Sky rocketing stocks -- What is the right price?
Investors' dilemma is that they want to participate in the tech rally but the numbers look too high. While many of these gravity-defying stocks aren't worth their current prices, a few are. Here's how to tell the difference and when to buy them.
First, when a stock has stratospheric valuations, there's a reason: extremely high expectations. Investors expect the company to perform in an exceptional way in two areas: growth in revenues and growth in earnings. The challenge for investors is to discern which of these high-flying stocks deserve their attention.
Look for a stock that is essential, better performing. Does that mean you just buy the stock and hope? Definitely not. It does mean you start to monitor it and when the stock misses an earnings report or doesn't grow revenues fast enough, you look to buy. That takes patience. There's also the risk that the company won't make a misstep, and you won't buy it. If it happens that way, it will be the first company in history to do so. Granted the level may be much higher than the current one when you finally buy it, but the value of the stock may be much better. In other words, the P/E would be lower than the current levels.
The characteristics of the stocks you want to focus on are:
Market leaders who dominate their niche. The big tend to get bigger, win more contracts and have the largest R&D budgets.
Earnings that are growing, at an increasing rate, every year.
Revenue growth that exceeds the industry average.
Strong management.
Competing in an high and long-term growth oriented industry sector.
When you find all of these factors in a stock, it won't be a cheap one. But if you want to own it, sometimes you have to pay more than you would like. Currently, that's the entry fee for owning the best stocks in the technology areas. If you are patient and wait for some time you can pick some scrips at a relatively good price.
The key to making the big money with these stocks is to own them for a long time, letting them continue to grow. Even if you buy only a few shares, over time you can do very well as the stock grows, splits, and grows again. Many Infosys shareholders started with 10 shares and now own hundreds. When you buy a great company, you own part of it, so having a small piece of a great one is much better than owning a lot of shares in a loser. If you're interested in making the big bucks, add some sky-rocketting stocks to your portfolio.
Discount sales in most sectors – Buy at a bargain.
There are lot of good stocks available at bargain prices. There are ways of finding the stocks, which are currently out of favor.
First, look for stocks that are out of favor for a temporary reason.
Second, look for stocks within sectors that are currently out of favor.
Third, use the tight screening methods to bring stock into your “Watch List” Here are some of the parameters to use and benchmarks to begin your search:
P/E ratio: Use a minimum of 10 and a maximum of 30. With current P/E ratios closer to 30, stocks with low P/Es can sometimes signal out of favor stocks. When you find these, make sure you're reading all the latest news items and check the analysts' thinking at ICICIDirect.
Price-to-Sales Ratio: Also called PSR. This is a macro way of looking at a stock. Many investors like to find stocks with a PSR below 1. It's a good number to start with, so put in .5 as a maximum and leave the minimum open. Be careful though, because many stocks will always carry a low PSR. You're looking for the stocks that have historically been high and are temporarily low.
Earnings growth: Look for atleast 20 per cent. If you can find a stock that has its earnings growing at 20% and its P/E at 10, you've got something worth investigating further. This is known as the PEG or P/E-to-Growth ratio. Sharp investors are looking for a ratio well below 1. In this example, the stock would have had a PSR of .5 (10/20).
Return on Equity: Start at 20% as the minimum and see who qualifies. The return on equity tells you how much your invested rupee is earning from the company. The higher the number, the better your investment should do.
By using just this combination of variables, you can find some interesting stocks. Try to squeeze your search each time you screen by tightening your numbers on each variable. And when you do find a stock, make sure you read all the relevant information from all the stock resources on the Web.
Should you buy more if the stock you own keeps climbing?
You can buy additional shares if your stock advances 20% to 25% or more in less than eight weeks, provided the stock still shows signs of strength
Cracking Buying Points
Here are some buying points for your reference
1. Strong long-term and short-term earnings growth. Look for annual earnings growth for the last three years of 25% or greater and quarterly earnings growth of at least 25% in the most recent quarter.
2. Impressive sales growth, profit margins and return on equity. The latest three-quarters of sales growth should be a minimum of 25%, return on equity at least 15%, and profit margins should be increasing.
3. New products, services or leadership. If a company has a dynamic new product or service or is capitalizing on new conditions in the economy, this can have a dramatic impact on the price of a stock.
4. Leading stock in a leading industry group. Nearly 50% of a stock's price action is a result of its industry group's performance. Focus on the top industry groups and within those groups select stocks with the best price performance. Don't buy laggards just because they look cheaper.
5. High-rated institutional sponsorship. You want at least a few of the better performing mutual funds owning the stock. They're the ones who will drive the stock up on a sustained basis. 6. New Highs. Stocks that make new highs on increased volume tend to move higher. Outstanding stocks usually form a price consolidation pattern, and then go on to make their biggest gains when their price breaks above the pattern on unusually high volume.
7. Positive market. You can buy the best stocks out there, but if the general market is weak, most likely your stocks will be weak also.
Cracking Selling Point
The decision of when and how much to buy is a relatively easy task as against when and what to sell. But then here are some pointers, which will assist you in deciding when to sell. Keep in mind that these parameters are not independent pointers but when all of them scream together then its time to step in and sell.
1. When they no longer meet the needs of the investor or when you had bought a stock expecting a specific announcement and it didn't occur. Most Pharma stocks fall into this category. Sometimes when they are on the verge of medical breakthroughs as they so claim, in reality if doesn’t materialize into real medicines; the stock will go down because every one else is selling. It's then time to sell yours too immediately, as it didn’t meet your need.
2. When the price in the market for the securities is an historical high. It's done even better than you initially imagined, went up five or ten times what you paid for it. When you get such a spectacularly performing stock, the last thing you should do is to sell all of it. Don't be afraid of making big money. While you liquidate a part of your holding in the stock to get back your principal and some neat profit, hold on to the rest to get you more money; unless there is some fundamental shift necessitating to sell your whole position. To repeat do not sell your whole position.
3. When the future expectations no longer support the price of the stock or when yields fall below the satisfactory level. You need to constantly monitor the various ratios and data points over time, not just when you buy the stock but also when you sell. When most ratios suggest the stock is getting expensive, as determined by your initial evaluation, then you need to sell the stock. But don't sell if only one of your variables is out of track. There should be a number of them screaming that the stock is fully valued.
4. When other alternatives are more attractive than the stocks held, then liquidate your position in a stock which is least performing and reinvest the same in a new buy.
5. When there is tax advantage in the sale for the investor. If you have made a capital gain somewhere, you can safely buy a stock before dividend announcements i.e. at cum-interest prices and sell it after dividend pay out at ex-interest prices, which will be way below the price at which you had bought the stock. This way the capital loss that you make out of the buy and sell can be offset against the capital gain that you had made elsewhere and will hence cut your taxes on it.
6. Sell if there has been a dramatic change in the direction of the company. Its usually a messy problem when a company successful in one business decides to enter another unrelated venture. Such a decision even though would step up the price initially due to the exuberant announcements, it would begin to fall heavily after a short span. This is because the new venture usually squeezes the successful venture of its reserves and reinvesting capability, thus hurting its future earnings capability.
7. If the earnings and if they aren't improving over two to three quarters, chuck out the stock from your portfolio. To get a higher price on a stock, it needs to constantly improve earnings, not just match past quarters. However, as an investor, you need to read the earnings announcements carefully and determine if there are one-time charges that are hurting current earnings for the benefit of future earnings.
8. Cut losses at the right level. But do not sell on panic. The usual rule for retail investor is to sell if a stock falls 8% below the purchase price. If you don't cut losses quickly, sooner or later you'll suffer some very large losses. Cutting losses at 8% will always allow investors to survive to invest another day.
However, this is not exactly the right way to do it. Some investors have certain disciplines: take only a 10% or 20% loss, then get out. Cut your losses, let your winners ride, etc. The only problem with that is that you often get out just as the stock turns around and heads up to new highs. If you have done your homework on a stock, you will experience a great deal of volatility and a 5 to 8 % move in the stock is part of the trading day. To simply get out of a stock that you've worked hard to find because it goes down, especially without any news attached to it, only guarantees you'll get out and lose money. Stay with a good stock. Keep up with the news and the quarterly reports. Know your stock well, and the fluctuations every investor must endure won't trouble you as much as the uninformed investor. In fact, many of these downdrafts are great opportunities to buy more of a good stock at a great price, not a chance to sell at a loss and miss out on a winner.
Sunday, December 26, 2010
The market Talks, Listen to Spot the best
Market Direction.
Is the Market Heading South?
Check out the NSE Nifty and BSE Sensex charts every day. Observe the price and volume changes, there may be some selling on a rising day. The key is that volumes may increase on a day as the index closes lower or is range-bound. Studying the general market averages is not the only tool. There are other indicators to spot a topping market: A number of the market's leading stocks will show individual selling signals. In a falling market start selling your worst performing stocks first. If the market continues to do poorly, consider selling more of your stocks. You may need to sell all your stocks if the market doesn't turn around. If any stocks fall 8% below your purchase price, sell immediately. However, if you have tremendous confidence on the company stick to your pick.
Is the Market Turning Upwards?
After a prolonged fall, the market will try to bounce back and try to rally from the low levels. However, you can't tell on the first or second day if the rally is going to last, you don't buy on the first or second day of a rally. You can afford to wait for a second confirmation that the market has really turned and a new uptrend or bull market has begun. A follow-through will occur if the market rallies for the second time, showing overwhelming strength by closing higher by one per cent with the volume higher than the day's volume. A strong rebound usually occurs between the fourth and seventh session of an attempted rally. Sometimes, it can be as late as the 10th or 15th day, but this usually shows the turn is not as powerful. Some rallies will fail even after a follow-through day. Confirmed rallies have a high success rate, but those that fail usually do so within a few days of the follow-through. Usually, the market turns lower on increasing volume within a few days.
When the market begins a new rally, stocks from all sectors don't rush out of the gates at the same time. The leading industry groups usually set the pace, while laggards trail behind. After a while, the top sprinters may slow down and pass the baton to other strong groups who lead the market still higher.
Investors improve their chances of success by homing in on these leading groups. Investors should be wary of stocks that are far beyond their initial base consolidated point/stage. After the market has corrected and then turns around, stocks will begin shooting out of bases. Count that as a first-stage of a breakout. Most investors are wary of jumping back into the market after a correction. Plus, the stock hasn't done much lately; so many investors won't even notice the breakout. But the fund managers would take buy positions at this stage.
After a stock has run up 25 per cent or more from its pivot point, it may begin to consolidate and form a second-stage base. A four-week or other brief pause doesn't count. A stock should form a healthy base, usually at least seven weeks before it qualifies. Also, when a stock consolidates after rising around 10 per cent, it's forming a base on top of a base. Don't count that it as a second stage.
When the stock breaks out of the second-stage base, a few more investors see this as a powerful move. But the average investor doesn't spot it. By the time the stock breaks out of the third-stage base, a lot of people see what's going on and start jumping in.
When a stock looks obvious to the investment community, it's usually a bad sign. The stock market tends to disappoint most investors. About 50-60% of third-stage bases fail.
But some stocks keep going and eventually form a fourth-stage base. At this point, everybody and their sisters know about this stock. The company's beaming CEO shows up on the cover of business publications. But while thousands of small investors rush into this "sure thing," the top mutual funds may quietly trim or liquidate their holdings.
Most fourth-stage breakouts fail, though not necessarily right way. Some will rise 10% or so before reversing. Fourth-stage failures usually undercut the lows of their old bases.
But a stock can be reborn and begin a new four-base life cycle all over again. All it takes is a sizable correction.
How Do You Define A Bear Market?
Typically, market averages falling 15% to 20% or more.
Buying Volatile Stocks.
Buying at the right moment is the best defence against a volatile market. When the stock of a top-class company rises out of a sound price base on heavy volume, don't chase it more than five per cent past its buy point. Great stocks can rise 20-25% in a few days or weeks. If you purchase at those extended levels, what may turn out to be a normal pullback could shake you out. That risk rises with a more volatile stock.
Caution Signals from the Market!!!
There are several signs in the stock market that suggest caution, even though they're all very bullish. Here are some of them and what they might mean, based on past experience. First, everybody's bullish. If everyone's bullish, that means they've already bought their stock and are hoping more people will follow their enthusiasm. Most individual investors are fully invested. And as long as large inflows are still going into equity mutual funds, everything's fine. Watch out when the flows turn into trickles. There won't be buying power to keep boosting stocks.
Second, fear of the Economy/Political scenario. This is an initial indicator, which would pull of sporadic selling that could eventually mount into an outright bear market.
Third, new records for the SEBI week after week. That’s exuberance and won't continue. The technology sector is leading this market, and there's plenty of growth ahead for the group, but the pricing for many of the tech stocks is way ahead of the earnings. Most of the tech stocks are priced to perfection, meaning that if they don't report earnings above the analysts' expectations, they'll be in for a bashing. Too much good is already priced into many of these stocks. Fourth, a record season for IPOs. While there's always been a push to get financing done when the market is upbeat, this last penultimate (second last) season had been one for the records. Records never last. That's not how the market works. The penultimate season saw IPOs such as Hughes Software, HCL Technologies being subscribed several times over, with premium listings as they opened. This was followed by dismal erosion of value for those IPOs. What followed is issues such as Ajanta Pharma, Cadilla etc, opened at deep discounts. Two emotions drive markets: fear and greed. Usually there is some fear and some greed. Markets usually do best when they climb a wall of fear, meaning that every one expresses fear of investing but stocks continue to go higher. When that sentiment changes to bullish, the market roars ahead. Because the market is depressed, the next psychological state will be fear, and there will be a pull back, nothing severe. This great economy isn't going to stop growing, but many stocks are too far ahead of their numbers and will be pulling back when the market has a bad day.
Go for quality stocks and not quantity
New investors often want to make a quick buck (some old investors do, too). Sometimes you can do that if you get lucky. But the really big money in investing is made from holding quality stocks a long time. Many investors ask for information on cheap stocks. The usual premise is that they don't have much money, and they want to own thousands of shares of something, that way when it goes up, they'll make big money. The problem is these stocks don't go up. They're a scam for the brokers, and the spread between the bid and the ask on these stocks is enormous, making it impossible to sell them at a profit.
Instead of trying to buy thousands of shares of a worthless stock for Rs 10000, let's see what else you can do with it. These examples are all split adjusted and show what that Rs. 10000 can do when you buy the right stocks.
If you had bought Infosys in 1991 for Rs share (split adjusted), you would own n shares
Obviously it's easy to look back to find great stocks. And you had to hold onto these volatile issues to reap these rewards. But the point is that quality stocks are worth holding. In the above examples, the owners have paid no taxes because there have not been any gains taken. The only commission paid was the original one. And as long as the stocks continue to produce good earnings, there's no reason to sell them. Again, it's easy to pick the good ones looking back, going forward, which stocks are the best ones to own?
Do your research thoroughly. Build a portfolio of stocks, one stock at a time, even with Rs 10000. Be sure to diversify over several industries over time. And only buy the best, no matter how few shares that might be. Then be patient, keep up with the news on the stock, and let the stock grow. That's the way the big money is made.
How many stocks should you own?
Buying a large number of stocks is time-consuming and will distract you from focusing on the absolute best stocks. Most investors simply cannot keep track of a large number of stocks, so concentrate on just a few of the best. Use this simple guideline to determine the number of stocks to own:
| Less than Rs. 20,000 | 1 or 2 stocks |
| Rs. 20,000 to Rs. 50,000 | 2 or 3 stocks |
| Rs. 50,000 to Rs. 2,00,000 | 3 to 5 stocks |
| Rs. 2,00,000 to Rs. 5,00,000 | 5 to 7 stocks |
| Rs. 5,00,000 or more | 7 to 10 stocks |
Some more Stock tips
1. New products, services or leadership. If a company has a dynamic new product or service, or is capitalizing on new conditions in the economy, this can have a dramatic impact on the price of a stock.
2. Leading stock in a leading industry group. Nearly 50% of a stock's price action is a result of its industry group's performance. Focus on the top industry groups, and within those groups select stocks with the best price performance. Don't buy laggards just because they look cheaper.
3. High-rated institutional sponsorship. You want at least a few of the better performing mutual funds owning the stock. They're the ones who will drive the stock up on a sustained basis.
4. New Highs. Stocks that make new highs on increased volume tend to move higher. Outstanding stocks usually form a price consolidation pattern, and then go on to make their biggest gains when their price breaks above the pattern on unusually high volume.
5. Positive market. You can buy the best stocks out there, but if the general market is weak, most likely your stocks will be weak also. You need to study our "The market talks. Listen, to spot the best." - Module 8 and learn how to interpret shifts in the market's trend.
6. You should not buy on dips. This is a strategy that doesn't give you a strong probability of making a profit. Remember a stock that has dipped 25% needs to rise 33% to recover the loss and a stock that has dipped 50% needs to double to get back to its old high.
Fundamental Analysis
Fundamental Analysis is a conservative and non-speculative approach based on the "Fundamentals". A fundamentalist is not swept by what is happening in Dalal street as he looks at a three dimensional analysis.
The Economy
![clip_image002[1]](http://investara.blog.co.in/files/2010/12/clip_image0021.gif "clip_image002[1]"){kind=small}
The Industry
![clip_image002[2]](http://investara.blog.co.in/files/2010/12/clip_image0022.gif "clip_image002[2]"){kind=small}
The Company
All the above three dimensions will have to be weighed together and not in exclusion of each other. In this section we would give you a brief glimpse of each of these factors for an easy digestion
![clip_image002[3]](http://investara.blog.co.in/files/2010/12/clip_image0023.gif "clip_image002[3]"){kind=small}
The Economy Analysis
In the table below are some economic indicators and their possible impact on the stock market are given in a nut shell.
| Economic indicators | Impact on the stock market | |
| 1. | GNP -Growth -Decline | -Favourable -Unfavourable |
| 2. | Price Conditions - Stable - Inflation | -Favourable -Unfavourable |
| 3. | Economy - Boom - Recession | -Favourable -Unfavourable |
| 4. | Housing Construction Activity - Increase in activity - Decrease in Activity | -Favourable -Unfavourable |
| 5. | Employment - Increase - Decrease | -Favourable -Unfavourable |
| 6. | Accumulation of Inventories | - Favourable under inflation - Unfavourable under deflation |
| 7. | Personal Disposable Income - Increase - Decrease | -Favourable -Unfavourable |
| 8. | Personal Savings | - Favourable under inflation - Unfavourable under deflation |
| 9. | Interest Rates - low - high | -Favourable -Unfavourable |
| 10. | Balance of trade - Positive - Negative | -Favourable -Unfavourable |
| 11. | Strength of the Rupee in Forex market - Strong - Weak | -Favourable -Unfavourable |
| 12. | Corporate Taxation (Direct & Indirect - Low - High | -Favourable -Unfavourable |
The Industry Analysis
Every industry has to go through a life cycle with four distinct phases
i) Pioneering Stage
ii) Expansion (growth) Stage
iii) Stagnation (mature) Stage
iv) Decline Stage
These phases are dynamic for each industry. You as an investor is advised to invest in an industry that is either in a pioneering stage or in its expansion (growth) stage. Its advisable to quickly get out of industries which are in the stagnation stage prior to its lapse into the decline stage. The particular phase or stage of an industry can be determined in terms of sales, profitability and their growth rates amongst other factors.
The Company Analysis
There may be situations were the industry is very attractive but a few companies within it might not be doing all that well; similarly there may be one or two companies which may be doing exceedingly well while the rest of the companies in the industry might be in doldrums. You as an investor will have to consider both the financial and non-financial aspects so as to form a qualitative impression about a company. Some of the factors are ![clip_image002[4]](http://investara.blog.co.in/files/2010/12/clip_image0024.gif "clip_image002[4]"){kind=small}
History of the company and line of business ![clip_image002[5]](http://investara.blog.co.in/files/2010/12/clip_image0025.gif "clip_image002[5]"){kind=small}
Product portfolio's strength ![clip_image002[6]](http://investara.blog.co.in/files/2010/12/clip_image0026.gif "clip_image002[6]"){kind=small}
Market Share ![clip_image002[7]](http://investara.blog.co.in/files/2010/12/clip_image0027.gif "clip_image002[7]"){kind=small}
Top Management ![clip_image002[8]](http://investara.blog.co.in/files/2010/12/clip_image0028.gif "clip_image002[8]"){kind=small}
Intrinsic Values like Patents and trademarks held ![clip_image002[9]](http://investara.blog.co.in/files/2010/12/clip_image0029.gif "clip_image002[9]"){kind=small}
Foreign Collaboration, its need and availability for future ![clip_image002[10]](http://investara.blog.co.in/files/2010/12/clip_image00210.gif "clip_image002[10]"){kind=small}
Quality of competition in the market, present and future ![clip_image002[11]](http://investara.blog.co.in/files/2010/12/clip_image00211.gif "clip_image002[11]"){kind=small}
Future business plans and projects ![clip_image002[12]](http://investara.blog.co.in/files/2010/12/clip_image00212.gif "clip_image002[12]"){kind=small}
Tags - Like Blue Chips, Market Cap - low, medium and big caps ![clip_image002[13]](http://investara.blog.co.in/files/2010/12/clip_image00213.gif "clip_image002[13]"){kind=small}
Level of trading of the company's listed scripts ![clip_image002[14]](http://investara.blog.co.in/files/2010/12/clip_image00214.gif "clip_image002[14]"){kind=small}
EPS, its growth and rating vis-à-vis other companies in the industry. ![clip_image002[15]](http://investara.blog.co.in/files/2010/12/clip_image00215.gif "clip_image002[15]"){kind=small}
P/E ratio ![clip_image002[16]](http://investara.blog.co.in/files/2010/12/clip_image00216.gif "clip_image002[16]"){kind=small}
Growth in sales, dividend and bottom line
Value, Growth and Income
Growth, Value, Income and GARP are one of the most rational ways of stock analysis. A brief on each of them is given here for your understanding.
Growth Stocks
The task here is to buy stock in companies whose potential for growth in sales and earnings is excellent. Companies growing faster than the rest of the stocks in the market or faster than other stocks in the same industry are the target i.e the Growth Stocks. These companies usually pay little or no dividends, since they prefer to reinvest their profits in their business. Individuals who invest in growth stocks should make up their portfolio with established, well-managed companies that can be held onto for many, many years. Companies like HLL, Nestle, Infosys, Wipro have demonstrated great growth over the years, and are the cornerstones of many portfolios. Most investment clubs stick to growth stocks, too.
Value Stocks
The task here is to look for stocks that have been overlooked by other investors and that which may have a "hidden value." These companies may have been beaten down in price because of some bad event, or may be in an industry that's looked down upon by most investors. However, even a company that has seen its stock price decline still has assets to its name-buildings, real estate, inventories, subsidiaries, and so on. Many of these assets still have value, yet that value may not be reflected in the stock's price. Value investors look to buy stocks that are undervalued, and then hold those stocks until the rest of the market (hopefully!) realizes the real value of the company's assets. The value investors tend to purchase a company's stock usually based on relationships between the current market price of the company and certain business fundamentals. They like P/E ratio being below a certain absolute limit; dividend yields above a certain absolute limit;
Total sales at a certain level relative to the company's market capitalization, or market value. Templeton Mutual funds are one of the major practitioners of this strategy.
Growth is often discussed in opposition to value, but sometimes the lines between the two approaches become quite fuzzy in practice.
Income.
Stocks are widely purchased by people who expect the shares to increase in value but there are still many people who buy stocks primarily because of the stream of dividends they generate. Called income investors, these individuals often entirely forego companies whose shares have the possibility of capital appreciation for high-yielding dividend-paying companies in slow-growth industries.
Keep investing, panic not on your existing stocks
Here's the best tip we can give you if the volatility in the market has spooked you or if you had seen a large profit wash away in the falling market: ignore your stocks right now and keep your investing attention to something else.
Focus all your efforts and time on the company your stock represents. That's because there are really two elements at work when investing: the stock, which is part of the stock market, and the company, something the stock is supposed to represent. But the company works in a different universe from the stock market, involved more in the real world of profits and losses rather than the emotional tide of fear and greed, the two major forces behind the stock market. With the uncertainty prevailing in the market, fear is rampant and some of it is justified, but there are lots of good companies that might be hammered by that emotion. That's why you'll do better if you research your companies in depth rather than trying to figure out if the morning sell off is the beginning of the end or just a hick up on the road to true wealth. But let's say you've done all your numbers, and everything looks great. You've checked for the latest news and you still can't tell why your stock is down. Then you might want to call the company directly and ask for the Investor Relations department. Don't expect the investor relations person to tell you any secrets or unpublished information but you can ask a few questions and get a better feeling about the company:
1. Why is the stock down so dramatically? Are there rumours the company has heard?
If so, what is the company's response to them.
2. Is there anything the company can say about the stock being down?
3. Are the officers of the firm buying or selling the stock?
4. Is the company buying its own shares right now?
You will hence get a sense of how the company is responding to its stock being down, and maybe hear about news that has just been published but you haven't read. Then, when you've done all you can to determine that the company in which you've invested is indeed doing everything well, you can ignore the stock and be assured that this too shall pass. If you determine that the stock is down for a good reason and seems to be going lower, then you can sell it and move on to another company. In either case, you can make a decision based on the company and not the stock.
The P/E ratio as a guide to investment decisions
Earnings per share alone mean absolutely nothing. In order to get a sense of how expensive or cheap a stock is, you have to look at earnings relative to the stock price and hence employ the P/E ratio. The P/E ratio takes the stock price and divides it by the last four quarters' worth of earnings. If AB ltd is currently trading at Rs. 20 a share with Rs. 4 of earnings per share (EPS), it would have a P/E of 5. Big increase in earnings is an important factor for share value appreciation. When a stock's P-E ratio is high, the majority of investors consider it as pricey or overvalued. Stocks with low P-E's are typically considered a good value. However, studies done and past market experience have proved that the higher the P/E, the better the stock.
A Company that currently earns Re 1 per share and expects its earnings to grow at 20% p.a will sell at some multiple of its future earnings. Assuming that earnings will be Rs 2.50 (i.e Re 1 compounded at 20% p.a for 5 years). Also assume that the normal P/E ratio is 15. Then the stock selling at a normal P/E ratio of 15 times of the expected earnings of Rs 2.50 could sell for Rs 37.50 (i.e rs 2.5*15) or 37.5 times of this years earnings.
Thus if a company expects its earnings to grow by 20% per year in the future, investors will be willing to pay now for those shares an amount based on those future earnings. In this buying frenzy, the investors would bid the price up until a share sells at a very high P/E ratio relative to its present earnings.
First, one can obtain some idea of a reasonable price to pay for the stock by comparing its present P/E to its past levels of P/E ratio. One can learn what is a high and what is a low P/E for the individual company. One can compare the P/E ratio of the company with that of the market giving a relative measure. One can also use the average P/E ratio over time to help judge the reasonableness of the present levels of prices. All this suggests that as an investor one has to attempt to purchase a stock close to what is judged as a reasonable P/E ratio based on the comparisons made. One must also realize that we must pay a higher price for a quality company with quality management and attractive earnings potential.
Do it yourself - Basic investment strategies
A few benchmarks for stocks - A quick and easy measuring stick.
These are a few benchmarks that can help you decide if you should spend more time on a stock or not. They are easily available and can be of great use in screening good stocks.
Revenues/Sales growth.
Revenues are how much the company has sold over a given period. Sales are the direct performance indicators for companies. The rate of growth of sales over the previous years indicates the forward momentum of the company, which will have a positive impact on the stock's valuation.
Bottom line growth
The bottom-line is the net profit of a company. The growth in net profit indicates the attractiveness of the stock. The expected growth rate might differ from industry to industry. For instance, the IT sector's growth in bottom-line could be as high as 65-70% from the previous years whereas for the old economy stocks the range could be anywhere in range of 10- 15%.
ROI - Return on Investment
ROI in layman terms is the return on capital invested in business i.e. if you invest Rs 1 crore in men, machines, land and material to generate 25 lakhs of net profit , then the ROI is 25%. Again the expected ROI by market analysts could differ form industry to industry. For the software industry it could be as high as 35-40%, whereas for a capital intensive industry it could be just 10-15%.
Volume
Many investors look at the volume of shares traded on a day in comparison with the average daily volume. The investor gets an insight of how active the stock was on a certain day as compared with previous days. When major news are announced, a stock can trade tens of times its average daily volume.
Volume is also an indicator of the liquidity in a stock. Highly liquid stocks can be traded in large batches with low transaction costs. Illiquid stocks trade infrequently and large sales often cause the price to rise/fall dramatically. Illiquid stocks tend to carry large spreads i.e. the difference between the buying price and the selling price. Volume is a key way to measure supply and demand, and is often the primary indicator of a new price trend. When a stock moves up in price on unusually high volumes it could indicate that big institutional investors are accumulating the stock. When a stock moves down in price on unusually heavy volume, major selling could be the reason.
Market Capitalization.
This is the current market value of the company's shares. Market value is the total number of shares multiplied by the current price of each share. This would indicate the sheer size of the company, it's stocks' liquidity etc.
Company management
The quality of the top management is the most important of all resources that a company has access to. An investor has to make a careful assessment of the competence of the company management as evidenced by the dynamism and vision. Finally, the results are the single most important barometer of the company's management. If the company's board includes certain directors who are well known for their efficiency, honesty and integrity and are associated with other companies of proven excellence, an investor can consider it as favourable. Among the directors the MD (Managing Director) is the most important person. It is essential to know whether the MD is a person of proven competence.
PSR (Price-to-Sales Ratio)
This is the number you want below 3, and preferably below 1. This measures a company's stock price against the sales per share. Studies have shown that a PSR above 3 almost guarantees a loss while those below 1 give you a much better chance of success.
Return on Equity
Supposedly Warren Buffet's favorite number, this measures how much your investment is actually earning. Around 20% is considered good.
Debt-to-Equity Ratio
This measures how much debt a company has compared to the equity. The debt-to-equity ratio is arrived by dividing the total debt of the company with the equity capital. You're looking for a very low number here, not necessarily zero, but less than .5. If you see it at 1, then the company is still okay. A D/E ratio of more than 2 or greater is risky. It means that the company has a high interest burden, which will eventually affect the bottom-line. Not all debt is bad if used prudently. If interest payments are using only a small portion of the company's revenues, then the company is better off by employing debt pushing growth. Also note capital intensive industries build on a higher Debt/Equity ratio, hence this tool is not a right parameter in such cases.
Beta
The Beta factor measures how volatile a stock is when compared with an index. The higher the beta, the more volatile the stock is. (A negative beta means that the stock moves inversely to the market so when the index rises the stock goes down and vice versa).
Earnings Per Share (EPS)
This ratio determines what the company is earning for every share. For many investors, earnings is the most important tool. EPS is calculated by dividing the earnings (net profit) by the total number of equity shares. Thus, if AB ltd has 2 crore shares and has earned Rs 4 crore in the past 12 months, it has an EPS of Rs 2. EPS Rating factors the long-term and short-term earnings growth of a company as compared with other firms in the segment. Take the last two quarters of earnings-per-share increase and combine that with the three-to-five-year earnings growth rate. Then compare this number for a company to all other companies in your watch list within each sector and rate the results on how it outperforms all other companies in your watch list in terms of earnings growth. Its advisable to invest in stocks that rank in the top 20% of companies in your watch list. This is based on the assumption that your portfolio of stocks in the "Watch List" have been selected by using some basic screening tools so as to include the best of the stocks as perceived and authenticated by the screening tools that you had used.
Price / Earnings Ratio (P/E).
Read about this most important investor tool in the next part of this module.
Can You Match Upto Market Experts?
Can an individual investor match upto market experts?
Yes, he can. The popular opinion is that an investor has no chance in today's volatile markets. The methodology used by professionals, investment strategies and links to worldwide happenings imply that there is no scope for the individual investor in today's institutionalized markets. Nothing could be further away from the truth. E-broking is one solution to the lay investor as these websites provide online information from wire agencies such as Reuters, expert investment advice, research database which is available with the institutions. The advent of online broking has bridged the gap between institutions and the retail investor.
A fund manager is faced with many disadvantages. Typically, a fund manager will not buy high-growth stocks, which are available in small volumes. In some cases an attractive position cannot be capitalized by a fund as the situation might be ultra vires to the fund’s objectives. Sometimes, the fund manager’s risk exposure is high in particular scrips and volumes held, high too. Hence his liquidity is curbed while smaller volumes give the individual investor a higher level of liquidity. A researched view can tilt the scales in favour of the small investor.
Singing the market’s tune. Not always. Be a contrarian!
When markets start rising, more people step aboard. And when the indices start falling there is panic selling. Most of the times new investors are late in identifying a rally and are late entrants, leaving them with high-priced stocks.
Contrarians buy on bad news, and sell on good news. “Buy low, sell high” is a well-known cliché. That’s how an investor must think in order to profit from stock investing. All stock-market investors embrace the motto "Buy low, sell high." But few act accordingly. The herd mentality restricts us from pursuing a contrarian investment strategy, though it consistently beats the market. There are proven techniques for selecting undervalued stocks which are rarely followed.
The contrarian strategy advises you to pay a cursory look at a company's business fundamentals, stocks trading at below-market multiples of EPS, cash flow, book value, or dividend yield before taking an investment decision. Historically, stocks that are cheap by any of the above measures tend to outperform the market. To do contrary, you would require to go against the crowd, buying stocks that are out of favour and sell a few of Dalal Street’s darlings. This requires overriding powerful instincts.
Power of the World Wide Web (www)
Internet has changed the way the retail investor invests. Stock prices, volume information, investment tools, technical analysis is at his fingertips. Many sites offer Spot Reviews of news breaks and result analysis, which help investors to from an opinion on a particular stock. As the world is networked with the Web you can consult with experts from across cities states. As the internet is flooded with information, an overload, its imperative that you learn to figure out which information is useful and which is not.
Forming Investment Clubs:
If you as an individual investor do not have enough money to invest, or know not enough about investing and do not have the time to learn too. Well, a perfect solution then will be to join or form an investment club.
Investment clubs are formed by people who pool in their money to invest in stocks, bonds, mutual funds and other investments. The appeal is simple: A club has the funds to diversify its investments better than an individual and the knowledge base is wider. Investment clubs can be formed between family, friends and people who work together. However, forming a club with co-workers is a lot easier. But bear in mind that the biggest complaint among club members is finding a convenient time and place to meet each month. Forget not, you can talk about club news over the water cooler or canteen too. To form a club
First step, send out a memo or email asking select members to come to an introductory meeting. During that first meeting, discuss monthly dues. How much can people afford?
Secondly, give members a profile personality test to see where everyone stands. Are they risk takers or conservative investors? Club members should be compatible when it comes to investment goals.
Make sure you recruit people who are truly committed, which means meeting once a month and sharing the workload when it comes to researching companies, picking stocks and reviewing the club's portfolio.
It's common for members to get impatient and to jump ship shortly after the club's formation. Alternatively, member participation tends to drag due to a personal or financial crisis arises. The first few years are the crucial building blocks of a club. Members who survive the two-year hump tend to hang on for the long haul -- 20 years or more. Still, every club must prepare in its bylaws how to bring in new recruits and handle departing members who want to cash out.
Finally, once you have hammered out the goals and operation of the proposed club, if a sufficient number -- around 10 -- are still interested, then you are ready to forge ahead.
Yes, he can. The popular opinion is that an investor has no chance in today's volatile markets. The methodology used by professionals, investment strategies and links to worldwide happenings imply that there is no scope for the individual investor in today's institutionalized markets. Nothing could be further away from the truth. E-broking is one solution to the lay investor as these websites provide online information from wire agencies such as Reuters, expert investment advice, research database which is available with the institutions. The advent of online broking has bridged the gap between institutions and the retail investor.
A fund manager is faced with many disadvantages. Typically, a fund manager will not buy high-growth stocks, which are available in small volumes. In some cases an attractive position cannot be capitalized by a fund as the situation might be ultra vires to the fund’s objectives. Sometimes, the fund manager’s risk exposure is high in particular scrips and volumes held, high too. Hence his liquidity is curbed while smaller volumes give the individual investor a higher level of liquidity. A researched view can tilt the scales in favour of the small investor.
Singing the market’s tune. Not always. Be a contrarian!
When markets start rising, more people step aboard. And when the indices start falling there is panic selling. Most of the times new investors are late in identifying a rally and are late entrants, leaving them with high-priced stocks.
Contrarians buy on bad news, and sell on good news. “Buy low, sell high” is a well-known cliché. That’s how an investor must think in order to profit from stock investing. All stock-market investors embrace the motto "Buy low, sell high." But few act accordingly. The herd mentality restricts us from pursuing a contrarian investment strategy, though it consistently beats the market. There are proven techniques for selecting undervalued stocks which are rarely followed.
The contrarian strategy advises you to pay a cursory look at a company's business fundamentals, stocks trading at below-market multiples of EPS, cash flow, book value, or dividend yield before taking an investment decision. Historically, stocks that are cheap by any of the above measures tend to outperform the market. To do contrary, you would require to go against the crowd, buying stocks that are out of favour and sell a few of Dalal Street’s darlings. This requires overriding powerful instincts.
Power of the World Wide Web (www)
Internet has changed the way the retail investor invests. Stock prices, volume information, investment tools, technical analysis is at his fingertips. Many sites offer Spot Reviews of news breaks and result analysis, which help investors to from an opinion on a particular stock. As the world is networked with the Web you can consult with experts from across cities states. As the internet is flooded with information, an overload, its imperative that you learn to figure out which information is useful and which is not.
Forming Investment Clubs:
If you as an individual investor do not have enough money to invest, or know not enough about investing and do not have the time to learn too. Well, a perfect solution then will be to join or form an investment club.
Investment clubs are formed by people who pool in their money to invest in stocks, bonds, mutual funds and other investments. The appeal is simple: A club has the funds to diversify its investments better than an individual and the knowledge base is wider. Investment clubs can be formed between family, friends and people who work together. However, forming a club with co-workers is a lot easier. But bear in mind that the biggest complaint among club members is finding a convenient time and place to meet each month. Forget not, you can talk about club news over the water cooler or canteen too. To form a club
First step, send out a memo or email asking select members to come to an introductory meeting. During that first meeting, discuss monthly dues. How much can people afford?
Secondly, give members a profile personality test to see where everyone stands. Are they risk takers or conservative investors? Club members should be compatible when it comes to investment goals.
Make sure you recruit people who are truly committed, which means meeting once a month and sharing the workload when it comes to researching companies, picking stocks and reviewing the club's portfolio.
It's common for members to get impatient and to jump ship shortly after the club's formation. Alternatively, member participation tends to drag due to a personal or financial crisis arises. The first few years are the crucial building blocks of a club. Members who survive the two-year hump tend to hang on for the long haul -- 20 years or more. Still, every club must prepare in its bylaws how to bring in new recruits and handle departing members who want to cash out.
Finally, once you have hammered out the goals and operation of the proposed club, if a sufficient number -- around 10 -- are still interested, then you are ready to forge ahead.
Investment Goals
Investment Goals.
Investment avenues should always be treated as tools which will generate good returns over a period of time. To take a short term view would be fatal. In the stock markets, prices fluctuate very fast for the lay investor. To get the maximum returns begin with a two-year perspective.
Begin with an understanding of yourself.
What do you want from your investments?
It could be growth, income or both.
How comfortable are you to take risks?
It's only human if your first reaction on an adverse market movement is to sell and run away. To shield yourself against short term trading risks one has to take a long-term view. Renowned experts such as Benjamin Graham and Warren Buffet rarely shuffle their portfolio unless there is some change in the fundamentals of a company. Once you see the kind of returns you can generate over time, you'll come to realize that it really doesn't matter if your stock drops or rises over the course of a few hours or days or weeks or even months. Mutual funds are a good way to begin investing in the stock market. Funds render investment services with professionalism and give a good diversification over many sectors. If volatility is not your cup of tea, then you might consider buying fixed income securities.
Planning and Setting Goals: Investment requires a lot of planning. Decide on your basic framework of investments and chart your risk profile.
Ask yourself: What is the investment "time horizon"? Time horizon is the time period between the age at which you would like to start investing and at the age by which you would need a consolidated amount of money for any said purpose of yours.
One should also find out if there are there any short-term financial needs?
Will be a need to live off the investment in later years?
Your investments could be for retirement, a down payment for a house, your child's education, a second home or just for incremental income to take up a better standard of living.
Make clear-cut, measurable and reasonable goals. Be more specific when you decide your goals. For example you must reasonably predict how much amount of money would require and at what time inorder to satisfy any of the above stated needs?
If arriving at these figures looks cumbersome or daunting, our online interactive calculators will help you figure out your future money requirements. The answers to the above will lead you directly to “The type of investments will you make”.
Is time on Your side ?
The time frame you seek to invest on, your investment profile and the moblizable resources are interdependent and are not mutually exclusive.
How much time do you want to spend on investing?
You can be active, allocate an hour every day or just spend a few hours every month.
Another important factor is when do you need the money?
To help put all of this into context, you also need to look at how various types of investments have performed historically. Bonds and stocks are the two major asset classes that have been used by investors over the past century. Knowing the total return on each of the above and the associated volatility is crucial in deciding where you should put your money.
Moblizable Resources
After you zero in on your investments its time to decide on how much money you want to invest. Setting investment goals and checking out on allocable monetary resources go hand in hand. It is necessary to fix your monetary considerations as soon as you decide on the basic investment framework.
Some of your basic monetary considerations could be:-
The amount of initial investments that you can pump in.
The sources for the money that you need for investments.
The foreseeable bulk expense which prevents you from saving or which may force you to liquidate your existing portfolio (this expense itself may be your investment goal).
Money that you need to have as back up for emergencies.
The amount of savings that you can afford to allocate every month on a continual basis for such number of year that you may desire.
Answers to all or atleast the most important of these would logically lead you to where you ideally have to invest your money in, can it be equity, mutual funds or bonds.
Investment avenues should always be treated as tools which will generate good returns over a period of time. To take a short term view would be fatal. In the stock markets, prices fluctuate very fast for the lay investor. To get the maximum returns begin with a two-year perspective.
Begin with an understanding of yourself.
What do you want from your investments?
It could be growth, income or both.
How comfortable are you to take risks?
It's only human if your first reaction on an adverse market movement is to sell and run away. To shield yourself against short term trading risks one has to take a long-term view. Renowned experts such as Benjamin Graham and Warren Buffet rarely shuffle their portfolio unless there is some change in the fundamentals of a company. Once you see the kind of returns you can generate over time, you'll come to realize that it really doesn't matter if your stock drops or rises over the course of a few hours or days or weeks or even months. Mutual funds are a good way to begin investing in the stock market. Funds render investment services with professionalism and give a good diversification over many sectors. If volatility is not your cup of tea, then you might consider buying fixed income securities.
Planning and Setting Goals: Investment requires a lot of planning. Decide on your basic framework of investments and chart your risk profile.
Ask yourself: What is the investment "time horizon"? Time horizon is the time period between the age at which you would like to start investing and at the age by which you would need a consolidated amount of money for any said purpose of yours.
One should also find out if there are there any short-term financial needs?
Will be a need to live off the investment in later years?
Your investments could be for retirement, a down payment for a house, your child's education, a second home or just for incremental income to take up a better standard of living.
Make clear-cut, measurable and reasonable goals. Be more specific when you decide your goals. For example you must reasonably predict how much amount of money would require and at what time inorder to satisfy any of the above stated needs?
If arriving at these figures looks cumbersome or daunting, our online interactive calculators will help you figure out your future money requirements. The answers to the above will lead you directly to “The type of investments will you make”.
Is time on Your side ?
The time frame you seek to invest on, your investment profile and the moblizable resources are interdependent and are not mutually exclusive.
How much time do you want to spend on investing?
You can be active, allocate an hour every day or just spend a few hours every month.
Another important factor is when do you need the money?
To help put all of this into context, you also need to look at how various types of investments have performed historically. Bonds and stocks are the two major asset classes that have been used by investors over the past century. Knowing the total return on each of the above and the associated volatility is crucial in deciding where you should put your money.
Moblizable Resources
After you zero in on your investments its time to decide on how much money you want to invest. Setting investment goals and checking out on allocable monetary resources go hand in hand. It is necessary to fix your monetary considerations as soon as you decide on the basic investment framework.
Some of your basic monetary considerations could be:-
The amount of initial investments that you can pump in.
The sources for the money that you need for investments.
The foreseeable bulk expense which prevents you from saving or which may force you to liquidate your existing portfolio (this expense itself may be your investment goal).
Money that you need to have as back up for emergencies.
The amount of savings that you can afford to allocate every month on a continual basis for such number of year that you may desire.
Answers to all or atleast the most important of these would logically lead you to where you ideally have to invest your money in, can it be equity, mutual funds or bonds.
Tax aspects of Mutual Funds
Tax Implications of Dividend Income
Equity Schemes
Equity Schemes are schemes, which have less than 50 per cent investments in Equity shares of domestic companies.
As far as Equity Schemes are concerned no Distribution Tax is payable on dividend. In the hands of the investors, dividend is tax-free.
Other Schemes
For schemes other than equity, in the hands of the investors, dividend is tax-free. However, Distribution Tax on dividend @ 12.81 per cent to be paid by Mutual Funds.
Tax Implications of Capital Gains
The difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset is called capital gain. If the investor sells his units and earns capital gains he is liable to pay capital gains tax.
Capital gains are of two types: Short Term and Long Term Capital Gains.
Short Term Capital Gains
The holding period of the Mutual Fund units is less than or equal to 12 months from the date of allotment of units then short term capital gains is applicable.
On Short Term capital gains no Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be added to the total income of the Investor and taxed at the marginal rate of tax. No TDS.
NRIs: 30 per cent TDS from the gain.
Long Term Capital Gains
The holding period of Mutual Fund units is more than 12 months from the date of allotment of units.
On Long Term capital gains Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be taxed
A) at 20 per cent with indexation benefit or
B) B) at 10 per cent without indexation benefit, whichever is lower. No TDS.
NRIs: 20 per cent TDS from the Gain
Surcharge
Resident Indians : If the Gain exceeds Rs 8.5 lakhs, surcharge is payable by investors @ 10 per cent.
Domestic Companies: Payable by the investor @ 2.5 per cent.
NRIs: If the Gain from the Fund exceeds Rs 8.5 lakhs, surcharge is deducted at source @ 2.5 per cent.
Indexation
Indexation means that the purchase price is marked up by an inflation index resulting in lower capital gains and hence lower tax.
Inflation index for the year of transfer
Inflation index = ----------------------------------------------------
Inflation index for the year of acquisition
Equity Schemes
Equity Schemes are schemes, which have less than 50 per cent investments in Equity shares of domestic companies.
As far as Equity Schemes are concerned no Distribution Tax is payable on dividend. In the hands of the investors, dividend is tax-free.
Other Schemes
For schemes other than equity, in the hands of the investors, dividend is tax-free. However, Distribution Tax on dividend @ 12.81 per cent to be paid by Mutual Funds.
Tax Implications of Capital Gains
The difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset is called capital gain. If the investor sells his units and earns capital gains he is liable to pay capital gains tax.
Capital gains are of two types: Short Term and Long Term Capital Gains.
Short Term Capital Gains
The holding period of the Mutual Fund units is less than or equal to 12 months from the date of allotment of units then short term capital gains is applicable.
On Short Term capital gains no Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be added to the total income of the Investor and taxed at the marginal rate of tax. No TDS.
NRIs: 30 per cent TDS from the gain.
Long Term Capital Gains
The holding period of Mutual Fund units is more than 12 months from the date of allotment of units.
On Long Term capital gains Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be taxed
A) at 20 per cent with indexation benefit or
B) B) at 10 per cent without indexation benefit, whichever is lower. No TDS.
NRIs: 20 per cent TDS from the Gain
Surcharge
Resident Indians : If the Gain exceeds Rs 8.5 lakhs, surcharge is payable by investors @ 10 per cent.
Domestic Companies: Payable by the investor @ 2.5 per cent.
NRIs: If the Gain from the Fund exceeds Rs 8.5 lakhs, surcharge is deducted at source @ 2.5 per cent.
Indexation
Indexation means that the purchase price is marked up by an inflation index resulting in lower capital gains and hence lower tax.
Inflation index for the year of transfer
Inflation index = ----------------------------------------------------
Inflation index for the year of acquisition
Choosing a Mutual fund
Mutual fund is the best investment tool for the retail investor as it offers the twin benefits of good returns and safety as compared with other avenues such as bank deposits or stock investing. Having looked at the various types of mutual funds, one has to now go about selecting a fund suiting your requirements. Choose the wrong fund and you would have been better off keeping money in a bank fixed deposit.Keep in mind the points listed below and you could at least marginalise your investment risk.
Past performance
While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. Also check out the two-year and one-year returns for consistency. How did these funds perform in the bull and bear markets of the immediate past? Tracking the performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls in a bad market.
Know your fund manager
The success of a fund to a great extent depends on the fund manager. The same fund managers manage most successful funds. Ask before investing, has the fund manager or strategy changed recently? For instance, the portfolio manager who generated the fund’s successful performance may no longer be managing the fund.
Does it suit your risk profile?
Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry loses the marketmen’s fancy. If the investor is totally risk averse he can opt for pure debt schemes with little or no risk. Most prefer the balanced schemes which invest in the equity and debt markets. Growth and pure equity plans give greater returns than pure debt plans but their risk is higher.
Read the prospectus
The prospectus says a lot about the fund. A reading of the fund’s prospectus is a must to learn about its investment strategy and the risk that it will expose you to. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.
How will the fund affect the diversification of your portfolio?
When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
What it costs you?
A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.
Finally, don’t pick a fund simply because it has shown a spurt in value in the current rally. Ferret out information of a fund for atleast three years. The one thing to remember while investing in equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right equity mutual fund will pay off big -- if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.
Past performance
While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. Also check out the two-year and one-year returns for consistency. How did these funds perform in the bull and bear markets of the immediate past? Tracking the performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls in a bad market.
Know your fund manager
The success of a fund to a great extent depends on the fund manager. The same fund managers manage most successful funds. Ask before investing, has the fund manager or strategy changed recently? For instance, the portfolio manager who generated the fund’s successful performance may no longer be managing the fund.
Does it suit your risk profile?
Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry loses the marketmen’s fancy. If the investor is totally risk averse he can opt for pure debt schemes with little or no risk. Most prefer the balanced schemes which invest in the equity and debt markets. Growth and pure equity plans give greater returns than pure debt plans but their risk is higher.
Read the prospectus
The prospectus says a lot about the fund. A reading of the fund’s prospectus is a must to learn about its investment strategy and the risk that it will expose you to. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.
How will the fund affect the diversification of your portfolio?
When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
What it costs you?
A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.
Finally, don’t pick a fund simply because it has shown a spurt in value in the current rally. Ferret out information of a fund for atleast three years. The one thing to remember while investing in equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right equity mutual fund will pay off big -- if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.
Choosing a fund
Mutual fund is the best investment tool for the retail investor as it offers the twin benefits of good returns and safety as compared with other avenues such as bank deposits or stock investing. Having looked at the various types of mutual funds, one has to now go about selecting a fund suiting your requirements. Choose the wrong fund and you would have been better off keeping money in a bank fixed deposit.Keep in mind the points listed below and you could at least marginalise your investment risk.
Past performance
While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. Also check out the two-year and one-year returns for consistency. How did these funds perform in the bull and bear markets of the immediate past? Tracking the performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls in a bad market.
Know your fund manager
The success of a fund to a great extent depends on the fund manager. The same fund managers manage most successful funds. Ask before investing, has the fund manager or strategy changed recently? For instance, the portfolio manager who generated the fund’s successful performance may no longer be managing the fund.
Does it suit your risk profile?
Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry loses the marketmen’s fancy. If the investor is totally risk averse he can opt for pure debt schemes with little or no risk. Most prefer the balanced schemes which invest in the equity and debt markets. Growth and pure equity plans give greater returns than pure debt plans but their risk is higher.
Read the prospectus
The prospectus says a lot about the fund. A reading of the fund’s prospectus is a must to learn about its investment strategy and the risk that it will expose you to. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.
How will the fund affect the diversification of your portfolio?
When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
What it costs you?
A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.
Finally, don’t pick a fund simply because it has shown a spurt in value in the current rally. Ferret out information of a fund for atleast three years. The one thing to remember while investing in equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right equity mutual fund will pay off big -- if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.
Past performance
While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. Also check out the two-year and one-year returns for consistency. How did these funds perform in the bull and bear markets of the immediate past? Tracking the performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls in a bad market.
Know your fund manager
The success of a fund to a great extent depends on the fund manager. The same fund managers manage most successful funds. Ask before investing, has the fund manager or strategy changed recently? For instance, the portfolio manager who generated the fund’s successful performance may no longer be managing the fund.
Does it suit your risk profile?
Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry loses the marketmen’s fancy. If the investor is totally risk averse he can opt for pure debt schemes with little or no risk. Most prefer the balanced schemes which invest in the equity and debt markets. Growth and pure equity plans give greater returns than pure debt plans but their risk is higher.
Read the prospectus
The prospectus says a lot about the fund. A reading of the fund’s prospectus is a must to learn about its investment strategy and the risk that it will expose you to. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals. But remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean it does not have significant risk. Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you.
How will the fund affect the diversification of your portfolio?
When choosing a mutual fund, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.
What it costs you?
A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.
Finally, don’t pick a fund simply because it has shown a spurt in value in the current rally. Ferret out information of a fund for atleast three years. The one thing to remember while investing in equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right equity mutual fund will pay off big -- if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.
Risk vs Reward in Mutualfunds
Risk vs Reward
Having understood the basics of mutual funds the next step is to build a successful investment portfolio. Before you can begin to build a portfolio, one should understand some other elements of mutual fund investing and how they can affect the potential value of your investments over the years. The first thing that has to be kept in mind is that when you invest in mutual funds, there is no guarantee that you will end up with more money when you withdraw your investment than what you started out with. That is the potential of loss is always there. The loss of value in your investment is what is considered risk in investing.
Even so, the opportunity for investment growth that is possible through investments in mutual funds far exceeds that concern for most investors. Here’s why.
At the cornerstone of investing is the basic principal that the greater the risk you take, the greater the potential reward. Or stated in another way, you get what you pay for and you get paid a higher return only when you're willing to accept more volatility.
Risk then, refers to the volatility -- the up and down activity in the markets and individual issues that occurs constantly over time. This volatility can be caused by a number of factors -- interest rate changes, inflation or general economic conditions. It is this variability, uncertainty and potential for loss, that causes investors to worry. We all fear the possibility that a stock we invest in will fall substantially. But it is this very volatility that is the exact reason that you can expect to earn a higher long-term return from these investments than from a savings account.
Different types of mutual funds have different levels of volatility or potential price change, and those with the greater chance of losing value are also the funds that can produce the greater returns for you over time. So risk has two sides: it causes the value of your investments to fluctuate, but it is precisely the reason you can expect to earn higher returns.
You might find it helpful to remember that all financial investments will fluctuate. There are very few perfectly safe havens and those simply don't pay enough to beat inflation over the long run.
Types of risks
All investments involve some form of risk. Consider these common types of risk and evaluate them against potential rewards when you select an investment.
Market Risk
At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk". Also known as systematic risk.
Inflation Risk
Sometimes referred to as "loss of purchasing power." Whenever inflation rises forward faster than the earnings on your investment, you run the risk that you'll actually be able to buy less, not more. Inflation risk also occurs when prices rise faster than your returns.
Credit Risk
In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?
Interest Rate Risk
Changing interest rates affect both equities and bonds in many ways. Investors are reminded that "predicting" which way rates will go is rarely successful. A diversified portfolio can help in offseting these changes.
Exchange risk
A number of companies generate revenues in foreign currencies and may have investments or expenses also denominated in foreign currencies. Changes in exchange rates may, therefore, have a positive or negative impact on companies which in turn would have an effect on the investment of the fund.
Investment Risks
The sectoral fund schemes, investments will be predominantly in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of equities.
Changes in the Government Policy
Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund
Effect of loss of key professionals and inability to adapt business to the rapid technological change.
An industries' key asset is often the personnel who run the business i.e. intellectual properties of the key employees of the respective companies. Given the ever-changing complexion of few industries and the high obsolescence levels, availability of qualified, trained and motivated personnel is very critical for the success of industries in few sectors. It is, therefore, necessary to attract key personnel and also to retain them to meet the changing environment and challenges the sector offers. Failure or inability to attract/retain such qualified key personnel may impact the prospects of the companies in the particular sector in which the fund invests.
Having understood the basics of mutual funds the next step is to build a successful investment portfolio. Before you can begin to build a portfolio, one should understand some other elements of mutual fund investing and how they can affect the potential value of your investments over the years. The first thing that has to be kept in mind is that when you invest in mutual funds, there is no guarantee that you will end up with more money when you withdraw your investment than what you started out with. That is the potential of loss is always there. The loss of value in your investment is what is considered risk in investing.
Even so, the opportunity for investment growth that is possible through investments in mutual funds far exceeds that concern for most investors. Here’s why.
At the cornerstone of investing is the basic principal that the greater the risk you take, the greater the potential reward. Or stated in another way, you get what you pay for and you get paid a higher return only when you're willing to accept more volatility.
Risk then, refers to the volatility -- the up and down activity in the markets and individual issues that occurs constantly over time. This volatility can be caused by a number of factors -- interest rate changes, inflation or general economic conditions. It is this variability, uncertainty and potential for loss, that causes investors to worry. We all fear the possibility that a stock we invest in will fall substantially. But it is this very volatility that is the exact reason that you can expect to earn a higher long-term return from these investments than from a savings account.
Different types of mutual funds have different levels of volatility or potential price change, and those with the greater chance of losing value are also the funds that can produce the greater returns for you over time. So risk has two sides: it causes the value of your investments to fluctuate, but it is precisely the reason you can expect to earn higher returns.
You might find it helpful to remember that all financial investments will fluctuate. There are very few perfectly safe havens and those simply don't pay enough to beat inflation over the long run.
Types of risks
All investments involve some form of risk. Consider these common types of risk and evaluate them against potential rewards when you select an investment.
Market Risk
At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk". Also known as systematic risk.
Inflation Risk
Sometimes referred to as "loss of purchasing power." Whenever inflation rises forward faster than the earnings on your investment, you run the risk that you'll actually be able to buy less, not more. Inflation risk also occurs when prices rise faster than your returns.
Credit Risk
In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?
Interest Rate Risk
Changing interest rates affect both equities and bonds in many ways. Investors are reminded that "predicting" which way rates will go is rarely successful. A diversified portfolio can help in offseting these changes.
Exchange risk
A number of companies generate revenues in foreign currencies and may have investments or expenses also denominated in foreign currencies. Changes in exchange rates may, therefore, have a positive or negative impact on companies which in turn would have an effect on the investment of the fund.
Investment Risks
The sectoral fund schemes, investments will be predominantly in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of equities.
Changes in the Government Policy
Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund
Effect of loss of key professionals and inability to adapt business to the rapid technological change.
An industries' key asset is often the personnel who run the business i.e. intellectual properties of the key employees of the respective companies. Given the ever-changing complexion of few industries and the high obsolescence levels, availability of qualified, trained and motivated personnel is very critical for the success of industries in few sectors. It is, therefore, necessary to attract key personnel and also to retain them to meet the changing environment and challenges the sector offers. Failure or inability to attract/retain such qualified key personnel may impact the prospects of the companies in the particular sector in which the fund invests.
Types of Mutual Funds
Types of Mutual Funds
Getting a handle on what's under the hood helps you become a better investor and put together a more successful portfolio. To do this one must know the different types of funds that cater to investor needs, whatever the age, financial position, risk tolerance and return expectations. The mutual fund schemes can be classified according to both their investment objective (like income, growth, tax saving) as well as the number of units (if these are unlimited then the fund is an open-ended one while if there are limited units then the fund is close-ended).
This section provides descriptions of the characteristics -- such as investment objective and potential for volatility of your investment -- of various categories of funds. These descriptions are organized by the type of securities purchased by each fund: equities, fixed-income, money market instruments, or some combination of these.
Open-ended schemes
Open-ended schemes do not have a fixed maturity period. Investors can buy or sell units at NAV-related prices from and to the mutual fund on any business day. These schemes have unlimited capitalization, open-ended schemes do not have a fixed maturity, there is no cap on the amount you can buy from the fund and the unit capital can keep growing. These funds are not generally listed on any exchange.
Open-ended schemes are preferred for their liquidity. Such funds can issue and redeem units any time during the life of a scheme. Hence, unit capital of open-ended funds can fluctuate on a daily basis. The advantages of open-ended funds over close-ended are as follows:
Any time exit option, The issuing company directly takes the responsibility of providing an entry and an exit. This provides ready liquidity to the investors and avoids reliance on transfer deeds, signature verifications and bad deliveries. Any time entry option, An open-ended fund allows one to enter the fund at any time and even to invest at regular intervals.
Close ended schemes
Close-ended schemes have fixed maturity periods. Investors can buy into these funds during the period when these funds are open in the initial issue. After that such schemes can not issue new units except in case of bonus or rights issue. However, after the initial issue, you can buy or sell units of the scheme on the stock exchanges where they are listed. The market price of the units could vary from the NAV of the scheme due to demand and supply factors, investors’ expectations and other market factors
Classification according to investment objectives
Mutual funds can be further classified based on their specific investment objective such as growth of capital, safety of principal, current income or tax-exempt income.
In general mutual funds fall into three general categories:
1] Equity Funds are those that invest in shares or equity of companies.
2] Fixed-Income Funds invest in government or corporate securities that offer fixed rates of return are
3] While funds that invest in a combination of both stocks and bonds are called Balanced Funds.
Growth Funds
Growth funds primarily look for growth of capital with secondary emphasis on dividend. Such funds invest in shares with a potential for growth and capital appreciation. They invest in well-established companies where the company itself and the industry in which it operates are thought to have good long-term growth potential, and hence growth funds provide low current income. Growth funds generally incur higher risks than income funds in an effort to secure more pronounced growth.
Some growth funds concentrate on one or more industry sectors and also invest in a broad range of industries. Growth funds are suitable for investors who can afford to assume the risk of potential loss in value of their investment in the hope of achieving substantial and rapid gains. They are not suitable for investors who must conserve their principal or who must maximize current income.
Growth and Income Funds
Growth and income funds seek long-term growth of capital as well as current income. The investment strategies used to reach these goals vary among funds. Some invest in a dual portfolio consisting of growth stocks and income stocks, or a combination of growth stocks, stocks paying high dividends, preferred stocks, convertible securities or fixed-income securities such as corporate bonds and money market instruments. Others may invest in growth stocks and earn current income by selling covered call options on their portfolio stocks.
Growth and income funds have low to moderate stability of principal and moderate potential for current income and growth. They are suitable for investors who can assume some risk to achieve growth of capital but who also want to maintain a moderate level of current income.
Fixed-Income Funds
Fixed income funds primarily look to provide current income consistent with the preservation of capital. These funds invest in corporate bonds or government-backed mortgage securities that have a fixed rate of return. Within the fixed-income category, funds vary greatly in their stability of principal and in their dividend yields. High-yield funds, which seek to maximize yield by investing in lower-rated bonds of longer maturities, entail less stability of principal than fixed-income funds that invest in higher-rated but lower-yielding securities.
Some fixed-income funds seek to minimize risk by investing exclusively in securities whose timely payment of interest and principal is backed by the full faith and credit of the Indian Government. Fixed-income funds are suitable for investors who want to maximize current income and who can assume a degree of capital risk in order to do so.
Balanced
The Balanced fund aims to provide both growth and income. These funds invest in both shares and fixed income securities in the proportion indicated in their offer documents. Ideal for investors who are looking for a combination of income and moderate growth.
Money Market Funds/Liquid Funds
For the cautious investor, these funds provide a very high stability of principal while seeking a moderate to high current income. They invest in highly liquid, virtually risk-free, short-term debt securities of agencies of the Indian Government, banks and corporations and Treasury Bills. Because of their short-term investments, money market mutual funds are able to keep a virtually constant unit price; only the yield fluctuates.
Therefore, they are an attractive alternative to bank accounts. With yields that are generally competitive with - and usually higher than -- yields on bank savings account, they offer several advantages. Money can be withdrawn any time without penalty. Although not insured, money market funds invest only in highly liquid, short-term, top-rated money market instruments. Money market funds are suitable for investors who want high stability of principal and current income with immediate liquidity.
Specialty/Sector Funds
These funds invest in securities of a specific industry or sector of the economy such as health care, technology, leisure, utilities or precious metals. The funds enable investors to diversify holdings among many companies within an industry, a more conservative approach than investing directly in one particular company.
Sector funds offer the opportunity for sharp capital gains in cases where the fund's industry is "in favor" but also entail the risk of capital losses when the industry is out of favor. While sector funds restrict holdings to a particular industry, other specialty funds such as index funds give investors a broadly diversified portfolio and attempt to mirror the performance of various market averages.
Index funds generally buy shares in all the companies composing the BSE Sensex or NSE Nifty or other broad stock market indices. They are not suitable for investors who must conserve their principal or maximize current income.
Getting a handle on what's under the hood helps you become a better investor and put together a more successful portfolio. To do this one must know the different types of funds that cater to investor needs, whatever the age, financial position, risk tolerance and return expectations. The mutual fund schemes can be classified according to both their investment objective (like income, growth, tax saving) as well as the number of units (if these are unlimited then the fund is an open-ended one while if there are limited units then the fund is close-ended).
This section provides descriptions of the characteristics -- such as investment objective and potential for volatility of your investment -- of various categories of funds. These descriptions are organized by the type of securities purchased by each fund: equities, fixed-income, money market instruments, or some combination of these.
Open-ended schemes
Open-ended schemes do not have a fixed maturity period. Investors can buy or sell units at NAV-related prices from and to the mutual fund on any business day. These schemes have unlimited capitalization, open-ended schemes do not have a fixed maturity, there is no cap on the amount you can buy from the fund and the unit capital can keep growing. These funds are not generally listed on any exchange.
Open-ended schemes are preferred for their liquidity. Such funds can issue and redeem units any time during the life of a scheme. Hence, unit capital of open-ended funds can fluctuate on a daily basis. The advantages of open-ended funds over close-ended are as follows:
Any time exit option, The issuing company directly takes the responsibility of providing an entry and an exit. This provides ready liquidity to the investors and avoids reliance on transfer deeds, signature verifications and bad deliveries. Any time entry option, An open-ended fund allows one to enter the fund at any time and even to invest at regular intervals.
Close ended schemes
Close-ended schemes have fixed maturity periods. Investors can buy into these funds during the period when these funds are open in the initial issue. After that such schemes can not issue new units except in case of bonus or rights issue. However, after the initial issue, you can buy or sell units of the scheme on the stock exchanges where they are listed. The market price of the units could vary from the NAV of the scheme due to demand and supply factors, investors’ expectations and other market factors
Classification according to investment objectives
Mutual funds can be further classified based on their specific investment objective such as growth of capital, safety of principal, current income or tax-exempt income.
In general mutual funds fall into three general categories:
1] Equity Funds are those that invest in shares or equity of companies.
2] Fixed-Income Funds invest in government or corporate securities that offer fixed rates of return are
3] While funds that invest in a combination of both stocks and bonds are called Balanced Funds.
Growth Funds
Growth funds primarily look for growth of capital with secondary emphasis on dividend. Such funds invest in shares with a potential for growth and capital appreciation. They invest in well-established companies where the company itself and the industry in which it operates are thought to have good long-term growth potential, and hence growth funds provide low current income. Growth funds generally incur higher risks than income funds in an effort to secure more pronounced growth.
Some growth funds concentrate on one or more industry sectors and also invest in a broad range of industries. Growth funds are suitable for investors who can afford to assume the risk of potential loss in value of their investment in the hope of achieving substantial and rapid gains. They are not suitable for investors who must conserve their principal or who must maximize current income.
Growth and Income Funds
Growth and income funds seek long-term growth of capital as well as current income. The investment strategies used to reach these goals vary among funds. Some invest in a dual portfolio consisting of growth stocks and income stocks, or a combination of growth stocks, stocks paying high dividends, preferred stocks, convertible securities or fixed-income securities such as corporate bonds and money market instruments. Others may invest in growth stocks and earn current income by selling covered call options on their portfolio stocks.
Growth and income funds have low to moderate stability of principal and moderate potential for current income and growth. They are suitable for investors who can assume some risk to achieve growth of capital but who also want to maintain a moderate level of current income.
Fixed-Income Funds
Fixed income funds primarily look to provide current income consistent with the preservation of capital. These funds invest in corporate bonds or government-backed mortgage securities that have a fixed rate of return. Within the fixed-income category, funds vary greatly in their stability of principal and in their dividend yields. High-yield funds, which seek to maximize yield by investing in lower-rated bonds of longer maturities, entail less stability of principal than fixed-income funds that invest in higher-rated but lower-yielding securities.
Some fixed-income funds seek to minimize risk by investing exclusively in securities whose timely payment of interest and principal is backed by the full faith and credit of the Indian Government. Fixed-income funds are suitable for investors who want to maximize current income and who can assume a degree of capital risk in order to do so.
Balanced
The Balanced fund aims to provide both growth and income. These funds invest in both shares and fixed income securities in the proportion indicated in their offer documents. Ideal for investors who are looking for a combination of income and moderate growth.
Money Market Funds/Liquid Funds
For the cautious investor, these funds provide a very high stability of principal while seeking a moderate to high current income. They invest in highly liquid, virtually risk-free, short-term debt securities of agencies of the Indian Government, banks and corporations and Treasury Bills. Because of their short-term investments, money market mutual funds are able to keep a virtually constant unit price; only the yield fluctuates.
Therefore, they are an attractive alternative to bank accounts. With yields that are generally competitive with - and usually higher than -- yields on bank savings account, they offer several advantages. Money can be withdrawn any time without penalty. Although not insured, money market funds invest only in highly liquid, short-term, top-rated money market instruments. Money market funds are suitable for investors who want high stability of principal and current income with immediate liquidity.
Specialty/Sector Funds
These funds invest in securities of a specific industry or sector of the economy such as health care, technology, leisure, utilities or precious metals. The funds enable investors to diversify holdings among many companies within an industry, a more conservative approach than investing directly in one particular company.
Sector funds offer the opportunity for sharp capital gains in cases where the fund's industry is "in favor" but also entail the risk of capital losses when the industry is out of favor. While sector funds restrict holdings to a particular industry, other specialty funds such as index funds give investors a broadly diversified portfolio and attempt to mirror the performance of various market averages.
Index funds generally buy shares in all the companies composing the BSE Sensex or NSE Nifty or other broad stock market indices. They are not suitable for investors who must conserve their principal or maximize current income.
Why invest in Mutual Funds
Investing in mutual has various benefits which makes it an ideal investment avenue. Following are some of the primary benefits.
Professional investment management
One of the primary benefits of mutual funds is that an investor has access to professional management. A good investment manager is certainly worth the fees you will pay. Good mutual fund managers with an excellent research team can do a better job of monitoring the companies they have chosen to invest in than you can, unless you have time to spend on researching the companies you select for your portfolio. That is because Mutual funds hire full-time, high-level investment professionals. Funds can afford to do so as they manage large pools of money. The managers have real-time access to crucial market information and are able to execute trades on the largest and most cost-effective scale. When you buy a mutual fund, the primary asset you are buying is the manager, who will be controlling which assets are chosen to meet the funds' stated investment objectives.
Diversification
A crucial element in investing is asset allocation. It plays a very big part in the success of any portfolio. However, small investors do not have enough money to properly allocate their assets. By pooling your funds with others, you can quickly benefit from greater diversification. Mutual funds invest in a broad range of securities. This limits investment risk by reducing the effect of a possible decline in the value of any one security. Mutual fund unit-holders can benefit from diversification techniques usually available only to investors wealthy enough to buy significant positions in a wide variety of securities.
Low Cost
A mutual fund let's you participate in a diversified portfolio for as little as Rs.5,000, and sometimes less. And with a no-load fund, you pay little or no sales charges to own them.
Convenience and Flexibility
Investing in mutual funds has it’s own convenience. While you own just one security rather than many, you still enjoy the benefits of a diversified portfolio and a wide range of services. Fund managers decide what securities to trade, collect the interest payments and see that your dividends on portfolio securities are received and your rights exercised. It also uses the services of a high quality custodian and registrar. Another big advantage is that you can move your funds easily from one fund to another within a mutual fund family. This allows you to easily rebalance your portfolio to respond to significant fund management or economic changes.
Liquidity
In open-ended schemes, you can get your money back promptly at net asset value related prices from the mutual fund itself.
Transparency
Regulations for mutual funds have made the industry very transparent. You can track the investments that have been made on you behalf and the specific investments made by the mutual fund scheme to see where your money is going. In addition to this, you get regular information on the value of your investment.
Variety
There is no shortage of variety when investing in mutual funds. You can find a mutual fund that matches just about any investing strategy you select. There are funds that focus on blue-chip stocks, technology stocks, bonds or a mix of stocks and bonds. The greatest challenge can be sorting through the variety and picking the best for you.
Professional investment management
One of the primary benefits of mutual funds is that an investor has access to professional management. A good investment manager is certainly worth the fees you will pay. Good mutual fund managers with an excellent research team can do a better job of monitoring the companies they have chosen to invest in than you can, unless you have time to spend on researching the companies you select for your portfolio. That is because Mutual funds hire full-time, high-level investment professionals. Funds can afford to do so as they manage large pools of money. The managers have real-time access to crucial market information and are able to execute trades on the largest and most cost-effective scale. When you buy a mutual fund, the primary asset you are buying is the manager, who will be controlling which assets are chosen to meet the funds' stated investment objectives.
Diversification
A crucial element in investing is asset allocation. It plays a very big part in the success of any portfolio. However, small investors do not have enough money to properly allocate their assets. By pooling your funds with others, you can quickly benefit from greater diversification. Mutual funds invest in a broad range of securities. This limits investment risk by reducing the effect of a possible decline in the value of any one security. Mutual fund unit-holders can benefit from diversification techniques usually available only to investors wealthy enough to buy significant positions in a wide variety of securities.
Low Cost
A mutual fund let's you participate in a diversified portfolio for as little as Rs.5,000, and sometimes less. And with a no-load fund, you pay little or no sales charges to own them.
Convenience and Flexibility
Investing in mutual funds has it’s own convenience. While you own just one security rather than many, you still enjoy the benefits of a diversified portfolio and a wide range of services. Fund managers decide what securities to trade, collect the interest payments and see that your dividends on portfolio securities are received and your rights exercised. It also uses the services of a high quality custodian and registrar. Another big advantage is that you can move your funds easily from one fund to another within a mutual fund family. This allows you to easily rebalance your portfolio to respond to significant fund management or economic changes.
Liquidity
In open-ended schemes, you can get your money back promptly at net asset value related prices from the mutual fund itself.
Transparency
Regulations for mutual funds have made the industry very transparent. You can track the investments that have been made on you behalf and the specific investments made by the mutual fund scheme to see where your money is going. In addition to this, you get regular information on the value of your investment.
Variety
There is no shortage of variety when investing in mutual funds. You can find a mutual fund that matches just about any investing strategy you select. There are funds that focus on blue-chip stocks, technology stocks, bonds or a mix of stocks and bonds. The greatest challenge can be sorting through the variety and picking the best for you.
Sunday, September 19, 2010
What is a Mutual Fund
Like most developed and developing countries the mutual fund cult has been catching on in India. There are various reasons for this. Mutual funds make it easy and less costly for investors to satisfy their need for capital growth, income and/or income preservation.
And in addition to this a mutual fund brings the benefits of diversification and money management to the individual investor, providing an opportunity for financial success that was once available only to a select few.
Understanding Mutual funds is easy as it's such a simple concept: a mutual fund is a company that pools the money of many investors -- its shareholders -- to invest in a variety of different securities. Investments may be in stocks, bonds, money market securities or some combination of these. Those securities are professionally managed on behalf of the shareholders, and each investor holds a pro rata share of the portfolio -- entitled to any profits when the securities are sold, but subject to any losses in value as well.
For the individual investor, mutual funds provide the benefit of having someone else manage your investments and diversify your money over many different securities that may not be available or affordable to you otherwise. Today, minimum investment requirements on many funds are low enough that even the smallest investor can get started in mutual funds.
A mutual fund, by its very nature, is diversified -- its assets are invested in many different securities. Beyond that, there are many different types of mutual funds with different objectives and levels of growth potential, furthering your chances to diversify.
And in addition to this a mutual fund brings the benefits of diversification and money management to the individual investor, providing an opportunity for financial success that was once available only to a select few.
Understanding Mutual funds is easy as it's such a simple concept: a mutual fund is a company that pools the money of many investors -- its shareholders -- to invest in a variety of different securities. Investments may be in stocks, bonds, money market securities or some combination of these. Those securities are professionally managed on behalf of the shareholders, and each investor holds a pro rata share of the portfolio -- entitled to any profits when the securities are sold, but subject to any losses in value as well.
For the individual investor, mutual funds provide the benefit of having someone else manage your investments and diversify your money over many different securities that may not be available or affordable to you otherwise. Today, minimum investment requirements on many funds are low enough that even the smallest investor can get started in mutual funds.
A mutual fund, by its very nature, is diversified -- its assets are invested in many different securities. Beyond that, there are many different types of mutual funds with different objectives and levels of growth potential, furthering your chances to diversify.
Growth of Mutual Funds
The Indian Mutual fund industry has passed through three phases.The first phase was between 1964 and 1987 when Unit Trust of India was the only player.By the end of 1988,UTI had total asset of Rs 6,700 crores. The second phase was between 1987 and 1993 during which period 8 funds were established (6 by banks and one each by LIC and GIC).This resulted in the total assets under management to grow to Rs 61,028 crores at the end of 1994 and the number of schemes were 167.
The third phase began with the entry of private and foreign sectors in the Mutual fund industry in 1993. Several private sectors Mutual Funds were launched in 1993 and 1994. The share of the private players has risen rapidly since then. Currently there are 34 Mutual Fund organisations in India. Kothari Pioneer Mutual fund was the first fund to be established by the private sector in association with a foreign fund.
This signaled a growth phase in the industry and at the end of financial year 2000, 32 funds were functioning with Rs. 1,13,005 crores as total assets under management. As on August end 2000, there were 33 funds with 391 schemes and assets under management with Rs. 1,02,849 crores. The Securities and Exchange Board of India (SEBI) came out with comprehensive regulation in 1993 which defined the structure of Mutual Fund and Asset Management Companies for the first time.
The third phase began with the entry of private and foreign sectors in the Mutual fund industry in 1993. Several private sectors Mutual Funds were launched in 1993 and 1994. The share of the private players has risen rapidly since then. Currently there are 34 Mutual Fund organisations in India. Kothari Pioneer Mutual fund was the first fund to be established by the private sector in association with a foreign fund.
This signaled a growth phase in the industry and at the end of financial year 2000, 32 funds were functioning with Rs. 1,13,005 crores as total assets under management. As on August end 2000, there were 33 funds with 391 schemes and assets under management with Rs. 1,02,849 crores. The Securities and Exchange Board of India (SEBI) came out with comprehensive regulation in 1993 which defined the structure of Mutual Fund and Asset Management Companies for the first time.
Securities lending
Securties lending program is from the NSE. It is similar to the Badla from the BSE, only difference being the carry forward system not being allowed by the NSE. Meaning this is a where in a holder of securities or their agent lends eligible securities to borrowers in return for a fee to cover short positions.
Insider trading:
Insider trading is illegal in India. When information, which is sensitive in the form of influencing the price of a scrip, is procured or/and used from sources other than the normal course of information output for unscrupulous inducement of volatility or personal profits, it is called as Insider trading. Insider trading refers to transactions in securities of some company executed by a company insider. Although an insider might theoretically be anyone who knows material financial information about the company before it becomes public, in practice, the list of company insiders (on whom newspapers print information) is normally restricted to a moderate-sized list of company officers and other senior executives. Most companies warn employees about insider trading. SEBI has strict rules in place that dictates when company insiders may execute transactions in their company's securities. All transactions that do not conform to these rules are, in general, prosecutable offenses under the relevant law.
Insider trading:
Insider trading is illegal in India. When information, which is sensitive in the form of influencing the price of a scrip, is procured or/and used from sources other than the normal course of information output for unscrupulous inducement of volatility or personal profits, it is called as Insider trading. Insider trading refers to transactions in securities of some company executed by a company insider. Although an insider might theoretically be anyone who knows material financial information about the company before it becomes public, in practice, the list of company insiders (on whom newspapers print information) is normally restricted to a moderate-sized list of company officers and other senior executives. Most companies warn employees about insider trading. SEBI has strict rules in place that dictates when company insiders may execute transactions in their company's securities. All transactions that do not conform to these rules are, in general, prosecutable offenses under the relevant law.
Badla financing
In common parlance the carry-forward system is known as 'Badla', which means something in return. Badla is the charge, which the investor pays for carrying forward his position. It is a hedge tool where an investor can take a position in a scrip without actually taking delivery of the stock. He can carry-forward his position on the payment of small margin. In the case of short-selling the charge is termed as 'undha badla'. The CF system serves three needs of the stock market :
Quasi-hedging: If an investor feels that the price of a particular share is expected to go up/down, without giving/taking delivery of the stock he can participate in the volatility of the share. ? Stock lending: If he wishes to short sell without owning the underlying security, the stock lender steps into the CF system and lends his stock for a charge. ? Financing mechanism: If he wishes to buy the share without paying the full consideration, the financier steps into the CF system and provides the finance to fund the purchase The scheme is known as "Vyaj Badla" or "Badla" financing. For example, X has bought a stock and does not have the funds to take delivery, he can arrange a financier through the stock exchange 'badla' mechanism. The financier would make the payment at the prevailing market rate and would take delivery of the shares on X's behalf. You will only have to pay interest on the funds you have borrowed. Vis-à-vis, if you have a sale position and do not have the shares to deliver you can still arrange through the stock exchange for a lender of securities. An investor can either take the services of a badla financier or can assume the role of a badla financier and lend either his money or securities. On every Saturday a CF system session is held at the BSE. The scrips in which there are outstanding positions are listed along with the quantities outstanding. Depending on the demand and supply of money the CF rates are determined. If the market is over bought, there is more demand for funds and the CF rates tend to be high. However, when the market is oversold the CF rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same. The scrips that have been put in the Carry Forward list are all 'A' group scrips, which have a good dividend paying record, high liquidity, and are actively traded. The scrips are not specified in advance because it is then difficult to get maximum return. All transactions are guaranteed by the Trade Guarantee Fund of BSE, hence, there is virtually no risk to the badla financier except for broker defaults. Even in the worst scenario, where the broker through whom you have invested money in badla financing defaults, the title of the shares would remain with you and the shares would be lying with the "Clearing house". However, the risk of volatility of the scrip will have to be borne by the investor.
Quasi-hedging: If an investor feels that the price of a particular share is expected to go up/down, without giving/taking delivery of the stock he can participate in the volatility of the share. ? Stock lending: If he wishes to short sell without owning the underlying security, the stock lender steps into the CF system and lends his stock for a charge. ? Financing mechanism: If he wishes to buy the share without paying the full consideration, the financier steps into the CF system and provides the finance to fund the purchase The scheme is known as "Vyaj Badla" or "Badla" financing. For example, X has bought a stock and does not have the funds to take delivery, he can arrange a financier through the stock exchange 'badla' mechanism. The financier would make the payment at the prevailing market rate and would take delivery of the shares on X's behalf. You will only have to pay interest on the funds you have borrowed. Vis-à-vis, if you have a sale position and do not have the shares to deliver you can still arrange through the stock exchange for a lender of securities. An investor can either take the services of a badla financier or can assume the role of a badla financier and lend either his money or securities. On every Saturday a CF system session is held at the BSE. The scrips in which there are outstanding positions are listed along with the quantities outstanding. Depending on the demand and supply of money the CF rates are determined. If the market is over bought, there is more demand for funds and the CF rates tend to be high. However, when the market is oversold the CF rates are low or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocks gets a return for the same. The scrips that have been put in the Carry Forward list are all 'A' group scrips, which have a good dividend paying record, high liquidity, and are actively traded. The scrips are not specified in advance because it is then difficult to get maximum return. All transactions are guaranteed by the Trade Guarantee Fund of BSE, hence, there is virtually no risk to the badla financier except for broker defaults. Even in the worst scenario, where the broker through whom you have invested money in badla financing defaults, the title of the shares would remain with you and the shares would be lying with the "Clearing house". However, the risk of volatility of the scrip will have to be borne by the investor.
Circuit Filters And Trading Bands
In order to check the volatility of shares, SEBI has come with a set of rules to determine the fixed price bands for different securities within which they can move in a day. As per Sebi directive, all securities traded at or above Rs.10/- and below Rs.20/- have a daily price band of ±25%. All securities traded below Rs. 10/- have a daily price band of ± 50%. Price band for all securities traded at or above Rs. 20/- has a daily price band of ± 8%. However, the now the price bands have been relaxed to ± 8% ± 8% for select 100 scrips after a cooling period of half an hour. The previous day's closing price is taken as the base price for calculating the price. As the closing price on BSE and NSE can be significantly different, this means that the circuit limit for a share on BSE and NSE can be different.
Types Of Orders
There are various types of orders, which can be placed on the exchanges:
Limit Order : The order refers to a buy or sell order with a limit price. Suppose, you check the quote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price. Market Order : Generally a market order is used by investors, who expect the price of share to move sharply and are yet keen on buying and selling the share regardless of price. Suppose, the last quote of RIL is Rs 251 and you place a market buy order. The execution will be at the best offer price on the exchange, which could be above Rs 251 or below Rs 251. The risk is that the execution price could be substantially different from the last quote you saw. Please refer to Important Fact for Online Investors. Stop Loss Order : A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the Share is reached or crosses a threshold price called as the trigger price. The trigger price will be as on the price mark that you want it to be. For example, you have a sold position in Reliance Ltd booked at Rs. 345. Later in case the market goes against you i.e. go up, you would not like to buy the scrip for more than Rs.353. Then you would put a SL Buy order with a Limit Price of Rs.353. You may choose to give a trigger price of Rs.351.50 in which case the order will get triggered into the market when the last traded price hits Rs.351.50 or above. The execution will then be immediate and will be at the best price between 351.50 and 353. However stock movements can be so violent at times. The prices can fluctuate from the current level to over and above the SL limit price, you had quoted, at one shot i.e. the LTP can move from 350…351…and directly to 353.50. At this moment your order will immediately be routed to the Exchange because the LTP has crossed the trigger price specified by you. However, the trade will not be executed because of the LTP being over and above the SL limit price that you had specified. In such a case you will not be able to square your position. Again as the market falls, say if the script falls to 353 or below, your order will be booked on the SL limit price that you have specified i.e. Rs. 353. Even if the script falls from 353.50 to 352 your buy order will be booked at Rs. 353 only. Some seller, somewhere will book a profit in this case form your buy order execution. Hence, an investor will have to understand that one of the foremost parameters in specifying on a stop loss and a trigger price will have to be its chances of executionability as and when the situation arises. A two rupee band width between the trigger and stop loss might be sufficient for execution for say a script like Reliance, however the same band hold near to impossible chances for a script like Infosys or Wipro. This vital parameter of volatility bands of scrips will always have to be kept in mind while using the Stop loss concept.
Limit Order : The order refers to a buy or sell order with a limit price. Suppose, you check the quote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price. Market Order : Generally a market order is used by investors, who expect the price of share to move sharply and are yet keen on buying and selling the share regardless of price. Suppose, the last quote of RIL is Rs 251 and you place a market buy order. The execution will be at the best offer price on the exchange, which could be above Rs 251 or below Rs 251. The risk is that the execution price could be substantially different from the last quote you saw. Please refer to Important Fact for Online Investors. Stop Loss Order : A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the Share is reached or crosses a threshold price called as the trigger price. The trigger price will be as on the price mark that you want it to be. For example, you have a sold position in Reliance Ltd booked at Rs. 345. Later in case the market goes against you i.e. go up, you would not like to buy the scrip for more than Rs.353. Then you would put a SL Buy order with a Limit Price of Rs.353. You may choose to give a trigger price of Rs.351.50 in which case the order will get triggered into the market when the last traded price hits Rs.351.50 or above. The execution will then be immediate and will be at the best price between 351.50 and 353. However stock movements can be so violent at times. The prices can fluctuate from the current level to over and above the SL limit price, you had quoted, at one shot i.e. the LTP can move from 350…351…and directly to 353.50. At this moment your order will immediately be routed to the Exchange because the LTP has crossed the trigger price specified by you. However, the trade will not be executed because of the LTP being over and above the SL limit price that you had specified. In such a case you will not be able to square your position. Again as the market falls, say if the script falls to 353 or below, your order will be booked on the SL limit price that you have specified i.e. Rs. 353. Even if the script falls from 353.50 to 352 your buy order will be booked at Rs. 353 only. Some seller, somewhere will book a profit in this case form your buy order execution. Hence, an investor will have to understand that one of the foremost parameters in specifying on a stop loss and a trigger price will have to be its chances of executionability as and when the situation arises. A two rupee band width between the trigger and stop loss might be sufficient for execution for say a script like Reliance, however the same band hold near to impossible chances for a script like Infosys or Wipro. This vital parameter of volatility bands of scrips will always have to be kept in mind while using the Stop loss concept.
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