A robust economy, impressive corporate earnings growth,
relatively stable interest rates and the rising recognition of domestic
companies in the overseas markets have made India a favourite investment
destination for overseas fund managers.This is over and above the increasing
interest among domestic institutional and individual investors, alike, for
availing themselves of investment opportunities in this fast emerging financial
market. Accordingly, the long-term prospects of the Indian stock market, which
measures the pulse of the Indian economy, continue to be buoyant as almost all
industrial sectors have been benefiting from the country's economic growth.
At a more micro level, you must realize that
irrespective of how much you earn and save, the returns that you receive on
your savings should outpace inflation by a substantial margin, if you wish to
be able to fulfil your dreams and aspirations and build up a corpus for your
retirement years. Investing in stocks has time and again proved to be the best
way to do so. This is especially true now, with the economy showing so much
promise, which in turn is reflected in the stock market. However, you must be
ready to stay invested for the long term and ignore temporary ups and down
which the market is bound to face on its long term upward climb. In a nutshell,
investing in well chosen stocks for the long term is a sure-fire way to build
This is one of the basic principles in investing:
Taking reasonable risks could result in higher long-term rates of returns.
Equity shares promise higher rates of return over the long term. On the other
hand, debt instruments offer more stable but lower returns. As an investor, you
should be able to judge whether the perceived risk is worth taking in order to
get the expected return and whether a higher return is possible for the same
level of risk and vice versa. The only way you can do this is if you are aware
of all the risks that you are up against. Here’s a list of the more common
risks that are attached to investing in equity.
These risks are not unique to any company and affect all stocks. They stem from
factors related to the economy such as money supply, the level of government
borrowing, the industrial policy, global economic conditions, etc. These are
also known as non-diversifiable risks, since investors cannot avoid these
risks, however diversified their portfolios may be.
This is the risk that applies to a specific industry and therefore, to stocks
of companies belonging to that industry. A large scale shift in demand, a rise
in input prices and regulatory changes are factors that augment such a risk.
For instance, consumers’ preference for cheaper polyester clothing hampered the
demand for cotton fabrics in the 1990s. Another example is the risk borne by
Indian tyre companies when international prices of natural rubber rise.
It is defined as the inability of the management to take decisions in the
larger good of the company and its minority shareholders. Decisions that
benefit only the company's directors and its promoters would classify as a
management risk. Further, even a shareholder-friendly management can be a risk
if it is unable to manage a company's growth in both good and bad times alike,
and lacks the necessary dynamism to lead the company.
Business risks mainly arise from the fact that a company's earnings before
interest and taxes (EBIT) can vary, depending on various factors. Demand is the
first among these factors. If the demand for the company's product is not
stable or predictable, its revenue won't be stable or predictable either. The
company's ability to increase prices or absorb cost increases is another key to
its profitability. Companies differentiating their products through branding
are better equipped to pass on cost increases and earn above average profits.
Thirdly, if fixed costs are a substantial portion of total expenses, business
risk is definitely higher (unless such costs also create a strong entry
barrier) since the company's earnings then are more susceptible to variations
Financial risks arise when debt represents a high proportion of the company's
capital structure (which comprises net worth and debt). A calling back of debt
by the creditors or the company’s inability to secure adequate funds in future
could result in a collapse in the operations of the firm whose stock you have
This risk arises out of variations in exchange rates of the rupee against the
U.S. dollar and other major currencies. Profits of companies who import a
relatively large part of their raw materials and those that export a large part
of their goods or services are impacted when the rupee depreciates or
appreciates, respectively. A weakness in the rupee also prompts foreign
investors to withdraw from the stock market by selling their shares and
converting those rupees into dollars. While they may re-enter at lower levels,
the withdrawal of foreign investors often forces stock indices to tumble in the
short-term, posing a big risk for domestic investors.
Inflation can hit a company's profits badly if it is not able to pass on the
effects to consumers. In some cases, even if inflation eases, wage hikes can
rarely be rolled back. Worse still, inflation can inflate corporate profits
through overvaluation of closing inventory and this can lead to an increased
Before trying to understand the differences between top-down and bottom-up
investing, remember that both of these approaches have the same goal - to find
out great stocks. Top-down investing involves analyzing the ‘big picture’.
Investors using this approach look at the economy and try to forecast which
industry will generate the best returns. They then look for individual
companies within the chosen industry and add the stock to their portfolios. For
example, suppose you believe there will be a drop in interest rates. Using the
top-down approach, you might determine that the home-building industry would
benefit the most from the macroeconomic changes and then limit your search to
the top companies in that industry.
Conversely, a bottom-up investor overlooks broad sector
and economic conditions and instead focuses on selecting a stock based on the
individual attributes of a company. Advocates of the bottom-up approach simply
seek strong companies with good prospects, regardless of industry or
macroeconomic factors. What constitutes ‘good prospects’, however, is a matter
of opinion. Some investors look for earnings growth while others find companies
with low P/E ratios attractive. Bottom-up investors will compare companies
based on these fundamentals. They feel that as long as the firms are strong,
the business cycle or broader industry conditions are of no concern.
The P/E yardstick
One of the key determinants of a good valuation yardstick is its usage. The
price to earnings (P/E) multiple wins hands down on that score, being easily
one of the most popular valuation tools not only in India but across the globe.
Conceptually, the P/E multiple represents the premium
that the market is willing to pay on a company’s earnings, based on its future
growth. The ratio is most often used to conclude whether a stock is undervalued
or overvalued. The P/E ratio is calculated by dividing a stock's current share
price by its earnings per share (EPS) for a 12-month period (mostly the last
reported full-year EPS). In effect, the ratio uses the company's earnings as a
guide to value it.
While using P/E as a yardstick for measuring stocks,
remember that a stock with a lower P/E is not necessarily a better investment
than a stock with a higher P/E. Most P/E ratios you see for publicly-traded
stocks are an expression of the stocks’ current prices compared to their
previous 12-month earnings. A low P/E must be coupled with the company’s
ability to grow revenues and earnings at least as quickly as the price in
future to remain attractive. It must also be noted that average P/E ratios tend
to vary from industry to industry. Typically, companies in very stable, mature
industries which have more moderate growth potential have lower P/E ratios than
those in relatively young, fast-growing industries with more robust future
potential. Thus, when you compare P/E ratios of two companies as potential
investments, it is important to compare firms from the same industry with
similar characteristics. Otherwise, if you simply purchased stocks with the
lowest P/E ratios, you would likely end up with a portfolio full of similar
companies, which would leave you poorly diversified and exposed to more risk
than if you had diversified into other industries with higher-than-average P/E
At the same time, stocks with high P/E ratios need not
turn out to be good investments.The important thing is that when looking at P/E
ratios as part of your stock analysis, consider what premium you are paying for
a company's earnings today and determine if the expected growth warrants the
premium. Also, compare it to its industry peers to see its relative valuation
and try to determine whether the premium is worth the cost of the investment.
flow (DCF) analysis
It can be hard to understand how stock analysts come up with a ‘fair value’ for
companies, or why their target price estimates vary so wildly. The answer often
lies in how analysts use the valuation method known as discounted cash flow
(DCF). In simple terms, DCF tries to work out the value of a company today,
based on projections of how much money the firm is going to make in the future.
DCF analysis says that a company is worth all of the cash that it could make
available to investors in the future. It is described as ‘discounted’ cash flow
because cash in the future is worth less than cash today.
DCF serves as a reality check to the fair value prices
found in brokers' reports. DCF analysis requires you to think through the
factors that affect a company, such as future sales growth and profit margins.
It also makes you consider the discount rate, which depends on a risk-free
interest rate, the company's costs of capital and the risk its stock faces. All
of this will help you understand what drives the value of a company’s stock.
This will enable you to put a more realistic price tag on the company's stock.
Using a DCF model probably entails a more in-depth
understanding of the company finances than relying on traditional valuation
measures such as the P/E ratio. This analysis treats a company as a business
rather than just a ticker symbol and a stock.
Economic value added (EVA) is a financial concept that
cuts away market chaos to focus on a single investment question: Is a company
creating or destroying wealth for shareholders? By trying to answer this
question, you will take the first step to pick stocks that outperform the
market, which is the dream of every long-term investor.
EVA is defined as the difference between a company's net operating profits
(NOPAT) and its total cost of invested capital over a given time period. This
capital charge is necessary to compensate the providers of debt and equity for
use of their capital investment at a rate adequate for the risk incurred.
EVA = net operating profits after tax - cost of invested
If the EVA is positive, the company has created value
above the minimum return required by investors, and if it is negative, wealth
has been destroyed.Implicit in the EVA calculation is an important concept -
equity requires a return. Not only that, but the cost of equity is typically
the most expensive form of invested capital and is linked to factors such as
prevailing interest rates and corporate risk. Financial statements recognize
the cost of debt, identified as interest expense, but not the cost of equity.
Calculating a company's profit while leaving out the cost of equity is like
playing volleyball without the net.
With the full cost of capital deducted from NOPAT, EVA
shows whether capital is being used efficiently in the company, and with
further analysis, whether high-return businesses are subsidizing low-return
businesses or which geographical regions or business segments of a company's
operations add value or destroy value.
Investing using EVA
Recognizing how, in the long term, the efficiency with
which a company uses its capital determines how well its stock performs, EVA
can provide valuable predictive insights into the future performance of stocks.
To describe how to apply EVA to investment strategies, one additional concept -
market value added - is required.Market value added (MVA) is the difference
between the total market capitalization of a company's debt and equity and the
total invested capital. It represents the market's perception at a point in
time of the company's ability to successfully invest its capital in the future.
Companies which have demonstrated superior EVA performance are typically
accorded a higher MVA, a premium over their current invested capital to
recognize their perceived potential to gain wealth. Companies, which have an
eroding EVA, may find their MVA languishing or, in fact, negative, reflecting
negative sentiments in their stock price.From the company's perspective, the
best category is where wealth is being created (high EVA) and the market is
rewarding this wealth creation with a high MVA. Growth and momentum investors
may find opportunities in this group of companies.
Managing investments is a serious business. It can be a
time-consuming task, because it requires intelligent planning, continuous
monitoring and periodic adjustments. And it can be challenging, because it
requires expert knowledge and experience. Equity investment does not provide
you the luxury of sleeping over your investment just as would be possible in
case of fixed income securities. Indian markets no longer work in isolation.
You need to be very well aware of not only happenings of national interest but
global issues which affect the future prosperity of your investment. Selecting
stocks for one’s portfolio is only the beginning of the investment process. You
need to review your valuation metrics to determine which stocks remain
undervalued and which are approaching or have surpassed their fair value.
If you have invested in the equity markets your
investment needs to be continuously monitored. Even if you buy into equity with
a long-term view, you still need to assess the performance of your portfolio on
a regular basis. To assess the stock performance you need to monitor the
performance of the company as well as the industry. You also need to keep in
mind the economical, political and global factors affecting the firm.
Therefore, take a closer look at the following factors while measuring the
performance of stocks:
companies’ quarterly performances You must have noticed that
every three months - at the end of June, September, December and March - the
newspapers are full of advertisements about the financial results of companies.
That's because companies are required by law to publish their financial results
every quarter. They must also send the results to the stock exchange where they
are listed. Now you can track the performance through the year since the
quarterly results show the most recent performance of companies. While glancing
through quarterly results, keep a watch on the following numbers:
Revenues reveal 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 firm, which will
have a positive impact on the stock's valuation.
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 per cent from the
previous years whereas for the old economy stocks the range could be anywhere
between 10 per cent and 15 per cent.
* ROI (return on investment)
ROI in layman terms is the return on capital invested in business. For
instance, if you invest Rs 1 crore in men, machines, land and material to
generate Rs 25 lakh of net profit, then the ROI is 25 per cent. 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 per cent, whereas for a
capital-intensive industry it could be just 10-15 per cent.
* PSR (price-to-sales ratio)
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 a PSR below 1 gives you
a much better chance of success.
* ROE (return on equity)
Supposedly Warren Buffet's favorite ‘number’, the ROE measures how much your
investment is actually earning. Around 20 per cent is considered a good level.
* Debt-to-equity ratio
This measures how much debt a company has compared to the equity. The
debt-to-equity ratio is arrived at by dividing the total debt of the company
with the equity capital. A D/E ratio of 2 or greater is risky. It means that
the company has a high interest burden, which will eventually affect its
bottom-line. If the firm is using only a small portion of its revenues to pay
off interest, then the company is better off by employing debt to enhance
growth. However, note that companies in capital intensive industries have
higher debt/equity ratios. Hence, this tool is not the right parameter to
assess such firms.
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).
*EPS (earnings per share)
This ratio determines what the company is earning for every share. For many
investors, earnings are the most important tool. EPS is calculated by dividing
the earnings (net profit) by the total number of equity shares.
* P/E ratio (price/earnings
ratio) 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. A significant increase in earnings can enhance
share value. When a stock's P/E ratio is high, a majority of the investors
consider it as pricey or overvalued. Stocks with low P/Es are typically
considered as having good value. However, studies done and past market
experience have proved that the higher the P/E, the better the stock.
Just by glancing at the results for the fourth quarter,
you can easily conclude whether the company has made a profit or loss. Is that
profit high or low? Is it good enough? To answer those questions, you will have
to compare the quarterly numbers with those of the same quarter in the previous
year. To make comparisons easy, companies provide these numbers, too.
So, you can check out the growth in each item by
comparing it with the numbers in the corresponding quarter of the previous
year. While going through the results, the extraordinary items and the other
income should be excluded as they are not recurring items. All of the above
give a fair idea about the stock and its prospects, but you should always take
care while comparing a stock with that of peers.
Study overall trends
in capital markets and the economy
The return on equity is directly dependent on the situation prevailing in the
economy. The government’s policies, budgetary issues, reforms promoting a
particular sector and the global impact on the Indian market need to be
considered before deciding on a stock. For instance, a government’s decision to
allow foreign direct investment in real estate, and remove the multi-fibre
agreement in textiles would give an edge to these industries over others. The
outlook for the stock market also depends on the outlook for basic economic
factors such as:
The supply of funds coming principally from business and personal savings
The demand for funds arising from financing expenditure by consumers, business
The growth rate for real GDP (the total market value of all the goods and
services produced within the borders of a nation during a specified period)
The inflation rate and anticipated inflationary pressures.
Normally, a stock is bought after going through its
fundamentals and its fair value is determined taking into account the
investment horizon. So, a sale would be made when the stock approaches its fair
value. However, deteriorating business fundamentals or negative earnings
revision may also prompt an early exit from the stock. Continuous monitoring
and reviewing would enable you to keep track that if the information or
expectation does not yield the desired result then you could sell the stock. An
investment made with a long-term perspective also needs to be reviewed to check
for any unfavourable technical factors, political or economical instability
affecting the rationale for holding the stock. On the other hand, improving
business conditions, new products or a change in management that might help a
company strengthen earnings may require you to increase the holding period for
a particular stock. Thus, it might help you to make more returns by reviewing
your selling decision.
Securities Transaction Tax (STT)
STT is levied on the value of certain transactions. These transactions include
the purchase and sale of equity shares, purchase and sale of units of an equity
oriented fund, sale of a unit of an equity oriented fund to the mutual fund and
sale of a derivative. The rates applicable on different transactions differ
depending on the type of security that is traded and whether the transaction is
delivery based or not. Further, in some cases the seller is required to pay the
tax and in other cases the buyer has to pay (see table below).
Transaction in recognized stock exchanges
units of equity oriented mutual fund (delivery based)
Sale of equity shares and units of equity oriented
mutual fund (delivery based)
Sale of equity shares and units of equity oriented
mutual fund (non-delivery based)
Sale of derivatives
Rate of STT from June 1, 2006
0. Purchase of equity shares and 017%
Tax treatment of long - term capital gains in the
hands of the seller
Exempt from tax under section 10(38) [long- - term
capital losses, if any, shall be ignored]
Income is generally treated as business income
Income is generally treated as business income
Tax treatment of short-term capital gains in the
hands of the seller
Taxable at the rate of 10% (+surcharge +education
cess) under Section 111A
Income is generally treated as business income
Income is generally treated as business income
Tax treatment of business income in the hands of the
If income is shown as business income, one can claim
tax rebate under Section 88E
One can claim tax rebate under Section 88E
One can claim tax rebate under Section 88E
Surcharge:Nil; Education cess:Nil
Note:STT is not applicable in the case of government securities,
bonds, debentures, units of mutual fund other than equity oriented mutual fund.
In such cases, tax treatment of short-term and long-term capital gains shall be
as per normal provisions of law.
In case of redemption or repurchase of units of an equity fund the rate of STT
leviable is 0.25%
If equity or preference shares of a company are held
for more than 12 months before being sold, then they are known as long-term
capital assets. The gains which arise on the sale of such assets are known as
long term capital gains. No tax is applicable to long-term capital gains
arising on the transfer of equity shares from 1st October 2004, if such
transaction is covered by Securities Transaction Tax under Section 10(38).
Short-term capital gains:
If equity or preference shares of a company are held for less than 12 months
before being sold, then they are known as short-term capital assets. The gains
which arise on the sale of such assets are known as short term capital gains.
Such gains are taxed at the rate pf 10 per cent plus a surcharge and an
education cess.Short term capital gains cannot be set off by investing in
capital gains bonds under Section 54EC. Investors could avail themselves of
this benefit only when it comes to long-term capital gains.
Short and long term capital
A capital loss (short-term/long-term) can be carried forward for a maximum
period of eight years from the assessment year in which the loss was first
A short-term capital loss can be set off against any capital gain (long-term
and short-term). However, a long-term capital loss can be set off only against
a long-term capital gain.
Capital gains tax on bonus/rights shares
A bonus on equity shares has a zero (nil) cost of acquisition. At the time of
sale of bonus shares, the holding period is calculated from the date of
allotment of bonus shares and the net sales proceeds are treated as a capital
gain and taxed accordingly.
Rights shares:The cost
of acquisition of the rights issue on equity shares is the amount paid for
acquiring such a right. Here too, the holding period is reckoned from the date
of allotment of rights shares and the net sales proceeds are treated as a
capital gain and taxed accordingly.
Valuation of capital gains on
shares sold in case of multiple demat accounts
In the case of multiple demat accounts, the capital gain on the sale of shares
has to be computed on a FIFO basis with reference to the particular account
from where the shares are sold. The FIFO method was introduced to bypass the
process of determining the cost on a one-to-one basis with the particular
depository participant (DP).
Capital gains tax on the sale of
Split shares represent the sub-divided shares of a lot of shares. The cost of
such shares gets proportionately divided and the period of holding also
continues to be the same as that of the original lot. Capital gains are
determined as the difference between the sale price and the proportionately
divided cost price and the period of holding determines whether these are short
term or long term gains. For instance in the case of a 1:1 split of shares
which have been purchased at Rs 100 per share, if each share is sold for Rs 80,
within one year after the date of purchase, the cost price is considered as Rs
50 and the sale price is Rs 80. Therefore, short term capital gains tax is
applicable on the gain of Rs 30.
Tax on dividend income
Dividend received from investment in shares is not taxable in the hands of the
recipient. The company that distributes the dividend is required to pay
dividend distribution tax on dividend declared, distributed or paid out.
Tax break on investment in equity
Investing in the IPOs of certain specified infrastructure companies renders you
a tax break under section 80C of the income tax act. You can claim a deduction
of up to Rs 1 lakh from taxable income for the amount that you invest in such
After you have built a portfolio investment strategy on
the basis of your risk-return profile and a time horizon, you have to implement
it. Stock trading can be done through two ways, either offline broking or
To begin trading, you must first find a broker to
execute your trades. Of late, most transactions are carried out in the
electronic form. For this, you have to open a ‘demat account’ with a depository
who should be registered with the regulatory authority. A depository is an
organization which holds securities of investors in the electronic form at the
request of the investors through a registered depository participant. It also
provides services related to transactions in securities. After opening the
demat account you should open a trading account with your broker. The broker
issues contract notes detailing purchase and sale transactions, bills
containing the charges (stamp duty, brokerage, securities transaction tax and
service tax) levied on the purchase and sale transactions. SEBI (Securities and
Exchange Board of India) prescribes guidelines for the rate at which charges
are levied, the frequency of issuing contract notes and also the format.
Let’s say you strongly feel that the price of a stock
will go up and so much so that you don't mind taking some extra risk. You can
make money by buying the stock now and selling it later when the price
increases. But what if you don’t have the money to buy? Well, you could ‘go
long’ on that stock; that is, you ask your broker to buy the stock without
paying him the full amount now. Instead, you can pay him a token amount called
the margin money. When you buy on margin you are actually buying stocks on
credit. Your broker will lend you the part money if you have enough collateral
in the form of adequate stocks in deposit with the broker. Since it’s a loan
the broker is giving you, he will also charge you interest. You could have also
borrowed money from some other sources to buy those stocks. But, usually
brokers try to offer interest rates lower than other sources. Buying long
allows you to buy more shares than you can afford. And, if your hunch about a
stock's price rise turns out to be correct, you stand to gain more than what
you could have without a margin buy. But, the longer it takes for the stock to
rise to the price level you had expected, the less will be your gain. To be
safe, the stock price should rise enough to pay off the loan amount, the
interest incurred and the transaction cost. Buying long becomes risky if your
calculations go wrong. If it takes a much longer time for the stock price to
reach the level than what you had estimated, your profits will reduce because
by that time the interest cost on the borrowed money would also have risen. And
if your estimate completely goes wrong and the stock's price falls, you
immediately start making losses. You break even when the stock price rises
enough to pay off the loan amount, the interest incurred and the transaction
Cost of investing in equity
You would incur costs when you open demat and trading accounts. Brokers usually
have recurring and one-time charges (account opening fees). Recurring charges
are the annual maintenance fee and the brokerages on transactions.
Brokerage is usually 0.25-0.85 percent of the
transaction value or a flat rate (between Rs 10 and Rs 50) on a per trade
basis, whichever is less. Some brokerages charge customers with large accounts
less. Annual charges for the demat account can be anything between Rs 250 and
Rs 750. The brokerage may or may not include service tax.
If you are an active investor with a high trading turnover, brokerage charges
will leave a dent on the profits. Obviously, the lower the percentage rate, the
If you are a low volume investor — active or passive — a stiff minimum charge
will hurt. Therefore, choose a broker or a Web trader who either does not
specify a minimum charge or levies a low one.
Electronic trading (e-trading) connects buyers and
sellers in geographically separate locations in a virtual trading platform.
Now, you can use your computer via the internet to e-trade. With reference to
shares, e-trading means the buying and selling of equity vielectronic means. In
practical terms, you must register as a client with an e-broker as you do with
a broker and can start trading.
Most banks offer online trading facilities and these
are three-in-one accounts – that is, bank, demat and trading accounts. The
expenses incurred here are the minimum balance one has to maintain with the
bank, and the demat and the trading account opening charges. Normally the
following charges are levied.
Account opening charges - Charges for opening an
account stand at around Rs 700. This is inclusive of legal documentation
charges. This amount will be debited from the customer’s savings account.
Brokerage – Various brokers may charge different rates
but they cannot charge beyond that specified by the government and regulatory
bodies. You may be charged at the rate of the higher of 0.5% of the transaction
value or Rs 25. In case of a square off, brokerage will be charged at the rate
of 0.15 per cent of the transaction value on each leg subject to a minimum of
Rs 7.50 on each leg of the transaction.
If you buy 100 shares of X Ltd. at the rate of Rs 190, brokerage charged will
be Rs 95 (0.5 per cent of 19,000).
If you buy 10 shares of Y Ltd. at the rate of Rs 180, the brokerage charged
will be Rs 25.
If you buy 100 shares of X Ltd. at the rate of Rs 190 and sell 100 shares of X
Ltd at the rate of Rs 200 in the same settlement, brokerage will be charged at
the rate of 0.15 per cent of 19,000 + 0.15 per cent of 20,000 = Rs 58.50
If you buy 10 shares of Y Ltd. at the rate of Rs 180 and sell 10 shares of Y
Ltd at the rate of Rs 175 in the same settlement, brokerage will be charged at
the rate of 7.5 +7.5 = Rs 15.
There are no account opening charges. A quarterly minimum balance will,
however, have to be maintained.
Depository participant (DP)
There are no account opening charges. However, the DP will levy an annual
maintenance charge as well as transaction charges for each trade.
Online trading gives first-time and low-volume
investors an edge over physical broker trading in terms of convenience. Also,
it is more transparent. Banks that offer trading platforms make for seamless
trading and payment options. The entire transaction process — from placing the
order to making payments and delivery — takes place seamlessly, and requires
minimal follow-up. In addition, the costs are largely the same regardless of
whether you are trading offline or online.
Every person who invests in the market has his
individual experiences to share; nevertheless there are few common
misconceptions. To become a successful market player one must be well aware of
the truth behind these. For instance, very often we hear people saying that the
elderly are not supposed to take risks. They must be very conservative because
their earnings power is limited. Well, who decided that young people could
afford to lose their money? Taking another example, it is easy to say that
stocks that go up must come down but laws of physics do not apply in the stock
market. There is no gravitational force that pulls stocks back to even. To give
you a better understanding, let us go through the widely prevalent myths in the
market that one must be beware of.
Myth 1: The market is always
Most people believe the market is all-knowing and that the current price of a
stock reflects all material information about the company, its history and its
prospects. This does not hold true always. Often you would have noticed a stock
double or triple in the space of a month but this sharp rise is not preceded by
any new information about the company. It’s very rare for a company’s
fundamentals to change so significantly over a short span of time. So, what’s
changing is simply the market’s perception about the stock. Understanding what
the market is trying to say is different but to conclude that it’s invincible
would be a big mistake. The market will paint a new picture every day so it
will be far more useful to consider the market as extremely prone to swinging
to extremes, rather than as an all-knowing and all-powerful force that many
market watchers assume it to be. For only then can you use the market to your
benefit, and buy low and sell high, rather than become its slave and let it
affect not only your wealth but also your health.
Myth 2: Price is not an issue
while investing in good companies
A large number of investors propound that one cannot go wrong if you buy into
good companies, no matter what their share prices are. This philosophy is often
ascribed to Warren Buffett, and his so-called followers swear by it. The truth
is that, though Buffett believes in buying the best businesses, he acknowledges
that if your entry price is unrealistically high, you might have to wait an
eternity before you make decent returns from the stock. Usually, in such cases,
your patience runs out on you, and you exit at an inappropriate time.
Let us take the example of Wipro, which rose to almost
Rs 10,000 in February 2000. This translated into a P/E (price-earnings) ratio
of almost 800 on its earnings for the year ended March 2000. Yet, investors
continued to buy Wipro as if the sky was the limit. Wipro is a fantastic
company, no doubt, but sometimes speculators are able to generate a frenzy that
leaves rationality in the dumps, and along with it, the fate of many investors.
Those who purchased Wipro at that five-figure price are mostly unlikely to see
those levels again. So, the price at which you buy a stock is
important.Buffett, in fact, advises investors to answer two questions while
searching for investment picks: which company and at what price.
Myth 3: When a stock hits its
52-week low, it’s time to buy
Bottom fishing is a popular investor pastime, but it’s usually the fisherman
who get the fish. The 52-week high/low is one of the most widely used
parameters by many investors to buy or sell a stock. The logic: all stocks have
a 52-week low and 52-week high, and that range is usually at least 100 per
cent. So, if you can buy a stock near its low and sell it near its high, you
should be able to earn good returns but grabbing a rapidly falling stock
results in a lot of surprises, because inevitably you grab it in the wrong
place. For instance, attempting this strategy with technology stocks would call
for a lot of courage to face up to the consequences. Most technology investors
tend to follow ‘momentum investing’ (buy a stock when it starts to gain
momentum and sell it when it begins to lose steam). When momentum takes a stock
to a new low, there’s no telling where it will eventually end up. Moreover, a
rebound does not always take place. On the contrary, the stock might just keep
sinking to new lows, till it reaches a point where nobody wants to buy it at
all. So, if you are interested in buying a stock, it ought to be for a more
sensible reason. An investor needs to research his stocks very well. Zeroing in
on the blue chips is not easy, as there are only a handful of companies that
follow such a trend. So, before you jump to any conclusions, think really hard.
Myth 4: Rupee cost averaging is
always a good defensive stock strategy
Rupee cost averaging advocates buying more of a stock if its price falls in
order to average out the purchase price. Say, you bought 100 shares of a
company at Rs 100 (total consideration: Rs 10,000), after which it falls to Rs
50. At this price, you should buy 200 more shares (total amount invested
remains Rs 10,000) so as to bring down your purchase price.
Sure, you bring down your purchase price, but is it
worth it? If you buy something whose intrinsic value is only Rs 10, first at Rs
100 and then at Rs 50, no matter how much you average down, you will still be
buying onions at the price of orchids, and sooner or later, either your money
will run out or you may be the only investor left in the company!
So, the more important thing to look at is the true
worth of your investment. Once you have figured that out, it is much easier to
apply theories like rupee cost averaging or buying a stock when it hits its
Myth 5: Penny stocks are great
buys, as they have little downside
Is a stock priced at Rs 10 cheaper than another priced at Rs 1,000? Well, some
people will tell you it is. Their reasoning: how much lower can the stock
priced at Rs 10 go? Chances of price going to zero are more in favour of a
penny stock rather than in case of Wipro or Infosys. However, some people may
say that all the upside is already factored in the Rs 1,000 stock. The story is
already recognised and there is no more to be gained from buying this stock.
But, the truth is that the absolute price of a stock
has absolutely nothing to do with its future prospects, and hence, its
valuation. A stock issued at Rs 10 (maybe 10 years ago) and now quoting at Rs
1,000 suggests that the company has done well over these last 10 years in terms
of earnings and profitability while on the other hand, stocks trading at or
below par suggest something drastically wrong with the company and/or its
Don’t take any company for granted – whether it is
Infosys or just a penny stock. Put their annual reports under the lens every
year before taking any investment decision. The price of a stock must be viewed
in relation to its earnings, its book value, the dividend per share and
revenues per share, rather than on an absolute basis. More importantly, you
must also analyze qualitative factors relating to the company’s business, its
longevity, profitability and sustainability of those profits.
Myth 6: Fallen angels will all go
back up, eventually
Frequently people say that a particular stock has gone down 20 percent or more,
so it should not go lower. Shareholders of TV18 would have a good experience of
this. The share got listed at Rs 1,450 in the boom of 2000 and with the bear
market it went on making new lows and each time the stock continued its
southward journey until it reached the price of Rs 36. Taking another
hypothetical example suppose you are looking at two stocks:
XYZ made an all-time high last year around Rs 50 but has since fallen to Rs 10
ABC is a smaller company but has recently gone from Rs 5 to Rs 10 per share
Which stock would you buy? Believe it or not, all
things being equal, a majority of investors choose the stock that has fallen
from Rs 50 because they believe that it will eventually make it back up to
those levels again. Thinking this way is a cardinal sin in investing! Price is
only one part of the investing equation. The goal is to buy good companies at a
reasonable price. Buying companies solely because their market price has fallen
will get you nowhere. Make sure you don't confuse this practice with value
investing, which is buying high-quality companies that are undervalued by the
Myth 7: P/E ratio tells you
whether stocks are cheap or expensive
P/E ratios are easy to find. Every newspaper, magazine and stock report
publishes P/E ratios. Everybody seems to talk about them when discussing
stocks. So, P/E ratios must be a great way to compare stocks.
As an investor if you were told that ABC Ltd had a P/E
of 7, and XYZ Ltd had a P/E of 14, would you buy ABC Ltd instead of XYZ Ltd?
You might, but you wouldn’t be comfortable making that decision because one
needs more information. You’d like to know a whole lot of things before you
decide which stock to buy. One of the most important things you’d like to know
is the worth of each stock based upon its earnings, profitability and other key
financial data. In other words, you would like to have a sense of the stock’s
intrinsic value. P/E ratios don’t say anything about a stock’s value!
What investors need is a ‘value-to-price’ ratio. With this ratio, investors
would know immediately whether a stock was cheap, expensive or fairly priced.
But this means we have to have a way of computing value. Of course, there are
theories and formulas for computing intrinsic value. But they are complex, and
some sophisticated investors even say they are unfathomable. Consequently, most
investors don’t look at stock’s intrinsic value. They resort to trivial devices
like comparing P/E ratios.
What determines stock prices?
Stock prices are driven by market information in the short term. In the long
term, dividends, bonus, capital expenditure plans, mergers and acquisitions,
and government regulations affecting the sector together add up to impact stock
How much does a share cost?
The market sets the price and it all depends on how many buyers and sellers
think the share is worth that much on that day. Some stocks sell for less than
Rs 10 a share, others for more than Rs 1,000 a share. But do not be misled that
a Rs 10 share is better than a Rs 1,000 share. The market determines the price
of each stock, depending on the company’s potential.
What returns can one expect from
his/her investments in equity shares? What are the risks?
Equity shares are ‘high-risk, high-return’ investments. The major distinction
of equity investment from all other investment avenues is that while the return
from many avenues such as bank deposits small saving schemes, debentures,
bonds, etc. are fixed and certain, the earnings from equity investments are
highly uncertain and varied. A good scrip picked up at the right time could
fetch great returns and the return on a mediocre or poor company’s scrip may be
meagre or it may even turn negative; that is, the invested fund itself may be
eroded. In short, if the investment in fixed income category instruments is
secured and risk-free to a large extent, investment in equities and related
fields could be termed as risky.
What are market orders, limit
orders and stop orders?
There are several types of orders that you can dictate to a broker. The most
common type, which is a regular buy or sell order, is called a market order.
Another type of order is a limit order wherein you ask the broker to trade only
if the price reaches a specific level. In a stop order, you tell the broker to
sell your shares if the price drops to a certain level to prevent significant
losses because if it drops to that level it is likely to drop further and your
losses are likely to increase.
What do bullish and bearish
When the market goes up it is called a bullish trend and when the market goes
down it is called a bearish trend.
What is ‘taking a position’?
When you act upon a stock and buy into it, you are taking a position. A
position is an amount of money committed to an investment in anticipation of
favorable price movements.
There are two kinds of positions:
are what most people do. When you buy long, that means you are anticipating an
upward movement in the price, and that is how you profit. People usually buy
stocks expecting to sell them later at higher prices and hence make profits.
Short positions are the tricky ones. When you
buy short, you are anticipating a fall in the price and the fall is the source
of your profit. The shares will be sold and when the price falls they will be
repurchased and the difference is where the investor profits. Of course, the
investor who borrowed the shares carries the risk of not having the price move
as anticipated, in which case he may lose money while repurchasing the stocks.
What is a contract note?
It is a statement of confirmation of trade(s) done on a particular day for and
on behalf of a client. A contract note is issued in the prescribed format and
manner, establishing a legally enforceable relationship between the member and
client in respect to the trades stated in that contract note. Contract notes
are made in duplicate, where the member and client both keep one copy each.
Stocks often drop excessively on
just a little bit of bad news. Why?
If one piece of bad news gets out, investors begin to fear that more bad news
is lurking around the corner. Similarly, if one stock in a sector gets into
trouble (especially if it is an event that could easily happen to any other
company in the same business), there is a suspicion that others, too, will
suffer. For instance, investor confidence in Internet companies took a beating
after March 2000, when popular Web-based companies in the U.S. faced
Is it advisable to buy stocks on
the basis of information published in newspapers?
You will probably end up being the last in the queue. Everyone reads that news,
and the stock price has probably already reflects that news. In fact, stock
prices tend to drop on a major news announcements following the old jungle
saying: "Buy on rumours, sell on news."
If one invests for the long term,
can he/she simply ignore the short term?
If one invests for the long term, can he/she simply ignore the short term? It
is true that a 'buy and hold' strategy is superior to one that is based on
market timing. But, that does not mean you wait for all negative developments
to emerge before reacting. Hence, you need to look for positive or negative
signals in the short term. If these continue for some time they may have
long-term implications. However, avoid the temptation to profit from short-term
price swings. It may happen that you decide to sell stock ABC at a price hoping
to cover it later at a lower price. But then if the up-move is happening for
some sound fundamental reason, you will end up losing. Similarly, it may also
happen that you cover up your position at a lower price only to see the stock
price falls further as the share may have been downgraded for a genuine reason.
It is important that you do not miss the big picture.
How can one take advantage of
general fluctuations in stock prices?
If you think the market is ‘too high’, you might give a stop-loss to preserve
profits, liquidate some of your positions to capture profits and reduce your
exposure or delay any new purchases. If you think the market is ‘too low’, then
you might keep some money aside for fresh purchases or cover your position, if
you have sold the stock short before.
What are the four things that a
trader fears most?
The four fears are:
Fear of being wrong
Fear of losing money
Fear of missing out
Fear of leaving money on the table
An opportunity comes every now and then, but these fears do not let us take
full advantage of it. For instance, we enter the trade too soon - before the
market generates a signal, or too late - long after the market generated the