Everything to Know About What are Neo banks And what is its future: Technology is taking over! Every company today faces one of the biggest threats of keeping up with technology or being branded as outdated. The same goes for traditional banks.
In this article, we discuss the new tech-savvy type of banks called Neobanks and their possible role in our banking environment. Here, we’ll cover exactly what are Neo banks and how are they changing the financial systems. Let’s get started.
What are Neo banks?
A Neo bank is a 100% digital bank that operates only through online platforms and apps without having any physical branches like traditional banks. These banks attract customers who are tech-savvy and prefer managing their money through apps.
Neo banks are more flexible, inclusive, and accessible in comparison to traditional banks. Neo Bank services are usually limited compared to traditional banks to
Saving and checking account,
Payment and transfer of money and
Financial educational products
How does Neo Banks function?
Neo banks function differently than a traditional bank. These banks are customer-oriented with technology playing a major role in helping them achieve this. But this also means that several traditional means of revenue are no longer available to these banks. One of the revenue means through which Neo Banks maintain profitability is its subscriptions.
The business model allows Neo banks to provide customer-tailored requirements. This allows them to charge a subscription fee or a premium for various additional and advanced services.
Another means through which Neo banks could boost their profits in the future is if they increase their lending to customers. This however involves increased risk and could involve several challenges. Currently one of the most attractive models for Neo banks is offering their service to established financial institutions.
Partnering with traditional banks allows them a way around the restrictions placed by the RBI. Neo banks here provide back-end digital services to traditional banks. The near future could also see several acquisitions made by traditional banks of Neo banks.
How do Neo Banks operate in India?
As a customer, a Neo bank may only seem like an app that stores and facilitates the transfer of funds. But these offerings are limited in India in comparison to traditional banks. In India, Neo banks are not allowed to hold customer deposits as the RBI still requires a physical presence as per its 2014 guidelines. This forces Neo banks to partner with traditional banks.
Despite this, in the last year, we have seen several Neo banks thriving in the country. This can be attributed to a major shift due to the pandemic forcing digitization of services. Neobanks are further attractive in these aspects as they incur lower overheads further encouraging traditional banks to keep up. They are cost-effective as their operations do not require any costs related to a bank’s physical presence. This allows them to cut fees and expand services.
Different Neo Banks in India
Walrus Club
Niyo
InstantPay
RazorPayX
Advantages of Neo Banks
Following are some of the advantages over traditional banks:
1. Low Cost
Functioning as a Neo bank removes any costs associated with branches and staff associated with running these branches. These also allow these banks to offer other benefits to customers like higher interest rates and fewer fees. In addition, these banks around the world do not even offer credit facilities which reduce the risk with which these banks function and further drives down their costs.
2. Convenient
Neo Banks allows us to access the banking services without having to go through the hassle of visiting a physical branch. These banks also at times provide debit cards in order to suit the preference and make it more convenient for their customers.
3. Reduced Processing time
Neo banks allow users to skip the various time-consuming processes. In an episode of Fintech Podcast Founder of Built for Mars, Peter Ramsey experimented with opening bank accounts with different banks in the UK. The results are shown above in the number of working days taken to open a bank account.
Unsurprisingly the list includes several NeoBanks outperforming traditional banks.
Disadvantages of Neo banks
This new style of banking won’t be attractive to all mainly due to the following reasons:
1. No Physical Branches
This is one of the biggest challenges which these banks would face in India if regulators approved their independent presence. The majority of Indians prefer speaking to someone from the bank for their transactions face to face. This allows them to build trust with the respective bank. This is completely absent in the Neo bank model.
2. Only Tech Savvy customers
Since Neo banks mainly operate through online platforms and apps, they reduce their customer base to only those who are tech-savvy. This wipes out a major portion of the market who aren’t comfortable using banking services through apps and online platforms.
3. Less Regulated
These digital are less regulated and are not even considered fully functional banks in India. This also means they are allowed to offer fewer services. This further reduces a potential customer’s trust in them.
Neo banks and Budget 2021
Although a significant focus of the budget was placed on restructuring the ailing banking sector, the FM has also created room for Fintech growth in the near future. The FM announced the allocation of RS.1500 to boost digital payments. This recognizes the growth of fintech firms which also includes Neo banks in the last 5 years and also their potential.
This will further lead to increased adoption of digital payments. In addition to this, the FM also announced the move to set up GIFT City (Gujarat International Finance Tec-City). This further recognizes the importance of fintech like these digital Banks in the banking sector and the need for Fintech hubs throughout the country.
Closing Thoughts – Future of Neo banks
The future of a fully-fledged Neo bank seems steep. This is because it would involve several changes made to the regulation put in place by the RBI in order to recognize them with a banking license.
The next challenge would be gaining trust in an environment where clients find it hard to trust traditional banks as they too have been increasingly failing in the recent past. But their introduction would eradicate several barriers. The first being the physical and geographical challenges. The Indian population still remains severely under banked. These digital banks would lead to a rise in inclusion throughout the country to all areas with internet connectivity.
It is already evident that traditional big banks have realized the importance of Neo banks. This is primarily because Neo banks have exploited the cracks in a traditional banking system. This has forced them to develop partnerships with Neo banks as customers demand faster and better services online.
This demand from customers has only intensified during the Covid-19 era which promotes lesser contact. Further, the online segment offers huge growth prospects to a traditional-Neo partnership. So one can expect to see a greater role played by Neo banks in the near future.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Tips to Analyze the Management of a Company for Investing in Stocks: “There are no bad companies, only bad managers”. You’ll hear every great investor stress the importance of a company’s management. But for retail investors like us, it is hard to directly assess the management. There is no CEO that would deny an investor like Buffet but unfortunately, that does not hold true for everyone.
In this article, we are going to discuss how to analyze the management of a company for investing in any stock. Here, we’ll identify the factors that we can look into, in order to assess the management of a company
How to Analyze the Management of a Company for Investing?
The executives that run a company are responsible for shaping the future of the company. We often don’t realize that ultimately a company is run by humans. Due to this assessment, the management quality is often overlooked.
On the other hand, management quality isn’t quantifiable and unfortunately, we cannot use interactions to judge each management. But despite this, there still are a considerable number of factors that help retail investors assess the quality of management. They are mentioned below:
1. Background of Promoters / Top managers
The very first step in assessing the management quality would be finding the background of the top management and promoters. This would include their accomplishments, the performance of the company under them, and any other relevant information.
If they have accomplished good and stable growth for a considerable period (10 years) it could be a testament to their leadership. On the other hand, if we come across news that portrays the management in a negative light it’s better to stay away from the individual. Thankfully due to technology, this can be done simply by googling the individuals’ name. This information can also be used to assess the competence of the promoters and management.
2. Promoter holding
It is also important to note the stake held by promoters in a company. Promoters holding a 50% or more stake in a company is a good sign. On the other hand, promoters holding a low stake in the business and news that they may keep selling is a red flag. Another sign could be Institutional investor holdings.
You can find the promoter’s holding of any publically listed company on Trade Brains Portal. Simply, go to Portal, search the company name and navigate to the Shareholding pattern section.
3. Future Plans, Strategy, and goals
It’s really important to check the future plans, strategy, and goals in order to analyze the management of a company for investing in any stock. For it, simply start by going through the Vision, Mission, and Value statement of the company.
Together, mission and vision guide strategy development, help communicate the company’s purpose to shareholders and inform the goals and objectives set to determine whether the strategy is on track. Hence, these defined future statements for the company can help an investor to decide whether to select a stock to invest in the Indian stock market or not.
4. Remuneration of the Managers
The remuneration paid to managers is made available through the annual reports. This parameter gives us an insight into the aims of the managers. One of the major factors to look for here is the proportion of managerial remuneration increase in comparison to profits.
If the company has performed negatively in terms of profits but the CEO gets a raise, it is a sign of poor leadership. Also, the % increase in remuneration is higher than the % increase in profits is another red flag. One can also compare the salaries of the CEO within the same industry in order to understand the difference.
Further, also look into perks to the employee. If the company is giving good perks to its staff and employees, then again it’s a sign of good management. The performance of a company depends a lot on the performance of its staff and employees. Happy employees will give their best performance. However, if there are continuous strikes or increasing worker union demands, then it means that the management is not able to fulfill the needs of its workers and employees. Such cases are a bad sign for investors in the company.
5. Communication & Transparency
Communication and Transparency are the most important factors while judging the management. The integrity of the management is the key to the growth of the company. It’s the management’s duty to give ‘fair’quarterly and annual results to its shareholders.
Just as the management announces the good results of the company proudly; in the same way, the management should come forward in times of bad results to explain its reasons to its shareholders. Good management always maintains the transparency of its organization.
In 2018 Elon Musk received a lot of flak after he tweeted “Am considering taking Tesla private at $420. Funding secured.” This however was false and Musk had to later suffer the consequences from regulatory authorities. This was an example of poor communication.
Being at the top of a company it is important that CEOs communicate things as they are and do not hide or manipulate information or as seen above play pranks.
It is also important to have a background check on other individuals in top posts too. This includes the board of directors, chairmen, independent directors, etc. We also often see bureaucrats appointed to the board as independent directors.
Although they may bring significant administrative experience. The post is at times offered in return for other favors like govt approvals etc.
7. Emphasis on Share Price
Often Share Price is used to measure the success of the promoter/ managers. Although the managers are expected to create wealth for investors it is not healthy for the top management to take decisions solely on the share price.
The top management obsessed with the share price is a red flag. These managers may not take decisions that might be better in the long run if it affects the shareholders in the short term. It’s also important to note that theShare Price of a company is a function of market forces.
8. Related Party transactions
Another important section of the annual reports is “Related Party Transactions”. This section represents the transaction that the company had with the promoter’s other entity or their relatives’ entity, joint ventures, etc. This section would reveal details if the promoters profit from the company at the expense of other shareholders. Hence the section must be studied in detail.
9. Management Forecast
The annual reports also include sections like the “The Directors Report”, “Management Discussion and Analysis”. These reports show the plans of the management and projections about the future of the business.
10. Capital Allocation
Capital Allocation is the manner in which the management uses the free cash flows in a company. These include reinvestment into the business, paying dividends, holding as cash, etc. The skillset of a CEO is also determined by observing how he manages to manage the cash in order to keep the investors happy and grow the business.
Generally, the cash in a business is generated through its profits. But on receiving dividends, investors must also identify the source. In 2014, companies like L&T, Hindalco paid out dividends even when the company’s net debt to Ebitda increased.
11. Promoter’s buying and share buybacks
The promoters of the company have the best knowledge about the company’s performance. The management and the top officials can understand the future aspects of the company and if they believe that the company will outperform in the future, they are mostly correct. Therefore, promoter’s buying and share buybacks are signals that the owners trust in the future of the company.
In addition, the other scenario, where the promoters or CEO is selling some of their stocks, is an independent activity and cannot be treated as a bad signal. We cannot judge the company’s future just because the promoters are selling a small portion of their stocks once in a while. Maybe, the promoters need money to start another venture, buy a new house or enjoy a vacation. Everyone has the right to sell stocks when they need them the most, and so do the founders.
In short, the promoter’s buying and share buybacks are signals of a good company. However, we cannot judge the company’s future based on the promoter’s selling some portion of their stock. Anyways, if the promoters are selling a lot of stocks continuously without explaining the reason, then it’s a matter of further investigation.
Closing Thoughts
In this article, we discussed how to analyze the management of a company for investing in any stock. The importance of a quality management team cannot be stressed more. This also forms an important part of qualitative analysis. Only considering the financial results does not give us the full picture of the business. Using the factors mentioned above will give us a clearer picture of the business. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
A Complete Guide for Beginners to Learn How to Invest in Share Market in India: Hello Investors. Today we are going to discuss one of the most elementary topics for a newbie- How to invest in share market in India? I have been planning to write this post for a number of days as there are many people who are willing to invest, however, do not know how to invest in share market. Through this article, they will get the answers to their question and learn the step-by-step process of how a beginner can start investing in the Indian share market.
Please note that this post might be a little longer as I am trying to cover all the basics that a beginner should know before entering the stock investment world. Make sure that you read the article till the end, cause it will be definitely worthwhile reading it. Let’s get started.
Pre-requisites Before You Start Investing
For investing in the Indian stock market, there are a few pre-requisites that I would like to mention first. Here are the few things that you will need to invest in share market:
Bank Savings account
Trading and Demat account
Computer/laptop/mobile
Internet connection
(Thanks to Reliance Jio, everyone has 4G internet connection now.. 😀 )
For opening a demat and trading account (usually opened altogether and called 2-in-1 account), the following documents are required:
PAN Card
Aadhar card (for address proof)
Canceled cheque/Bank Statement/Passbook
Passport size photos
You can have your savings account in any private/public Indian bank.
Where to open your trading and demat account?– This will be discussed later in this post on the section ‘choose your stock broker’ (STEP 4).
Get your documents ready. If you do not have a PAN card, then apply as soon as possible (if you are 18 years old or above).
3 Basic Advice Before You Start Investing
When you are new to the stock market, you enter with lots of dreams and expectations. You might be planning to invest your savings and make lakhs in return.
Although there are hundreds of examples of people who had created huge wealth from the stock market, however, there are also thousands who didn’t.
Here are a few cautionary points for people who are just entering the world of investing.
— Pay down your ‘High-Interest’ debts first
If you have any kind of high-interest paying debts like personal loans, credit card dues debts, etc, then pay them first. The interests of these loans can be even as high as your returns from the market. There is no point in wasting your energy to give all the returns you made from the market as interests of your debts. Pay down these debts before entering the market.
— Invest only your additional/ surplus fund
Stop right there if you are planning to invest your next semester tuition fee, next month flat rent, savings for your daughter’s marriage which is going to happen next year or any similar reasons.
Only invest the amount that won’t affect your daily life. In addition, investing in debts/loans is really a bad idea, especially when you are new and learning how to invest in the share market.
— Keep some cash in hand
The cash in hand doesn’t just serve as your emergency fund. It also serves as your key to freedom. You can take big steps like changing your little flat, or quit your annoying job or simply shifting to a new city, only when you have cash in hand.
Do not get trapped by investing all your money and later losing your freedom. Do not sacrifice your personal freedom in the name of financial freedom.
Now that you have understood the pre-requisites and the basics, here are the seven steps to learn how to invest in share market on your own. Do follow the step sequences for an easy approach to enter the stock market world.
How to Invest in Share Market in India?
Step 1: Define your investment goals
It’s important to start with defining your investment goals. Start with end goals in mind. Know what you want.
Do you want to grow your saved money (capital appreciation) to beat inflation and get higher returns? Do you want to build a passive income from your investments through dividends? Are you investing for a specific goal? Or do you just want to have fun in the market along with creating wealth?
If you want to just have fun and want to learn, that’s okay. But make sure that you do not over-invest or get too much attracted to the market? Moreover, most people start the same way and define their goals later.
Anyways, if you are starting for Goal-Based Investing, do remember that the time frame for different investment goals will be different. Your goal can be anything like buying a new house, new car, funding your higher education, children’s marriage, retirement, etc. However, if you are investing in your retirement, then you have a bigger time frame compared to if you are investing in buying your first house.
When you know your goals, you can decide how much you want and for how long you have to remain invested.
Step 2: Create a plan/strategy
Now that you know your goals, you need to define your strategies. You might need to figure out whether you want to invest in the lump sum (a large amount at a time) or by SIP (systematic investment plan) approach. If you are planning small periodic investments, analyze how much you want to invest monthly.
There’s a common misconception among our society that you need large savings to get started. Say, one lakh or above. But that’s not true. As a thumb rule, first, build an emergency fund, and next start allocating a fixed amount let’s say 10-20% of your monthly income to save and invest. You can use the remaining portion of your earnings for paying your bills, mortgages, etc. Nevertheless, even if your allocated amount turns out to be Rs 3-5k or more, it’s good enough to build an investing habit.
There are a number of decent books on stock market investing that you can read to brush up on the basics. Few good books that I will suggest the beginners should read are:
Besides, there are a couple of more books that you can read to build good basics of the stock market. You can find the list of ten must-read books for Indian stock investors here.
Step 4: Choose your stock broker
Deciding on an online broker is one of the biggest steps that you need to take. There are two types of stockbrokers in India:
Full-service brokers
Discount brokers
— Full-Service Brokers (Traditional Brokers)
They are traditional brokers who provide trading, research, and advisory facility for stocks, commodities, and currency. These brokers charge commissions on every trade their clients execute. They also facilitate investing in Forex, Mutual Funds, IPOs, FDs, Bonds, and Insurance.
Few examples of full-time brokers are ICICIDirect, Kotak Security, HDFC Sec, Sharekhan, Motilal Oswal, etc
— Discount Brokers (Budget Brokers)
Discount brokers just provide the trading facility for their clients. They do not offer advisory and hence suitable for a ‘do-it-yourself’ type of clients. They offer low brokerage, high speed and a decent platform for trading in stocks, commodities, and currency derivatives.
A few examples of discount brokers are Zerodha, Upstocs, 5 Paisa, Trade Smart Online, Paytm Money, Groww, etc.
I will highly recommend you to choose discount brokers (like Zerodha) as it will save you a lot of brokerage charges.
Initially, I started trading with ICICI direct (which is a full-service broker), but soon realized that it was too expensive when compared to discount brokers. It doesn’t make sense to pay extra brokerage charges even if you get similar benefits. And that’s why I shifted to Zerodha as my broker. (Related Post: Different Charges on Share Trading Explained- Brokerage, STT & More)
Zerodha (a discount broker) charges a brokerage of 0.01% or Rs 20 (whichever is lower) per executed order on Intraday, irrespective of the number of shares or their prices. For delivery, there is a zero brokerage charge in Zerodha. Therefore, the maximum brokerage that you’ve to pay per trade while using the Zerodha platform is Rs 20 and it doesn’t depend on the volume of trading.
This is way cheaper compared to ICICI direct (full-service broker) which asks a brokerage of 0.55% on each transaction. If you buy stocks for Rs 50,000 in ICICI direct, then you have to pay a brokerage of Rs 275 for delivery trading i.e. when you hold the stock for more than one day in your demat account.
Further, as this amount is charged on both sides of the delivery transaction (buying & selling), hence you have to pay a total of Rs 550 for the complete transactions in ICICI direct (way too expensive than Zerodha).
Step 5: Start researching common stocks and invest.
Start noticing the companies around you. If you like the product or services of any company, dig deeper to find out more about its parent company, like whether it is listed on the stock exchange or not, what is its current share price, etc.
Most of the products or services that you use in day to day life — From soap, shampoo, cigarettes, bank, petrol pump, SIM card or even your inner wears, there is a company behind everyone. Start researching about them.
For example- if you’ve been using HDFC debit/credit card for a long time and satisfied with the experience, then investigate further about HDFC Bank. The information of all the listed companies in India is publicly available. Just a simple ‘Google search’ of ‘HDFC share price’ will give you a lot of important pieces of information. (Try it now!)
Similarly, if your neighbor bought a new Baleno car lately, they try to find out more about the parent company, i.e. Maruti Suzuki. What other products it offers and how is the company performing recently- like how are its sales, profits, etc.
You do not need to start investing in stocks with hidden gems. Start with the popular large-cap companies. And once you are comfortable in the market, invest in mid and small caps.
Step 6: Select a platform to track your performance
You can simply use an excel or google spreadsheet to track your stocks. Make a spreadsheet with three tables containing:
The stocks that you are interested in and need to study/investigate,
Those stocks that you have already studied and found decent,
Miscellaneous stock- for the other stocks that you want to track.
Else, you can do this by creating multiple watchlists on our Trade Brains Portal. Our Research and Analysis Portal offers users to make up to 5 watchlists and create portfolios. You can sign up on Trade Brains Portal for free to track your stock performance.
This way, you can easily follow the stocks. In addition, there are also a number of financial websites and mobile apps that you can use to keep track of the stocks. However, I would suggest you track your stocks on Trade Brains Portal.
Step 7: Have an exit plan
It’s always good to have an exit plan. There are two ways to exit a stock. Either by booking profit or by cutting a loss. Let’s discuss both these scenarios. Basically, there are only four scenarios when you should sell a good stock in your portfolio:
When you badly need money
When the stock fundamentals have changed
When you find a better investment opportunity and
When you have reached your investment goals.
If your investment goals are met, then you can exit the stocks happily. Or at least, book a portion of the profit from your stock portfolio and shift it to other more safer investment options. On the other hand, if the stock has fallen under your risk appetite level, then again exit the stock. In short, always know your exit options before entering.
That’s all. There were seven steps that will help you learn how to invest in the share market. Now, here are a few other important points that every stock market beginner should know:
10 Additional points to take care
1. Start small
Do not put all your money on the market in the beginning. Start small and test what you have learned. You can start even with an amount of Rs 500 or 1000. For beginners, it’s more important to learn than to earn. You can invest in a large amount once you have more confidence and experience.
2. Diversify your portfolio
It’s really important that you diversify your portfolio. Do not invest all in just one stock. Buy stocks from companies in different industries.
For example, two stocks of Apollo Tyres and JK Tyres in your portfolio won’t be called a diversified portfolio. Although the companies are different, however, both companies belong to the same industry. If there is a recession/crisis in tyre sector, then your entire portfolio might be in RED.
A diversified portfolio can be something like Apollo tyres and Hindustan Unilever stocks in your portfolio. Here, Apollo Tyres is from Tyre industry and Hindustan Unilever is from FMCG industry. Both the stocks are from different industry in this portfolio and hence is diversified.
Blue chips are the stocks of those reputed companies who are in the market for a very long time, financially strong and have a good track record of consistent growth and returns in the past many years.
For example- HDFC banks (leader in the banking sector), Larsen and turbo (leader in the construction sector), TCS (leader in the software company), etc. A few other examples of blue-chip stocks are Reliance Industries, Sun Pharma, State bank of India, etc.
These companies have stable performance and are very less volatile. That’s why blue-chip stocks are considered safe to invest in compared to other companies. It’s recommendable for beginners to start investing in blue chips stocks. As you gain knowledge and experience, you can start investing in mid-cap and small-cap companies.
This is the biggest reason why people lose money in the stock market. They do not carry enough research on the stocks and blindly follow their friends/colleague’s tips and advice.
The stock market is very dynamic and it’s stock price and circumstances change every second. Maybe your friend has bought that stock when it was underpriced, however now it’s trading at a higher price range. Maybe, your friend has a different exit strategy than yours. There are a number of factors involved here, which may end up with you losing the money.
Avoid investing in tips/advice and do your own study.
5. Avoid blindly following the crowd
I know a number of people who have lost money by blindly following the crowd. One of my colleagues invested in a stock just because the stock has given a double return to another of my college in 3 months. He ended up losing Rs 20,000 in the market just because of his blind investing.
Will you buy ABC company which produces Vinyl sulphone easter and dye intermediates even though you have zero knowledge of the chemical industry?
If you will, then it’s like giving some stranger a one lakh rupee and expecting him to return the money with interests. If you are lending money to someone, you ask a number of questions like what he does, what is his salary, what is his background, etc. However, while investing Rs one lakh in a company that people do not understand, they forget this common logic.
7. Know what to expect from the market
Do not set unrealistic expectations for the stock market. If you want to make your money double in one month, from the stock market, then you have set your expectations wrong. Have a logical expectation from the market.
People are happy with 4% simple interest from the savings account, but a return of 20% in a year sounds underperformance for them.
Do not get distracted if your portfolio starts performing too well or too bad in the first few months of investing. Many people increase their investment amount just in few weeks if they see their stock doing too well, and end up losing in the long run.
Similarly, many people exit the market soon and are not able to get profits when their stocks start performing. Have discipline and follow your strategy.
9. Invest regularly and continuously increase your investment amount
The stock investment gives the best returns when you invest for the long term. Do not invest in lump sump at just one time and wait for the next 10 years to see how much returns you got. Invest regularly whenever you get a good opportunity. Further, increase the investment amount as your savings increase.
10. Continue your education
Keep learning and keep growing. The stock market is a dynamic place and changes continuously. You can only keep up with the stock market if you also continue your education.
Besides, there are a number of more lessons which you will learn with time and experience.
Ready to start your journey to become a succesful stock market investor? If yes, then here’s an amazing course for newbie investors: HOW TO PICK WINNING STOCKS?
That’s all for this post on how to invest in the share market in India. I hope this is helpful to the readers. If you still have any doubt on this topic of how to invest in share market, feel free to comment below. I’ll be glad to help. Take care and happy investing.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Understanding the Roles of Depositors – CDSL and NSDL in the equity market: As investors and traders, we are well versed with the term Demat (Dematerialization) account. This is because a Demat account is one of the most basic requirements in order to trade or invest in the stock market. Today, we take a look at the organization behind these accounts in the Indian markets i.e. Indian depositories, the NSDL, and the CDSL.
Through this article, we’ll discuss the various roles of depositors in the equity market and the services provided by CDSL and NSDL to Indian investors. Let’s get started.
What are CDSL and the NSDL? And why are they Important?
The Central Depositories Services India Ltd. (CDSL) and National Securities Depository Ltd.(NSDL) are depositories for the Indian markets.
In order to understand what a depository does let us compare securities to cash. The depositories are to securities what banks are to cash. Just like a bank holds your cash and allows you to access it through an electronic form, the depository holds our shares, bonds, mutual funds, etc. for all shareholders in electronic form. These entities have played a pivotal role in the digitalization of the Indian Stock Markets.
Let us go back in time to the early ’90s a period when the stock markets still were heavily dependant on the physical transfer of shares. This was done through share certificates. Thanks to the move initiated by Stock Holding Corporation of India Limited(SHCIL) in 1992 when it paid the groundwork for the NSDL through a concept paper “National clearance and Depository System”. The Government of India promulgated the Depositories Ordinance in September 1995, followed by the passing of The Depositories Act by the Parliament in August 1996.
The NSDL was soon established in 1996 followed by the CDSL in 1999. These two act as depositories to the two exchanges in the country; the NSDL to the NSE and the CDSL to the BSE. The Demat accounts mentioned earlier are actually just a front for the CDSL and NSDL holding your shares.
The transfer from a physical to digital format saw numerous benefits like:
Faster settlement cycles
Elimination of all risks associated with physical certificates
Elimination of bad deliveries
No more stamp duty
Immediate transfer and registration of securities
Faster distribution of non-cash corporate benefits like rights and bonus
Elimination of problems related to the transmission of Demat shares
Reduction in the handling of huge volumes of paper
Periodic status reports
Reduction in brokerage for trading in dematerialized securities.
Elimination of problems related to change of address of the investor
Elimination of problems related to selling securities on behalf of a minor
Ease in portfolio monitoring
The depository system effectively ensured a smooth transition to an electronic one.
Can you Choose your Depository?
An investor does not have the option to select a depository. The depository is selected by the depository participant. A Depository Participant is a financial institution, broker, bank, etc that the shareholder may be in touch with, and respectively can create a Demat account through them. The CDSL has 599 depository participants registered with itself whereas the NSDL has 278 depository participants registered with it.
For an investor or trader to choose a depository of his liking there has to be some difference between the two depositories. Apart from the exchanges, the number of depository participants and years formed there are no striking differences between the two. The services provided, their functioning, and strategy remain the same.
We, however, can find outwith which depositories we have our Demat account with using the account number. A Demat account with NSDL will begin with ‘IN’ followed by 14 numerals. A Demat account with CDSL will have 16 numerals.
What are the Roles of Depositors? Services by CDSL and NSDL!
Here are a few of the top roles and the services provided by NSDL and CDSL for Indian equity investors:
Maintenance of Demat accounts
Rematerialisation and dematerialization
Trade settlement
Share transfers
Market and off-market transfers
Distribution of non-cash corporate actions
Nomination/transmission
Account opening
Account statement
Changing account details
The Depositories also provide shareholder details to companies at the time of dividend payouts. The companies use this information to pay dividends to shareholder accounts.
The efficient functioning of an economy is highly dependant on its financial system. In this article, we discussed the key roles of depositors i.e. CDSL and NSDL in the equity market.
The CDSL and NSDL have been pivotal in not only ensuring facilitating the system but also enhancing its productivity post digitalization. It is also important to note that ever since their existence there have never been any major glitches, a testament to the efficient transformation from physical to electronic format.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
List of Eligibility Criteria for an IPO in India: An Initial Public Offering( IPO) is a route through which a company raises funds through the market. The Indian markets saw 123companies opting for IPO’s in the FY 18-19 in order to get themselves listed on the country’s two primary exchanges, the BSE (Bombay Stock Exchange) and NSE ( National Stock Exchange).
But as open these exchanges may be for companies to apply and get listed on them there are still requirements a company has to meet in order to be considered eligible to be listed. Today, we take a look at the eligibility criteria for an IPO in India. Here, we’ll look into financial requirements and other legal & compaliance norms that a company has to meet for an IPO.
Eligibility Criteria for an IPO: What makes a company ready for an IPO?
1. Paid-up Capital
The paid-up capital of a company is the amount of money it receives from shareholders in exchange for shares in an IPO. according to the eligibility requirements, it is necessary that the company has a paid-up capital of at least 10 crores.
In addition to this, it is also necessary that the capitalization (Issue Price * No. of equity shares post issue) of the company should not be less than 25 crores.
2. Offering to be made in IPO
If the minimum requirements are met then based on the post IPO equity share capital the minimum percentage to be offered in an IPO is decided.
If the post IPO equity share capital is less than Rs. 1600 crore then at least 25% of each class of equity shares must be offered.
Ifthe post IPO equity share capital is more than Rs. 1600 crore but less than Rs. 4000 crore then a percentage of equity shares equivalent to Rs. 400 crore rupees must be offered.
Ifthe post IPO equity share capital is more than Rs. 4000 crore then at least 10 percent of each class of equity shares must be offered.
Companies that do not meet (a) and satisfy (b) and (c) are required to increase the public shareholding to at least 25% within 3 years of the securities being listed on the exchange.
3. Financial requirements of a company
The company must have a net worth (assets – liabilities) of at least 1crore for each of the last 3 years.
The company must have tangible assets of at least Rs. 3 crore in each of the 3 preceding years. Out of these assets, a maximum of 50% must be held in monetary assets.
The average operating profit for each of the last three years must be at least Rs.15 crore.
If the company has changed its name in the last one year it must have earned at least 50% of the revenue for the preceding full year from the activity indicated by the new name;
The existing paid-up share capital of the company must be fully paid or forfeited. This means that the company looking for an IPO should not have partly paid-up shares as a part of its equity.
4. Other requirements for the company
The company looking to get listed on a stock exchange must provide the annual reports of the 3 preceding financial years to the NSE. It can go ahead with the listing requirements if
The company has not been referred to the Board for Industrial and Financial Reconstruction (BIFR).
The net worth of the company has not been wiped out by the accumulated losses resulting in negative net worth.
The company has not received any winding up petition admitted by a court.
4. Promoters/Directors Requirements
The next set of requirements are pertaining to the promoters, directors, selling shareholders of the company. Promoters here are people who have experience of a minimum of 3 years in the same line of business. In order to be considered a promoter, they also have to hold at least 20% of the post IPO equity share. This 20% can be held either individually or severally.
It is necessary that these promoters/directors/selling shareholders (henceforth individuals)
Do not have any disciplinary action taken against them by the SEBI. i.e. they should not have been debarred from accessing the markets. If these individuals are still serving their debarred period then the company cannot go ahead with the IPO with them as promoters/directors. But if the period of debarment is already over at the time of filing a draft offer prior to IPO then this restriction is not applicable.
If these individuals were prior to the IPO also promoters/ directors of another company that is debarred from accessing the markets then the company cannot go ahead with the IPO with them as promoters/ directors. But if the period of debarment is already over for the other company at the time of filing a draft offer prior to IPO then this restriction is not applicable.
If these individuals have been classified as wilful defaulters by any bank or financial institution or consortium then the company can not go ahead with the IPO with them as promoters/ directors. A willful defaulter is one who has not met repayment obligations like loans to these banks, financial institutions, etc.
It is necessary that none of the promoters/ directors have been categorized as a fugitive economic offender under the Fugitive Economic Offenders Act 2018.
Note on Statutory Lock-in:
It is also necessary to note that after the IPO the post-IPO paid-up capital of the promoters is subject to a one-year lock-in period. After one year at least 20% of post-IPO paid-up capital must be locked in for at least 3 years (Since the IPO). This, however, is not applicable to venture capital funds or alternative investment funds (category I or category II) or a foreign venture capital investor that has invested in the company.
If the post IPO shareholding is less than 20 percent, alternate investment funds, foreign venture capital investors, scheduled commercial banks, public financial institutions, or IRDAI registered insurance companies may contribute for the purpose of meeting the shortfall. This contribution, however, is subject to a maximum of 10% post issue paid-up capital. This 20% statutory lock-in is not applicable if the issuer does not have any identifiable promoters.
5. Other factors that SEBI considers in an IPO Verification
The SEBI may also reject the draft offer document for the IPO for any of the following reasons.
The ultimate promoters are unidentifiable;
the purpose for which the funds are being raised is vague;
The business model of the issuer is exaggerated, complex, or misleading, and the investors may be unable to assess risks associated with such business models;
There is a sudden spurt in business before the filing of the draft offer document and replies to the clarification sought are not satisfactory; or
Outstanding litigation that is so major that the issuer’s survival is dependent on the outcome of the pending litigation.
In this article, we discussed the Eligibility Criteria for an IPO in India. After going through the requirements one would realize that these requirements hover around the financial and litigations faced by the company its directors and promoters. These requirements are put in place to ensure quality companies are offered to investors.
These requirements also go a step further to protect investors by ensuring that the company and the people managing it are credible. These restrictions filter out financially weak companies and companies that are run by those that have the potential of swindling investors of their money. Most importantly the restrictions play an important role in ensuring the quality of the Indian stock markets.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding the basics of Commodity Trading in India: Commodity trading had been around in India for hundreds of years. But as history took its course we were victims of invasions, government policies, and their amendments made commodity trading a rarity even though it was flourishing in other countries.
Today with favorable laws being implemented commodity trading is once again being accepted even in rural India. And with the strengthening of our stock markets commodity trading has regained its impotence. Today we try and understand what commodity trading is and the different means through which they can be accessed.
What is a commodity?
Commodities in simple terms are raw materials or agricultural products that can be bought and sold. These are basic goods in commerce used as building blocks of the global economy. One very important characteristic of a commodity is that its quality may differ slightly but is essentially uniform across producers. These commodities are asset classes just like bonds and apart from being exchanged for money in real life they are also traded on dedicated exchanges throughout the world.
Classification of Commodities.
Commodities are classified into 4 broad categories.
Agricultural – Corn, beans, rice, wheat, cotton, etc.
Energy – Crude Oil, Coal, and other fossil fuels
Metals – Silver, Gold, Platinum, Copper.
Livestock and Meat – Eggs, Pork Cattle.
Going through the examples above the characteristics of commodities being uniform becomes clearer. The market treats all goods of the same type as equals regardless of who produced them as long as they meet certain quality requirements. This characteristic is known as fungibility regardless of who mined, farmed or produced.
Take the example of cold drinks. The demand for a Coke differs from that for Pepsi. This is because the brand too comes into play. Even if one of them loses their quality it still may be favored due to brand loyalty. Let us compare this with a commodity. Never would you have heard that “ the crude oil this year sourced from the US is bad unlike that from Saudi Arabia the previous year”. Despite them having some differentiating properties. Karl Marx describes it best:
What is commodity trading?
Now that we have gone through what commodities are let us have a look at how commodity trading comes into the picture.
1. Commodity trading by buyers and sellers
Commodity trading came into play as a means to protect the buyers and producers from price volatility that takes place. Take a farmer for eg. Inorder to protect himself from future price fluctuations what a farmer can do is enter into a futures contract. A futures contract is a legal agreement to buy or sell a commodity at a predetermined price at a specified time in the future. The buyer of the futures contract has the obligation to buy and receive the underlying commodity when the contract expires. The seller here takes on the obligation to provide and deliver the underlying commodity at the contract expiration date.
This instrument is useful to farmers as he already knows the production cost of his soft commodity is going to take. Adding the required percentage of profit he can enter into the future contract with the buyer i.e. regardless of what the price in the market 6 months hence he will sell his commodity at Rs.50/kg. The buyer in this contract agrees to buy the commodity at Rs. 50/kg. regardless of the price 6 months hence. The farmer protects himself from losses of price falls but in return also forgoes the additional profit he may make from an increase in price in exchange for guaranteed cash flow.
Such future contracts are available for all categories of commodities. These contracts are also widely used in the airline sector when it comes to fuel. This is done in order to avoid market volatility of crude oil and gasoline.
2. Commodity Speculators
Another type of commodity trader is the speculator. The speculator enters the future contract but never intends to make or take delivery of the actual commodity when the futures contract expires. These investors participate in order to profit from the volatile price movements. Investors here close out their positions before the contract is due in order to avoid making or taking actual delivery of the commodity.
These investors enter into the future contracts generally to diversify their portfolio beyond traditional securities and hedge against inflation. This is because the prices of stocks generally move in the opposite direction o commodities.
In times of inflation the prices of commodities increases. This is because the demand for goods and services increases due to investors flocking to invest in commodities for protection. With the increase in demand, the price of goods and services rises as commodities are what is used to produce these goods and services, their price rises too. This makes commodities a good asset for hedging. Over the years this has also led to various assets traded in the financial markets. These include currencies and stock market indices.
Speculative Trading in Commodities for profit
It goes without saying that commodities are extremely risky because of the uncertainties associated with it. One cannot predict weather patterns, natural calamities disasters, epidemics that may occur. But then why do speculative investors still indulge in commodities if not for hedging and diversification? This is because of the huge potential for profits. Due to the high levels of leverage that exists in a future contract small price movements can result in large returns or losses.
In order to reduce this risk, most futures contracts also provide ‘options’. In the case of options, one has the right to follow through on the transaction when the contract expires. Unlike a future where you are obligated. Hence if the price does not move in the direction that you predicted you would have limited your loss to the cost of the option you have purchased. To understand better we can look at options as placing a deposit on a purchase instead of outrightly purchasing. In case things go sideways the maximum you stand to lose is your deposit.
Commodity trading in India
Commodities just like other asset classes are bought and sold on an exchange. These exchanges are called commodity exchanges and they tend to be specialized for such securities.
The commodity exchanges present in India are:
Multi Commodity Exchange – MCX
National Commodity and Derivatives Exchange – NCDEX
National Multi Commodity Exchange – NMCE
Indian Commodity Exchange – ICEX
Ace Derivatives Exchange – ACE
The Universal Commodity Exchange – UCX
The trading of commodities in the commodity market is regulated by SEBI and facilitated by MCX. The MCX provides a platform for trading in stocks. More than 100 commodities are traded in the Indian Commodity futures markets. Some of the top traded commodities are Gold, Crude oil, Copper cathode, Silver, Zinc, Nickel, Natural Gas, and Farm Commodities.
Other Commodity investment options for individual investors.
Using futures and options to invest in commodities is often challenging for amateur investors. They may prove to be extremely risky for investors who do not have a background or understand how prices or commodities will likely move in the future. Hence investors can also opt for indirect exposure when it comes to commodities in the following ways.
1. Stocks
Investors interested in entering the market for a particular commodity can do so by investing in stocks related to that commodity. For eg. If one is looking to use gold in order to hedge, diversify or make a profit he can go ahead and invest in the stock of a jewelry company, mining company, or any firm that deals in bullion. The advantage that a new investor receives here is that of public information related to the company which will help him make decisions and predictions. The disadvantage that comes along with investing in commodities is that the price of the stock is not purely based on the commodity but is also influences by company-related matters.
2. ETF’s and ETN’s
Investors can make use of ETF’s and ETN’s in order to take advantage of the price fluctuations. Using futures contracts, commodity ETFs track the price of a particular commodity or group of commodities that comprise an index. The price of these indexes is tracked by these ETF’s. In order to simulate the fluctuations in price or commodity index supported by the issuer, ETN’s are dedicated. ETN’s are unsecured debts designed to mimic the price fluctuations of the commodity.
3. Mutual and Index Funds
Mutual funds at times invest directly in commodity-related industries like Energy, Food processing, metals, and mining giving exposure to the portfolio. There also exists a small number of commodity index mutual funds that invest in futures contracts and commodity-linked derivative instruments providing investors with greater exposure to commodity prices.
4. Physical investment in commodities.
Another method through which investors receive exposure to commodities is by investing directly in them i.e. by purchasing physical raw commodities. This is more common with metals as other commodities require a purchase in huge quantities to have any useful impact. We often see people buy gold in times of crisis. This may be done through the purchase of gold biscuits.
Closing Thoughts
Commodity trading provides investors with a vast number of benefits. These benefits range from the increased potential of returns, diversification, and a potential hedge against inflation.
But there also exist a number of disadvantages that mainly revolve around the volatile and speculative nature of the security. The increased opportunities in these markets come with increased risks.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding what are bonus shares: Everyone loves a bonus. This may be at work or also on simple shopping purchases. These bonuses also exist in the stock market under Bonus Shares. But does a bonus share issue in the stock resembles the same ones we experience in our day do day lives?
Today we take a closer look at understanding a Bonus Shares issue. Here, we’ll look into what are bonus shares, why are they issued, their pros, cons, and more. Let’s get started.
What are Bonus Shares?
Bonus shares, also known as scrip dividends are additional shares given to shareholders without any extra cost. These shares are issued to the shareholders based on a constant ratio that decides how many shares a shareholder is to receive based on the number of shares already held by him.
These shares, however, are issued from the company’s accumulated earnings. Hence these bonus shares are issued only by companies that have accumulated retained earnings or large free reserves. As bonus shares are issued from the profits (retained earnings or reserves) it is also called capitalization of profits.
Here are a few of the recent bonus shares offered by different public companies in India:
Here are some of the reasons why a company may opt to issue shares.
Bonus shares are issued by the company when the company has performed well but has not generated enough cash that they pay out dividends. This ensures that investors who depend on dividends for income will still be able to earn from the sale of the bonus shares in the market. On the other hand, it also pleases investors who are not looking for dividend payouts.
Bonus shares also issued to encourage retail participation. At times the price per share of the company becomes so high that it becomes difficult for investors to easily sell them or to buy them in the market. By issuing bonus shares take care of this as the total worth of the shares remains the same but the price per share reduces allowing them to be easily traded on an exchange.
Another reason why a bonus share may be issued is when a company is looking to restructure its reserves.
How are bonus shares calculated?
Let us take the example of company ‘A’. Say the company announces a bonus in the ratio of 2:3. Here for every three shares held by the shareholder he receives two additional shares.
The price in the above case also gets adjusted. If the shares are at a book value of Rs. 50 per share. Post the bonus issue the value would drop to Rs. 30. This would not change the total book value of the shares held by the shareholder if he held 3 shares valued at Rs. 150 prior to the issue he would be left with 5 shares post the bonus with a book value of Rs.150.
Similarly, the stock price too is adjusted on a proportionate basis. This also answers the question that “Does a Bonus share issue increase the net worth of your holdings?”. The answer is “No”.
What is the record and Ex-date in a bonus issue?
Shares are traded on a regular basis, this would make it hard for the company to decide which investor is eligible to receive the shares.
This is also because the delivery after the purchase of the shares into the Demat account happens on a T+2 days basis( 2 days after the shares are purchased). In order to avoid confusion, an Exdate and record date is used. An Ex-date is used to decide who receives the shares.
The record date is the cut-off date set by the company. The Ex-date is always one day before the record date. You are eligible for the bonus shares if you purchase the shares one day prior to the Ex-date. If you want to sell the shares but are holding onto them you need to hang onto the shares until the ex-date.
What are the advantages and disadvantages of a Bonus Issue?
Advantages of Bonus Shares
– Bonus shares increase the liquidity of the shares which makes it easier for the shareholders to sell and buy.
– The issue of Bonus shares creates the perception that its size has increased. This due to the increase in share capital due to the transfer from reserves and due to increase in shares outstanding after the bonus issue in accordance with the ratio set.
Disadvantages of Bonus Shares
– Investors who depend on dividends from the company may have to sell their shares to ensure liquidity. This, in turn, may reduce their stake in the company in comparison to those who hold onto their shares. This reduction in stake may be viewed unfavorably.
– Bonus shares require the transfer of reserves to share capital. This may upset some shareholders as these reserves could have been paid as a dividend in later years resulting in increased dividends.
Are there any tax implications for the bonus issue?
One may be under the impression that as the bonus shares are issued out of reserves that are used to pay dividends they too may be subject to taxes. This is not the case on receipt of bonus shares.
The shareholder is not required to pay any dividend if he receives bonus shares. However, he is subject to capital gain tax if and when he chooses to sell the bonus shares received.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
A Beginner’s Guide on How to Trade Commodities in India: In olden times, commodities like grains, cotton, oil, cattle, etc were heavily traded among the people and communities to meet their requirements. You might have seen movies of people carrying goods on the top of Camels to trade with others. Not much has still changed even in the 21st century. Even now, people and countries trade these items. And these days, anyone can trade in commodities to make substantial profits, apart from trading in traditional stocks and other derivatives instruments.
In this article, we are going to discuss the step-by-step process of how to trade commodities in India. Here, we’ll first cover the basics like what is a commodity, who are commodity buyers and sellers, the types of commodities traded in India, etc. Later, we’ll get into the technicalities like margin required and how exactly to trade in commodities in India. Let’s get started.
What is a Commodity?
In simplest words, a commodity is any raw material that has a physical form and which can be bought or sold and are interchangeable in nature with another similar commodity. Some of the traditional examples of commodities include Grains, Wheat, corn, soybeans, or other foodstuffs, Cattle or other stock animals, Cotton, oil, gold, etc.
Investing/trading in commodities is a good way to diversify your portfolio with assets other than stocks, gold, etc. Investors or Traders can buy commodity directly in the spot (cash) market or via derivatives market by trading in Futures and Options.
Types of Commodity traders
There are generally two types of commodity traders – Hedgers and Speculators.
— Hedgers are buyers or producers of commodities that use commodities futures contracts for hedging purposes. These traders take the delivery position of the original commodity when the futures contract expires.
— The second types of trader are the Speculators who enter the market for the sole purpose of profiting from the price movement or volatility of commodity futures contract.
Commodity trading exchanges in India
In India, the commodities are traded via five exchanges. Traders are allowed to trade commodity derivative contracts from any of the following exchanges:
National Stock Exchange of India Limited (NSE)
Bombay Stock Exchange (BSE)
Multi Commodity Exchange of India Limited (MCX)
National Commodity and Derivatives Exchange Limited (NCDEX)
Indian Commodity Exchange Limited (ICX).
An interesting point to mention here is is that NSE and BSE launched trading in commodities only in 2018. Further, the commodities market is regulated by SEBI. (Earlier it was regulated by Forwards Markets Commission (FMC), which was later merged with the SEBI in 2015). All the commodities in India are traded via the online portals.
Margin required to trade Commodity in India
Commodities are products that require higher-margin, compared to any other product like equity futures or options. Different products under the preview of a commodity require a different amount of margins.
Here is a list of the most actively traded commodity along with the margin required for Normal (or delivery) mode and MIS (Margin Intraday Square off) mode.
Pic: Intraday and Normal margin for various commodities (source: www.zerodha.com)
If we were to carefully look at the picture above, for different commodities the margin varies with the change in the price of the commodity futures contract. The images above clearly give information about the Normal margin, the Intraday margin, and the price levels for which the margins are calculated.
List of commodities traded in India
The commodity sector in India has been divided into five sectors namely – Agriculture, Metals and Materials, Precious metals and materials, Energy and, Services. These sectors are again classified and divided into various constituents.
(Image: List of various commodity sectors and its constituents (source: www.indiainfoline.com))
Tips before Entering the Commodity Trading
Here are a few factors to be kept in mind before deciding to enter the commodity trading:
Commodity trading is one the fastest growing product, for trading in India.
Although risky by nature, but if done with careful analysis and complete understanding, commodity trading adds the required pinch of diversification to the portfolio.
The margin required to trade commodities is slightly on the higher side.
The amount of margin required to trade the commodity keeps on changing depending upon changes in the price of futures contact of those commodities.
How to Trade Commodities in India? Step-by-Step Explanation
By now, you would have understood what commodity trading is, its various nuances, the margin requirements, the various players in commodity trading, and the different products. Let us now try and understand as to how does one start commodity trading in India.
For the sake of explanation, we have used Zerodha’s web (as they are the discount brokers with the highest customer base), to explain the steps.
Step 1: You need to have a trading account with one of the brokers that allow commodity trading (for example, Zerodha, Angel broking, 5Paisa, etc.). If you don’t have one, here’s an article on the best discount brokers in India, so that you can pick the one that suits you the best.
After opening the trading account, a separate form has to be filled, which activates the commodity trading along with equity trading in the same account. The margin account for equity trading and Commodity trading is different. The margin of Equity cannot be used for Commodity trading and vice-versa.
Step 2: We need to have a sufficient margin balance in our commodity trading account. Margin is the minimum amount of money required to trade. The amount of margin required varies from a Normal trade to a MIS (Margin Intraday Square off) trade.
The main difference between these two is that in case of Normal trade, the position can be carried over to the next day. However, in case of a MIS trade, the position will automatically get squared off before the end of the day.
The amount of margin required is the least for the Covered order. The covered order is that order for which the stop loss is pre-decided. And, hence the margin is least.
Now, if we carefully look at all the images above, the first image shows the amount margin required for Crude oil October futures contract in Intraday MIS mode (Margin = Rs. 2,00,410). The second image shows the margin required when we trade NRML (Normal) contract (Margin = Rs. 4,00,882). And the third image shows the amount of margin required for a covered order (Margin = Rs. 88,026).
Step 3: The next important step that we need to consider, is to select the commodities, which we wish to trade. And upon selecting the commodities, it is advised to have all the commodities for various expiries pinned to the watch list.
(Image: Watch list of the commodities (source: www.zerodha.com))
Step 4:After Shortlisting the commodities to be traded, the next step is to place the order. After selecting the contract, we just need to punch in the trade on the ticket.
Now, we have two ways to take the trade – Limit order & Market order. If we place the market then we end up buying or selling at the existing market price. But if we place a limit order then we can choose the price at which we want to place the order.
Step 5: The next step while trading options is to check in the order book if the order has been placed. We can do that by simply clicking on the orders tab, and we can see the list of all the order which have been placed or canceled or executed.
Step 6: The last, but the most important step is the continuous monitoring of the positions. We should always be on the constant lookout for opportunities to trade and always have a stop loss for the existing trade.
Conclusion
In this article, we discussed the step-by-step procedure on how to trade Commodities in India. Here are a few key takeaways from this post:
Commodity trading is done by both hedgers and speculators.
It is one of the most common form of portfolio diversification method used by investors or traders.
The amount of margin required to trade is slightly on the higher side, so the trades must be entered after doing a careful analysis of the technical and fundamental picture.
We can do both Intraday (MIS) trading and NRML (delivery based trading) while trading commodities.
It is always advised to have proper risk management (stop loss and target) for all the trades
That’s all for this post on how to trade Commodities in India for beginners. I hope it was useful to you. If you still have any queries to related to this topic, feel free to comment below. I’ll be happy to help. Happy Trading and Money Making!!
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
Understanding what are Black Swan Events in Stock Market: European explorers would have been more than taken aback when they first encountered the first black swan in the 17th century during their conquest in Australia. After all, if you’re habituated on seeing white swans all your life and suddenly a swan of black colour appears, you might also be astonished.
Anyways, this concept of seeing something rare and totally different is not only limited to swans or birds. The black swan we are discussing today in the world of investing holds the similar astonishing features of a real black swan. In this article, we’ll discuss what are black swan events in the stock market, examples of a few past black swan events and how can you handle black swan events while investing. Let’s get started.
What are Black Swan Events?
A Black Swan in finance is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. This theory is basically a metaphor that describes an event that comes as a surprise, but can have a major effect.
The theory was put forward by former Wall Street trader, Nassim Nicholas Taleb in 2001 which was later popularized through his book ‘Black Swan’, which came out a year before the crash of 2009. The theory illustrates the limitations of learning from our observations and experience just as when a black swan was discovered in Australia.
One may have seen millions of white swans throughout his life but it would take only one black swan to shatter his belief that all swans are white. Today we take a closer look in order to understand black swans in the finance world and how we can prepare for them.
What makes an event a Black Swan?
There are no limitations to ways in which a Black Swan event can manifest itself. The causes of black swan may be a natural disaster, wars, or even an outbreak of a virus. These events do not always have to have sudden consequences but instead can be slow like the fall of the Roman Empire. Taleb identifies three common characteristics between all Black Swans
They are so rare that the possibility that they might occur is unknown.
They have a catastrophic impact
When it does occur and when it is explained in hindsight the event actually seems predictable.
The effects of black swan events are magnified and tend to be catastrophic primarily because they confound our expectations that a universe is an orderly place.
A Few Different Black Swan Events in Stock Market in Past
The stock market has experienced multiple black swan events in the past. Here are some of the most infamous Black Swans in the recent past.
1. Harshad Mehta Scam
The Harshad Mehta Scam, when exposed, had staggering effects on the Indian economy that had just opened up to the world. The scam amounted to Rs. 4025 crores which today would amount to Rs. 24000 crores. The scam resulted in the BSE Sensex falling by almost 45%. It took almost 18 months to recover post this. You can read more about Harshad Mehta Scam here!
2. 2008 Recession
This recession was one of the biggest since the great depression. It is estimated that over $10 trillion was wiped out in the global equity markets. The financial crisis of 2008 is one of the most recent Black Swan events, caused due to the US mortgage and credit crisis. It also caused the largest bankruptcy in Lehman Brothers. In hindsight, many rightly say that it was bound to happen and a few outliers even predicted it.
3. The 9/11 Attacks
The Attacks on the twin towers of New York World Trade Centre too is a Black Swan. The attacks led to the closure of the NYSE and NASDAQ. Estimates state that up to 1.4 trillion was lost within a week. The airline industry was the worst impacted due to the attack.
Quick Note: The event of Crude Oil Prices diving into negative in April 2020 that broke into the news for its extraordinarily inconceivable negative price dump, was also an example of Black Swan events. You can read more about this event here.
Is the COVID-19 Pandemic a Black Swan Event?
The pandemic has been argued to be a black swan event by many sources. But the classification would also depend on the region.
For a country like China, the virus is most definitely a black swan as they were caught by surprise when the virus first broke out in December. Other countries like India, however, could have seen it coming as they were adversely affected only months later.
In an interview with Bloomberg last weekNassim Nicholas Taleb said, “It was not a black swan. It was a white swan. I’m so irritated people would say it is a black swan,” while referring to coronavirus. “There is no excuse for companies and corporations not to be prepared for that. And there’s definitely no excuse for governments not to be prepared for something like this,” Taleb added.
How can Investors handle a black swan event?
We regularly come across predictions given by the so-called finance gurus on television etc. The very first step would be to ignore these so-called predictions and forecasts. Taleb criticizes prediction that may even extend up to 30 years bu what we don’t realize is that we cannot even predict the next summer because our cumulative prediction errors for political and economical events are so monstrous.
– Steps Prior to the Black Swant Event
1. Diversifying Investments
Regardless of whether the market is undergoing a bull or bear run, it is best to also follow the basics of investing and diversify. Investors who only invest in equities face tremendous value damage. But instead, if his investments are spread across equities, liquid assets, and gold then the damages will be lower. This will help an investor survive the Black Swan.
However, there are investors who strive during a black swan. It is also important to note that if a person invests solely with the fear that a black swan event may occur at any given moment his returns would severely be impacted. What we could do is hedge our portfolios by means of diversification so that they perform in a bullish run and reduce losses when a black swan hits. For this investors have a look for assets that are likely to underperform during the bull run but provide returns when the market crashes and then include them in your portfolio.
One example would be the Universa Investments fund run by Taleb and Mark Spitznagel. This fund has benefitted hugely during the coronavirus. Its returns for 10 years prior to the pandemic were low or loss-making. During the pandemic, however, the fund had risen by 3600%. Despite the losses made the fund is still up 200%. One report also shows that if an investor had only invested 3.3% of his portfolio in the Universa fund and the remaining in the S&P500 tracker fund, the investor would still see returns of 0.4% in March despite the benchmark index falling 12%.
– Steps to take during a black swan event
2. Staggering Investments
While investing during an ongoing black swan event it is best that the investors stagger their investments over a period of time instead of investing lump sums in one go. This is because the duration of a black swan event is difficult to predict. Staggered investments will provide investors the opportunity to take advantage of falling prices during bearish trends.
3. Take Shelter in Safer Investment Options like Gold
Gold is considered a safe-haven when a black hawk event occurs. It is best to diversify investments beforehand into gold. During the Arab oil embargo between 1971 and 1979, when the world was rocked, the prices of gold skyrocketed 2400%. The increase in gold prices during black swan events has repeated time and again for eg. 9/11, the 2008 crisis, and again during COVID-19.
4. Only look for companies that are already financially sound instead of ideas
Prior to black swans when the market is doing good even companies with weak financials but great innovative ideas are able to raise funds and strive. But after a crash, these companies find it hard to even survive. Hence during a black swan, it is best to invest in financially sound companies that are cash-rich, have good ROCE, low debt, and good management.
Closing Thoughts
Black Swans are generally considered to result in negative connotations but the result generally depends on the perspective of the individual. Take the example of John Paulson during the 2008 crisis or George Soros in 1992.
Predicting a black swan can be next to impossible as there are just too many events that can happen at any given time and their prediction in the past took a lot of skill and luck. However, what we can control is making our portfolios as Black Swan Proof as possible.
That’s all for this article on Black Swan Events in stock market. I hope it was useful to you. If you have any queries related to black swan events, feel free to comment below. I’ll be happy to help. Take care and happy investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
A Definite Guide to starting Intraday Trading for Beginners in India: If you want to make a livelihood from the stock market, the most popular approach is day trading or Intraday trading. Unlike investing, where you have to wait months and years to book the profits, here gains can be made within hours and sometimes even within minutes. Moreover, with the advancement of the internet and technology, day trading can be learned and started even from your phone and that too comfortably sitting on your sofa at home.
In this article, we’ll cover the step-by-step procedure to start Intraday trading for beginners in India. Here, we’ll also discuss what is intraday trading, who are intraday traders, thumb rules for day trading, and more. Let’s get started.
What is Intraday Trading?
As the name would suggest, Intraday trading is a type of trading where both the buying and selling activity in a stock (or an asset) is completed the same day i.e. in the same trading session.
Here, the trading is not done with the objective of holding or carrying a position over the next day or weeks. The main objective while intraday trading is to earn quick profits and exit your position as soon as possible. Further, the holding time for assets can vary between a few minutes to some hours.
In addition, generally, Intraday trading is done for high beta stocks i.e., the stocks that have high fluctuations in their prices on day to day basis. If the prices do not move at all in the entire day, there won’t be any opportunity for the intraday traders to make money from that stock.
— Who are Intraday Traders?
There is a proven theory on the market- “The more time you spend in the market, the more rewarding it is”. Intraday trading is generally done by traders who are very active participants in the market i.e., they have an eye on the market in every passing second.
One thing which one must keep in mind while doing intraday trading is that one should not become too greedy while taking intraday trades. If we have strict profit targets and stop-loss levels, then it goes a long way in selecting the right trades for intraday trading. Stop-loss is an advance order to sell the shares if the share price reaches a particular price point. Therefore, it helps to automate the selling process in different market scenarios.
For example, suppose I am doing intraday trading for shares of Reliance Industries Limited (RIL). The current price per share is Rs. 2200. Therefore, if I buy one share at CMP and have a target price of 2225 and stop-loss at 2185, then by rule we should stick to those levels and not increase our profit targets or trail our stop losses, as the market starts to move.
— Some Thumb Rules in Intraday Trading for Beginners
Here are some of the best rules that beginners must follow while doing Intraday trading to maximize profits and limit the losses:
Always chose liquid stocks for intraday trading that can easily be entered or exited.
Have entry and exit points in mind before entering the trade.
Always have a stop loss for trades, as the position might drift away and huge losses might be incurred.
It’s important to have a trading mentality and not the mentality of the investor while doing Intraday trading.
One should be willing to take multiple trades in the same companies or indices as the market might provide multiple trading opportunities.
Always take trades in the direction of the market. Remember “Trend is your friend.”
Mean reversion trades are generally not a good strategy for intraday trading.
— What products can be traded intraday?
You can do intraday trading in almost all stocks that are trading in the stock exchanges. You can also trade in Indices.
Further, Intraday trading is done not only in the cash segment but even in the derivatives segment (Futures and Options). Derivate segments are big contributors to the intraday trading market. And the margin required to trade Intraday futures contract is comparatively lesser than that of delivery contracts.
If we look at the images above, then we see that in the window with the order type selected as MIS Intraday, the amount of margin required is 1/5th of the amount of margin required to trade in overnight (NRML) mode.
How to do Intraday Trading for Beginners In India?
Having understood the basic premise of Intraday trading and its elementary characteristics, the next important point of consideration is how does one go about doing intraday trading in India. Following is a step by step procedure which should explain the complete procedure. For the sake of explanation, we have used Zerodha’s kite trading platform to explain the steps as they are the discount brokers with the highest customer base.
Step 1: You need to have a trading account with one of the brokers (For example, Zerodha, Angel broking, 5Paisa, etc.). If you don’t have one, here’s an article on the best discount brokers in India, so that you can pick the one that suits you the best. Anyways, the steps required for Intrady trading are almost the same for any othe broker that you choose.
Step 2: You need to have a sufficient margin balance in your trading account. Margin is the minimum amount of money required to trade. The amount of margin required varies from a regular trade to a MIS (Margin Intraday Square off). The main difference between these two is that, in case of regular trade, the position can be carried over to the next day but in case of a MIS trade, the position will automatically get squared off before the end of the day.
The Margin allowed to trade for MIS trades varies anywhere between 4x to 20x depending on the nature of the stock and its expected volatility. Therefore, Margin trading gives us the power of leveraging.
Step 3:The next important step which we need to consider is to select the share/asset we wish to intraday trade for that particular day and add those shares to one separate watch list. This step is of prime importance because it is practically not possible to keep an eye on all the shares listed on NSE and BSE.
However, having a watch list of the selected stocks gives us an opportunity to moderate and buy the stocks and take maximum advantage of all the intra-day trading opportunities.
Therefore, if we carefully look at the image above, it can be seen that it becomes very easy to keep a watch on the selected shares if we make a separate watch list of all the shares that we wish to intraday trade.
Step 4: The next step in this process is to select the share in which you wish to trade. And after selecting the share, we just need to punch in the trade on the ticket.
Now, we have two ways to take the trade – Limit order & Market order. If we place the market then we end up buying or selling at the existing market price. On the other hand, if we place a limit order then we can choose the price at which we want to place the order.
And the next thing to choose is the kind of order i.e., either normal order or MIS order. If we choose the limit order, then the margin required is exactly the same as the current value of the stock. But if we choose MIS order, then the margin required to trade varies anything between 5% to 20% of the current stock price.
Now, if we carefully look at the image above, we see that in the window we have chosen the MIS Intraday option and hence the margin required to trade 7 shares of Marico is comparatively lesser than the actual trading price of one share.
Step 5: The next step while trading options is to check in the order book if the order has been placed. We can do that by simply clicking on the orders tab and we can see the list of all the order which have been placed or canceled or executed.
Step 6: The last, but the most important step in Intraday trading is the continuous monitoring of the positions. We should always be on the constant lookout for opportunities to trade and always have a stop loss for the existing trade. If we follow these rules, then we always have a better chance of having a successful and rewarding trading career.
In this article, we discussed the exact steps to start Intraday Trading for Beginners in India. To conclude, here are a few takeaways from this post.
Intraday trading has been on a rise in India. And with the growing education about trading and investing, this trend is likely to grow at a faster pace in the future.
While trading Intraday, buying and selling of the stocks should be completed within the same day.
Intraday trading could be done for both cash stocks and in the derivatives market also.
It is always advised to have proper risk management (stop loss and target) for all the trades
And for a long and rewarding career, it is always advised to have a proper trading rules and discipline.
That’s all for this post on how to do Intraday trading for beginners. If you still have any queries related to this article, feel free to comment below. I’ll be happy to help. Take care and happy trading.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
Understanding what are Preferred Stocks and why are they beneficial: The dream security for many would be one that provides you both the inherent security found in bonds and returns of an equity stock at the same time. Luckily enough for us, such financial instruments exist and not only provide security but also steady returns in the form of dividends. This flexible security is known as a Preferred Stock or a Preference Share.
Today, we are going to discuss what are preferred bonds. Here, we’ll cover their meaning and also clear out what these bond and equity hybrids are in order to better understand and decide if they can actually be preferred over their parents
What are Preferred Stock/Preference Shares?
Many of us do not know that there are two types of stocks. The first being the common stock which we are accustomed to. The second being preference shares.
Preference Shares or Preferred Stocks offer investors preferential right over common stock when it comes to earnings and asset distribution. However, in exchange for these preferential rights, preference shares do not possess the voting rights in a company that the common stock holds.
What are the benefits of Preferred Stocks?
The investors benefit in the following ways when it comes to preference shares
1. Fixed Income
This means when dividends are announced, the payments will first have to be made to preference shareholders and only then to common shareholders. The dividend rates of preference shares are fixed at a predetermined rate or some other floating factor depending on the terms of the issue.
The decision on when dividends have to be paid is at the discretion of the board. This is because the Preference shareholders do not possess and voting rights in order to influence the board members or decisions.
2. Security in the case of winding up
Also in the case of winding up of a company, it is the preference shareholders who have priority in claiming the company assets. Only after the obligations to Preference shareholders are fulfilled will the obligations to common stock begin.
It is because of the above reasons that the Preference shares are known to be a hybrid. Just like bonds they offer regular returns with no voting rights. But like equity, the shares are allowed the trade and have the potential to appreciate in price.
Hierarchy of Bonds, Preference shares, and Equity shareholders
— In terms of Returns
It is the interest on bonds that are first serviced from the profits made by the company. Only then will the preference shareholders be paid the dividends due to them. In a case where the profits made are not sufficient then the preference shareholders and common shareholders can be left out. This is because unlike for bonds if the company does not pay preference shareholders it does not mean that the company is in default.
The bonds here are treated as debt whereas preference shares are not. In a scenario where there are sufficient returns first the interest on bonds is paid. Next, the preference shareholders are paid based on the rates set. Lastly, the remaining amount is paid to the equity shareholders. Only then is the remainder paid to the common shareholders. The dividends to preferential shareholders are preferred but not guaranteed.
Unlike bonds and preference share, there is no rate set to equity. This means that there is no upper limit nor lower limit to the dividends they receive. In exchange for preferential treatment, the preference shareholders will never receive dividends in excess of the rates prescribed to them.
Despite this common stock are greater wealth creators in comparison to preferred stock and bonds. This is because there is no limit on the increase in the stock price. When it comes to Preference shares the price generally looms around the face value.
— In terms of Claim over Assets
In the case of winding up, it is the bondholders who are first paid off followed by the preference shareholders and then the common stockholders.
— In terms of Risk
Preferred stocks are less riskier in comparison to equity. But when compared to bonds preference shareholders are considered to be riskier. This is because they fall back when it comes to being compared over the claim of assets and fixed interest rates that bonds have.
Equity shareholders are the riskiest here as they get leftovers of the bondholders and preference shareholders in the case of winding up. In a case, where the company is performing poorly, the share prices of common stock are also adversely affected.
Types of Preferred stock
There are various types of preferred stock. The following are the most commonly used
1. Cumulative Preference Shares
Say a company is in a bad shape and is forced to suspend dividends for the year. Here if the shares are Cumulative Preference shares, they are still entitled to receive the dividend for the year. Such a missed dividend payment will be added to the dividend payments of the following years and paid to the cumulative preference shareholders.
Eg. Company ABC has issued Cumulative Preference shares. ABC has issued 3000 10% cumulative preference shares at Rs.100 face value. Here the dividends payments ABC is obliged to make is Rs 30,000. But due to COVID-19, the ABC can only pay Rs. 10,000 of the dividend in 2020. Here the Rs. 20,000 is carried forward as arrears and paid the next year. Hence ABC will have to make a total dividend payment of Rs. 50,000 in 2021. Amount arising from Rs. 20,000 carried forward and Rs. 30,000 accruing in 2021.
2. Convertible Preference Shares
These preference shares can be exchanged for a predetermined number of common shares. Convertible Preference Shares can be converted only when the Board of Directors decides to convert them.
3. Callable preference Shares
Callable preference shares can be called back similar to bonds. In a call, the shares issued are bought back by the company by paying its holders the par value and at times a premium. This is done by the company in situations when the interest rates in the market fall. In such a situation the company realizes that it does not have to keep servicing the preference shares at the high rates it was issued a few years ago. The company simply calls back the shares and then reissues it at lower rates.
4. Perpetual Preferred Stock
Here there is no fixed date on which the investors will receive back the capital. Here shares are issued in perpetuity.
The types of preference shares mentioned above are common examples. The company, however, may combine one variant with the other and issue a preference share eg. Convertible Cumulative Preference Shares. If there are multiple issues of preference shares the shares may be ranked by priority.
In preference shares, the highest-ranking is called prior, followed by preference, 2nd preference, etc. The dividends and final settlements will be made in the order of this ranking.
Where are these Preference Shares available?
Preference shares are traded on the same exchanges like that of common stock. However, their issues are rare as companies do not generally go for preferred stock making their market small and their liquidity limited. The price of preference shares on these exchanges are determined by a variety of factors like dividend rate, the creditworthiness of a company, type of preference share eg, cumulative, convertible, etc.
The share prices of Preference shares like bonds have an inverse relationship with interest rates.
Apart from looking at the type of preference share and the interest offered, it is also important necessary to figure out why the company issuing Preference Shares?
It is a known fact that companies issue preference shares in order to avoid dilution of capital. But it is also noticed that companies issue preference shares when they have trouble accessing other means of capital. This may be because banks are refusing loans due to their low creditworthiness. Raising money through Preference Shares is cheaper as it gives the option to the company to only serve them when they are able to, unlike other debt instruments.
Another reason may also be that preference shares do not reduce the creditworthiness of a company, unlike debt that is added to the balance sheet. The company can issue preference shares that act like debt but are shown as equities in the balance sheet. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Introduction to Socially Responsible Investing (SRI): Deciding how you want to invest your money is often hard. You need to take many factors into consideration such as risk, returns, taxes, and inflation. It takes a lot of forethought and groundwork to figure out a way to get the best return on your investments.
Yet, there are some investors who choose to invest in companies that are not only financially stable but also make a positive impact on the environment. Here, we are talking about Sustainable or ethical investors, who in the investing world are also known as Socially responsible investors.
Today, we are going to discuss what is Socially responsible investing or SRI, why it is important, and finally, how to become a Socially Responsible investor. Let’s get started.
What is Socially Responsible Investing?
Socially Responsible Investing or SRI is choosing to invest in stocks that provide a financial gain as well as do social good. Here, investors tend to look into the ethical factor along with the fundamentals of a company become investing.
In SRI, the companies are evaluated based on the ESG index: environment, social justice, and corporate governance.
SRI helps in creating a big impact on the world along with making good returns. Although the socially-responsible investing concept is still up and coming in India, it is expected to gain greater momentum in the next few years. Companies have become more aware of the ESG factors and are looking to incorporate more of it into their business practices.
Socially Responsible Investing History
Socially responsible investing began in the early 1700s when the Quakers refused to participate in the slave trade in the U.S. Pastor John Wesley, the leader of the Methodist church claimed it was a sin to make a profit at the cost of your neighbor’s well-being. He stated that it was unethical to gamble and invest in industries that used toxic chemicals.
For many decades after John Wesley’s speech, investors avoided industries such as tobacco and liquor referring to them as ‘sin industries’. This evolved in the 1960s when investors decided to invest their money in companies that promoted social causes such as women’s rights and civil liberty.
Socially responsible investing played a huge role in South Africa during the 1980s when investors began pulling out their money due to the apartheid or the segregation of races. SRI had a prominent role in helping bring an end to the apartheid in 1994.
Sustainability Indexes
If you look into the American and European nations, they already a family of indices evaluating the sustainability performance of thousands of companies trading publicly. The Dow Jones Sustainability Indices (DJSI) launched in 1999, are the longest-running global sustainability benchmarks worldwide. To be incorporated in the DJSI, companies are assessed and selected based on their long-term economic, social and environmental asset management plans.
For India, S&P BSE has three main indices that measure corporate sustainability: S&P BSE 100 ESG INDEX, S&P BSE GREENEX, and S&P BSE CARBONEX. For NSE, a few of the Sustainability Indexes are the Nifty 100 ESG Index and Nifty 100 enhanced ESG index.
Nifty100 ESG Index is designed to reflect the performance of companies within the Nifty 100 index, based on Environmental, Social and Governance (ESG) scores. The weight of each constituent in the index is tilted based on ESG score assigned to the company i.e. the constituent weight is derived from its free-float market capitalization and ESG score.
Nifty100 Enhanced ESG Index is designed to reflect the performance of companies within the Nifty 100 index based on Environmental, Social and Governance (ESG) score. Companies should have a normalized ESG score of at least 50% to form part of this index. The weight of each constituent in the index is tilted based on ESG score assigned to the company, i.e. the constituent weight is derived from its free-float market capitalization and the ESG score.
How to be a Socially Responsible Investor?
Here are a few points that can help you become a socially responsible investor:
— Know the difference
The first and foremost important step to becoming a socially responsible investor is to know the difference between traditional and responsible investing. The difference might be in returns that you get from your investments. The returns from socially responsible investing may differ a little from the traditional one as you might be leaving behind a lot of high return investment options. However, always remember the reason why you have opted for this way of investing.
— Do your research
This is where investors use negative and positive screening to shortlist investment options. In the negative screening, they avoid investing in companies that don’t relate to their social values. Many mutual funds that are socially responsible screen out tobacco and liquor companies. One type of negative screening is divestment, this is where investors take their money out of certain companies because they do not like their business practices or social values.
Along with screening out negative companies, it is also important for investors to choose companies that align with their values. These are companies that strive to bring change to a social aspect that the investor finds important along with their socially responsible business practices. This is also known as impact investing or incorporation of ESG.
— Use your influence as a shareholder
Shareholders not only invest in companies that align with their values but they also use their position to influence the actions of the company in which they own stock. Investors do this by filing a shareholder resolution. This is a document outlining the shareholder’s suggestions for management on how to run the company in a more socially responsible way.
— Invest in the community
This is where an investor invests in companies that have a positive impact on the community. This is usually done in low-income areas where the investment is used to provide loans to people and small-business owners who would otherwise have trouble getting approved for a loan. Community investments also support ‘green companies’ that have a large carbon footprint on the environment.
— Lead by examples
Socially responsible investing is still in the early adoption phase. By making the right investment choices, you can make a real positive impact on the community- along with building wealth. Moreover, sooner or later, social consciousness will become the selling point for global companies. And you, being a part of it, can lead the movement.
How to get started with Socially Responsible Investing?
1. Decide what your social principles are
Before you choose your stocks you need to decide what social goals you want to promote. You should focus on your values and what you want to achieve through your investments.
2. Decide what your financial goals are
The next step is to decide what financial goals you want to achieve through your investment just as you would with any other investment. You need to decide how much return you need to meet your goals as well as how much risk you are willing to handle. SRI has been shown to provide comparable returns as a traditional stock would.
3. Choose the fund that meets your needs and goals
Once you have decided what your social and financial goals are, the next step is to find the investment that’s right for you. The most common ESG funds in India include Tata Ethical Fund, Taurus Ethical Fund, and Reliance ETF Shariah BeES.
Social investing has also resulted in the success of micro-finance. This was created by social investors to create an impact on small businesses and has now become an industry worth over $8bn and is now a mainstream financial service.
Socially Responsible investing is becoming increasingly popular in India and there has been a visible shift in the market strategy adopted by many participants as they incorporate social, economic and governance (ESG) factors into their investment process. Stakeholders realize the importance of their role in financial markets to influence sustainable growth.
According to the Indian Impact Investors council ‘more than 30 impact funds have invested in social enterprises in India’. There has been $2billion investment in over 300 companies in India.
While socially responsible investing is still not as big as traditional investing in India, it is still a rapidly growing market. Social investing in India has helped provide basic needs such as housing and education to the poor. Many investors have now realized the power and influence they have to make a positive impact on society.
Understanding the pros and cons of Investing in Foreign Stocks: Indian investors have always been known to be inward-looking. That is, they would prefer to invest in the Indian markets over foreign ones. This has been the case even though it’s been over 15 years since they were first permitted to invest in foreign equities.
One of the major reasons for this has been the fact that India being a developing nation has an economy that grows faster than many developed countries. Today we discuss the possible benefits that an investor may receive while investing in foreign markets and also the limitations of doing so.
Benefits of Investing in Foreign Stocks /International markets
1. Diversification
Generally, when we talk about diversification we generally refer to investing across various industries and different MCAP’s. But by investing in foreign markets we can receive the same benefits of diversification even if the companies that we include in our portfolio already exist in the same industry or MCAP. The main purpose of diversification is to protect the portfolio. By investing abroad the portfolio is safeguarded from any domestic risks that might affect the domestic markets as a whole.
2. Market rebound rate
We earlier mentioned that that Indian investors prefer to invest in Indian securities as they provide a better growth rate. Markets around the world at times undergo crises at the same time. Rare as this should be this has already occurred twice post 2000. Keeping the growth rate aside let us try and notice the performance of markets post such crisis.
The Recession of 2008 saw economies stagnating all around the world. Even though they were first triggered by problems in the US, the Indian economy too suffered from the crash. The Indian markets suffered a fall of 55% compared to the heights it touched at the end of 2007. It can be noticed that the period of December 2007 to December 2013 the Indian markets gained only 4.3% after rebounding. Let us compare this to the US markets. During the recession, the US markets fell by about 50%. But during the same period from December 2007 to December 2013, the US market provided close to 50% returns after rebounding to previous levels.
Let us also take the 2nd instance where we have seen markets all around the world contract. This has been due to the pandemic that we are still suffering through. If we notice the US markets since their heights in February we can see that the markets fell 30% by March but have already rebounded and touched new heights gaining 15% returns. The Indian markets, on the other hand, suffered a fall of over 35% and have still not previous levels.
3. Exposure
Another added advantage of investing in foreign markets is the exposure an investor will receive in terms of securities available to him. Let us dial back time to the early 2000s and observe the options available to Indian investors when it comes to technology-driven securities. They are limited to TCS, Infosys, and Wipro.
On the other hand, foreign markets provided the likes of Apple. Microsoft, Google. At times even legal jurisdictions bar from certain companies to operate in a country. Investors, however, have the option to simply invest in foreign countries.
Risks involved while Investing in Foreign Stocks
1. Currency Exchange
One of the major problems investors face is due to the changing exchange rates. International stocks are priced in the currency of the country they are based in. For an Indian investor, this causes is a problem because he is now not only exposed to the uncertainty of the stock but also the uncertainty of the currency.
Take for example the shares of ABC Ltd. in the US are worth $100. After the purchase is made the stock rises to $110. But at the same time, the dollar weakens by 15%. If a domestic investor sells off his position and converts it to rupees he would not only forgo the 10% gain but also suffer an additional 5% loss due to the exchange rate. But with the added risk there also exists the added opportunity of making gains during the exchange. If the rupee weakens in the above case, the investor would walk away with a 25% gain.
2. Taxability
The gains that an individual makes from foreign investments can be taxed twice. First when the shares are sold in a foreign country. And secondly in India. This, however, depends on whether the individual is considered as a resident or any other status. The rates applicable here will depend on whether the gains are considered as Long term capital gain or Short term capital gain depending on the period the asset was held. This is known as Double taxation.
This can be avoided if there exists a tax agreement between the foreign country and India. This tax agreement is known as the Double Tax Avoidance Agreement. India currently has DTAA with more than 80 countries, including the US, the UK, France, Greece, Brazil, Canada, Germany, Israel, Italy, Mauritius, Thailand, Spain, Malaysia, Russia, China, Bangladesh, and Australia.
3. Political Unrest
When investing in a foreign country the investor must be aware of the potential political risk. This makes it necessary that the investors follow up on major political events such as elections, trade agreements, tax changes, and civil unrest. A country with unfavorable factors makes investing there not worthwhile even if the company is a good performer.
4. Lack of regulation
Investors looking to invest in foreign markets must be aware that foreign governments may not have the same level of regulations that are followed in India. They may have different disclosure and accounting rules followed respectively. This makes it harder and time-consuming for investors to keep up with the inconsistencies that of regulations in different countries.
There exist numerous advantages and risks that exist while investing in foreign stocks. The existence of risks does not mean one should turn a blind eye to over half of the investment opportunities available to an investor. This is because a majority of such opportunities exist in foreign markets.
Investors should, however, pick an opportunity where the risks are considered and assessed and still remains attractive as an investment.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding what are Non-Banking Financial Companies (NBFCs) in India: One of the key approaches to make money from the stock market is to select a fast-growing industry and look for the best investment opportunity in that industry. If the industry is growing at a good pace, the chances are that the top constituent companies in that industry will too grow at a similar pace.
One industry that is very powerful, growing at a good pace since last decade and is often confused by banking industry in NBFC in India. In this article, we are going to discuss what are Non-Banking Financial Companies (NBFCs) in India, their examples, the definition of NBFCs as per RBI and a few top NBFCs in India. Let’s get started.
What are Non-Banking Financial Companies (NBFCs)?
In simple terms, Non-Banking Financial Companies are financial institutions that do not possess a banking license from the RBI but still provide bank-like financial services like loans, credit facility, retirement planning, etc.
The need for an NBFC arises when the banking structure already present does not fulfill all the financial needs in the economy. These may be due to rules and regulations that bind the banking sector or lack of reach in the service provided and accessibility to certain consumers across the nation. Here are some of the examples of NBFC’s:
Investment Banks
Mortgage Lenders
Money Market Funds
Insurance companies
Hedge and Private Equity Funds
P2P lenders
Currency Exchanges
Pawnshops
Chit Funds
After reading the definition, we must not mistake the role of an NBFC to a mere backup for banks in India. NBFC’s provide and lead in various services when compared to banks. NBFCs have alone made up for a 12.5% rise in Gross Domestic Product of our country.
NBFCs according to the RBI
According to the Reserve Bank of India (RBI), Non-Banking Financial Companies (NBFC) in India can be defined as:
“A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.” (Source: RBI)
The RBI uses the 50-50 test in order to judge if financial activity forms the principal business of a company or not in order to be considered as an NBFC. According to this test
Financial Assets must constitute more than 50% of the total assets (And)
Income from these financial assets must constitute more than 50% of the gross income.
Companies that fulfill the criteria mentioned above are to be registered as NBFCs.
Difference between an NBFC and a Bank?
Even though a few activities may be performed by both they do possess the following differences:
NBFC cannot accept demand deposits: Demand deposits refer to deposits that can be withdrawn without any prior notice. NBFC’s are restricted from providing this service and banks provide then in the form of Current A/C and Savings A/C.
NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself
Deposit insurance facility: The deposits placed in banks are backed by insurance in order to protect the depositor against the failure of a bank. NBFC’s are not required to Insure the deposits placed.
Reserve Ratio: Banks are required to maintain a portion of their deposits as reserves as directed by the RBI. An NBFC is under no such requirement.
Foreign Capital: When it comes to banks the level of foreign investment is capped at 74%. Whereas 100% of foreign investment is allowed in an NBFC
Do all NBFC’s fall under the purview of RBI?
Not all NBFC’s fall under the purview of the RBI. Different NBFC’s are governed by different laws depending on the function they perform.
NBFC
GOVERNING BODY
Merchant Banker
Venture Capital Fund
Stock Exchange
Stock Broker
Sub Broker
That’s all for this post on Non-Banking Financial Companies in India. I hope it was useful for you. If you have any doubts related to NBFC in India, feel free to comment below. I’ll be happy to help. Happy Investing.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding what happens to the equity shares when a company files bankruptcy: During the economic volatility period, investors tend to become more alert with regards to their investments in the form of shares of various companies. Generally, they try to sell their stocks if they find out that the company may not do well in the future or it may take longer than expected to recover. In such cases, companies get hit quite badly because investors are reducing and the market volatility affects the share price too.
The current unprecedented time of COVID-19 too is such that the majority of the investors have already taken necessary actions in order to safeguard their investments. The fear of losing money if the company goes bankrupt has made everyone scratch their heads quite often. However, it is not necessary that if a company is bankrupt then investors will certainly lose all of their money but the fact is that the common stockholders are the last ones on the list of preference for payment. There has also been a misconception of using insolvency and bankruptcy as a synonym but they both are different.
In this write-up, we will be discussing what happens to the shares of the equity shareholders when a company files bankruptcy. Here, we’ll be covering do we mean by insolvency and bankruptcy, options under the bankruptcy, the preference of the payment when any company files bankruptcy and relaxations, and exemptions provided by the government under the stimulus package during the global disease outbreak.
Understanding Insolvency and Bankruptcy
Solvency is a financial state or a condition when a person, firm, company, or any other legal entity’s total assets exceed its total liabilities at any point in time and it can meet its long-term debts and financial obligations. The opposite of it is called “Insolvency”.
The inability to repay its debts/obligations is a state of insolvency and it can be temporary as well. Such a situation may rise from poor cash management, increased expenses, reduction in cash inflow, or because of some unpredictable accidents, mishappenings or pandemic situations resulting in huge losses to the entity/firm. Here, the person or an entity is not even able to raise enough cash in order to pay off its liabilities and obligations in the due course.
The state of insolvency usually leads to filing for bankruptcy, although, it can be avoided by taking corrective actions such as negotiating terms with credits and other lenders, cutting down overhead costs to a large extent, and by generating surplus cash.
The Bankruptcy, on the other hand, is a legal procedure when an insolvent person or an organization declares its inability to pay off its debts. Under bankruptcy, the person or an entity seeks help from the government to repay its debts and obligations. The bankruptcy does not mean the closure of the company as there may be a chance for the company to recover to its normal state.
When a company files for its bankruptcy, it may ask the government to help the company restructure or reorganize its debts and repayment terms to ease out the repayments. The other option the company may seek from the government is to liquidate the company and decide the order of repayment by realizing cash from its assets.
Technically, the companies themselves file for their bankruptcy but sometimes, creditors may also file the application in the relevant court to declare the company as bankrupt. The Registrar of Companies may also pass a special resolution to declare an entity as bankrupt.
As discussed earlier, the two options under the Bankruptcy filing procedure provides flexibility to the corporates to either reorganize its debts and get some time to recover or to liquidate the company if the operations have already started closing down.
The Insolvency and Bankruptcy are now solely controlled by the Insolvency and Bankruptcy Code (IBC), 2016. In case of a reorganization, the relevant court appoints a resolution professional who will decide the terms of reorganization considering relevant laws and regulations of the code along with creditors’ and other lenders’ considerations.
Not only that, but the company is also given 180 days (further extended by 90 days upon presenting a valid reason) of the moratorium period. In this period, the company cannot transfer its assets or raise cash by itself, no creditor or any other lender can initiate any legal proceedings or enforcement against the company.
The common stockholders’ shares may reduce in value as the restructuring under insolvency affects the company’s share price. Also, since all other creditors and lenders will have more preference over the restructuring terms, the stock value after the reorganization may also get terribly hit. However, if the company proposes a strong plan post the restructuring then investors may be able to get the same value or more in the long term.
The second option of liquidation is more menacing and never liked by the investors. Under the liquidation procedure, the liquidator appointed by the court prepares liquidation terms and order of preference of payment where the common stockholders are the last ones to be paid back their investment. Sometimes, investors may not even get anything against the stock they hold.
— The Order of Preference for the Payment
While liquidating, an important point to mention is that everybody is not always equal in the tiers of creditors. Moreover, each tier must be paid in full before any money is repaid to the next tier. The order of preference under the Bankruptcy is provided under Section 178 of the Companies Act 2013 as provided below:
Firstly, the costs and expenses incurred by the bankruptcy professional appointed by the court, are paid.
Secured creditors are paid as they hold some security against their money receivable from the company.
Wages due to the employees
Financial debts payable to the unsecured creditors
Government and statutory dues
Any other debts of the unsecured creditors
Preference shareholders
Equity Shareholders
Quick Note: In the above order of Preference for the Payment, please note that the equity shareholders are last in the line and mentioned at the end. This is because the shareholders are practically the owners of the company and and therefore have accepted a greater risk compared to others.
Recent relaxations by the Government: COVID19 Stimulus Package
Due to the unprecedented time recently faced by everyone in our country and across the globe, the government as a part of the stimulus package announced the suspension of initiation of fresh insolvency proceedings for the next six months from 25th March. According to the stated announcement, there will be no default on the part of a company if the default is occurring out of the global disease outbreak.
Moreover, the minimum threshold amount to initiate the insolvency proceedings has also been increased from Rs. One Lakh to Rs. One Crore to cater many MSME sector companies. The government also declared sector-specific relaxations. This indicates that the investors’ money is safe for now and if the government can provide a pre-packaged resolution plan to certain companies then that will save the investors’ investments.
The Pre-Pakaged Resolution Plan (a Pre-Pack) is kind of a remedy provided by the government to the companies facing financial stress where the company and its creditors mutually agree on the sales terms with the buyer before initiating insolvency.
Companies that bounced back post Bankruptcy
Although, no investor would like his company to file bankruptcy but if that happens, there are examples of companies that filed bankruptcy and came back from the brink of the debt. Below are a few examples of such companies:
General Motors: During the economic fall down in 2009, GM had filed bankruptcy due to heavy debts and pensions exceeding its total value of assets. However, post-bankruptcy it had bounced back stronger than before.
Converse: The company filed for bankruptcy but later Nike acquired the stake in this company and since than the market cap of this company is rising.
Marvel Entertainment: Marvel had to file for bankruptcy due to the hefty debts as comic books sales fell badly, later on, Disney bought the stake and it managed to survive.
Closing Thoughts
The Bankruptcy and Insolvency are always scary for any investor. Being a holder of common stock of a listed company gives the last priority of being paid the invested money back. This is why it is always advisable to study the company before investing.
Studying the financials, due diligence reports, and other such statutory compliance will provide information to a greater extent about the company’s financial health and if they have any plan to file insolvency if their debts are already piling up. Moreover, post insolvency if the companies get better insolvency resolution plans then too the money will be safe.
The IBC 2016 has successfully reduced the time taken for resolution plans and not only that, but the recovery rates for the creditors have also increased over the period of time. Adding to that, the recent relaxations may also prove to be a financial booster for the majority of the MSME sector companies. However, the statistics of last year’s bankruptcy filing show a huge spurt by 123% compared to 2018.
The bottom line should be to study well before investing and be always cautious of what is happening in the company you have invested your money as the bankruptcy procedures can be sometimes painful or it may turn out to be a game-changer.
An overview of the Rupee Cost Average Approach: One of the basic strategies to succeed in the stock markets is to buy more when the prices are low. However, this involves in-depth knowledge to judge shares that are underpriced and perfect purchase timing. Today we try and look for answers in Rupee Cost Average (RCA) to reduce our losses from overpriced securities and make success in the long run.
What is Rupee Cost Average (RCA)?
Basically, Rupee Cost Average is an investment technique of buying a fixed amount of a particular investment consistently on a regular schedule over a long period of time, regardless of price. The Rupee Cost Averaging approach results in the average cost of the investment being lower in comparison to a single lump sum transaction.
RCA Relation with SIP
SIP (Systematic Investment Plan) allows an individual to invest in a fund, a predetermined amount at regular intervals. If we look at the above explanation of RCA we realize that a SIP allows us to buy fixed amounts in a fund on a regular schedule regardless of the price of the unit in the fund. Hence SIP helps an investor apply the RCA method and reap its benefits provided he/she indulges in the SIP for a long period of time.
Example to Understand Rupee Cost Average in SIP
Say for example we have Rs 4000 and decide to invest in an Index fund that tracks with the Sensex. As of January 1st, you have 2 options i.e to either invest in a lump sum or to invest by means of a SIP.
— Scenario 1: You Invest in a lump sum on January 1, 2020
Date
Amount Invested
NAV
Units
SENSEX
01/01/2020
4000
413.0602
9.6838
41,306.02
— Scenario 2: You decide to follow a SIP (with a decision to do so even after the amount is exhausted)
Date
Amount InvestedÊ
NAV
Units
SENSEX
01/01/20
1000
413.0602
2.4209
41,306.02
01/02/20
1000
397.3553
2.5166
39,735.53
02/03/20
1000
381.4402
2.6216
38,144.02
04/01/20
1000
282.6531
3.3579
38,265.31
Total
4000
(Avg) 360.4522
11.0971
The difference we should note in the two scenarios above are :
– Breakeven
In scenario one to make a profit the NAV per unit would have to rise above Rs 413.0602. In Scenario 2 if we are to observe the average cost on Investment would be lower.
Average cost = Amount Invested/ Units Received i.e. = 4000/11.0971 => Rs 360.45229.
Hence the breakeven is lower in the second case while investing through the SIP route.
— Units Received
If the units received are compared it becomes apparent the more units are received in Scenario 2. In RCA more securities are purchased when prices are low and fewer securities are bought when prices are high. This allows any losses that were made during a purchase made when the prices are high to be balanced off when the prices are reduced.
Generally, when we find products available at reduced costs we make sure we take advantage of the situation even if it resorts to hoarding. When it comes to stocks of a company, however, it is noticed that investors react differently.
Unfortunately, healthy companies with strong financials are also exposed to market falls. In such situations, investors panic and sell their shares invested in the company. Nonetheless, an investor with good financials observes the financials of the company, and if it looks good, he views the situation as an opportunity. He takes advantage of the situation and gains more shares.
However, it is observed that many market participants follow basic human instincts. They do this to protect their capital from further reduction. What RCA does is protect us from our own psychology. When we indulge in RCA through a SIP we keep investing regardless of the price. When the market falls and even when the market rises. Hence if followed we reap the benefits of RCA in the long term.
The Dow Jones market as on 03/09/1929 closed at $383. The Great Depression followed and devastated the US economy. The US stock market then took over 25 years to reach levels it stood at before The Great Depression. On 23/11/1954 the Dow Jones closed at $385. This would mean an investor would gain only $2 ( per $385) over a period of 26 years if he invested in 1929.
However, if an investor invested using DCA( Dollar Cost Average in the US) $10000 every year, the $260,000 investments over 25 years would be worth $1.5 million as of 11/23/1954.
This is because by spreading the investments even to periods when the markets were low the investor would benefit by not only making up for the loss incurred when the markets were high but also make larger profits when the markets normalize.
Closing thoughts
The Rupee Cost Average investment strategy definitely safeguards an investor from market bubbles. Unlike other investment strategies, applying RCA doesn’t involve complex strategy and does not even require daily market tracking. This makes it easier for any individual to engage and take advantage of the market. RCA, however, does not shed light on the right time to sell.
In the current situation of ‘The Great Lockdown, we can notice that the Sensex has fallen from the all-time high of January. But if an investor understands RCA applies accordingly, he would be able to profit greater once the market normalizes.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Introduction to Options Trading: Options are financial instruments whose value is derived from the value of an underlying (aka involved) asset like security or an asset. An options deal offers the buyer the opportunity to buy or sell depending on one’s view on the value of involved security. Owning a call option gives the right to buy shares on expiration at strike price and owning a put option gives right to sell at strike price at expiry.
The options when bought or sold need not necessarily be exercised at the Expiry and at strike price. They can be exercised anytime until the options expiry. So if used judiciously the options are considered less risky than stocks or futures contract. Because of this system, options are considered derivative securities – which means their price is derived from involved assets. However, options, do not represent ownership in the company.
Let’s understand with an example
Imagine Mohan has a wedding in his house after four months and wants to buy gold for the same. However, he is fearful of the fact that the gold price might go up in the future. Therefore, to protect himself from the risk of price fluctuations, he goes to a Jewelry shop, and enters into an agreement with the shop owner whereby he fixes the price for jewelry for buying four months down the line, at the current price of Gold.
But, you must be wondering as to, what is the incentive here for the Jewelry shop owner to fix the price because he is potentially taking a big price risk. If the price goes up after four months, still he’ll have to sell the jewelry at the pre-determined price. Here, his incentive is a small fee (i.e. Premium/Token) that he will be charging to Mr. Mohan for fixing the price of gold. And this fee here is non-refundable.
Say, four months down the line if the price of gold goes up then Mr. Mohan has the right to buy gold at the pre-decided price. On the other hand, if for some reason if the price of gold comes down then he does not have to exercise his right, i.e. he may choose to buy jewelry from some other shop at the discounted current price. He merely stands to lose his premium/token.
Why would an investor use options?
When an investor or trader is buying an options contract, he/she is betting on the stock price to go in his favour (up for call option and down for pit option). The price at which one agrees to buy the involved asset via the option is called the “strike price,” and the price paid for having this right is called the “options premium.”
Benefits of Options Contract
Here are a few key benefits of Options contracts:
As the name would suggest, the Options contract gives the right to option buyer to exercise his contract if he wishes to. If the Spot price doesn’t go in favor of the buyer of the contract he does not have to exercise his right, he stands to lose just the premium.
One time premium is the only fee that option buyer has to pay to ride the momentum of underlying price and be a part of a bigger game.
If an option seller is of the opposite view to that of option buyer, he can just sell the option contract and pocket premium income.
The options are less risky than equities. Say for example if a trader wants to buy 1000 shares of Reliance, then at CMP (Rs 1400 per share), one has to shed out Rs 14,00,000 (fourteen lakhs). But one can express the same view by buying 2 Call option contracts (500 shares each). Say if he buys At the Money contract of 1410 CE by paying a premium of 35 per lot. Then, his total cost would be = (500*35*2)= Rs. 35000 only. So, now If option were to expire Out of Money for option buyer, he just stands to lose premium only. But, if the share price of Reliance Industries comes down to Rs. 1300, then total loss of equity shareholders will be Rs. 1,00,000 (1000*100).
Return on investment for an option buyer is very high because the cost paid is just the premium and the potential return is unlimited.
Call and Put Options
The Call/Put options are financial derivative instrument, meaning that their movement is dependent on the price movement of the involved asset or security. The real purpose of buying a call option is that the trader/investor is expecting the price of the involved security to move up in the near future and vice versa for the call option seller.
A Put option is bought by the trader or investor when he expects the price of an involved asset to fall in near future and vice versa for put option seller or writer. The option writer although earns premium while selling but runs the risk of giving up the involved asset in case the options goes in favor of option buyer.
Breaking down Call Options
For U.S. style options, a call option buying contract gives the buyer to buy the involved asset at strike price anytime till the expiry date of contract. In case of an European style option, the call option owner has the power to exercise only on the expiry date.
It is beneficial for the call buyer to power his right to sell his call option if the spot price moves above strike price before expiry and call option writer to bind by his promise.
The premium paid by the option buyer gives him the right to buy the involved stock or security at strike price until the expiry of options agreement. If the price of the asset moves beyond the strike price, the option will be In the money
The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the option writer’s income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going above the strike price.
Call options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money call option will be to buy the option with the strike below 9500 (say 9400 CE), An At the money call option will be to buy an option will the strike price at 9500 and an Out of money call option will be to but strike price above 9500 (say 9600 CE). An In the money call option are the most expensive ones and the out of money options are the cheapest but they carry the most risk of expiring worthless.
Breaking down Put Options
Options contract duration can vary from very short term (weekly) to long term (monthly contracts). It is profitable for the put option buyer to exercise or sell his option if the spot price of the involved security comes below the strike price.
The premium paid by the put option buyer gives him the right to sell the involved stock or security at strike price until the expiry of options agreement.
The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the put option writers income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going below the strike price.
Just like Call option, even Put options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money put option will be to buy the option with the strike above 9500 (say 9600 PE), An At the money Put option will be to buy an option will the strike price at 9500 and an Out of money Put option will be to but strike price below 9500 (say 9400 PE).
An In the money pall option are the most expensive ones and the out of money put options are the cheapest but they carry the most risk of expiring worthless.
Various Option strategies depending on one’s view on Market
Market view
Option
Position Name
Other trading Alternatives
Premium
Bullish
Call Option (Buy)
Buy CE
Buy Futures(Spot)
Pay
Bearish
Put Option (Buy)
Buy PE
Sell Futures
Pay
Flattish or Bullish
Put Option (Sell)
Sell PE
Buy Futures (Spot)
Receive
Flattish or Bearish
Call Option (Sell)
Sell CE
Sell Futures
Receive
Closing Thoughts
In this article, we have discussed two basic options types: Call Options and Put options. But from the graph above, we see there are four different options trading players i.e., Call Option Buyer, Call option seller, Put option buyer, Put Option Seller.
Call option and put option buyers have limited risk to the tune of option premium but have unlimited gains potential. But the call and put options writer’s risks are unlimited and the maximum reward is the premium charged from option buyers.
To Summarize, an option is a contract which is optional i.e., it is not obligatory for the buyer to buy or sell the involved security or asset at pre decided strike price within the stipulated/expiration time. Because they’re cheaper to purchase (compared to buying same number of shares), they have the power of leveraging limited money of the investor.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
Do You Need a Finance Degree For a Career in Stock Market? The finance industry in India has been growing at a very fast pace for the last two decades. And along with the growth in the industry, there’s also a boom in job opportunities and enthusiasts willing to work in this field.
Although there are many job opportunities available in the stock market, however, one of the most frequently asked questions is- “Can a student from non-finance degree get a job on Dalal street?” How much relevant is having a finance, commerce or business degree to land a job in the world on the stock market.
Well, the short answer to this question is that you do not need a finance or business degree to get all the jobs in the stock market. A lot of financial companies hire employees from Engineering, mathematics, science, computing or economics background. In the era of internet technology, most of the financial giants are looking more for the skills and the aptitude of the candidates rather than just the degree.
Anyways, there are still a few careers in the market like Investment Banking, Equity Research, Risk Management, Portfolio Management, etc where a special skill set and expert knowledge of finance is required and having a degree can give an advantage to the candidates.
Nonetheless, having or not having a finance/commerce/business degree is just the starting point. There are a lot more things that you need to know if you want to build a career in the stock market industry which we are going to discuss in this post.
It’s always beneficial to have a background in Finance
When you have a background in finance, business, accounting or commerce, you already have got a minor exposure to the investing world. You might already know the lingo and familiar with the frequently used terms in the stock market like dividends, assets, liabilities, etc.
On the other hand, most of the non-finance guys are not even familiar with the most common terms of the market. Moreover, they find reading and understanding financial statements is quite challenging compared to people with a finance background.
Getting a job at Dalal Street Market
In a scenario where you are appearing in a job interview for a financial position, knowing these financial terms can help you impress the interviewer or at least not feeling like a dumb one. Besides, as stated, in a few financial positions, the interviewers create a barrier by shortlisting only candidates with a graduate degree in finance, commerce, business or accounting. And in all these cases, having a degree can be advantageous for you.
Moreover, if you want to become a SEBI registered investment advisor or research analyst, you will require an educational qualification of graduate or post-graduate degree in finance/accounting/commerce, etc. If you don’t meet the educational qualification, you cannot become a SEBI registered advisors/analyst and hence can’t have a career in the advisory field.
Overall, if you’re planning to become an investment advisor/research analysis, you’ll require a degree in these fields. Nonetheless, you can always enroll in post-graduate degrees of one or two years to get the degree and meet the educational qualifications.
When it comes to trading & investing or managing your own portfolio, you don’t require any degree.
Anyone can open their trading accounts and start trading in stocks. Many engineers, math/science majors, arts graduate or even people who don’t have any degree have been investing successfully and made a huge fortune from the market. A lot of successful stock market traders/investors do not have any background in finance or never did any course in this field. One of the best examples is Charlie Munger, a successful stock investor and vice-chairman of Berkshire Hathaway.
In short, if you are not interested in a 9-to-5 job or career in the Dalal street and just want to trade in stocks on your own, you won’t require any degree or certification. Here you can make money by using your knowledge and skillsets.
What to do when you don’t have a degree in Finance/Commerce?
It’s often said that Self-Education is the best form of learning. Even though if you do not have a degree in finance, you can learn the skills and impress the interviewer with your enthusiasm to master the market.
Start by learning the lingo. It’s really important to know financial terms if you want to break the initial barrier of entering the stock market world. Know the most frequently used investing terms and how to read the financial statements.
Further, if possible, take a few online courses to learn the trading/investing concept. Attend local investing workshops, seminars, etc. It would be best if you can find a mentor. Expand your knowledge base and try simulating platforms to trade in stocks without risking your money. And finally, try to land an internship in the finance company so that you can have a real experience of how things work in this industry.
Most people believe that a career in the stock market is only for people with finance or business background. But this is not true. Do not stop yourself from entering the exciting world of the stock market just because you do not have a finance degree. Here, having a skill set is more important compared to a degree. Moreover, even if you do not have a graduation degree in Finance/Commerce, you can go for reputed financial certifications like CFA, FRM, PRM, etc that will put you in the same position as those with degrees.
My final advice will be to focus on enhancing your skills and acquiring specialized knowledge. This will help you more in building your dream life than chasing over degrees.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
A complete NISM Certification Guide for Beginners: The majority of Commerce students that I come across these days are looking to make their career in the field of Finance. Even, a substantial number of engineering graduates whom I personally know, are currently changing their career to the Financial Services. At present, the Finance industry in India and across the globe is growing at a rapid pace. Therefore, it is of no doubt in saying that professional degrees and courses like MBA (Finance), CFA, FRM, and CFP are attracting a huge number of students every day.
However, apart from these mentioned courses, is there any other course which can give you the license to work as a self-employed individual in the Finance sector? Do you know of any course which is comparatively easier to pursue, affordable and gives you the ticket to pursue a career in the Finance industry?
The answer to both the questions is “NISM certification”.
But hey! Are you hearing the word ‘NISM’ for the first time? Even if yes, then you don’t need to worry at all. In this article, I would share a brief overview of the wide range of NISM courses available and how you can get certified with NISM.
What is NISM?
NISM (National Institute of Securities Markets) is headquartered in Navi Mumbai, India and offers a wide range of courses to the Indian students. It is a public trust which was established by SEBI (Securities and Exchange Board of India). SEBI is the apex body which regulates the securities markets in India.
The SCI (School for Certification of Intermediaries) is one of the six schools of excellence at NISM. The SCI is engaged in the development of Certification examinations and Continuing Professional Education (CPE) programmes in the Financial Markets domain. These are conducted for validating and enhancing the abilities of the associates working in the Indian capital markets.
What does the NISM offer?
The NISM campus in Patalganga (Maharashtra) offers two full-time courses in Finance. The first one is PGPSM (Post Graduate Programme in Securities Markets) and the other is PGD (Post Graduate Diploma) in FinTech.
Apart from these two stated courses, NISM also offers a few other long term courses in collaboration with international bodies. You can have a look at those courses clicking here.
Further, there are 22 short term certification courses offered by NISM. In this article, we would predominantly hold a discussion on these certifications. A majority of these short term courses are mandated by SEBI for those who are either self-employed like an investment advisor or research analyst or working in the Financial Services industry in India.
The rests are voluntary certifications that have not been mandatory for the finance professionals. But, the voluntary certifications are beneficial in the sense that they provide advanced knowledge in some specific area.
For example, Mutual Fund Distributors Certification Examination (Series V C) is a voluntary exam but its contents and way of testing the candidates is more difficult than other Mutual Funds exams.
Note: You can find the list of all the available 22 courses on the website of NISM here.
How to register for a NISM certification exam?
In order to register for any course offered by NISM, you first need to create your account on the NISM website. Click on this link and it will take you to the home page of the website. While creating your account, make sure you have a digital copy of your photograph, aadhar card and PAN card with you.
After you are done with the account creation, you can choose any module of your choice. To register for any module exam, you have to select the exam date, time and center first. After that, it will take you to the payment gateway.
Once you have paid the required exam fees, you would get the soft copy of the workbook (study material) and the hall ticket in your account. Take a physical printout of your hall ticket and carry it with you to the exam center on the day of your exam.
The NISM provides the students with soft copies of the study materials in the ‘pdf’ format. The content covers both theoretical and practical aspects of the Financial Markets. These courses teach you various jargons which you need to know for pursuing a career in the Financial Markets.
Anyways, you can also enroll in these courses if you are simply interested in gaining knowledge. These programmes teach you the key theoretical concepts of the Stock Market, Mutual Fund, Financial Planning, and many others. The exams are based on MCQ (Multiple Choice Questions) and the students are tested on their conceptual understanding. Although you don’t get the opportunity to work on demo projects here, you certainly get the chance to solve case study questions in the exams. Further, you cannot carry a scientific calculator in the exam. But, you are definitely allowed to do rough works in MS Excel, OpenOffice or digital calc on the given desktop in the exam hall.
The NISM certification exams majorly focus on the practical understanding rather than emphasizing on mugging up theories. The best feature of these certifications is that the course modules are updated in every year.
How much time does it take for the completion of a NISM course?
In case of a NISM certification examination, you don’t need any significant amount of time to complete the same unlike CA, CFA, or MBA (Finance). Practically speaking, you can book your exam slot at any time. However, it is recommended that you should prepare for at least two weeks to a month before taking any module exam. This is because when you register for an exam, you get the study material covering a minimum of 100 pages which needs a decent time for complete reading.
If you are only looking to clear the exam, you can do the same by referring to the mock tests of private institutions. But, if you are looking to gain knowledge of the financial markets and clear the exams with distinction marks, you must study the workbooks given to you by NISM.
What is the registration fee to be paid to opt for a NISM certification exam?
The registration fee for any exam is pretty reasonable in nature. Here, you don’t need to pay over 30 or 40 thousand rupees to write a semester of MBA or a level exam in CFA.
Today, you can register in a NISM exam for as low as Rs 1200. The module exam with the highest registration fee is Rs 3000. Whenever you are enrolling for an exam of NISM, you have to pay the required fees. If you are unable to attempt that exam or fail in the same, you have to pay the same fee again for re-appearing in the exam.
How’s the difficulty level of a NISM exam?
The difficulty level of the NISM exams is between average to moderately high. For some exams, the contents and way of testing could be more difficult than the rests. The NISM Investment Advisor Exams (Level 1 and 2) contain relatively more practical contents as compared to the other courses. On the other hand, exams like the NISM (Series VI) Depository Operations Certification Examination contain a very high share of theory portion in their syllabus.
In order to pass a module, you need to secure a minimum of 60% score in most of the module exams. Besides, these exams come with negative marking of 25% per question. A very few exams like NISM (Series V A) Mutual Funds Distributors Certification Examination have a minimum passing marks criteria of 50% and also they don’t have any negative marking feature.
Closing Thoughts
NISM exams are definitely one of the best in the industry if you are a fresher and willing to make a career in Finance. These certification exams are sufficient to give you an initial push in your career. They are strong enough to add a few keywords in your resume and make it look better than your peers. But, you must understand that clearing these exams are not going to make you stand at par with the jobseekers having CA, CFA, FRM or MBA (Finance) in their portfolio.
Nonetheless, in case you are looking for a job after graduation, these courses can help you in getting shortlisted on India’s top job websites. It is easy to start your career as a Mutual Fund Selling Agent or an Equity Dealer clearing the required NISM exams. But, if you are aiming for a career in Portfolio Management, Investment Banking or Fund Manager, you should look for the premier courses in Finance.
Financial statements are one of the widely relied upon tool to analyze a business. However, there are many ways in which companies cook their books and create a false impression of the company’s financial health using accounting gimmicks and financial shenanigans. In this post, we are going to look at how companies cook books and how you can identify such financial shenanigans using accounting red flags.
If you look into the past, you will find that cooking books is not a recent phenomenon, but has existed for a long time. We all know one or the other company which has resorted to accounting gimmicks to dupe investors into believing that the company is doing well. Each market has its own share of such “gutsy” companies which, instead of genuinely improving the business, resorts to cooking books to show improved performance.
Why Companies Cook Books?
The question is, why do companies need to cook books? Why does the management resort to such gimmicks instead of being honest with their investors? Well, cooking books is not just about looking great on paper, some of the common reasons why companies do so are explained below:
1. To meet or exceed market expectations:
Let’s honestly admit one thing, the world is a fiercely competitive place and everyone wants to be on the top of their game. Miss the mark by a few points, and the company’s stock price gets hammered badly by the market.
With ever intensifying competition and “Go big or go home” thinking, the management of every company is pressed to either beat or at least meet the growth expected by the market.
With such mounting pressure to perform, companies that fail to deliver as per expectations, often get involved in cooking books and create a false image of healthy growth.
2. Vested Interests of the Management:
The second reason why companies cook books is because the management has its own vested interest behind it. Nowadays, many companies offer share price linked incentives to their managers.
Such schemes are offered to align the interests of the shareholders to that of management so that both can benefit from the good performance of the business.
Incentives linked to the share price motivates the managers of the company to work harder and deliver a good performance.
When the times are tough, and business struggles to perform, top managers, driven by greed of incentives and fear of being penalized for poor performance start window dressing the accounts to paint a rosy picture of company’s performance.
3. To show a consistent growth rate by under-reporting current spurt of growth:
This is something that does not happen pretty often, but there are times when companies do under-report their financial performance. Why? Let me explain.
Investors love companies with strong consistent performance and growth, and company managers know this very well. There are some companies that have a seasonal business, where they perform well when times are favorable and do poorly otherwise.
Such companies during good times minimize the current earnings by under-reporting the revenues or by inflating current period expenses by postponing good financial information for the future period when the company is more likely to underperform.
This again creates an illusion for investors that the company has performed well compared to its peers even during tough times.
As a result, such companies command higher valuations which they do not actually deserve.
How Companies cook books?
Management of the companies may have different reasons behind cooking books, but the way it is achieved has hardly ever changed.
The only way management of the companies can manipulate books is by concealing information, in other words, by hiding it in places where it is difficult to detect easily.
So how do companies cook books? Well, as I said earlier, it’s all about hiding crucial information about the company within the financial statements so that they are not easily traceable.
There are only three ways a company can manipulate earnings, by manipulating earnings, profit, and cash flow.
1. Earnings Manipulation:
Earnings manipulation occurs when companies try to inflate (or in some cases, hide) their earnings such as revenue. There are two ways companies manipulate their earnings.
— Recording Revenue prematurely: Booking revenues in advance is one of the most commonly used financial shenanigan by the companies. It includes booking revenues even before the goods are sold or a project is completed.
An example of such premature recording of revenue was seen in Sobha Developers in 2008-09. In Q1 of 2008-09, Sobha Developers decided to recognize the revenue earlier during a project cycle. This led to a 20% jump in the company’s profits before tax.
— Recording income from investment as revenue: The second most common way to manipulating earnings is by recording revenue from other sources as operating revenue.
If proceeds from the sale of an asset (such as land, building, plant, and machinery) or income from an investment (such as maturity of a bond or proceeds from the sale of shares) is recorded as revenue, it will boost the total revenue of the company.
Since these are a one-time phenomenon, and cannot be repeated in the future, recording such one-time sources of revenue gives a false impression of improved financial performance.
2. Profit Manipulation:
Profit is considered to be the blood of a business, something which is necessary for the survival and prosperity of a business. Just like revenue, even profits can be manipulated in many ways.
From hiding expenses to making a simple change in the way in which depreciation is calculated, there are numerous ways a company can manipulate its profits numbers. Some of the most common ways companies cook books in terms of profit are as follows:
— Making expenses look like earnings: A simple change in accounting policy can have a significant impact on the way profits are presented. Many companies use this approach to manipulate Net Profits.
For example, a simple change in the way depreciation is calculated can change the entire picture, helping company management boost profits.
For Example, a small change in depreciation policy in case of Jet Airways created profits out of thin air. In the Q2 of 2008-09, Jet airways changed its depreciation policy from written down value method to straight-line value method, as a result of which, Jet Airways was able to write back ₹920 crores to its Profit and Loss account.
— Hiding Expenses as Capital Expenditure: Another way to boost profits is by treating expenses as capital expenditure; that is instead of treating it as expenses during the current financial year, it is treated as investment made to expand the business.
One such incident can be found in the USA, wherein the years 1990, AOL was found guilty of delaying expense.
AOL was distributing installation CDs as a part of its marketing campaign, but instead of treating it as an advertising expense, AOL decided to view it as capital expenditure. As a result of this, the entire amount was transferred from profit and loss statement to balance sheet of the company where the campaign would be expended over a period of years.
Because of AOL’s treatment of expenses as Capital Expenditure, the entire amount was written off the P&L Statement, which resulted in boosted profits.
3. Cash Flow Manipulation:
Cash flow is considered to be the most reliable source of the true financial health of the company for the simple reason that cash is difficult to manipulate. Investors like Warren Buffett rely heavily on numbers like free cash flow to assess the financial health of the business.
Since companies know this well, they have devised new ways where it is possible to manipulate the cash flow of a company using accounting gimmicks.
Detecting such tricks can be quiet challenging for an amateur investor who does not have a deep understanding of accounting and finance or does not have free time to go through the books of the company.
Some of the most common cash flow related financial shenanigans are explained below:
— Showing financing cash flow as operating cash flow: There are two ways a company can generate cash for itself, first, from its own business, where profits earned by the business get converted to cash, and second by borrowing cash from an external source in the form of loan by issuing bonds or bank loan.
The cash received from business operations is called Cash Flow from Operating Activity, and cash received from an external source is treated as cash flow from financing activity.
Many companies try to boost their operating cash flow by treating financing cash flows as operating one, which leads to a wrongful impression that the company is generating a lot of operating cash flow from its business.
— Using acquisitions as a boost to operating cash flow:
Cash flows can also be manipulated using mergers and acquisitions, especially if the target company is rich in cash.
Management often tries to win support from its shareholders by convincing the shareholders that a particular acquisition will be highly beneficial for the company.
As soon as the merger takes place, all the cash that belonged to the target company, now becomes a part of the parent company, thus boosting overall cash flow statements.
Investors must always be wary of the financial history of the target company and its business and find out if the merger is really going to benefit the business.
If an acquisition is happening just because it will boost the EPS or the cash flows of the parent company, with no meaningful benefit to the business, then such acquisitions must be avoided at all costs.
Cooking books is not limited to manipulating earnings or hiding crucial details about the weak performance of the company, management of companies go beyond the books and create their own parameters of measuring the growth and performance of a company.
Such parameters, though necessary in certain industries, are still non-standard as per the accounting standards. Because of such creative parameters, managements get an opportunity to change their definition of performance as per their requirements, allowing them to use creative methods to put encouraging but false performance numbers in front of investors.
Some of the examples of such no-standard parameters are explained below:
— Same Store Sales (Used In Retail Stores and Restaurants):
Same store sales is a parameter to measure the performance of retail stores. It gives information about how much sales revenue a store is generating during a fiscal year or more.
Same store sales also give investors an idea of how much revenue a company is generating from its existing stores and how much is contributed by new stores. If the percentage of sales revenue from new store sales is rising, it’s strong evidence that new stores are performing well, sounds rational, right?
This is where companies get a chance to manipulate with numbers without getting noticed. The management of the company may alter the criteria of eligible stores to be used in the metric.
For example, in one financial year, a company may use only those stores older than 3 years to show the same store sales performance while in the next year, if the performance of the stores older than 3 years deteriorates, the management may change the criteria and use only those stores that are older than 5 years.
Companies may keep changing their eligibility criteria as per their suitability to present the desired picture.
— ARPU (Average Revenue Per User):
ARPU stands for Average Revenue Per User and is a performance metric generally used by Telecom companies or DTH service providers. Just like same store sales, ARPU can also be used for manipulating earnings of a company.
Most telecom companies, especially in this age of smartphones, not only generate revenue from selling data, but also by selling ad space, and this is where the manipulation begins.
The right way to calculate ARPU is by calculating total revenue generated from data services provided divided by the total number of subscribers.
However, some companies, to show encouraging revenue growth add advertising revenue to the revenue from subscription, thereby falsely boosting the total ARPU.
How to detect if a company is cooking books?
So far we have seen why and how companies cook books, but the biggest question is, is it possible to detect these financial shenanigans? How would you know that a company is cooking books?
While detecting some of these financial shenanigans requires a degree in finance, most of them can be traced pretty easily if you just observe carefully.
— Improved Revenue with an absence of Cash Flow:
If the complicated accounting terms are giving you nightmares, and you have no clue what to do, here is something very simple and logical thing you can do. Just Watch out for cash flow.
Increase in revenue of the company should be reflected with an increase in cash flow of the company. If you see operating cash flow declining or stagnant even if the revenue is marching upwards, or if cash flow is much slower than the revenue generated, it usually means that the company is generating revenue but is unable to collect cash, or even worse, the revenue numbers are simply fake and bogus.
— If Q1+Q2+Q3+Q4 is not equal to FY:
In an ideal situation, if the financial results are audited, the annual sales and profits should simply be a sum of all the four quarterly sales and profit numbers, except for minor variations.
If there is a significant variation between annual sales and profit numbers and sum of all quarterly numbers, you can say that the books have been manipulated at least to some extent.
— If a company is on an acquisition spree:
Companies make acquisitions as it helps the acquirers grow inorganically while making an acquisition, companies make sure that the interests of both the companies are aligned and that the resources that an acquiring company needs are available with the company that is being acquired, at a bargain price.
In simple words, any acquisition should add value to the company more than what is being paid for it. There are many instances when companies are on an acquisition spree. Firms that make numerous acquisitions can get into trouble, their financials get restated and complicated to understand.
Aside from complicating things, acquisitions usually increase the risk of cooking books and bury the evidence under many layers of financial statements. So if a company is a serial acquirer, but does not show significant improvement in its financial performance, there is a good chance that the acquisitions were made simply to manipulate the numbers.
— If the company has bulging Trade Payables:
Many companies, especially in a competitive, customer-centric market loosen their credit terms, attracting more customers to buy goods and services now and pay later. While this is a great move that helps boost sales revenue, it may create a liquidity crisis in a company.
Longer credit duration means that company has to wait longer for the revenue to be converted into cash, but since a company has to meet its daily expenses in cash form, longer credit means company may run out of cash and may have to either borrow to meet its operational expenses or shut down its operations completely.
The best way to cross-check if the company’s revenue is simply because of loose credit terms is to check if there is a change in days receivables in the past few financial years.
If a company has increased the receivable days, it shows that all the revenue is just on paper and the cash is yet to be realized. Such practice is pretty common in infrastructure companies.
— If the CFO and auditors resign or get fired:
This is by far one of the most vital signs that a company is cooking books. There is an old saying in Latin “Who Watches the Watchmen?” when it comes to financial reporting, the watchmen are the Chief Financial Officer (CFO), and the corporate auditor.
If you find a company that is involved in some of the suspicious accounting activities as mentioned above, and you see the CFO of the company quitting abruptly for no valid or logical reasons, its time to stand guard and find out if there is something going on within the company that has not met your eyes yet.
The same rule applies to corporate auditors. IF a company frequently changes its auditors or fires them after some accounting issues come to light, be watchful and look for warning signs.
There have been many recent examples of auditors resigning after altercation from the company owners, which later revealed that company was involved in dressing up numbers to make things look good on the surface while it was really bad inside.
In the month of May 2018, Deloitte, corporate auditor of Manpasand beverages quit a few days before the declaration of annual result as the company was unable to share crucial data regarding capital expenditure and revenue. As a result, the stock price of Manpasand beverages tanked 20% within a day. You can read the news by clicking here
Another such incident happened recently where PWC (Price Waterhouse Coopers LLP) statutory auditor of Reliance Capital and Reliance Home Finance, quit just before the declaration of FY19 results.
In its resignation letter, PWC stated that as part of the ongoing audit for FY19, it noted certain observations and transactions, which, in its assessment, if not resolved satisfactorily, might be significant or material to the financial statements. You can read the new by clicking here
Conclusion:
If you are looking for a great investment, look for great businesses. The best way to understand if a business id great or not is by analyzing the financial statements of the company.
Since every investor relies on financial statements for his analysis, it’s important that companies remain honest and transparent and give only authentic information.
However, with the ever-mounting competition, and a race to perform better than peers puts a lot of pressure on the management to perform, because of which they often resort to unethical ways to manipulate the number so that the business “appears” healthy.
There is an Old Russian Proverb which means “Trust, but Verify”, taking things at face value can be dangerous and thus it is important that investors, even if they trust the management with the numbers, should always be vigilant and keep checking the authenticity before making an investment decision, after all, it’s your hard-earned money at risk, don’t take anyone else’s word for it.
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About the Author:
This article is a guest post by Ankit Shrivastava, a SEBI Registered Research Analyst. Ankit has been investing in stocks since 2004 and writes about fundamental analysis of companies, principles of investing, investment strategies and a lot more on his blog: Infimoney
Trade brains is a financial education blog focused to teach stock market investing and personal finance to the DIY (do-it-yourself) investors in order to make, grow & sometimes even spend money. #HappyInvesting
There are a number of decent books on stock market investing that you can read to brush up on the basics. Few good books that I will suggest the beginners should read are:
If we look at the images above, then we see that in the window with the order type selected as MIS Intraday, the amount of margin required is 1/5th of the amount of margin required to trade in overnight (NRML) mode.
