Debt Financing vs Equity Financing - Which One is Best? cover

Debt Financing vs Equity Financing – Which One is Better?

Difference Between Debt Financing and Equity Financing: Every company reaches a point where they have to raise funds for their growth needs or to survive, preferably the former. This need for capital is primarily raised through two financing options i.e. debt financing vs equity financing.

In this article, we take a look at what these two are and which one could be optimal. Keep Reading to find out!

What is Equity Financing?

Equity Financing refers to raising capital by selling off the promoters’ stake i.e. part of the ownership within the company in exchange for funds. 

One of the biggest advantages of equity financing is that the company receives funds without the obligation to pay back the capital.

These investments could be raised from the public through the markets by opting for IPO’s. Or in other cases through venture capitalists, angel investors, private equity funds, etc.

Debt Financing vs Equity Financing

In addition to the funds, the promoter could also benefit from the connections, experience, and connections these new investors bring with them. This is because they too have an interest and benefit if the business succeeds. In the case of IPO’s the company could enjoy the listing benefits.  

However, there is a tradeoff. In exchange for the funds, the new shareholders are given a stake which means that they now have a say within the company and can vote on important matters.

This could affect the decisions taken by the management as they now also have to take into consideration the interests of the new shareholders.

The risks could also extend to the promoters even being replaced in the management if they do not retain significant ownership.

What is Debt Financing?

Debt financing refers to borrowing money for a period with the intention of repaying the amount with interest. One of the most common ways of debt financing is be securing loans from banks.

However, debt financing also includes the company raising funds by selling off bonds, debentures, etc. to lenders. 

A Debt related quote on a brick wall | Debt Financing vs Equity Financing

In the case of debt financing, the amount is to be paid back at a fixed date and at a fixed interest.

One of the biggest advantages of debt financing is that the company can receive funds without the promoters letting go of any ownership. This allows them to maintain control over their business.

The lender has no control over the business and no say in the decision-making process. Other advantages include tax benefits as loans at times also include write-offs and deductions. 

The challenge however is that the loan has to be paid back. Even if the company goes bankrupt it is the lenders who are paid off first. This could be a herculean task if the company is not yet profitable or runs into a rough patch. The funds could turn around and affect the company’s ability to grow too.

Don’t believe it? Ask Anil Ambani. The ex-tycoon is still battling cases to get out of the debt spiral even after most of his companies had to shut down or be sold off due to too high debt.

Some Examples

Too much financial jargon? We can understand the two sources of capital through an example:

Take for example Ineedfund Ltd. is looking to raise capital worth Rs. 50 lakhs for their growth requirement. For equity financing, the promoters would have to let go of a 20% stake in the company in order to raise the funds.

On the other hand, the company has been offered a loan of Rs. 50 lakh from banks which has to be paid back in installments over 4 years at an interest rate of 5%. 

Here the management or the promoters have two options. The first is to let go of some stake that could affect their decision-making in the future. But here they are under no obligation to pay back the amount. The promoters can be tension-free and not worry about increasing their expenses. 

On the other hand, they also can take up the loan from the banks. Here the promoters can keep their stake and run the company as they feel is right without answering to new shareholders. On the other hand, they have to constantly make sure that they make the loan repayments along with interest on time.

The right decision here depends on a number of factors that we will discuss now.

Quick Read

Is Debt always bad for a company?

Is Debt Cheaper Than Equity?

Debt Financing vs Equity Financing illustration on a weighing machine

Debt is considered to be cheaper than equity as includes additional risk taken over by the new shareholders. In the case of the company going bankrupt, the company pays off its creditors while winding off first.

The shareholders are in a position where they may lose 100% of the capital they invested. Hence due to the increased risk is taken up by the shareholders, they often expect and demand higher returns. Their shares are also further subject to volatility in the markets. 

Is Debt Cheap Then?

A monkey thinking about something | Debt Financing vs Equity Financing

Although the cost of limited debt may be lower than equity, too much debt can cause serious trouble for the company. This is because debt comes with interest that has to be paid. Increased debt directly results in higher interest payments. 

Any slowdown in the business or other factors could hamper the business’s ability to pay interest putting the company into the defaulters’ category. This increases the risk for the creditors and increased risk will once again result in debt becoming more expensive.

This is because taking up loans now will become more expensive as due to the higher risk a higher interest rate will be charged. In the case of bond and debenture holders, this situation will also result in them demanding higher returns. 

These circumstances could further also increase the risk for the existing equity shareholders. If a company defaults the effects of this news will be carried onto the share price. This leads to the equity shareholders looking to get compensated for the added risk.

So Debt Financing vs Equity Financing – Which is the Better option Then? 

To find the answer to this question one must look at the company’s Weighted Average Cost of Capital (WACC). The WACC calculated the cost of the capital and the calculation uses appropriate weights for each category of the capital.

It includes both debt and equity in its calculation. It is calculated as follows. 

Formula for calculating WACC | Debt Financing vs Equity Financing

(Source: Fool.com)

WACC vs Leverage graph | Debt Financing vs Equity Financing

(Source: CFI)

What one should look for here is to ensure that the WACC is always balanced. If the WACC is leaning more towards point A it shows that the company has opted for too much equity with little debt. The end result however is a high cost of capital.

If the WACC is leaning more towards point B it shows that the company has opted for too much debt with little equity. Once again the end result here as well is a high cost of capital.

As you can see in the graph the most optimal point is C. This point represents that the company has managed a good balance between equity and debt. This shows the healthiest cost of capital for the company.

If the company is already leaning towards point A, it should try to balance its cost by financing its needs through debt. On the other hand, if the WACC of the company is already leaning towards point B it should try balancing it out using equity. 

Is Balancing Debt and Equity an Absolute Rule?

Absolutely not. Raising funds depends on a number of factors. They may include the stage that a company is in. At times if the company is going through a rough patch it may be hard to even get investors interested.

The company will be forced to opt for the debt at higher rates. Or the company, unfortunately, may not even qualify for debt as it also requires collateral.

The willingness of the promoters to let go of their stake also plays an important role. The interest rates in the economy also keep fluctuating and accordingly make it favorable or unfavorable to acquire debt.

In addition, it is also important to note that raising funds through equity financing can also be an expensive affair. As floatation costs for IPO’s are expensive too.

Hence a company will also need sufficient funds to even raise funds through an IPO.

Conclusion

At the end of the day, it is up to the company to choose the most optimal source of funds. These could be debt financing vs equity financing depending on the situation.

It is also important for investors to be wary of too much debt financing or only equity financing. This can be looked into by observing the company’s debt-equity ratio. An optimal debt-equity ratio ranges from 1 to 1.5 but isn’t the only factor to look into while investing.

That’s all for this post. Let us know what you think of companies being extremely wary of debt in the recent past in the comments below. Happy Investing!

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Mutual Fund Risk: 5 Types of Risks Associated with Mutual Funds

Understanding Types of Mutual Fund Risks: “Mutual Fund Investments are subject to market risks.” We have come across this quote numerous times. But what exactly are these market risks and why do they arise. Keep Reading to find out!

Mutual Funds Investment Basics

Mutual Funds are investment options where a collection of investors pool their funds which are then taken care of by a market expert known as an investment manager.

What the investment manager does here is he takes this pool and further invests in companies he feels provide the best investment opportunities among alternatives. But it is not necessary that these investments will always be secure as these securities have multiple factors affecting their price every day. 

The price of these securities in turn affects what we know as the NAV which is simply the market value of all the investments held by a fund minus the fund liabilities divided by the number of units.

As this NAV depends on the underlying investments, the rewards and risks that accompany them are carried forward to the investors of the mutual fund. This makes it important to know about these risks to make informed decisions while investing.

Risks Associated with Mutual Funds

Man balancing on a ropeway | Mutual Fund Risk cover

Below are the five types of mutual fund risks –

1. Market Risk

As mentioned earlier mutual funds invest in a variety of securities whose prices fluctuate due to the market risk. Market risk arises if these securities perform poorly in the market. Their poor performance can arise due to several factors rising in the markets. These could range from new policies implemented by the government that may be viewed as unfavorable to the economy, high rates of inflation, natural disasters, economic cycles. Etc.

Although a company may be performing exceptionally well, its price may still get affected due to the market reaction or in other words markets predicting that the company may be affected in the future. Since the fund invests in these securities this, in turn, affects the mutual fund.

2. Liquidity Risk

This risk in simple terms refers to an investment’s ability to be converted into cash whenever needed. There are a variety of investment options available in the market. At times investments come with certain restrictions like lock-in periods which further reduce the ability of an investor to convert his investments into cash. 

One of the best examples, in this case, is Equity Linked Saving Schemes (ELSS). ELSS funds come with a 3-year lock-in period. This in turn could affect an investor when he is in need of liquidity during the 3-year lock-in period.

ALSO READ

Investing in an Equity Mutual Fund? Here are the things to Consider!

3. Concentration Risk

Mutual funds invest in a variety of investments. The concentration here refers to the portfolio of the mutual fund investing only in a particular type of security or only in similar companies. This could be due to the investment managers prefers to invest only in blue chip securities or a particular sector.

It could affect the investor as any changes affecting these types of securities are carried on to him. An as the portfolio isn’t diverse enough there aren’t other options that cover or make up for the losses that arise due to this.

One of the best ways to counter this risk is by diversifying your portfolio. Every mutual fund discloses their type of securities that make up its portfolio and the portfolio composition. It is best to invest in funds that offer added diversification and aren’t limited to securities or sectors.

4. Interest Rate Risk

The Interest Rates are set by the RBI and are used to counter or match the country’s economic needs. These interest rates affect the credit flow within the country in turn affecting the demand, supply, consumption, etc. Debt securities are affected the most by changes in these interest rates. 

Say for example an investor commits himself to an investment that offers a 6% return. Thanks to the interest rate changes other alternatives now provide a higher interest rate. The investor now misses out on the added interest made available in other investments. These interest rates further affect the price of the securities too. 

It is generally debt funds or funds with a major portion of their portfolio invested in debt securities that are most susceptible to this risk.

5. Credit Risk

Credit Risk arises when the investment fails to pay the promised interest. Generally, when issuing debt the funds are raised from investors while promising them returns at a given interest rate. But it is not necessary that these rates will be met as the returns are dependent on the performance of the company.

In a situation where the company enters a crisis, it will either default or provide returns at a lower rate. It is always best to look at the credit rating given by agencies like CRISIL, Standard and Poors’s and Fitch, etc.

A simple rule of thumb is an investment with a high rating are safer and better alternatives in comparison to those with lower ratings. It is best to have a look at the quality of the fund portfolio based on the ratings given by these agencies to the individual securities. 

Quick Read

How to Buy Mutual Funds Online in India?

Closing Thoughts

One of the best ways to counter these mutual fund risks is to invest in funds that have diversified portfolios with no or reduced lock-in periods and whose risk appetite suits yours. Remembering the golden rule always goes a long way “Higher the reward, higher the risk”. Happy Investing! 

Face Value of a Share Cover

What is Face Value of Share? And Why is it Important?

Understand the Face Value of a Share: Some of the biggest challenges while entering the world of investing involves dealing with multiple jargons. In this article, we explain a very common confusion in the understanding of Face Value and other related terms.  

What is the Face Value of a Share?

The Face Value of a share in simple terms is the value of the share on paper i.e. the original cost of the share. The face value of the shares is also known as the nominal or par value of a share. When it comes to stocks the face value of a share will be mentioned in the share/bond certificate issued. If you already hold shares or know someone who does you can view the face value of the shares in the Demat Account. 

The face value for most shares in the Indian stock markets is set at INR 10. For example, here is the face value, market cap, and important value for ITC Ltd. (Source – TradeBrains Portal).

 

Face value from TradeBrains Portal

Who sets the Face Value?

The shares of Reliance have a face value of Rs. 10 whereas ITC has a face value of Rs. 1. If we take a look at the global markets Apple has a face value of $0.00001. So who sets this amount or through what computation do we arrive at this figure? 

First of all, it is important to understand that there is no fixed method or regulation for setting up the face value. These values are assigned arbitrarily by the company when the company gets listed on a stock exchange through an Initial Public Offer (IPO). 

The value however may affect the volatility of the shares in the market post the IPO. Take for example two companies ABC Ltd. and XYZ Ltd opt for an IPO to raise Rs. 1,00.000. ABC Ltd sets its share price at Rs. 10 and XYZ set its price at Rs. 1. This means that post the IPO ABC Ltd. will have 10,000 shares available in the market and XYZ Ltd. 1,00,000 shares. This means that there are more individual shares of XYZ Ltd. for purchase.

ALSO READ

Stock Market Basics for Dummies – What Beginner Need to Know?

What is the difference – Face Value vs Market Value?

Face value document

Another very important point to note is the difference between the face value and the market value of a share. These two have no relation and do not affect each other except in some special circumstances.

Let’s take again the example of the 3 companies mentioned above. The shares of Reliance, ITC, and Apple have a market value of Rs. 2005.35, Rs. 213.25 and $127.90 respectively. These values vary greatly from the face values we observed earlier. 

The Market Value is arrived at due to the factors of demand and supply for the particular share in the market. A greater demand oversupply would show an increase in the market value and vice versa the price will fall.

The shares we saw above have a high market price because they are highly demanded as long as they maintain good growth and give good return prospects. Their market value may fall too if the company begins performing poorly affecting the demand for the shares. The factors of demand and supply will have no impact on the face value of the shares.

Why is the Face Value Important? 

Multiple Dollar Notes

Being a prospective investor you must be wondering if the face value is not the price at which you eventually buy/sell the shares then why is it even important. The Face Value is used in the internal accounting for the company’s stock. One can find the face value used in the balance sheet to arrive at the total equity capital.

In addition to this, face-value also plays a very important role in corporate action. These include corporate actions like dividends, stock splits, reverse stock splits, etc. When it comes to dividends the face value sets a standard for the calculation of return rates or yield. Stock Splits on the other hand are one of the special occasions where both the face value and the market price are affected. 

Closing Thoughts

That’s all for this article. Let us know if the article helped in clearing doubts related Face Value of a stock.

You can read the difference between Face Value, Market Value & Book Value to get more insights. Also, comment on which other jargon you would like us to cover in our next post. Welcome to the world of investing. All the best!

Stock Market Basics - A Complete Guide to Share Market for Beginners!

Stock Market Basics for Dummies – What Beginner Need to Know?

Understanding the Stock Market Basics for Beginners: Are you feeling caught up in the stock market frenzy where literally everyone you know has begun speaking in market jargon? This is a position I too found myself in a few years back.

Don’t worry as we have decided to cover some basics in order to get your foot in the door. This article covers the stock market basic topics like What are shares, why are they issued, why are they bought by us, and more. Keep Reading!

What are Shares?

One could say that Shares are the most popular financial instruments available for investments. A Share, also known as equity or stock, represents a unit of ownership of a particular company. The total capital of a company is divided into smaller equal units and each unit is known as a share.

The owner of the share will have a right to vote and benefit from the profits of the company and suffer the losses that the company makes. Investors who hold shares of a company are known as shareholders. The influence a shareholder will have on a vote or his profits/losses will depend on the total number of shares held.

Take for eg. ABC Ltd. has a market capitalization of Rs. 10 Lakh. Each share has a face value of Rs. 100, meaning that there are a total of 10,000 shares. A shareholder owning 1,000 shares will own 10% of the company. His vote will carry the same weight and will be entitled to the same portion of profits passed on to the shareholders as dividends. 

Let us take another example of stock from the Indian Share Market. For example, Tata Consultancy Services (TCS) has a total of 375.24 Crores of outstanding shares in the market. Out of all these shares, 72.05% are held by the promoters i.e. the Tata Group as of Jan 2021. The remaining shares are held by the Public, Domestic Institutional Investors (DII), Foreign Institutional Investors (FII), etc. If you’ve got 1,000 shares of TCS, then you own approximately (1,000/375.24 Cr)th part of the company.

As you own more shares of that company, your ownership in that company will increase and you’ll be entitled to more benefits like voting dividends, voting rights, etc. However, if the company doesn’t perform well, you’ll also be entitled to losses made by the firm as you’re also the partial owner of the company.

How many shares can be issued by a company?

There is no upper limit on the number of shares that a company can issue. They depend on the capital a company raises and the denomination it sets.

For Example, if ABC Ltd. had issued shares at a face value of Rs.10 for a total valuation of Rs 10 Lakhs, then ABC Ltd. would have a total of 100,000 shares at the same capital. However, the minimum number of shares however is 1. 

Stock market basics – How much is a share worth?

The face value or the intrinsic value of a share is set at the time when capital is raised by a company. Generally, it could be at Rs. 5, Rs. 10, Rs. 100 etc. The value of the total shares held here out of the total capital would show one’s ownership within a company. 

The market value of a share however is different. This is the value at which an investor like you and me can buy a share.

The market value of a share is dependent on the forces of demand and supply. These factors affect the price of shares just like commodities. Say the demand exceeds the supply of shares or availability of shares in the secondary market (stock exchanges) then the prices will shoot up. Vice versa and the shares will fall down.  

Once a company enters the share market, there is a share price associated with all the public companies at which investors and traders can buy and sell its stock. For example, 1 Share of TCS is currently trading at Rs 3,266.50. You can find the share price of all the public companies at any financial research websites like Trade Brains Portal.

Different Types of Shares

There however are many different types of shares. When considered on the basis of ownership:

— Preferential Shares 

These shares are preferential in nature. Investors who hold preferential shares are entitled to receive preferential treatment when it comes to profits of the company, in the event of the company winding up over equity shares. Preferential shareholders however do not have any voting rights.

— Equity Shares

In simpler terms, these are the regular shares that are available in the market. They make up most of the shares of a company. Equity Shareholders do have voting rights but are paid after preferential shareholders or in the case of the company winding up.

Also Read

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Why do companies issue shares or Why do companies go for IPO?

ipo stock market

The first time when a private company enters the stock market and offers its shares to the public, it is called an Initial Public Offering or IPO or Going Public. The basic reason why companies issue their shares or go for an IPO is to raise capital or funds. 

Stock exchanges facilitate the exchange of shares for capital. The process involves shares being offered, shares being allotted to investors, and finally the shares being listed on an exchange where they can be bought and sold. By doing so companies can get access to a wider pool of investors which includes retail and domestic/foreign institutional investors.

Take the example of Tesla. Once Elon Musk sold PayPal he invested his fortunes in SpaceX, Tesla, and SolarCity. The $70 million which he invested in Tesla wouldn’t even get it close to where the company is today. For Tesla to truly grow in order to compete globally it required loads of funds. This was initially met through venture capitalists, but this too isn’t enough. The company opted for an IPO in 2010 raising $226 million. This could however only be possible if Musk was willing to let go of his ownership in the form of shares issued.

Similarly in India, there are a lot of private companies like Zomato, Paytm, Flipkart, Patanjali, etc whose shares are owned only the promoters currently, If they want to raise big money, they can offer their shares to the public via an IPO and enter the Indian stock market.

Now let’s take a look at why investors buy these shares?

Stock market basics – How do people make money from the Stock Market?

The main purpose of investors buying shares of a company is to make money. In the stock market investors make money in two ways. 

— Long Term Investing

The initial investment made by an investor in a company has the potential to grow at rates exceeding interest offered by savings accounts by multi-folds. Hence it is always advisable to stay invested in a stock for the long term.

Take the example of Bajaj Finance whose shares were worth Rs. 70.36 on 31 December 2010 is worth over Rs. 5200 today in April 2021. If you would have bought 100 shares of Bajaj Finance in 2010 at an initial investment value of Rs 7,036, your current investment value would be Rs 5.2 lakhs. Anyways, these investments must only be made after careful analysis of the company’s financials and if the shares are available at a cheaper price than their actual worth.

One of the best examples of long-term investors holding stocks for many years is Warren Buffet, whose net worth briefly exceeded $100 billion this year. 

Companies also reward those who stay invested through means dividends, bonus shares, right issues, etc. A portion of the profits of a company is distributed as dividends for each share held.

— Stock Trading 

Trading basically refers to the buying and selling of shares on a regular basis in the short term to make profits. These traders set strategies to take advantage of both rising and falling markets by buying and selling shares in a short time frame. Their profits however are infrequent and smaller per trade.  

How to Start Investing in Share Market?

Step 1: Learn the Basics

Step 2: Set up your brokerage account

Step 3: Research stocks & start investing

ALSO READ

How to Invest in Share Market in India? An Ultimate Beginner’s Guide!

Closing Thoughts

Now that you have understood the stock market’s basic terms like shares and why they are issued it is time to keep taking these baby steps as the world of investing is vast. Check out our article on How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?

Hope you have liked this small guide on some stock market basics. Let us know what other topics you would like us to cover. Welcome to the world of investing. All the best!

Free Float Market Capitalization Cover

What is Free Float Market Capitalization? MCap Methodology Explained!

FREE Float Market Capitalization: As a novice investor have you ever come across terms like Market Cap (MCpap) or the free float factor. In this article, we cover what is Market cap, how the MCap is computed, What is free-float market capitalization, and why it is necessary. Keep reading to find out.

What is Market Cap or MCap?

Stock Market Chart - Free Float Market Capitalization

Market Capitalisation (Mcap) gives investors the public perception of what a company is worth and is also used to further classify companies. It is calculated by multiplying all the company’s shares by the price of each stock in the market. Doing this gives us the total value of all the shares being traded in the market.

This figure gives investors an idea as to what the company is worth including its future prospects and what other investors are willing to pay for it in the present. Based on the MCap companies are further classified into

  • Large-cap companies – Rs 28,500 crore or more.
  • Mid-cap companies – above Rs 8,500 crore but less than Rs 28,500 crore.
  • Small-cap companies – less than Rs 8,500 crore

There are multiple ways to measure the market capitalization of a company. The two of the most commonly used methods are the total market capitalization method and free-float market capitalization. You can use TradeBrains’ portal to see the market capitalization of all the major Indian companies.

Let us have a look at how MCap is calculated in each of these methods along with examples. 

Free Float Market Capitalization Method

The shares can be further classified based on their ownership. Say shares may be held by retail investors or institutional investors, promoters, government, etc. What Free-float MCap does is it only includes shares that are readily available for trading in the secondary market.

Certain shares like those held by promoters are not freely traded in the market. The aim of this method is to distinguish between shares held for strategic control and others who invest based on the stock price.

According to the BSE, the following shares are to be excluded when computing MCap under free float:

  • Shares held by founders/directors/acquirers which have a control element
  • Shares held by persons/ bodies with “Controlling Interest”
  • The Shares held by the Government(s) as promoters/acquirers
  • Holdings through the FDI route
  • Strategic stakes by private corporate bodies/ individuals
  • Equity held by associate/group companies (cross-holdings)
  • Equity held by Employee Welfare Trusts
  • Locked-in shares and shares which would not be sold in the open market in the normal course

Therefore Free Float Mcap = (OUTSTANDING SHARES – Restricted Shares) * Price of shares in the market

For eg. ABC Ltd. has a total of 100,000 outstanding shares. Out of these 30,000 are held by the promoters. Apart from this, no other shares are restricted i.e. 70,000 shares are available to be freely traded in the market. If the shares are traded in the market at Rs. 50 it would mean that the MCap for the company under Free Float is Rs. 35,00,000. ( Rs. 50 * 70,000 shares)

Full Market Capitalization Method

Now let us understand the full market capitalization method which will help us better understand the difference between the two.

Under this method, the capitalization is computed using the total number of shares which include both the publicly available and the shares that are privately available. So under this method, the MCap of ABC Ltd. will be Rs. 50,00,000 ( Rs. 50 *100,000 shares).

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What is the Free Float Factor and How is calculated?

The free float factor gives us an idea of how many shares are freely available for trading in comparison to those total which also includes the privately held shares in the company. This gives traders and investors an idea of the number of shares that are available for trading.

Take once again the example of ABC ltd. the free float factor for the company will be 0.70. We arrive at this by dividing the shares available for trading to the public by the total shares outstanding i.e. 70,000 shares/ 100,000 shares. 

Why is Free Float MCap preferred over Total MCap?

The Free Float Market Capitalization is preferred mainly because it presents a valuation that shows the total number of shares that actually affect traders and investors who are participating in the market. Rather than include shares that are privately owned and cannot be accessed by anyone.

In addition, these restricted shares don’t play a role among the demand and supply factors for setting the price in the market. This allows the free float MCap to represent the sentiments of the market more accurately. This would not be possible in the case of Total MCap where a promoter or government holding a majority can have any influence.

Free Float is considered the best method globally in all stock exchanges. In India, both the NSE and the BSE use free float for their indexes i.e. Nifty and Sensex.

Does the Free Float Market Capitalization Matter?

The Free Float Market Capitalization allows investors to differentiate companies with the smaller free-float size and those with medium and large. It is important to note that the free float MCap is inversely proportional to the volatility of the shares in the market.

Companies with a lower free float factor would mean that it is easier for traders to influence the price. Companies having a higher free float factor would show a more stable stock as it is harder for a few large trades to influence the price.

The free float factor helps investors weed out the stocks to include only those that help meet their goals. Some investors may only prefer stocks with a large free float factor as they represent less volatile stocks.  

Closing Thoughts

The MCap and the free float factor are important criteria to look at while investing. In addition to this, they also have become exceptional instruments to ensure balance in investors’ portfolios and to weed out stocks. One must however carefully evaluate these factors before investing in a company.

Let us know your views about the post in the comments section below. If you are looking for a beginner’s guide on how to invest in the share market in India, you should check the article on our website. Happy Investing!

Moat Companies in India Cover

Top Moat Companies in India – Warren Buffett Style of Stocks!

List of Top Moat Companies in India: Have you ever wondered, if the greatest investor existed in the Indian stock markets, “What stocks would he pick?”. This question got us wondering about Warren Buffet too. Hence we have created a list of Buffets favourite type of stocks existing in the Indian stock market.

In this article, we’ll cover the list of top moat companies in India, which is the Warren Buffett style of stocks for investing. Keep Reading!

Warren Buffett Photo | Moat Companies in India

What are Moats?

The term Moat was popularised by Warren Buffet in the world of investing.

A simple dictionary definition of a moat would be – a deep, wide ditch surrounding a castle or fort, typically filled with water and intended as a defence against attack. These moats were created in medieval times in order to ensure that in the case of an attack it would make it as hard as possible for an enemy to breach the castle.

However, even modern companies have moats too in their businesses.

History of Moat | Moat Companies in India

Now picture the company as a castle and the attackers as new entrants or competitors. Business moats are generally put up by the company as some sort of competitive advantage that would act as a barrier to entry for new entrants. These could be in the form of brand identity, patents, size or market share, low-cost production, etc.

Warren Buffet has time and again expressed his love for these Moats stocks. 

“The most important thing [is] trying to find a business with a wide and long-lasting moat around it … protecting a terrific economic castle with an honest lord in charge of the castle,” – Warren Buffet

Top Moat Companies in India

Here we have compiled a list of Moats existing in the Indian markets. Possibly answering the question, “If Warren Buffet participated in the Indian markets, whats stocks would he invest in?”

1. Asian Paints

Asian Paints Logo

Asian Paints is one of the most obvious stocks on this list. The company was founded in 1942 and is engaged in the manufacturing, selling and distribution of paints, coatings, products related to home decor, bath fittings and providing of related services.

Over the years the company was successful in converting the paint commodity into an Asian Paints brand. They currently are India’s largest with a market share of almost 40%. It is also Asia’s 3rd largest paint company. In addition, the company has also maintained a good track record for consistent growth.

2. Shree Cements

Shree Cements limited logo

The next one on the list of moat companies in India is Shree Cements. The shares of Shree Cements are one of the most expensive cement stocks in the world. The company was formed in 1979 and is currently one of the biggest cement manufacturers in the country.

They recently joined an elite list of companies with Rs. 1 trillion Mcap. One of the biggest moats the company has set for itself has been its low production cost in the cement industry. The company has an EBITDA/tonne of Rs. 933/tonne whereas the industry average stands at only Rs 692/tonne.

3. TCS

TCS logo

Tata Consultancy Services recently surpassed Accenture to become the worlds largest IT firm by Mcap. TCS is a subsidiary of the Tata Group. The company is specialized in information technology (IT) services and consulting. They currently operate in 46 countries.

One of the biggest advantages was being the first software and services company in India in 1968 and also being the first Indian software company to set up operations in the US. They were also the first Indian company to develop an offshore delivery model giving them a cost edge.

Apart from its size being a significant moat they also benefit hugely from switching costs their clients may face. They still benefit from the first-mover advantage in the US as 95% of their new businesses come from their existing clients.

What we’re trying to find is a business that, for one reason or another — it can be because it’s the low-cost producer in some area, it can be because it has a natural franchise because of surface capabilities, it could be because of its position in the consumers’ mind, it can be because of technological advantage, or any kind of reason at all, that it has this moat around it.” – Warren Buffet.

4. Avenue Supermarts

DMart (Avenue Supermarts) Owner RK Damani

Avenue Supermarts Ltd. better known as DMart is an Indian chain of hypermarkets founded by Radhakishan Damani in 2002. They are spread across the country with 196 stores in 72 cities.

Again one of the biggest advantages the hypermarket has is its size. This helped it set up a moat by providing one of the lowest costs to its consumers. Due to their size, they are able to generate huge volumes of sales which allows them to negotiate the price of products at a cheaper rate from suppliers when buying in bulk. This results in products sold at lower costs in their stores in comparison to other competitors.

Also Read

10 Indian Companies with Monopoly in Their Industry!

5. Titan

Titan products | Moat Companies in India

Titan has been one of the greatest wealth creators in modern times. It is also responsible for creating a major chunk of the Big Bull- Rakesh Jhunjhunwala’s wealth. Titan, founded in 1984 is part of the Tata Group.

They are a lifestyle company engaged in the manufacture and sale of fashion accessories such as watches, jewellery and eyewear. They also introduced the Fastrack brand in the Indian markets and own over 60% of the domestic market share in the organized watch market. Titan is also the fifth-largest watch manufacturer in the world.

They sell jewellery through their Tanishq brand which is the largest branded jewellery maker in India. Titans brands like Tanishq enjoy strong customer loyalty giving them added advantages over their competitors.

6. Dr Lal Pathlabs

Dr Lal Path Labs Logo | Moat Companies in India

Dr Lal PathLabs Limited was founded in 1949 by Dr S. K. Lal. They perform diagnosis and testing on blood, urine and other human body viscera. The company operates on a hub and spoke distribution model which allows it to have greater flexibility and further extending its network.

The company has over 200 clinical labs across the country with 2,569 Patient Service Centers (PSC) and 6,426 Pick-up Points (PUP). This model puts it at an advantage in comparison to other standalone chains.

They also have a strong franchisee network furthering their reach and at the same time reducing their capital expenditure. The company has achieved good growth over the years and at the same time maintaining good financials.

“But we are trying to figure out what is keeping — why is that castle still standing? And what’s going to keep it standing or cause it not to be standing five, 10, 20 years from now. What are the key factors? And how permanent are they? How much do they depend on the genius of the lord in the castle?” – Warren Buffet.

7. Bajaj Finance

Bajaj Finance Limited Logo

 

Bajaj Finance has been one of the greatest wealth creators in the Indian markets in the last decade. It also makes it the most expensive NBFC stock. The company is a subsidiary of Bajaj Finserv and is one of the moat companies in India.

The company deals in consumer finance, wealth management and loans to SMEs. It has 294 consumer branches and 497 rural locations with over 33,000+ distribution points. Its attractive car, housing, small business loans and other commercial loan products have helped it achieve a customer base of 34.5 million in 2019.

One of their biggest loans has been cross-selling. Here Bajaj Finance has the ability to offer products to its existing customers. Cross-selling has helped it achieve to acquire 19.7 million customers.

8. Pidilite

Pidilite Products | Moat Companies in India

Founded in 1959, Pidilite Industries Limited is an Indian adhesives manufacturing company. Their brands include FeviKwik, Dr Fixit, M-seal, Acron etc.

Their leading brands have a 70% market share in the Indian adhesive and industrial chemical market. There are very little competitors can do when accompany owns such a large portion of the market.

And then if we feel good about the moat, then we try to figure out whether, you know, the lord is going to try to take it all for himself, whether he’s likely to do something stupid with the proceeds, et cetera.” – Warren Buffet.

9. Maruti Suzuki 

Maruti Suzuki Products | Moat Companies in India

Maruti Suzuki India Limited is the subsidiary of the Japanese auto manufacturer Suzuki Motor Corporation. The company has successfully maintained a market share of 50% for many years now in the Indian markets.

Other companies have been able to do very little over the years to capture a significant portion of the market. The runner up Hyundai only holds a market share of 17%.

10. SBI

State Bank of India (SBI) Logo

The State Bank of India (SBI) is India’s largest bank. The government-owned company holds a market share of 23% in terms of assets and 25% market share for total loans and deposits.

SBI is the biggest bank in India in terms of total assets. One of the biggest moats for the company has been the salary accounts being opened for all government employees. This also further allows them to cross-sell their products to their existing customer base. Another private equivalent to SBI has been HDFC. Recently Kotak Mahindra too signed an MoU with the Indian army to handle salary accounts. 

Closing Thoughts 

Investors like Warren Buffet make it seem too easy to find high-quality companies with wide moats. But identifying these moat stocks before they erupt and buying them at a fair price is challenging. Companies with moats can provide huge returns to their shareholders in the long run but it is very important to thoroughly research the stocks before investing as there are no guarantees.

We hope you have liked the list of best Moat companies in India. You may read about an economic moat and get more insights. Do let us know in which company you have invested or would like to invest in the comment section below. Happy Investing!

Debenture Explained What is Debenture Definition, Meaning, Types & more cover

Debenture Explained: What is Debenture? Definition, Types & more!

Understanding what is Debenture: Investors are always on the lookout for financial instruments to enhance their portfolios. One such instrument is Debentures. In this article, we will answer the questions like – what is debenture, what kind of investments they are, and how they work. Let’s get started.

What is Debenture?

Man holding money | What is a debenture

Debentures are debt instruments used by corporations to secure long-term debt. These instruments pay an interest rate (coupon rate) to the investors. At the same time, they exist for a limited period post which the capital is redeemed or repaid to the investors (debenture holders).

Corporations prefer to issue debentures as their features can be adjusted to the requirements of the company. For eg., they generally have a lower interest rate and longer repayment periods in comparison to traditional loans. 

The interest paid to debenture holders is paid out of the profits made by the company. Debenture holders are given priority over the shareholders for the interest payment. The interest due to debenture holders is paid to the debenture holders first from the profits and the remaining may be utilized for dividends etc. Also in the case of liquidation of a company,  debentures have priority over preferential and equity shares.   

These securities do not have any collateral, hence are unsecured. As debentures are unsecured investors buy these securities based on the creditworthiness, financials, reputation, and faith an investor has in the entity issuing it. 

However, it is also important to note that the word Debenture may have different meanings in different parts of the world. What we have seen so far represents debentures in India and countries like the US. In the UK however, debentures are unsecured. They represent documents that grant the lenders a charge over the asset. This gives the lenders a means of collecting their money back in the case of a default.

Components to look before investing in a Debenture

Debentures have 3 basic components and they should be looked into carefully before investing in:

1. Credit Worthiness

Credit rating agencies | Debentures

Since debentures are unsecured instruments it is very important to find out whether the company issuing them will actually be able to repay the debt. One must carefully look into the financials and the track record of the company before investing in them.

Investors can also make use of the credit ratings of the company. These are provided by credit rating agencies like Standard and Poor’s, Moody’s, and Fitch Ratings. Ratings are given to the companies based on a scale set by these agencies based on the creditworthiness of the borrower. Companies receiving the excellent rating are good investment option over companies receiving rating lower on the scale

2. Coupon Rate

Another important factor is what returns will the debenture be providing to investors. The coupon rate represents the yield or payment made by fixed income securities on their face or par value. This rate is either fixed or floating i.e. it can be fixed or constant at one rate or set as floating which changes.   

3. Maturity Date

The date of maturity is very important when it comes to debentures. It represents the date on or before which the company must pay back the debenture holders. The company may pay back the capital amount raised by debentures on this date which is generally the case. Or the company may pay a specific amount each year until the date of maturity.

ALSO READ

The Fundamentals of Stock Market- Must Know Terms

Risks Associated with a Debenture

As with every financial instrument, there are also few risks involved with debentures. Since debentures are unsecured they carry the risk of default. Debentures also carry interest rate risks.

Further, as debentures are issued over long periods debenture holders might find themselves receiving lesser returns from debentures over time in comparison to other investment options. It is also possible that the interest rate provided may be overtaken by the inflation rate.  

What are the types of debentures?

Debentures can be classified into 2 categories based on their convertibility

1. Convertible Debentures

Convertible Debentures are those which can convert into equity shares of the issuing corporation after a specific period. Here the debenture holders have the option to either hold the debentures until maturity and receive the interest payments on them. Or they can convert the debentures into equity shares.

2. Non-convertible Debentures

Non-convertible debentures (NCD) or traditional debentures are those which cannot be converted into shares or equities. NCD interest rates depend on the company issuing the NCD.

What is the difference between Debenture and bond?

A debenture is an unsecured type of debt issued by a company. They are issued simply based on the creditworthiness of the company.

A bond similar to a debenture is meant for companies and countries to raise capital providing interest in return. Bonds however are secured and backed by a specific asset of the issuer.  

ALSO READ

What are Bonds? And How to Invest in them in India?

Closing Thoughts

In this article, we explained what is debenture. In a nutshell, debentures are an important source of funds for companies. In addition to this, they also have become exceptional instruments used to balance the portfolios of investors.

One however must invest in debentures only after careful evaluation of the creditworthiness of the company and other aspects like coupon rate, expiry date, etc. Hopefully, we were able to answer – what is Debentures. Happy Investing!

neo banks - What are Neo banks And what is its future in India!!

What are Neo banks? And What is its Future in India!!

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

What are Neo banks?

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

Walrus logo

  • Niyo

Niyo Logo

  • InstantPay

InstantPay logo

  • RazorPayX

RazorPayX logo

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 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. 

How to Analyze the Management of a Company for Investing cover

How to Analyze the Management of a Company for Investing?

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?

warren buffett quote company management

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.

ALSO READ

What is Qualitative Analysis of Stocks? And How to Perform it?

6. Key Directors and chairman

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 the Share Price of a company is a function of market forces. 

amazon jeff bezos quote

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!

How to Invest in Share Market in India? An Ultimate Beginner’s Guide!

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:

  1. Bank Savings account
  2. Trading and Demat account
  3. Computer/laptop/mobile
  4. 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:

  1. PAN Card
  2. Aadhar card (for address proof)
  3. Canceled cheque/Bank Statement/Passbook
  4. 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.

Also read: 7 Things to do Before You Start Investing

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

11 Key Difference Between Stock and Mutual Fund Investing cover

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.

Quick Note: Stockbrokers like Zerodha allow investors to schedule their investments via Systematic Investment plans for stocks.

Step 3: Read some investing books.

7 Best Value Investing Books That You Cannot Afford to MissThere 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:

  1. Full-service brokers
  2. 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.

Read more here: Full service brokers vs discount brokers: Which one to choose?

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.

open account with zerodha

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).

In short, if you are planning to open a new trading account, I would recommend opening accounts in a discount broker so that you can save lots of brokerages. If you’re interested to open your account with Zerodha, here’s the direct link to fill account opening application!

Zerodha-open-an-account

Related Posts:

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.

Also read:

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:

  1. The stocks that you are interested in and need to study/investigate,
  2. Those stocks that you have already studied and found decent,
  3. 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:

  1. When you badly need money
  2. When the stock fundamentals have changed
  3. When you find a better investment opportunity and
  4. 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.

Also read: How to create your Stock Portfolio?

3. Invest in blue-chip stocks (for beginners)

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.

Also read: What are large-cap, mid-cap and small-cap stocks?

4. Never invest in ‘FREE’ tips/advice

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.

Related post: 6 Reasons Why Most People Lose Money in Stock Market

6. Invest in what you know and understand

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.

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

8. Have discipline and follow your plan/strategy

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.

what are the roles of depositors CDSL and NSDL

CDSL and NSDL – What are the Roles of Depositors?

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.

nsdl vs cdsl - What are the Roles of Depositors?

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.

Also read: What is SEBI? And What is its role in Financial Market?

Closing Thoughts

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. 

Eligibility Criteria for an IPO going public norms

Eligibility Criteria for an IPO: Requirements for a company to Go Public!

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.
  • If the 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.
  • If the 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.

  1. The ultimate promoters are unidentifiable;
  2. the purpose for which the funds are being raised is vague;
  3. 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;
  4. 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
  5. Outstanding litigation that is so major that the issuer’s survival is dependent on the outcome of the pending litigation.

Also read: How to Invest in Share Market? A Beginner’s Guide!

Closing Thoughts

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.

what are commodities and What is Commodity Trading?

What is Commodity Trading? Basics of Commodities in India!

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 commodity trading

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:

commodity quote

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:

  1. Multi Commodity Exchange – MCX
  2. National Commodity and Derivatives Exchange – NCDEX
  3. National Multi Commodity Exchange – NMCE
  4. Indian Commodity Exchange – ICEX
  5. Ace Derivatives Exchange – ACE
  6. 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.

Also read: How to Trade Commodities in India? Step-by-Step Guide for Beginners!

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.  

Understanding what are bonus shares

What are Bonus Shares? And How They Help Investors?

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

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:

Recent bonus shares in India

(Source: Moneycontrol)

Why are bonus shares issued?

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.

How to Trade Commodities in India? Step-by-Step Guide for Beginners!

How to Trade Commodities in India? Step-by-Step Guide for Beginners!

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.

Margin required to trade Commodity in India Margin required to trade Commodity in India

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.

oil trading zerodha futures margin

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.

Watch list of the commodities - How to Trade Commodities in India(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.

limit and market order commodity trading

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!!

What are Black Swan Events in Stock Market cover

What are Black Swan Events in Stock Market?

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.

black swan events

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

  1. They are so rare that the possibility that they might occur is unknown.
  2. They have a catastrophic impact
  3. 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 week Nassim 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.

black swan events quoteThat’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!

How to do Intraday Trading for Beginners In India cover

How to do Intraday Trading for Beginners In India?

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.

margin for different trades intraday tradingIf 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.

margins in intraday trading

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.

intraday trading for beginners

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.

Intraday trading for beginners

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.

Also read: 4 Best Intraday Trading Strategies for Beginners!!

Closing Thoughts

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.

  1. 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.
  2. While trading Intraday, buying and selling of the stocks should be completed within the same day.
  3. Intraday trading could be done for both cash stocks and in the derivatives market also.
  4. It is always advised to have proper risk management (stop loss and target) for all the trades
  5. 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.

What are Preferred Stocks? Meaning, Types, Benefits & More cover

What are Preferred Stocks? Meaning, Types, Benefits & More!

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.

Also read: How to Invest in Share Market? A Beginner’s Guide!

What to look before buying Preference Stocks?

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!

what is Socially Responsible Investing

Socially Responsible Investing (SRI): Why it matters?

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 cover

Also read:

Conclusion

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.

Investing in Foreign Stocks -Advantages and Risks cover

Investing in Foreign Stocks: Advantages and Risks

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.

largest stock exchanges by region

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 

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

currency exchange problems while investing in foreign stocks

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

political factors while investing in foreign stocks

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.

Also read: 3 Easy Ways to Invest in Foreign Stocks From India.

Closing Thoughts

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.