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MSE-IPF
MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
What are your rights as an investor in markets?

The Securities and Exchange Board of India (SEBI) has been working closely with the exchanges to constantly inform investors about their rights in equity markets. When you invest in the equity shares of a company, you become part owner of the company. Your demat credit is evidence that you are part owner of the company. You may have a very small proportion of ownership but you still have all the rights as a shareholder under the law. There are some rights that are available to the investor as an individual and some that are available as a group of shareholders. Let us look at individual rights first.

What are the individual rights that an investor enjoys?
  • An investor is entitled to receive the credit of the shares in his / her demat account. These shares can either be purchased in the secondary market or from the IPO market. In both the cases, the investor will get demat credit for the shares in the demat account. Issue of fresh physical certificates and physical transfers have been stopped from December 05th 2018 and hence all share delivery has to happen in demat mode only.
  • Shareholders are entitled to dematerialize their physical shares by opening a Demat account. This is of course subject to the company shares being admitted to dematerialization and unique ISIN allotted. Investors also have the option to rematerialize these shares and hold them in physical form, despite the limitations.
  • As the shareholder of the company, you are entitled to receive copies of the Annual Report containing the balance sheet, the profit & loss account, the cash flow statement and the Auditor’s Report.
  • The shareholder is also entitled to participate and vote in the annual general meetings (AGM) either personally or through proxy. Investors are also free to vote for or against any resolution based on their best judgement.
  • Shareholders are entitled to receive dividends in due time once approved in general meetings and paid out of (net of DDT). Nowadays dividends are directly credited to the mapped bank account of the shareholder. Similarly, the shareholder is also entitled to receive automatic credit in the demat account for bonus issues, stock splits, mergers and other corporate actions.
  • Shareholders, as investors in a company, are entitled to inspect the statutory registers at the registered office of the company by giving advance intimation to the company in which the investors hold shares.
  • To receive an offer to subscribe to / participate in special voluntary actions like rights issues and buyback of shares. The shareholder has the full discretion to decide upon whether they want to participate in these issues or not.
  • In case the shareholders are unhappy with certain aspects of a company’s functioning, the shareholders can apply to the Company Law Board (CLB) to call or direct the Annual General Meeting with requisite number of shareholders.
  • Shareholders of a company are also entitled to inspect the minute books of the general meetings (AGMs and EGMs) and to receive copies of the same for their perusal and records.
  • In extreme cases, the shareholders of the company are also entitled to legally proceed against the company by way of civil or criminal proceedings. In a worst case scenario, the shareholders, with requisite numbers, can also apply for the winding up of the company. In the event of any winding up or debt settlement by the company, the shareholder investors are entitled to receive residual proceeds from the process.

The above rights pertain to the investor as an individual. In addition, there are also rights that the shareholders as a group enjoy. Here are some of the key rights that can be exercised collectively.

  • A minimum number of shareholders can jointly requisite for holding an Extra-ordinary General Meeting (EGM).
  • A group of shareholders can also demand a poll or vote on any resolution that they are not entirely satisfied with.
  • Shareholders as a group can also apply to CLB to investigate the affairs of the company where they have some doubts of grave misdemeanours.
  • Minority shareholders above a certain threshold of ownership can also apply to the Company Law Board (CLB) for relief in cases of oppression of minority shareholders and / or mismanagement of the affairs of the company.

In addition to your investor rights as a shareholder of a company, you also have rights vis-à-vis the broker through whom you trade and the market overall. Such rights and obligations of investors are clearly laid out in the fine print of the Client-Broker agreement. Investors are advised to go through this fine print in detail to understand the exact nature of their rights and obligations as an active participant in the equity markets.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
Start investing small but start investing early

Catch them young and watch them grow; nowhere does this work more effectively than the realm of investments. Quite often, investors tend to believe that their corpus is too small for any serious investment. That is a myth! Today it is possible to invest in equities or mutual fund SIPs with an initial investment or as low as Rs.100 to Rs.1000. What really matters with respect to investments is that you must give time to these investments to actually fructify and grow. Smart investing is all about understanding the importance of investing early in life. The logic works something like this! When you start early you give more time for your corpus to generate returns. When you give more time for your corpus to generate returns you effectively give more time for your returns to generate more returns. In technical parlance this is called the power of compounding. Also when you start early, you have more time and greater leeway to experiment with new ideas and also to take corrective action when your portfolio performance goes contrary to your plan.

We can understand the importance of starting our investment journey early from two perspectives. Whether a lump-sum amount is invested or whether you invest in a systematic investment plan (SIP), your focus should be to give more time to your investments to actually fructify.

How investing early helps in case of lump-sum investment?

In the table below we look at the investment journey people who invest a lump-sum corpus for different periods of time. Each of them has invested a corpus of Rs.1 lakh but the difference is that they have invested this money at different ages ranging from the age of 20 to the age of 40. A person who invested Rs.1 lakh at the age of 20 has 35 years to grow his corpus while the person who invested Rs.1 lakh at the age of 40 has just 15 years to grow his corpus. Annual compounding is assumed at a standard rate of 14%.

Rs.1,00,000 invested at 14% for different time periods

Particulars

15 years

20 years

25 years

30 years

35 years

Accumulation Rs.7,13,793 Rs.13,74,349 Rs.26,46,192 Rs.50,95,016 Rs.98,10,018
Wealth Ratio 7.13 times 13.74 times 26.46 times 50.95 times 98.10 times

Remember, in all the above cases, there is a one-time investment and no further amounts invested. The above table clearly illustrates the benefits of investing early. The investor who invested a lump-sum of Rs. 1 lakh at the age of 40 could hold the investment for 15 years and the corpus grew to Rs.7.13 lakhs (a wealth ratio of 7.13 times). On the other hand the person who invested Rs.1 lakh at the age of 20 could hold the investment for 35 years and the corpus grew to Rs.98.10 lakhs (a wealth ratio of 98.1 times).

Let us go back for a moment to the Rule of 72. The Rule of 72 says that your corpus doubles in (72/yield) number of years. In the above case since the yield is 14%, the corpus doubles approximately every 5 years. That is why you will see that at every gap of 5 years the corpus nearly doubles. That is what explains the vast difference in the wealth ratio of the investor who was invested for 35 years and another investor who was there for just 15 years.

Logic of starting early applies to SIPs too

Wealth creation with a lump-sum corpus is clearly favouring the longer investment time frame. But what about SIPs, which is the investing norm for most individual investors as it syncs with their income flows? Let us take an alternate illustration and see how the same 5 people would fare if they had done a SIP of Rs.10,000 per month on the same fund at the same yield for the same number of years.

SIP of Rs.10,000 per month invested at 14% for different time periods

Particulars

15 years

20 years

25 years

30 years

35 years

Investment Rs.18,00,000 Rs.24,00,000 Rs.30,00,000 Rs.36,00,000 Rs.42,00,000
Accumulation Rs.61,28,538 Rs.1,31,63,463 Rs.2,72,72,777 Rs.5,55,70,556 Rs.11,23,24,859
Wealth Ratio 3.40 times 5.48 times 9.09 times 15.44 times 26.74 times

Even a SIP is more partial to longer investment tenures; exactly like a lump sum investment. A SIP of Rs.10,000 for 15 years gives a wealth ratio of just 3.40 times whereas the SIP for 35 years gives a wealth ratio of 26.74 times. Why does starting early matter so much?

Here is why starting investments early matter so much
  • By staying invested for a longer period of time, the cycles in the market and business get smoothened. This helps to overcome short term volatility and de-risks the portfolio.
  • It is all about the power of compounding. You will find the wealth ratio higher in case of lump-sum investment as the holding period is longer in each case compared to the SIP.
  • When you are invested in a growth plan, remember that over the longer term the principal and the intermediate returns are being reinvested. This effect becomes more pronounced as the holding period becomes longer.
  • There is a tipping point that happens around 15 years. After that the wealth accumulation becomes a lot more rapid. This concept of tipping point works for businesses and also for investments.

Starting early is not just about inculcating the habit of investment early but also about making money work harder for you. In the long run; that is what really counts!

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
Before you start investing, get rid of your debt

One may wonder as to how is debt related to investments. Actually there is a very subtle relationship. Most investors do not invest in lump-sum and they prefer to invest via systematic investment plans (SIP). That is because these SIPs give the benefit of rupee cost averaging and also give the added benefit of syncing with your sources of income flows. When you have too much of debt on your balance sheet, then your EMIs remain an overhang on your finances. Hence you are not able to commit yourself to regular investments in equities towards meeting your long term goals.

In the famous Shakespearean play, Hamlet, Polonius advises his son Laertes, “Neither a borrower nor a lender be; for loan oft loses itself and friend and borrowing dulls the edge of husbandry”. Be it households, businesses or economies; it is debt that normally takes these units to the brink of bankruptcy. Borrowings are part of our balance sheet and we borrow for buying a house or a car. But the problem is with reckless borrowing or high cost borrowing. If you are still paying 35% interest on your credit card or 20% on your personal loan then it is highly likely that you will create serious wealth issues. Your journey has to begin with reducing your debt so as to make your investing activity more meaningful and fruitful. One of the best ways of gradually reducing your debt and adding more power to your investments is through a process called laddering.

How laddering helps manage debt and enhance investment capability

Laddering is essentially about prioritization. For example, you pay interest rate of nearly 3% per month on a credit and when annualized the costs are as high as 40%. If you have a fixed corpus with you, what should you do? You can earn 9% on debt funds, 12% on balanced funds or 14% on equity funds. Rather, if you use the funds to repay and close out your credit card, you save nearly 40% cost per annum. That is almost akin to an investment that yields 40% return per annum. That is why; when you start off on your financial plan and investment allocation, first have a plan to get out of debt and then think about growing wealth.

But how do you go about laddering? There are some loans that are large in size and some that are linked to assets. Then there are loans like home loans and education loans which give you tax benefits on the interest paid. How do you prioritize and take a call in these circumstances. Here is the pecking order of laddering you must follow.

Start by reducing your credit card outstanding first…

A credit card costs you around 40% per annum so when you close your credit card you are effectively earning 40% annually. More importantly, you have a more certain corpus that you can fall back upon to plan your future investments. Paying 3% interest a month is hardly a smart way to manage your finances. Once you close your credit card outstanding, you not only save that outflow but you can invest your monies with lesser overhang of uncertainty.

Then target your personal loans…

Personal loans can be a stop gap arrangement but most people tend to use it for the full tenure. You can avoid that since these are fairly high cost loans. Personal loans cost between 16-18% and if you add up the other costs, they can go to 20%. Once your credit card dues are taken care of, the next step in the debt ladder is personal loans. You save the 20% interest cost and the EMI can now become a good EMI or a SIP investment. Don’t worry about exit loads as you can negotiate with your bank which is hungry for prompt repayments. Even assuming that you pay the exit load, you are better off without the loan.

You can look to tweak your home loan too; and why not?

Should you close a home loan if you have the liquidity? Interest on home loans gives you tax exemption under Section 24 of the Income Tax Act up to Rs.2 lakhs and the principal is also exempt under Section 80C. There are two things to watch out here. Firstly, there is no guarantee that the apartment you buy will appreciate in value, like it was 10-15 years back. Negative equity is a real threat to home loans. Secondly, apartments don’t come cheap. Your exemption limit of Rs.2 lakh is hardly enough to buy a 2 BHK apartment in smaller towns. Instead of paying EMIs that don’t give tax exemption you can repay what is not tax efficient and reduce your outflows. These can be directed towards your investments.

Debt can be a double edged sword in most cases. The quicker you get out of high cost debt, the better it is for a smooth investment journey.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
How diversification reduces risk of an investor

What exactly is diversification when it comes to your investments? It is all about not putting all your eggs in one basket. It is about spreading your risks. In other words, diversification is the antithesis of concentration. When you put all your money in one or two investment products then you run the risk of concentration. That is not a wise decision especially when you are relying on these investments to meet your long term goals. A better idea would be to spread your risk by diversifying.

There is an eminent logic to diversification

Diversification is all about reducing your risk and not about enhancing your returns. By diversifying you reduce your directional risk in the stock markets or in any other asset market. For example, if all your assets are going to move in the same direction then it means all your assets will give negative returns when the cycle turns down. You can argue that they will give positive returns when the cycle turns up by your investment strategy cannot be predicated on the likelihood. It must have an underlying plan and logic to it. That logic comes from diversification. How does diversification work? If you are heavily invested in cement industry and if the cement industry goes into a down cycle due to oversupply then your investments will underperform. So you diversify the investments with different industries to reduce the risk of cycles. Portfolio diversification is a risk-return trade-off. What does that mean? A diversified portfolio may underperform in specific cycles but over a longer period of time your portfolio will be much better off. Breaking down types of risk and how diversification fits in?

In financial parlance, you need to understand that there are two specific kinds of risk. Understanding these risks is fundamental to your understanding of diversification. In stock markets we divide risk into systematic risk and unsystematic risk. Unsystematic risk is unique to assets or sectors or themes. When we talk of risk reduction through diversification, we talk of unsystematic risk, which is why it is also called diversifiable risk.. Systematic risk is the risk that impacts all asset classes systematically. Examples of systematic risk are political uncertainty, shift in inflation, changes in interest rates, fall in GDP growth, global geopolitical risk etc. When we talk of diversifying risk, we talk of only reducing our unsystematic risk and that reduces the overall risk in the process.

The chart above is fairly illustrative and explains the unique features of unsystematic risk and systematic risk. You can see that the systematic risk is constant irrespective of the number of stocks that you add to the portfolio. Here are some key observations. Firstly, systematic risk remains constant through the stock additions even when you diversify across asset classes. Secondly, even unsystematic risk cannot really be reduced to zero because some element of unsystematic risk will remain in your portfolio despite diversification.

Different ways of diversifying your portfolio

Quite often we use the word diversification quite generically. In reality, there are a lot of sub-plots to diversification. Diversification happens across different levels and you need to address all these aspects to get a truly diversified portfolio.

  • You can diversify across asset classes. How does that work? This can be done by combining asset classes like equities, debt, hybrid asset classes, ETFs, index funds, gold, property, foreign assets etc. This will spread your risk your overall portfolio risk is reduced. Gold and equities typically move against each other and help in diversification.
  • How to diversify within debt? You diversify across quality; meaning across AA rated debt and AAA rated debt. You can also diversify across maturities. Longer maturities are more sensitive to shifts in interest rates compared to shorter maturities.
  • How to diversify across equities? The guiding principle is to diversify across sectors, themes and also across market capitalizations. Themes typically cover a number of sectors or sub-sectors and we can have themes like rate sensitivity, rural demand, consumption etc.

Diversification is one of the core principles of portfolio structuring.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
Some basic precautions you need to take in the stock markets

Trading and investing in the equity markets has an element of risk to it. Equities can be volatile and therefore profits and losses are part of the investing and trading game. You often get to hear about risk management and at the core of managing risk lies the basic precautions you take while buying and selling stocks in the stock market. Here is a list of precautions you need to take while trading in the stock markets. These precautions are not a strategy to make profits but these are precautionary steps for your market risk management.

Timing the market is much more complex than you can imagine

Quite often, traders believe that the easiest way to make money is to buy low and sell high. The problem is not with the through process but with the practicality of the idea. Practically, even the experienced traders and investors have found it hard to time the market consistently. Concentrate more on quality of stocks purchased rather than concentrating on trying to time the market. It is very hard to consistently buy low and sell high. The best approach is to buy into good stocks / companies and hold for the long run. Time works better than timing in the stock markets.

Don’t try to recover your losses by overtrading in the market

This is another cardinal blunder a lot of investors commit. When they make losses they try to outsmart the market by trading aggressively. In the process you only deepen your losses in the market. So trade to a plan and a certain strategy! Your overtrading has cost implications in terms of transaction costs and also tax implications. Never trade in panic as you are likely to be on the wrong side.

Keep a stop loss and adhere to it as a discipline

A stop loss is like an insurance against market volatility. Whether you trade long or short, you keep stop loss to protect your position when the market moves against you. Remember, that stop loss is a discipline and has to be adhered to. This means two things. Firstly, stop loss must be part of your trade initiation. Don’t wait for market movement to put a stop loss. Secondly, when the stop loss is approaching, don’t entertain second thoughts about averaging your position. That defeats the purpose of a stop loss.

Booking profits is also a discipline when the market moves in your favour

Profits can be realized only when you sell your positions and that is why regular booking of profits becomes critical. That explains why profit booking is so important. Even after the target is achieved, traders often try to retain that stock hoping that it will move further. There are two ways to approach this kind of a situation. Firstly, once you decided profit booking level is reached, you must not hold on unless you have a very strong reason. In case, you have reasons to believe the stock price can go further up, use trailing stop losses. Even when you keep trailing stop losses, there is an opportunity cost involved.

There is nothing like a risk-free trade in the capital markets

There is nothing like a risk-free trade and hence there is nothing like loss-free trading. All investment products are subject to volatility and risk under certain conditions. Equity indices can correct due to domestic or global triggers. Stocks can correct due to financial or non-financial challenges faced by the company or sector. Bonds can see volatility due to interest rate movements and due to credit quality issues. Trading in currencies also carries the risk of dollar volatility and Indian macros. All these risks get factored into your returns.

How you respond in the market is more important than how you react

When you think through before acting it is a response and when you act by instinct it is a reaction. In markets you must respond rather than reacting. This may be easier said than done when there is panic in the market, but that is an important quality you learn. When you panic in the markets, you subsidize the other trader who does not panic. A cool head will help you to take rational and well thought-through decisions. Panic makes you irrational and forces you to make wrong decisions. It is better to keep a cool head and respond tactically to market situations rather than to react by instinct.

Listen to the experts but be your own analyst

In the stock markets, there is no shortage of advice. There are SMS calls, WhatsApp forwards and there are experts on TV channels. While you can take inputs from these sources, there are two things to remember. Firstly, strictly adhere to broker research as most of the WhatsApp forwards may not be in your interest. Secondly, be your own trader or investor. Use your own discretion and judgement before taking an investment decision.

The famous trader, Jesse Livermore, used to say that there is no bull side and bear side but only the right side in the markets. Try to be on the right side of the markets as far as possible.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
How SEBI protects your interest as an investor?

Since the liberalization of capital markets in 1992, SEBI has played a pivotal role in the financial markets in two ways. Firstly, it has focused on protecting the integrity of the market mechanism from any kind of influence. Secondly, SEBI has also focused substantially on protecting the interests of the retail and small investors, who were the most vulnerable to stock market fluctuations in the past. SEBI had undertaken a number of initiatives to protect the interests of the investors. Here is a partial list of measures that SEBI has taken; both in terms of legislations and implementation to ensure that the interests of the small and retail investors are adequately protected in the markets.

Key measures undertaken by SEBI to protect investor interest
  • SEBI has issued guidelines to companies pertaining to (bringing new issues in the market) mutual funds, portfolio managers, merchant bankers, underwriters, lead managers, etc. These guidelines are aimed at for bringing transparency in operations and ensuring better disclosure and responsible actions by principals. In the process, the attempt is to prevent the exploitation of investors one way or the other.
  • SEBI has been instrumental in formulating and implementing a code of advertisement for public issues for ensuring fair and truthful disclosures. In order to reduce the cost of issue, the underwriting is made optional on certain terms. These steps are also for the protection of investors.
  • SEBI regulates all capital market intermediaries by keeping a close watch on all intermediaries and see that they follow the guidelines in the right spirit. It also takes penal actions including disgorgement of losses when the guidelines are not followed.
  • SEBI also issues public interest advertisements to inform and enlighten investors on the basic features of various instruments and minimum precautions they should take before choosing an investment. The SEBI desires to create awareness among investors about their rights and remedies if problem arise. SEBI has also published booklets enlightening the retail investors about the appropriate processes, their rights and precautions to be taken in the stock markets.
  • Today in case of any problems with intermediaries in the capital markets, the small investors are allowed to directly make complaints to SEBI. SEBI receives thousands of complaints relating to non-receipt of refund orders, allotment letters, non-receipt of dividend or interest and delays in the transfer of shares and debentures. SEBI publicly maintains a central database of all such complaints including status of redressal.
  • SEBI has made investor education one of its driving forces to inform and educate investors accordingly. Such programs are crucial to investor protection. SEBI also encourages the formation of investor associations that disseminate useful information through newsletters. These publications are for the education, guidance and protection of investors.
  • SEBI also regularly conducts surveys with respect to investments and opportunities for the benefit of small investors. The findings of the surveys are given wide publicity so as to provide proper guidance to investors regarding their investment decisions. Such surveys also give SEBI action points to focus on. For example, it was based on a survey of mutual fund investors that it became apparent that most investors had worries over the expense ratios. This eventually led to reduction in mutual fund costs.
  • Introduction of ASBA as a new instrument has been useful while submitting application for shares via IPOs. This new instrument was introduced through the co-operation of banks gives protection to investors as they get interest on the application money till the allotment of shares. Also the money only gets blocked and debited only on the date of allotment. The balance money is automatically released.
  • As an important means of protecting the interests of investors in the capital markets, SEBI has introduced norms for disclosure of quarterly and half yearly unaudited results of companies. It has also revised the format of prospectus to provide more information to investors. It also insists that every share application form be accompanied by an abridged prospectus. Transparency has always been the key to investor protection.
  • SEBI has also issued a detailed SAST code regarding takeovers of companies, mergers and amalgamations. It has introduced regulations governing substantial acquisition of shares and takeovers (SAST) and lays down the conditions under which disclosures and mandatory open offers to the public have to be made to the shareholders. The purpose is to ensure that the small investors are adequately protected.

In additional to the above legislative measures, SEBI has also taken procedural improvements to assist the retail and small investor. Some highlights are as under:

  • SEBI has worked towards substantial simplification of share transfers and allotment procedure in the case of IPOs. It is expected that implementation of the Chandrasekharan Committee recommendations will considerably ease the difficulties faced by investors on account of inordinate delays in share transfers and bad deliveries.
  • SEBI has also made all share transfers to be compulsorily done by demat mode only effective December 05th. This will eliminate any case of frauds in transfer, bad deliveries and signature mismatch cases. No transfers will be permitted of shares that are in physical form.
  • SEBI has also implemented a unique order code number for easy audit trail. All stock exchanges have been required to ensure that a system is put in place whereby each transaction is assigned a unique order code number which is intimated by the broker to his client. Once the order is executed, this number is to be printed on the contract note.
  • Time stamping of contracts is another step taken by SEBI to eliminate chances of frauds. Stock brokers have been required to maintain a record of time when the client has placed the order and reflect the same in the contract note along with the time of the execution of the order. This will ensure that the broker gives due preference in execution of client's order and charges the correct price to his client without taking advantage of any intra-day price fluctuation for himself.

If the stock markets have become a substantially more transparent and safer place to transact, then retail investors have to thank SEBI for the same.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
What is an IPO?

Are you new to investing and wondering what IPOs are all about? Or are you looking to know more about how you can invest in one? Well, here’s a quick guide on the basics of Initial Public Offerings or IPOs.

An Initial Public Offering is a process where a privately-owned company sells its shares to outside investors or the public for the first time. This process helps them turn into a public company. Here, external investors, who are interested in buying shares of the company, cannot be in any way involved at start of the company.

Often, the founders of small, privately-owned companies invest a large amount of their personal wealth or money while starting up their business. Once the business gains traction, they might need additional funds to continue this business growth. That is where an IPO comes in.

Why do companies offer an IPO?

A company might need money for expansion, repaying loans, improving business, renovating infrastructure, etc. With an IPO, the company gains liquid assets in exchange for company shares. Once the IPO shares are issued, the company is listed up on stock exchanges. A company is also seen as being trustworthy, since it goes through a rigorous process before being allowed to issue an IPO.

There are many advantages as to why a company decides to go public:

  • Helps raise capital: This capital can be used to fund capital expenditure, research and development, debts, etc.
  • Public awareness: Potential buyers / customers / investors are now aware about the company and its products.
  • Increases liquidity: The company starts reaping benefits in the form of cash for all the hard work applied.
  • Gives credibility: When a company enters the open market, the need for it to be managed better arises. Transparency in dealings and regular reporting to regulatory authorities is required. By doing so, the company adds to its credibility.
So what’s in it for you?

Well, while the excitement surrounding IPOs tends to be high, it might not always be that you reap rich returns. Long-term or experienced investors might have better luck in the IPO market than a short-term investors or a new-comer.

If you are planning on investing in an IPO for the first time, here are a few things that you need to remember:

  • Research well and evaluate the company
  • Pick companies that have strong investment brokers
  • Read the prospectus
  • Be cautious towards scanty, hyped and biased information
MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
What is a Contract Note and why is it important?

The Contract Note as a concept originated when electronic trading did not exist. Back then, investors would personally contact their brokers to place orders for stocks and bonds. The brokers would then execute the trade and send a confirmation of the price to the investor. The contract note was used as a de-facto reference point for investors to see their trades and the price at which they were made.

Times have changed now, investors can now see their trades being executed in real time with Exchange Order Numbers and time stamps. With trading going online, investors get the Contract Note via email, and physical copy on the same day () as the processing time is reduced and the note is system generated.

The function of a Contract Note still remains the same. It is still the legal record of any transaction carried out on a stock exchange through a stockbroker and it still serves as the confirmation of trade done on a particular day on behalf of an investor on a stock exchanges.

It is a receipt that the broker issues to the investor, informing or confirming the trade with complete details of the transaction in a prescribed format by Stock exchanges.

A valid Contract Note has the following details in a structured format:
  • SEBI registration number of the Trading Member / Sub-broker
  • Details of trades: Order number, Trade number, Trade price, Trade execution time, Traded security and quantity, Brokerage charged, Details of other service charges
  • Signature of Authorized Signatory or Digital Signature in Electronic format
  • Bylaws and regulations pertaining to Arbitration
How do you acquire a Contract Note?

There are two ways to acquire a Contract Note:

Online: Your Contract Note will be mailed to your email account in electronic format automatically after making your transaction.

Offline: Your broker/trading member will send your Contract Note to delivered to the registered address.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
How to interpret profit numbers in the Annual Reports

You can refer to it as the Income Statement or the Profit & Loss Account in an annual report. It means one and the same. Unlike the balance sheet, which is viewed at a point of time, the income statement is viewed over a period of time. This period can be one quarter or one year as is the norm. Remember, accounting is done on an accrual basis that means you book all incomes and expenses when they are accrued; not exactly when they are actually paid or received. When all the accrued incomes and expenses for the financial period accounted for, the net result that you have is the income statement or the P&L account. The P&L account is critical to understand whether the business under consideration is profitable or not and this gives rise to a number of other analytical ratios.

What is the purpose of a Profit & Loss Account (Income Statement)?

The income statement shows the profitability of any business over a specific period. It can cover any period of time, but is most commonly produced monthly, quarterly or annually. Indian companies report their profit statements on a quarterly basis and on an annual basis as per the extant regulations. What is the purpose of a profit & loss account? A profit and loss report is a useful tool for monitoring business activity. It highlights where their business is succeeding and where it is struggling. Equity investors use the financial statements to gauge the financial health of a potential investment, or to see what kind of return they are getting on an existing investment. Bond investors check the income statements to ensure that the company has the ability to generate cash flows to repay the debt. Potential acquirers use the income statement to gauge whether the profits of a company are adequate to justify an acquisition or a merger with the target company. In short, this income statement is the starting point to understand the nuances of a company’s performance.

Breaking up the P&L Account into revenues and expenses

In general, the profit and loss report is split into 2 sections; the inflows represented by the revenues and the outflows represented by the expenses. Revenues include the inflows from the primary business activities (i.e. sale of products and services), any revenue from secondary activities (e.g. bank interest) and any other financial gains. Revenues can also be extraordinary like a recovery of a loan or a one-time gain from the sale of a business division.

One the other hand, expenses detail all outflows on account of the primary activities of the company (e.g. material and labour costs), any administrative costs like salaries, wages, rent etc and the interest cost on borrowings. The depreciation is not exactly a cash outflow but it is still shown as an expense in the P&L account so that the company can use the tax shields from such expenses to fund their future asset renewals.

Difference between operating and non-operating items in the P&L account

The most important part of revenue section of your profit and loss report is total sales. Secondary revenue and other income can be unpredictable, so to grow your business you should focus on your primary sales revenue. Operating revenues and operating expenses refer to the core business of the company and this is the most important metrics as it represents the core that is sustainable. How much sales have risen or fallen since your previous profit and loss report and the breakeven level of sales are a lot more important from the core business point of view.

Operating profits matter more than non-operating profits as they can be harder to bring down. On the other hand, one can give too much credence to the non-operating flows either inflows or outflows. For example profits or losses on investments or sale of assets are not part of the regular business. Such items should be excluded from your definition of sustainable revenues. Let us now turn to the core profit flows of the business.

Different types of profits and when to apply these measures

The P&L account itself is a summation of different kinds of profits with each having a different interpretation and application. Let us look at some key profitability metrics.

Gross profit = Revenues - cost of goods sold

Gross profits represent the difference between total sales and the cost of producing the goods or services you sell. It is a barometer of the core production or service activity and becomes a guide to pricing the product or service appropriately and also gives you an idea of how much leeway the business when it comes to pricing. The gross profit margin (GPM) is normally more relevant than the absolute number as it gives a relative analytical picture.

Operating profit = Gross profit - operating expenses

Cost of goods sold refers to the costs that are directly attributable to the output. But there are other fixed costs like rent, salaries, office expenses, maintenance costs and depreciation which are also business expenses. When you deduct these other operating expenses from Gross Profit you get the Operating profit or (EBIT). Here again, the OPM has a lot more importance and impact than the absolute number.

Net profit = Operating profit – interest - taxes

This is called the “bottom line” because that is what shareholders earn after paying out all costs of the business. Some of the most important ratios like the net profit margins; ROE and ROA are based on this Net Profit only.

An understanding of the subdivision of profits is the key to understanding where the profit is coming from and what should be the analytical strategy in response.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
5 key ratios every investor must look at gauge health of a company

Ratios are the relative measures of financial statements. There are different facets of the income statement and the balance sheet which, when combined, can give interesting insights into the performance and health of the company in question. Ratios are always relative as opposed to profit and sales numbers that are absolute in nature. Ratios can be from within a single financial statement or from different financial statements. For example, the net profit margin and the operating margins are examples of ratios that are purely derived from the income statement. At the same time the current ratio and the debt/equity ratio are entirely derived from the balance sheet. However, ratios like the asset turnover ratio and the return on equity (ROE) or return on capital employed (ROCE) entail data points from the income statement and also from the balance sheet. It is this ability to cross breed parameters from different financial statements that make ratios so powerful.

Ratios are not just used by investors for buying or selling a stock. On the other hand, these ratios are used by credit rating agencies, company CFOs, competitors, bond investors, potential acquirers and the regulator to study trends in the company. Ratios are more often than not, a good starting point to identify potential winners of the future as well as potential problem areas in a company. Let us look at 5 such critical ratios that give a quick idea of the health of a company.

Current Ratio and Quick Ratio

It is said that the really solid good companies manage their working capital efficiently and the current ratio is all about how the working capital of the company is managed. Every manufacturing company needs a positive working capital. That means your short term liabilities must be funded with short term assets to avoid putting your long term assets under pressure. The current ratio is, therefore, a basic measure of solvency. Lenders generally want to see a 2:1 current ratio or better, although very high current ratio is not a very encouraging sign.

Current Ratio = Current assets (cash, receivables, and inventory) / current liabilities.

However, the problem with the current ratio is that it includes inventories as assets and quite often such inventories may not have a ready secondary market. That is where the quick ratio comes in handy. The quick ratio is the current ratio with inventory removed. The quick ratio tells you if you have enough readily available funds to cover short-term obligations. It should be at least 1:1 for manufacturing companies to give comfort.

Current Assets Turnover Ratio

Let us understand this ratio a little better as it is different from the current ratio. The current ratio just looks at the current assets and the current liabilities. The Current Assets Turnover Ratio tells you how quickly the company is collecting on receivables. It's also industry specific, but it should be as low as possible. If it jumps up, you could have a serious liquidity issue. Normally, this ratio is seen as a percentage of sales and the lower it is the better for the health of the company.

One can also extent the above argument of receivables to inventories too and focus on how quickly the inventory is turned around. Here also the ratio is compared with annual sales to get a relative picture. Think of inventory as frozen cash, so you would like to churn it as many times as possible. The ideal rate varies by industry, but you must look at the trend and also benchmark with the industry.

Return on Equity and the Return on Capital Employed

This ratio lets you know if you're using your assets efficiently and rewarding your stake holders adequately. While ROE only looks at equity shareholders, the ROCE looks at providers of equity and debt capital. A higher ROE and ROCE is better. Typically, manufacturing companies that are capital intensive have lower levels of ROE and ROCE whereas service companies are better at these ratios. Here again, the trend over the last few quarters and the benchmarking with the industry matters a lot more.

Operating Cash Flow Ratio

When you sell goods you give credit and create debtors as assets in your balance sheet. Similarly, when you buy inventories you get credit and create creditors as liabilities. This is part of the core working capital management of the company. The operating cash flow ratio tells you quickly about the volume of cash you are generating compared with the amount you will have to lay out. This basically shows you if the cash flows generated are good enough to pay your creditors on time and enjoy a good credit standing. The operating cash flows are normally compared with the current liabilities.

Net Profit Margins

It is the bottom line and measures how your profits after tax stack up against the total sales generated. The net profit margin or the NPM is the ratio of the net profits to the sales and here again the trend is important. A positive trend is always favourable and above-industry averages are always welcome.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
Steps to be a prudent investor

Planning to meet certain goals in your life by investing your savings? You can grow your wealth using the power of compounding, one of the most popular and effective methods used by investors to ensure good returns. But starting out as an investor can seem to be a daunting task, especially if you are transitioning from traditional methods of investment to more risky but potentially higher rewarding options. Here are a few steps that will help you to be a more prudent investor:

Research is key: Understanding the different kind of investment options that are on offer in the stock market. Investments can either be fixed-income based or market- linked. While market-linked investments (such as equity shares, mutual funds, ULIPs, NPS) help in navigating the volatility of a bullish or bearish market to help you generate good returns, fixed income investments (such as Treasury bonds, corporate bonds, certificates of deposit (CDs) and preferred stock) help in preserving your accumulated wealth to meet a desired goal. For example: an early retirement. Understand which will serve your purpose best and do your due diligence when narrowing in on a specific instrument.

Measure your risk appetite: General investor behaviour is to look out for high-performing funds that will give great returns in the short term. However, such plans do not exist. Invest knowing that risk and reward are inversely proportional. Have a realistic understanding of your ability and willingness to stomach large swings in the value of your investments to avoid taking on too much risk that could lead you to panic and sell at the wrong time.

Calculate your estimated potential returns: Investors should refer to the earnings calculator that gives an estimate of how much you can earn from an investment. However, it is quite dangerous to make investment decisions based on expected returns alone. Before making any buying decisions, determine if the investments align with their portfolio goals and refer to the performance of the investment in the past to establish its stability. All of this data will be available since SEBI guidelines mandate that this information be shared with potential and existing investors.

Customise your asset allocation plan: Investors should focus more on the asset class in which they are investing as it is a crucial part in building their investment portfolio. . Asset allocation is an investment portfolio technique that aims to balance risk by dividing assets among major categories such as cash, bonds, stocks, real estate, and derivatives. Every asset class has different levels of return and risk, so ensure that you create a combination that will adhere to your risk appetite and align them with your long-term goals.

Set your investment strategy based on your intent, the current market climate, past performance of each investment opportunity and realistic predictions of future market behaviour. The tips suggested above are important to remember every time you make an investment.

MSE IPF Blog - An Investor Education Initiative by MSE Investor Protection Fund
Things to remember before investing in IPOs

Initial Public Offerings or IPOs are shares of a privately owned company that are offered for the first time to the public to invest in. Most companies looking to go public tend to present a rosy picture of the prospects of the company, and it’s earning potential.

In today’s age, however, investors are more aware of the risks of making uninformed or hasty decisions in the hope of making a quick buck. With numerous companies entering the stock market, finding an IPO that provides long-term gains can be difficult. There have been several cases recorded where people have experienced big gains only during the initial days of the company going public.

The search may feel difficult, but certainly, it’s not impossible. Here are things you need to remember before you put your hard-earned money into an IPO:

  • 1. Research well: Finding information on companies who are about to go public is crucial. Do an online search for information on the company, its competitors, their financing, past press releases and overall industry health. Learn as much as you can about the company as this is a crucial step in making a smart investment.
  • 2. Always read the prospectus: Never skip reading the prospectus, because it’s the prospectus that lays out the company's risks, opportunities, and the proposed uses for the money raised from the IPO.

For example, if the share money is for repaying loans, or buying equity, then beware! But if the money is going toward research, marketing or expanding into new markets, then that is a good sign for you to invest. Also, read all the accounting ratios and figures carefully.

  • 3. Be cautious: When dealing with the IPO market, be a sceptic, question everything. With the information being scarce, there is always a degree of uncertainty surrounding IPOs. If your adviser is strongly recommending shares, then there is probably a reason for you to exercise caution before investing.
  • 4. Consider waiting for the lock-up period to end: A lock-up period is a contractual restriction which prevents insiders (large shareholders, company executives) who have acquired company shares before it went public, from selling the shares for a stated period, after it goes public.

Wait till they are free to sell their shares, because if they continue to hold their shares once the lock-up period has expired, then it is an indication that the company has a bright future.

Remember, when it comes to the IPO market, being well-informed is key!

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