotech LRTI Software & Programming 1695 291.26B 57.67
4 Adani Enterprises ADEL Coal 158.55 175.67B 53.92
5 Bata India BATA Footwear 1109 144.13B 47.74
6 Tata Consultancy TCS Software & Programming 1918.5 7130.75B 44.97
7 Bajaj Finance BJFN Consumer Financial Services 2564.9 1497.28B 43.9
8 Tech Mahindra TEML Software & Programming 697.9 684.05B 41.43
9 Indiabulls Ventures INDB Investment Services 379.85 235.61B 41.22
10 MindTree MINT Computer Services 837.7 139.19B 39.69
11 Nestle India NEST Food Processing 10923.35 1064.11B 38.56
12 Mphasis MBFL Software & Programming 1018.15 187.77B 38.52
13 Jubilant Foodworks JUBI Restaurants 1218.95 173.76B 38.14
14 Abbott India ABOT Biotechnology & Drugs 7466.25 157.83B 34.82
15 Avenue Supermarts AVEU Retail (Grocery) 1545.75 1031.01B 34.28
16 Ipca Laboratories IPCA Biotechnology & Drugs 801.85 101.97B 33.6
17 Divi’s Labs DIVI Biotechnology & Drugs 1447.15 392.45B 32.77
18 Hindustan Unilever HLL Personal & Household Prods. 1784.65 4009.29B 31.56
19 Adani Power ADAN Electric Utilities 50.8 194.66B 31.27
20 Britannia Industries BRIT Food Processing 3100.55 751.53B 30.64

 

HEG was the biggest wealth creator in the large-cap segment this year. This stock gave a return of over 83% in 2018. Currently, HEG is trading at a share price of Rs 3,675. Surprisingly, this stock was also one of the biggest winners in 2017. (Quick Note: The stock of HEG was hovering at just Rs 160 during the start of January 2017).

Next, L&T Technology services (+71%) and Infotech (+57%) –both have performed well followed by Adani Enterprises and Bata India. TCS has also given a return of over 44% this year.

A few other popular winners in this list are Bajaj Finance, Tech Mahindra, India bull ventures, MindTree, NESTLE and Avenue Supermart (DMart).

Top 20 Wealth Destroyers of 2018

S. No Name Symbol Industry Last Price Market Cap 1-Yr Chg (%)
1 Vodafone Idea VODA Communications Services 37.35 335.36B -62.89
2 Tata Motors DV Ltd TAMdv Auto & Truck Manufacturers 94.15 559.20B -60.83
3 Tata Motors TAMO Auto & Truck Manufacturers 172.5 559.20B -59.12
4 NBCC India NBCC Construction Services 54.15 100.86B -57.36
5 Motherson Sumi Systems MOSS Auto & Truck Parts 161.55 534.49B -57.13
6 Punjab National Bank PNBK Regional Banks 76.7 284.07B -56.41
7 CBI CBI Regional Banks 35.15 106.22B -53.54
8 Bharat Electronics BAJE Aerospace & Defense 87.95 215.91B -53.34
9 Aditya Birla Capital ADTB Consumer Financial Services 97.05 216.36B -48.12
10 Mangalore MRPL Oil & Gas Operations 72.8 131.23B -43.24
11 Hindustan Petroleum HPCL Oil & Gas Operations 246.3 381.94B -42.63
12 Sun TV Network Ltd SUTV Broadcasting & Cable TV 576.95 233.42B -42.28
13 Bharti Airtel BRTI Communications Services 309.1 1233.18B -41.52
14 Yes Bank YESB Regional Banks 182.3 424.05B -41.22
15 Bank of India BOI Regional Banks 100.9 171.04B -41.05
16 New India Assurance THEE Insurance (Miscellaneous) 183.9 306.93B -40.15
17 Steel Authority SAIL Iron & Steel 51.95 218.50B -39.2
18 Indian Bank INBA Regional Banks 238.4 115.26B -39.15
19 Emami EMAM Personal & Household Prods. 401.85 187.63B -38.67
20 Vedanta VDAN Metal Mining 196.4 745.40B -37.96

 

Interestingly, Vodafone Idea is the biggest loser in this list and has lost a market price of over 62% in this year. The stock was trading at a market price of Rs 104.60 at the start of the year, and currently, its share price is fluctuating at Rs 37.35.

Tata Motors is yet another beaten company on the street. Both fully paid ordinary shares and DVR are down by around 60% in this year. This stock is continuously declining for around two years, since it made its high of Rs 578.70 in September 2016. Currently, Tata motors ordinary shares are trading at a price of Rs 172.5.

A few of the other popular losing stocks in this list are NBCC, Motherson Sumi Systems, PNB, CBI, Bharat Electronics, Aditya Birla Capital, Mangalore Petronet, HPCL, Bharti Airtel and YES BANK.

Also read:

Closing Thoughts

Although it’s good to monitor the yearly returns of the companies, however, looking at the performance of stocks just for a year is not enough. It is the long-term returns of the stocks that matter the most for the wealth creation of shareholders.

Besides, a lot many big companies on the list are trading at a decent discount currently. Whether the losing companies mentioned above will continue to decline further or bounce back will depend on their future performances.

The share investors should consider these as opportunities to invest in amazing businesses at a fair value. Happy Investing.

Disclaimer: The stocks listed in this post should not be considered as recommendations. Please study the companies carefully or take the help of a financial advisor before investing.

goal based investing cover

The Real Truth About Goal-Based Investing!

Goal-based investing, also known as Target based investing or Goal-driven investing has been into a lot of buzzes lately. The name itself defines this investing strategy.

However, still many investors do not know what exactly is a goal-based investment and how to pursue it. In this post, I’ll try to answer the most frequently asked questions regarding goal-based investing. Here are the topics that we’ll discuss today:

  1. What is a goal-based investing?
  2. How is goal-based investing different from traditional investing?
  3. Why goal based investing is the key to long-term success?
  4. How to get started with goal-based investing?

This post may change the way you look towards investing. Therefore, make sure that you read this article till the end. Let’s get started.

1. What is a goal-based investing?

Although goal-based investing is not a new concept and many financial experts have been following this strategy over a long period, however, it started getting fame recently.

Goal-based investing is a new way of wealth management where the individuals focus on attaining specific objectives or life-goals through their investments. Here, before starting to invest, the individual tries to answer the question- “What exactly are you investing for?”.

The best part about the goal-based investing is that here the investors do not focus on getting the highest possible returns. But the aim of this investment is to reach the desired returns that meet their goals.

In a goal-based investment, the individuals periodically measure the progress on their returns against the specific goals. Instead of trying to outperform the market, they try to attain their goals within the desired time horizon.

Moreover, the goal can be person specific like planning for children education, retirement fund, buying a new house or even financial independence. A few factors included while planning goal-based investments are the aim of the person per age, risk tolerance, financial situation, and investment horizon.

2. How is goal-based investing different from traditional investing?

The main motive of traditional investing is to get higher returns and generally to beat the market.

Here, the individuals compare their returns with the index such as Sensex or nifty in order to find whether their personal investments are over or underperforming.

On the other hand, goal-based investing redefines the success based on the individual’s goals and needs, rather than whether they beat the market or not. This strategy tries to shift traditional investing to a personal financial goal approach and helps to invest based on needs and risk tolerance.

The problem with traditional investing is that they do not focus on the individual’s needs. In such a scenario, no matter, how good are the returns, if the individuals are not reaching your final goal, then the returns might not be good enough for the individuals. After all, investing is a long-term activity and NOT a phenomenon of beating the market for a year or two.

Goal-based investment allocates the funds depending on the individuals’ situation and aims. For example- if your goal is retirement, then you might choose a conservative strategy with a majority of investments in debt funds. On the other hand, if your goal is to build a corpus for your children’s marriage, you might choose an aggressive strategy with 50% investment is equity and rest 50% in debt.

goal based investing trade brains

3. Why goal based investing is the key to long-term success?

The biggest advantage of goal-based investing is that it increases the individual’s commitment to invest consistently in order to reach their life goals. Unlike traditional investing, here the individuals participate actively and observe the progress towards their goals.

Moreover, having a long-term strategy helps the individuals to avoid making impulsive decisions based on market fluctuations. As the individuals are more focused to achieve their goals, they are less inclined to make spontaneous decisions just with an expectation to get a little higher return. Goal-based investing prevents rash investment decisions by providing a clear process of identifying goals and choosing strategies to achieve them.

Lastly, it also avoids the situation of under-saving (and under-investing). As goal-based investing continuously monitors the progress of individuals towards their goal, and hence they remain updated on how far they are from their goals. In a case where they are under-investing, they can re-improvise their strategy so that they can reach their goal in time.

Also read:

4. How to get started with goal-based investing?

Although planning a goal-based investing requires a detailed study of the individual’s goals, financial situation, time-horizon, and risk tolerance. However, here are a few simple steps that can give you a rough idea of how to get started.

The first step is to clearly define your goals and the time horizon to attain them. The goal can be building a corpus for buying a new house, savings for children education/marriage, retirement etc. You can even have multiple goals and differentiate them as short-term, mid-term and long-term.

The next strategy is defining your strategy of where you’ll invest and how. Depending on the risk-tolerance, required rate of return and time horizon, you can choose different funds like equity, debt or a combination of both. Further, you also need to decide your monthly, quarterly or yearly contribution to all these funds.

The next step is to be disciplined in following your strategy. To attain your goals, you need to make consistent investments.

Finally, periodically monitor and review your progress towards your goal. If your progress is not in line with your purposes, you might need to revise your strategy and re-allocate your funds so that you can reach your goal in time.

Closing Thoughts

Goal-based investing is a relatively new way to achieve personal needs by investing in a definite strategy. It’s a good alternative over traditional investing which does not focus on the individual’s goals and financial situation.

Most individuals start investing in the market without any goal. There are even a few who invest in the market just for fun and to make a few extra bucks alongside their primary income source.  And it’s perfectly okay to start like that. However, with time you need to eventually decide a goal for your investments. It will help you reach them in time and to avoid situations of taking unnecessary risks just in order to get some extra returns.

Besides, another benefit of goal-based investing is that it helps in ‘Guilt-free spending’. Here, as you already know that all your goals have been taken care of, you can spend the additional income on something that you love without any guilt.

Final thoughts, “Investing is good. But it is even better when attached to a goal.”

Financials Signals That A Company May Be Declining cover

3 Financial Signals That A Company May Be Declining.

Do you know that out of the 30 companies in the constituents of Sensex in 1992, only seven are still the part of it?

Yes, that’s true. The remaining companies couldn’t maintain their growth & value and hence were thrown out of the list of the biggest thirty companies in India with time. (Read more here: The Sensex story in the 25-year reform period —The Hindu Business Line) .

Although becoming a large-cap company is a dream of most of the businesses, however, after becoming a mature company, many companies find it a little challenging to maintain their growth.

Moreover, the problem arises when they are not able to sustain their profitability and starts declining. There are a number of examples of companies which were once a market leader, however, couldn’t keep a sustainable profit margin and later either shut down or went bankrupt. The most common example is Kingfisher. 

Declining companies do not have much growth potential left and even the returns (and value) of their existing assets keep on sinking.

Therefore, as investors, it’s really important for us to continuously monitor the growth of our invested company. And if we are able to find some signals that the company is declining, it might be the time for exit from them.

After all, no matter how much we love our invested company, the main goal of our investments is to make money and if the company is continuously declining, there’s no point remaining invested. It’s really difficult for the declining companies to reward their shareholders. Further, we as investors have thousands of other options available to invest in the market. Then, why to stick with the declining companies?

In this post, we are going to discuss three clear signals that you can study from the financial statements which show that a company may be declining.

Besides, these financial signals are very simple to identify (even for the beginners). Therefore, make sure that you read this post till the very end. Let’s get started.

3 Financial Signals that a company may be Declining.

Although evaluating the exact financial health of a company requires a serious study of the statements of profit & loss, balance sheet and cash flow statement of the company. However, there are a few financial tools which send an easy signal for the investors to identify the declining companies. If all these three financial signals are negative for a company, then the company might be in a little trouble.

Here are the three simple financial signals that you can study to evaluate if a company is declining:

1. Declining Revenue:

If a company’s revenue is continuously declining for the past multiple years, it may be a warning sign for the investors.

The revenue of a company is the TOP LINE of the income statement. And if the TOP LINE is declining, in general, all the lower levels will follow the same trend.

Even a stagnant (flat) revenue for a continued longer period of time is a sign of caution for the investor. After all, there’s a fixed extent up to which a company can control its expense. And if the company want to increase its profit, then it has to increase its revenue eventually.

A flat or declining revenues for past multiple years is an indicator of operating weakness. Moreover, if you can find that the revenue of the competitors (and the industry) is growing over the same perio, then it sends even a stronger signal of a weak management and poor health of the company.

For example- here is the income statement of Reliance communication for the last five years. Here, you can easily notice the declining net sales (and total revenue) for the past multiple years.

Reliance communication income statement
Source: Equity Master

And this decline is in line with the stock return of this company. In the last five years, Reliance communication’s share price has shrunk by over 88%.

2. Negative Profit margin:

Profit margin is calculated by dividing the net profits by net sales realized over a given time period. It represents how much percentage of sales has turned into profits. In other words, the percentage figure indicates how many cents of profit the business has generated for each rupee of sale.

If the profit margin of a company is negative, it shows that the company is not able to generate profit from its regular business. A negative or declining profit margin of the company for a continued longer period of time can be taken as a warning sign for the investors.

Declining companies generally lose their market share to their competitors. And in order to keep up their sales, they often have to either give bigger discounts or to cut their profits. Moreover, they also lose the pricing power which further leads to a fall in the margin.

While evaluating companies, you can look into the three levels of the profit margins- Gross profit margin (GPM), Operating profit margin (OPM) and Net profit margin (NPM), each being a more refined level of profitability. As a rule of thumb, avoid investing in companies with a negative profit margin.

Anyways, if you’ve already invested and now find that the profit margin of the company is continuously declining for the past multiple years, then it might be a signal that this company is declining.

3. Big dividend payouts:

Dividend payout is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company.

It can be calculated by dividing the dividend per share (DPS) by earnings per share (EPS) of a company in a year. For example, if the DPS of a company for the current year is Rs 2 and its EPS is Rs 10, then the payout ratio is equal to 2/10 i.e. 20%.

If a company gives a consistent dividend to its shareholder, it is a healthy sign.

However, the problem arises when the company starts paying a major portion of its net income as dividends. In such a scenario, the company is not retaining enough income for investment in its growth or future plans.

There should be a balance between rewarding shareholders and the retaining income for its own growth. After all, if the company is not investing enough in itself, it will eventually become difficult for them to increase (or to maintain) their profitability in the future.

Declining companies generally pay out large dividends to their shareholders as they have a very little need (or scope) of reinvestment. As a rule of thumb, payout ratio greater than 70% for a company can be a warning sign for the investors.

Other financial signals:

Another financial tool that can give you a better picture of the financial situation of a company along with the above three financial indicators is the company’s debt level.

If the debt level of a mature company is continuously increasing at a high pace, it is a sign that the company has been aggressively financing its growth with debt. You can use debt to equity ratio to evaluate the debt level of a company. A high debt to equity ratio (greater than one) can be considered a high risk for the company.

Apart, there are also a few handfuls of financial ratios like Return on assets (ROA), Return on equity (ROE), interest coverage ratio etc that you can also study to check if your company is declining. A continuously declining ROA, ROE and interest coverage ratio can be a warning sign.

Also read:

Closing thoughts:

Even big mature companies are capable of declining over time and losing their value. And that’s why it is important for the investors to continuously monitor the growth of their invested company.

In general, a flat or declining revenue, negative profit margin and huge dividend payout can be considered signs of a declining company.

Anyhow, if the company takes necessary steps, it may recover back on track or even become a turn-around. However, if the management doesn’t take the significant steps in time, the company may decline further destroying the shareholder’s investment. 

swot analysis for stocks cover

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

SWOT Analysis for stocks is one of the most widely used tools for performing the ‘qualitative’ study of the company. It helps to understand the company’s market position and competitive advantages.

In this post, we are going to discuss what is SWOT analysis and how to use this tool for qualitative analysis of a stock.

What is SWOT Analysis?

SWOT Analysis focuses on four important factor while evaluating the quality of a company. Here’s what SWOT Analysis for stocks looks at:

  • S—> Strength
  • W—> Weakness
  • O—> Opportunity
  • T—> Threat

swot analysis for stocks

Our of the four factors of SWOT analysis, ‘strength’ and ‘weakness’ are the internal factors of a company and hence are controllable.

On the other hand, ‘opportunities’ and ‘threats’ are external factors and it’s little difficult for a company to control these factors. However, using the SWOT analysis of stocks, the management can identify the threat and opportunities and hence can take proper actions within time.

For example, Bharat Stage (BS)- IV fuel was launched in India in April’2017. This means the ban on the sale of all the BS-III compliant vehicles across the country after the launch date.

Those automobile companies who have already realized this big opportunity might have started working on the BS-IV vehicles months before the expected launch date. On the other hand, companies who haven’t done the opportunity/threat analysis properly would have faced a lot of troubles. They cannot sale the old BS-III model vehicles. Hence, a big loss of the finished products and the inventories.

Also read: BS-III vehicles: Auto-industry to absorb losses over Rs 12,000 crore.

Why use SWOT Analysis for stocks?

Here are few reasons why SWOT analysis for stocks is beneficial:

  • SWOT analysis is one of the simplest yet effective approaches for the qualitative study of a stock.
  • It helps in identifying weak points of a company that may become an issue in future.
  • It helps in finding the durable competitive advantage i.e. moat that will help to protect your investment in future.

Quick Note: During swot analysis for stocks, only include valid/verifiable statements. Do not add rumor/misleading pieces of information in the study.

Components of SWOT Analysis for stocks:

1. Strength

The strength of a company varies industry-to-industry. For example, a low non-performing asset (NPA) can be the strength of a banking sector company. On the other hand, cheap supplier or cost advantages can a big strength for an automobile company.

Here are few other strengths of a company that you should take notice while performing SWOT analysis of stocks:

  • Strong financials
  • Efficient Management (People, employees etc)
  • Big Brand recognition
  • Skilled workforce
  • Repeat clients
  • Cost advantages
  • Scalable business model
  • Customer loyalty

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

2. Weakness:

The ‘reverse’ of everything discussed in the ‘Strengths’ can be the weakness of a company. For example- Weak financials, in-efficient management, poor brand recognition, unskilled workforce, non-repetitive clients, un-scalable business and disloyal customers.

Besides, there are few other weaknesses that may affect the company:

  • Outdated technology.
  • Lack of capital
  • High Debt

For example- many companies in telecommunication industry ran out of business as they were using outdated 2G/3G technology. Similarly, in the energy sector, renewable power generation is the future technology and those companies who are ‘not’ working on the new technology might get outdated soon. In short, outdated technology adversely affects most of the industry.

3. Opportunity:

A company with a lot of opportunities has a lot of scopes to succeed and make profits in future. Here are few points that you need to consider while evaluating opportunities for a company:

  • Internal growth opportunity- (New product, new market etc)
  • External growth opportunity (Mergers & Acquisitions)
  • Expansion (Vertical or horizontal)
  • Relaxing government regulations
  • New technology (Research & Development)

4. Threats:

In order to survive (and moreover to remain profitable), it’s really important for a company to analyze its threats. Here are few of the biggest threats to a company:

  • Competition
  • Changing consumer preferences/ new trends
  • Unfavorable Government regulations

The changing consumer preferences are one of the repetitive threats that many industries face. Here, if no proper action is taken to retain the customer, then it might unfavorably affect the profitability of the company.

For example-  The new trend of ‘health awareness’ among the people may result in a decline in the sales of beverages/Soft drink companies. (These companies are fighting back this threat by introducing ‘DIET-COKE’).

Similarly, a preference towards ayurvedic products in India has already reduced the sales of non-ayurvedic FMCG companies (and a rise of PATANJALI).

Also read: How to Invest Your First Rs 1,000 in The Stock Market?

How to use SWOT ANALYSIS of stocks to study companies?

Swot analysis of stocks is quite useful while performing the comparative study of companies. Using these analyses, you can study the comparative strengths and weaknesses of different companies.

Let’s say there are two companies- Company A & Company B.

‘Strength’ of COMPANY A can be the ‘Weakness’ of COMPANY B. Similarly, ‘Opportunity’ for COMPANY A can be a ‘Threat’ to COMPANY ‘B’. For example-

  1. The loyal customers can be the ‘strength’ of company A. Whereas, disloyal customers can be a ‘weakness’ for company B.
  2. A new Merger & Acquisition (M&A) is an opportunity for company A. However, it is a threat to company B.

Also read: SWOT Analysis of FORD Motors.

CONCLUSION:

SWOT Analysis of stocks is a useful tool to analyze stocks based on their strengths, weakness, opportunities, and threats. If done properly before investment, SWOT Analysis can help an investor to understand the competitive advantages/disadvantages in order to make a reasoned decision.

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.