Category: Investments

This is another post from the Suggest a Topic page, and today we are going to look at the performance of some of the leading indices in India – their performance, as well as how they are constructed.

The post was triggered by the idea to see if one type of index is better than another, and if it is harder to beat one type of index than another.

My take on both of these questions is no, and here’s why.

For the first question – that of one index being better than another – most modern Indices are constructed using very similar methodology, and certainly all leading indices in India are constructed using more or less the same methodology, and that’s the free float market capitalization method.

So, there is not much by way of index construction that sets one apart from the other. But you will be surprised to know that one of the most popular indices in the world – the Dow Jones Industrial Average is not built using this modern method, and instead is a price weighted index.

This means that the price of the stocks determine how much weight it holds in the index rather than the market capitalization of the stock!

Then, the constituents of the index are determined by the editors of WSJ, and they have discretion to choose and leave out stocks!

Doesn’t this sound all too flawed?

But there is a great Stanford paper that critically examines the index against data from the past and comes up with astonishing results. In the paper the researchers find that even if the DJIA was constructed using some of the more modern methods the results wouldn’t be much different.

I have a full post on this subject here called Mythbusting the Dow, and I definitely recommend it.

The second question is if one type of index is harder to beat than another, and I don’t see how that can be possible.

I can see random walkers say that passive investing is always better than active investing, and while I don’t subscribe to that view, I can certainly see why they say that.

But on what basis do you say that one index is harder to beat than another? I fail to see the sense in that.

Now, let’s look at the numbers, and see what that show us. For this exercise I have taken all the major Indices based on the Sensex and Nifty, and looked at their returns for 4 periods.

1. Year To Date.

2. 3 Year till Jan 2011

3. 5 Year till Jan 2011

4. 10 Year till Jan 2011.

I took calendar years so that I can update this information easily later on, and compare it across other years.

Here are the results of that exercise.

	YTD	3 Year Till Jan 2011	5 Years Till Jan 2011	10 Years till Jan 2011
Nifty	-17.52%	0.90%	116.27%	390.87%
Sensex	-18.21%	1.46%	118.86%	416.82%
Nifty Junior	-16.62%	-1.08%	120.74%	406.86%
CNX 100	-17.37%	0.75%	88.00%	No Records
BSE 100	-17.60%	-4.14%	116.02%	425.12%
BSE 200	-17.85%	-4.54%	114.06%	479.27%
CNX 500	-17.06%	-6.50%	100.92%	444.12%
BSE 500	-17.61%	-7.32%	110.07%	509.85%
Nifty Midcap	-24.19%	-22.23%	62.33%	No Records
BSE Midcap	-17.52%	-20.57%	76.24%	No Records
Nifty Smallcap	-16.53%	-30.71%	84.90%	No Records
BSE Smallcap	-24.47%	-28.11%	62.28%	No Records

This is great data and shows that the performance of large caps has been much better than that of mid and small caps, and that’s mainly attributable to the fact that when the market goes down, the small and mid caps go down a lot more than the large caps, but they don’t bounce back with that great a vengeance.

You can observe that by going across the 3 year return column and seeing how much bigger the negative numbers are at the bottom compared to the top where the indices based on large caps are.

To me, that’s the single most important thing that emerges from this comparison – large caps have done better than small and mid caps in the past and if I were to go the index route, I would certainly prefer to own indexes on large caps or broad based indices rather than bet on small and mid cap stocks.

This is not only true because of the performance, but also because of the generally better corporate governance in large caps, increased liquidity, and the fact that most of our market is concentrated in a few very large companies.

So, the way I would approach this is to select a universe of stocks that I am interested in investing and then choose a low cost, high volume index provider on that universe.

Also, I didn’t see a list of consolidated indices and the explanation of their methodology, so I compiled one myself with data from NSE and BSE, and this will give you a snapshot on understanding what the various indices are and how they are constructed.

 

S.No.	Name	Description	Number of shares
1	BSE Sensex	This contains the 30 largest Indian companies on the basis of their free float market capitalization.	30
2	S&P CNX Nifty	This contains 50 of the largest Indian companies belonging to 23 sectors.	50
3	CNX Nifty Junior	The next rung of liquid securities after S&P CNX Nifty is the CNX Nifty Junior. It may be useful to think of the S&P CNX Nifty and the CNX Nifty Junior as making up the 100 most liquid stocks in India.	50
4	S&P CNX 100	CNX 100 index would comprise of the securities, which are constituents of S&P CNX Nifty, and CNX Nifty Junior	100
5	S&P CNX DEFTY	S&P CNX Defty is S&P CNX Nifty, measured in dollars.	50
6	S&P CNX 500	The S&P CNX 500 is India’s first broad based benchmark of the Indian capital market. The S&P CNX 500 represents about 94.92% of the Free Float Market Capitalization and about 91.68% of the total turnover on the NSE as on June 30, 2011.	500
7	BSE 100	A broad-based index, the BSE-100 was formerly known as the BSE National index.  This Index has 1983-84 as the base year and was launched in 1989.  In line with the shift of the BSE Indices to the globally accepted Free-Float methodology, BSE-100 was shifted to Free-Float methodology effective from April 5, 2004.  The method of computation of Free-Float index and determination of free-float factors is similar to the methodology for SENSEX.	100
8	BSE 200	The equity shares of 200 selected companies from the specified and non-specified lists of BSE were considered for inclusion in the sample for `BSE-200′. The selection of companies was primarily been done on the basis of current market capitalization of the listed scrips. Moreover, the market activity of the companies as reflected by the volumes of turnover and certain fundamental factors were considered for the final selection of the 200 companies.	200
9	BSE 500	BSE-500 index represents nearly 93% of the total market capitalization on BSE. BSE-500 covers all 20 major industries of the economy. In line with other BSE indices, effective August 16, 2005 calculation methodology was shifted to the free-float methodology.	500
10	BSE Midcap	The general guidelines for selection of constituents in BSE Mid-Cap & BSE Small-Cap Index are as follows:Trading Frequency: 1. The scrip should have been traded on 60% of the trading days in the last three months 2. Eligible universe shall comprise of companies aggregating 98.5% of average market capitalization 3. This list shall be categorized under large-cap, mid-cap and small-cap segment based on 80%-15%-5% market capitalization coverage respectively 4. BSE Mid-Cap Index shall comprise of scrips that gives market capitalization coverage between 80% & 95% from the list derived as per point no.3 above 5. BSE Small-Cap Index shall comprise of scrips that gives market capitalization coverage between 95% & 100% from the list derived as per pont no.3 above 6. Quarterly review of these indices shall be carried out as per the above criteria subject to a buffer of 3%	Variable
11	BSE Small Cap	See above	Variable
12	Nifty Midcap 50	The constituents and the criteria for the selection judge the effectiveness of the index. Selection of the index set is, inter alia, based on the following criteria:Stocks with average market capitalization ranging from Rs.1000 Crore to Rs.5000 Crore at the time of selection.   Stocks which are not part of the derivatives segment are excluded.   Stocks which are forming part of the S&P CNX NIFTY index are excluded.	50
13	Nifty Smallcap	The criteria for the CNX Smallcap Index include the following: All the companies that are listed on NSE, which individually constitute more than 5% free-float market capitalization of the universe, shall be excluded in order to reduce the skewness in the weightage of the companies in the universe. After step (a), the weightage of the remaining companies in the universe will be determined again. After step (b), the cumulative weightage will be calculated. After step (c), companies which form part of the cumulative percentage in ascending order upto the first 90 percent (i.e. up to 89.99 percent) of the revised universe shall be excluded. After step (d), companies within the range of 90th to 95th percentile shall be ranked in the descending order of aggregate turnover for the last six months. After step (e), the top 100 companies shall constitute the CNX Smallcap Index subject to fulfilment of the following additional criteria: The company must have a 3 years’ track record of operations with positive net worth. All constituents of the CNX Smallcap Index must have a minimum listing record of 6 months. Companies must have demonstrated a trading frequency of at least 90 % in the last six months The review will be carried out on a semi-annual basis.	100

As always, comments and questions welcome!

The latest company to come out with a NCD is Religare Finvest, and this is the fully owned subsidiary of Religare.

The NCD opens for subscription on the 9^th September 2011, and closes on the September 26^th 2011. The Religare NCD is going to give 12.5% for 5 years which is the maximum that any NCD has offered yet. They plan to raise Rs. 8 billion from this issue. The issue has been raised ICRA AA- (stable) by ICRA and Care AA- by CARE. These ratings indicate a high degree of safety regarding timely servicing of financial obligations and carrying low credit risk meaning they are very likely to pay interest on time, and unlikely to default on their debt.

The company has a gross loan portfolio of Rs. 79,346.21 million and 91% of that is backed by collateral. The company has grown at a very high rate in the past few years growing from a loan book of Rs 5.66 billion in 2007 to a loan book for Rs. 89.6 billion last year.

The total income grew from Rs. 973.25 million to Rs. 11,631.50 million in the same period. So the loan book grew at a CAGR of 73.75% and income by 64.24%.

The one thing that has lowered during this time is the Capital Adequacy Ratio which was 64.27% in 2009, 21.67% in 2010, and is down to 16.16% in 2011. I think this is one of the lower ones seen when compared with the other NCDs that have been recently issued.

Religare Finvest caters to the Small and Medium Enterprises as well as the retail segment for its business, but the biggest segment of its loan book is the loan against properties it gives out to the small and medium enterprises.

Here is the breakup in its loan book as on June 30 2011.

• SME Financing: Loan Against Property 36
• SME Financing: Commercial Assets 17
• SME Financing: Working Capital Loans 8
• SME Financing: Loans against marketable securities 8
• Corporate Auto Lease 2
• Retail Capital Market Finance: Loan against securities 16
• Corporate Lending 13

If you look at this mix then this seems to be a lot better than the other NCDs we’ve seen before. Mannapuram was of course all gold, India Infoline had a lot of real estate and stocks, and Shriram City Union had more than a quarter in gold, and 9% in personal loans as well.  On the other hand, Religare Finvest’s Capital Adequacy Ratio at 16.16% is lower than the other companies we have seen come out with NCDs.

Now let’s take a look at the terms of the issue itself.

Terms of the Religare Finvest NCD

The minimum investment required is Rs. 10,000 and the issue opens from September 9th 2011 and closes on September 26th 2011.

There are two series – one for 3 years, and the other one for 5 years, and both of them pay interest annually. The interest rate for retail investors is 12.50% for the 5 year series which is the highest coupon rate any NCD has offered yet. Here are the other details.

There are bound to be questions on whether there will be listing gains or not, and I’m 100% confident that I have absolutely no clue about it. But I do have a feeling that the retail part will be over subscribed so if you do decide to invest in them it will be a good idea to apply quickly, as the NCDs will be offered first come first serve basis.

When they do list, there will be six NCDs listing on the exchange, one for each maturity and coupon rate, and you can decide which one you want to buy at that time as well.

Those are some key things that caught my eye while going through the prospectus of this issue, and as always,  questions and comments are welcome!

If you are a new reader and have some basic questions about NCDs then you will find these two posts about NCDs useful: 

Introduction to NCDs Part I

Introduction to NCDs Part II

Vamsi had some excellent comments on yesterday’s post about rights issue, and I thought I’ll take those questions and create a full post based on them.

Essentially, the question was about the different terms used with respect to the capital structure of a company, and I’m going to write about a few terms that are used frequently while discussing share capital.

The first term is Authorized Share Capital, and this simply means the total number of shares that a company is allowed to issue. This is something that a company decides internally, and they can raise this limit (and they usually do) from time to time as the need arises.

When you read somewhere that a company has an Authorized Share Capital of say 237 million shares (like in the case of Religare Finvest) – there is not much you can make out by just that statement.

That’s because you need to know how many shares has the company actually issued out of its permissible limit of 237 million.

The number of shares it has issued is called Issued Share Capital, and this is the term that’s more important because this shows the number of shares that are currently issued by the company, and is also the number of outstanding shares of the company. In this case, the number of issued shares is 173,322,137, and that’s the number to look for.

A lot of you must be aware of the P/E ratio of a company, and that is calculated by dividing the market price of the share by the earnings per share.

But to calculate the earnings per share you need the total earnings, and the number of outstanding shares or issued shares. This is where the issued share capital is used. I see that Religare Finvest had a net profit of Rs. 1,147.75 million, and since we know that they have 173,322,137 shares – we can arrive at the Earnings Per Share by dividing 1147.75 million by the issued or outstanding shares to get an EPS of Rs. 6.62.

Yesterday I wrote about diluting of earnings and what I meant was if you issue new shares then this profit of Rs. 1,147.75 million will now be divided among those many more shares and the EPS available to each shareholder will be reduced.

The last term for today is Diluted EPS; very often you will see an EPS number, and then another number called Diluted EPS.

Diluted EPS is a term that is used to define EPS adjusted for future dilutions owing to stock options and other conversions like debt converted to equity.

Simply put, when a company issues stock options to its employees – the number of outstanding shares don’t increase immediately, but they will increase as the employees exercise their stock options. The diluted EPS takes this increased base into account and reduces the EPS to that extent.

The EPS may not completely dilute because not all employees may exercise their stock options and not all convertible bond holders may convert their debt to shares, but this calculation does give an idea of how low the EPS can go if everyone did so.

These are some common terms used with respect to the capital structure of a company, and the concepts themselves are quite simple if you don’t get lost in the maze of jargon.

This is another post from the Suggest a Topic page, and this time we’re going to take a look at rights issues, and as the commenter put it – the fuss about them.

A rights issue is when a company issues new shares, but offers it to their existing shareholders first. The existing shareholders then have an option to either buy the new shares or pass the offer. So, recently when the SBI rights issue was in the news, it was often said that the government is willing to subscribe to the rights issue, and that’s because they own 59.4% of SBI, and if any shares are issued without the government participating in the offer then their shareholding in the company will come down.

This will be clear with an example, so let’s look at the latest rights issue – that of Velan Hotels Limited. They are issuing 2,67,35,500 (2.67 cr) new shares as part of the rights issue at Rs. 23 per share, and the ratio is 69:20.

69:20 means that for every 20 shares that you currently own – you can subscribe up to 69 new shares. The rationale for this seemingly weird allocation ratio will be clear in a minute.

The number of outstanding shares in the company before the rights issue were 77,50,000 and when you add the 2,67,35,500 new shares to the existing shares you get a total of 3,44,87,500 shares.

Equity shares prior to the issue	 77,50,000.00
New Shares to be issued	 2,67,37,500.00
Total shares after the issue	 3,44,87,500.00

Now, when you divide the number of new shares to be issued (2,67,37,500) by the number of equity shares prior to the issue (77,50,000) you get 3.45.

Guess what you get when  you divide 69 by 20?

Exactly right – you get 3.45.

Now do you see where the weird ratio of 69:20 come from?

If the rights issue is offered in that ratio and if all existing shareholders subscribe fully to the rights issue then their ownership in the company will remain exactly the same as it was before the issue.

The issue of new shares doesn’t dilute their ownership in the company at all!

This will be clearer if we look at how the promoter stake changes in this issue with the rights issue, and what would have happened if there weren’t a rights issue, and a simple IPO to issue shares.

Before this issue, the promoters owned 56.35% of Velan Hotels, which means they had 43,67,426 shares in all.

Promoters own	 43,67,426.00
Equity shares prior to the issue	 77,50,000.00
Ownership Percentage	56.35%

Suppose this were a FPO or a fresh issue of shares, and the promoters didn’t subscribe to the fresh issue in the FPO. If that were to happen then the promoters will only own 12.66% of the company as seen from the numbers below.

Promoters Own	 43,67,426.00
Total shares including the new ones	 3,44,87,500.00
Ownership Percentage	12.66%

As you can see that would not be a good scenario for the promoters, and in fact other shareholders also. Their existing shareholding will be diluted by quite a bit.

However, the ratio of 69:20 means that the promoters by virtue of their 43,67,426 will have the option to buy 1,50,67,620 additional shares (43,67,426 x 3.45), and take the total shares they own to 1,94,35,046, which is 56.35% of the new total outstanding shares, and thus the rights issue doesn’t affect their ownership in the company at all.

Promoters Own	 4,367,426.00
Additional shares they can buy (3.45 times current holding)	 15,067,620
Total shares they own	 19,435,046
Total number of shares after the issue	34487500
Promoter stake in the company after the rights issue	56.35%

The fuss is essentially about retaining the same ownership in the company even after the issue of fresh issue of shares.

For small shareholders – the issue of ownership control doesn’t arise, but the earnings per share will reduce since there are now more shares for the same earnings, and so will the dividends so whenever a company comes out with a rights issue you have to evaluate it to see whether it makes sense for you to subscribe or if you are better off with getting rid of the existing position or should you do nothing at all. Right now I’m unable to think of any factors that need to be considered apart from of course the financial situation of the company, and the price at which the rights issue is being offered but if we ever discuss a live rights issue in the future, we will weigh in on those factors then.

The last thing about subscribing to the rights issue is that you can choose to subscribe to all of the shares you are eligible for, or a part of them. If you don’t do anything then no new shares will be subscribed to you.

The procedure to apply for new shares is that they send in a form to your address, and you have to fill in your details and submit that form to a collection center before the last date. You have to follow this process even if you do everything else online – to the best of my knowledge this process hasn’t been made online yet.

So, to summarize, rights issue is when a company issues fresh shares, but offers them to their existing shareholders in a pre determined ratio first. The existing shareholders can subscribe to these shares, and that helps them own the company in the same percentage that they did prior to the fresh issue.

 

The volatility that the American indices saw in August brought forth a flurry of articles about great dividend stocks, and I read a number of articles about large American companies like Intel, Pfizer, Johnson & Johnson, Vodafone, Astra Zeneca, Verizon etc. that give great dividend yields.

There are several large US companies that give dividend yields in excess of 3%, and that’s quite remarkable considering the fact that the fixed deposits in American banks fetch next to nothing.

I was curious to see if there are any large Indian companies that offer such great dividend yields. I went to the BSE website, and took a look at the dividend payouts in the last financial year (April 1 2010 – March 31 2011), and the current market price to calculate the dividend yields of the 100 biggest companies in the BSE 500.

Although there aren’t many very high yielding dividend stocks there are 23 which give dividend yields in excess of 2%. Let me share that subset with you first.

S.No.	Stock	Dividend Paid	Market Price	Dividend Yield	Notes
1	Hero Motors	110	2067	5.32	Interim Div on 15 April 2010 – Rs. 80 & final dividend on Sep 1 2010 Rs. 30
2	ITC Limited	5	203	2.46	Bonus of 1:1 so dividend is considered as Rs. 5 instead of Rs. 10
3	Bajaj Holdings	30	747	4.02
4	PFC	5	147	3.40
5	HPCL	12	379.55	3.16
6	ONGC	8	264	3.03	Stock split from 10 to 5 & then bonus 1:1 – original dividend was Rs. 32
7	ACC	30.5	1011	3.02	Includes special dividend of Rs.7.50
8	IOC	9.5	317	3.00
9	GSK Consumer Healthcare	68	2340	2.91	Includes special dividend of Rs. 25
10	SAIL	2.9	109	2.66
11	Oil India	34	1300	2.62
12	Tata Chem	9	355	2.54
13	PNB	22	912	2.41
14	Canara Bank	10	420	2.38
15	Union Bank	5.5	236	2.33
16	NHPC	0.55	24	2.29
17	NTPC	3.8	166.9	2.28
18	Bank of India	7	312	2.24
19	Cummins	13	614	2.12
20	BoB	15	728	2.06
21	REC Ltd	3.5	170	2.06
22	BPCL	14	682	2.05
23	Power Grid	2	99.5	2.01

As you can see I’ve tried to record special events like bonuses, splits, special dividends etc. wherever I noticed them as that makes a difference in calculating yields. This is because I’m using the current market price whereas the dividends were paid out in the last financial year, and the number of outstanding shares may be different due to these actions.

Now, here is the complete list.

Stock	Dividend Paid	Market Price	Dividend Yield	Notes
Reliance Industries	7	804	0.87
Infosys	15	2315	0.65
ITC Limited	5	203	2.46	Bonus of 1:1 so dividend has been considered 5 instead of 10
ICICI Bank	12	887	1.35
HDFC		660	0.00
L&T	12.5	1609	0.78
HDFC Bank	2.4	471	0.51	Stock split from 10 to 2, so dividend has been considered as Rs. 2.4 instead of Rs. 12
TCS	6	1021	0.59
SBI	20	1993	1.00
Bharti	1	408	0.25
ONGC	8	264	3.03	Stock split from 10 to 5 & then bonus 1:1 – original dividend was Rs. 32
M&M	9.5	766	1.24
HUL	3.5	320	1.09
Tata Steel	8	488	1.64
BHEL	17.9	1737	1.03
Axis Bank	12	1076	1.12
Tata Motors	15	755	1.99
NTPC	3.8	166.9	2.28
Coal India	0.4	386.9	0.10
Bajaj Auto	20	1623	1.23	Bonus 1:1
Jindal Steel	1.25	525.5	0.24
GAIL India	7.5	414	1.81
Sun Pharma	2.75	505	0.54	Stock split from Rs. 5 to Rs. 1
Hindalco	1.35	154	0.88
Hero Motors	110	2067	5.32	Interim Div on 15 April 2010 – Rs. 80 & final dividend on Sep 1 2010 Rs. 30
Wipro	6	334	1.80	Interim and final div of 6.00 is considered
Sterlite Industries	0.9375	133	0.70
Dr. Reddy’s	11.25	1509	0.75
Kotak Bank	0.425	442	0.10	Stock split from 10 to 5, original dividend Rs. 0.85
Nestle	21.5	4470	0.48
Tata Power	1.2	1021	0.12	Stock split from 10 to 1 original dividend is Rs. 12
Power Grid	2	99.5	2.01
Maruti	6	1081	0.56
Asian Paints	23.5	3252	0.72	Declared on 11 June 2011
Adani Enterprises	2	531	0.38
Cipla	2.8	280	1.00
Grasim Inds	30	2167	1.38
IDFC	1.5	110	1.36
PNB	22	912	2.41
BoB	15	728	2.06
Ultratech Cement	6	1114	0.54
Lupin	3	467	0.64
HCL Tech	3	397	0.76
Cairn		284	0.00
Ambuja Cem	2.6	135	1.93
BPCL	14	682	2.05
ACC	30.5	1011	3.02	Includes special dividend of Rs.7.50
Indus Ind Bank	1.8	252	0.71
Titan	1.25	210	0.60
STFC	4	672	0.60
GSK	40	2137	1.87
Sesa Goa	3.25	231	1.41
DLF	2	208	0.96
NMDC	2.15	221	0.97
Idea		100	0.00
United Spirits	2.5	893	0.28
Ranbaxy	2	478	0.42
JSW Steel	9.5	720	1.32
Mundra Ports	0.5	157	0.32
IOC	9.5	317	3.00
Siemens	5	870	0.57
Jaiprakash	0.94	61.85	1.52
Zee	2	117	1.71
Exide	1.3	147	0.88
Bosch	30	7232	0.41	This year they have declared Rs. 125 as dividends so far
Dabur	0.65	112	0.58
Yes Bank	1.5	278	0.54
SAIL	2.9	109	2.66
LIC Housing Finance	3.5	216	1.62
Colgate	5	979	0.51
Reliance Infra	7.1	451	1.57
Canara Bank	10	420	2.38
HPCL	12	379.55	3.16
Federal Bank	5	366	1.37
Rel Com	0.85	84	1.01
Cummins	13	614	2.12
Tata Chem	9	355	2.54
Bank of India	7	312	2.24
REC Ltd	3.5	170	2.06
GSK Consumer Healthcare	68	2340	2.91	Includes special dividend of Rs. 25
PFC	5	147	3.40
Adani Power		88	0.00
Crompton Greaves	0.8	150	0.53
Union Bank	5.5	236	2.33
Hindustan Zinc	1	131	0.76
Aditya Birla Nuvo	5	914	0.55
Cadila Healthcare	5	830	0.60
United Phosphorus	2	146	1.37
Reliance Capital	6.5	406	1.60
Bajaj Holdings	30	747	4.02
Container Corporation	15.5	940	1.65
Divi’s Labs	6	729	0.82
Jain Irrigation	1	174	0.57
Glenmark	0.4	323	0.12
Godrej Consumers	2	422	0.47
Reliance Power		84	0.00
Oil India	34	1300	2.62
Petronet	1.75	177	0.99
ABB	2	857	0.23
NHPC	0.55	24	2.29

This was a very time consuming exercise and I’ve tried to be as accurate as possible, however there is always a possibility of errors in compiling such data, so please let me know if you spot anything, and I’ll correct it.

I’m going to try to do a similar list for small cap stocks and see if the yields are better there, and that post will probably be up next week.

Update: Tata Motors to include the whole Rs. 15 from last financial year as Ashok has pointed out.

In my post about introduction to share buy backs I touched upon the two types of share buybacks that can take place in the Indian share market, and a recent comment by Raja52 about the buyback offer of Allied Digital and their share price presents a a good practical example of one type of share buyback that you should be particularly mindful of.

 

As I said earlier, a company can buy back its shares in two ways:

1. They can buy the shares from the stock market.
2. They can buy the shares from the shareholders by asking them to tender their shares.

It is important to know what route the company is going to follow. If they are going to buy the shares from the stock market, then the share buy back price is of little meaning to you.

Raja brought up the example of Allied Digital Services Limited. Their buy back price is Rs. 140, and the current market price of the share is just around Rs. 33!

Is that a great opportunity or what?

Not because of the share buyback  – it isn’t.

Allied Digital is going to buy the shares from the stock market and not from the shareholders, and the price of Rs. 140 is not actually the buy back price, but it’s the maximum price at which they can buy back their shares. When companies get approval from their boards to buy back their shares from the stock market, they have to set a maximum price. This is the upper limit beyond which the company can’t buy their shares from the share market.

So, if Allied Digital has set up a maximum price of Rs. 140 – it only means that they can’t buy shares at a price over Rs. 140. They can buy the shares at any price below Rs. 140, and can certainly buy it at the Rs. 33 or so at which it’s currently trading.

As far as retail investors buying the shares at 33, and selling it to Allied Digital 140 is concerned – it’s not going to happen, and in a way – the low price already tells you that. Had it been the buyback where the company had promised to buy its shares back from the investors directly – the 140 number had more importance, and they would have probably not even chosen such a high number.

Lesson: Find out if the company is buying shares from the public or from the share market, and if they are buying from the share market then ignore the buy back price because it’s really the maximum buyback price.

If the company is buying back from the shareholders then you have to look at how many shares they have offered to buy, how much time is left for the buyback to take place, and what is the difference between the current market price, and the offer price.

What decision you take depends on these variables, and they can be so different in every case that you will have to evaluate each offer on its own merit.

In general, I’d say don’t buy shares in companies you wouldn’t otherwise mind owning. ABB is a good example that comes to mind – they are a solid company that came up with a buy back offer last year, and the good thing about that is even if your shares don’t get accepted in the buy back you still own a very strong company with good prospects.

Other than that, I don’t think you can make generalizations and will have to evaluate each offer on its merit.

I got a few emails to write a general post on share buy backs yesterday, so here it is – an introductory post on share buy backs.

What is a share buy-back?

A buyback offer is when a company buys some of its shares from its shareholders and extinguishes them. This is usually done from shareholders other than the promoters themselves, and is most often a testament from the management and promoters on the strength of the company, and their commitment to increase the returns for the shareholders.

Why does a company do this?

Two main reasons come to my mind.

1. When a company thinks its share price is undervalued.
2. Eventual delisting.

When the share price is undervalued

They do this when they think that the share price is undervalued, or when they think that this is the best way to make use of their excess cash.

If they reduce the total number of outstanding shares then the EPS (Earnings Per Share) increases because EPS is PAT (Profit After Tax) divided by total outstanding shares.

If the EPS increases then the P/E multiple decreases, and when P/E decreases, the share price increases to bring the P/E back to the higher levels. This may not always happen, but theoretically this is what they are trying to achieve with a share buyback program. Other ratios like Return on Equity and Return on Networth also improve due to this.

In fact, I think only the Debt – Equity ratio can worsen due to this because now there is less of equity to support debt, but if a company does have a lot of debt in its books then its cash is much better utilized in paying that debt off and saving interest cost rather than buying back shares from its shareholders.

Eventual Delisting

Some companies, especially foreign owned companies get into buybacks because they want to eventually delist from the Indian stock exchange. Usually, they don’t buy their entire outstanding shares at one go, but conduct these buybacks over a period of time and buy in tranches of 5 or 10%.

How does a company carry out a buyback?

The first step is that a buyback is proposed which is then voted on and approved by the board. Then they announce the buyback in a newspaper, announce a start date when the public can start tendering their shares, a last date of withdrawal, a close date, date of notifying when the offer is accepted or rejected, and finally the date when the shares are extinguished.

They also have to declare the price at which they will carry out the buy back and the number of shares that they will buy back.

Usually companies will only buy back a certain percentage of their outstanding shares from the public. This is really important because some people who are not familiar with how this process works end up buying shares with the hopes of a sure – fire profit, and later realize that only part of their shares will be bought back.

For example – Amrutanjan recently came out with a buy back where they said they will buy about 9 lakh shares from the market at Rs. 900. That was at a 17% premium from the day when the buy back was announced. Say in a few days the share moved up to Rs. 820, and you see it trading there knowing that the buy back is at Rs. 900. You mistake this as a risk free profit of Rs. 80 thinking that you will buy the shares and sell them back at Rs. 900 in a few days.

This won’t happen because usually there are more shares offered for a buyback than the company actually wants to buy.

In these cases they buy back the shares in the proportion of the over subscription. So you will only get a part of your shares bought back, and if the price comes down below your purchase price then you are stuck with the remaining ones. So, this is not a risk free arbitrage opportunity at all.

How do you participate in the buy back offer?

There are two types of buy back programs – one is done through purchase from the stock market, and the second one is done through a tender form.

When a company carries out buy back from the stock exchange, they just declare that they are going to buy shares from the stock market, and there is nothing that you have to do here (except perhaps hope for a gain in share price).

When the company offers to buy shares through the tender route – they will send a tender form to all its shareholders with instructions on how to fill the form and where they can mail or drop the form.

I have never done this so I don’t have any practical experience, but from what I have read you need to fill up a Delivery Instruction Slip with the trading and demat account details, attach it with the Tender Offer Form, and then drop it at one of the company’s specified collection centers.

The slip will contain the following details:

1. Depository Name
2. DP Name
3. Beneficiary Account Number
4. Beneficiary Account Name

After receiving a response from all its shareholders within the cut off date – the company will calculate how many shares it got, and in what proportion can it carry out the buy back. You will then be notified of the number of shares that are accepted and the money will either be deposited directly electronically or be sent by a check. I think how you receive the dividend is a pretty good indication of how you are going to get this money.

Conclusion

A share buy back means a company buying back its shares from shareholders other than promoters, they do it to increase the shares prices or Delist, and they are done by either buying in the stock market directly, or asking shareholders to tender their shares.

This is the what, why and how of a buy back, and I’ve tried to cover all aspects to the best of my knowledge.

As always, questions, comments and emails are most welcome!

 

There are several filters that people use to alert them to good stocks. Taking note of great products and then finding out who manufactured them is one way; looking for good dividend paying stocks is another, and looking at companies who plan to buy back their own shares is a popular way as well.

The rationale behind this is that companies who are willing to buy back their own shares think that the shares are undervalued, and are investing in them. This is also an action that is focused on increasing the share values, so that’s another reason this method is used as well.

Just to be clear, this is not a list with only those companies that currently have buyback offers open, but also includes those companies that have concluded buybacks in the past. That’s because the idea of this list is not to find companies that provide opportunities to buy shares from the market and then offer them for the buyback but to see if there are generally any companies here that can be good long term investments.

Here is a list with some companies I could find.

S.No.	Company	Max Buyback Price	Close Date
 1	Allied Digital	Rs. 140	17 Feb 2012
 2	Deccan Chronicle	Rs. 180	3 Jan 2012
 3	FDC	Rs. 135	25 Jan 2012
 4	HEG	Rs. 350	13 Mar 2012
 5	Infinite Computer Solutions	Rs.230	10 April 2012
 6	PVR	Rs.140	26 May 2012
 7	Reliance Infra	Rs.725	13 Feb 2012
 8	SRF	Rs.380	25 Feb 2012
 9	Zee Entertainment	Rs.126	23 March 2012
 10	Piramal Healthcare	Rs.600	13 Apr 2011
 11	Lakshmi Machine Works	Rs.2045	24 Feb 2011
 12	India Infoline	Rs. 99	07 Feb 2011
 13	Siemens	Rs. 930	13 April 2011
 14	Merck	Rs. 435	21 May 2010
 15	Aegis Logistics	Rs. 143	6 Feb 2010
 16	Amrutanjan	Rs. 900	18 July 2011

 

To be honest, I’ve never been a big fan of finding companies in this way because sometimes I feel that buybacks are announced more as gimmicks to jack up share price, and many times when you look at companies offering a buyback program in India – you also find stronger competitors and that makes you think why not invest in those instead.

On the other hand, I’ve heard investors who have found good ideas this way, and since I’ve never had a post on this – I thought I’d start a post on this topic here.

I’m sure there are several other buy back shares that I’ve missed – do leave a comment if you know of any company that doesn’t figure in this list.

This is another post from the Suggest a Topic page, and we’re going to look at the recently introduced 91 Day T – Bill (Treasury Bill) on NSE this time.

This is an interest rate derivative which means that the price of the contract depends on interest rate movements. Globally interest rate derivatives are a much bigger market than equity derivatives, and as the Indian financial markets develop we will see more such products launched in India as well.

The 91 Day T Bill futures are probably of a lot more interest to institutional investors than retail investors because I don’t see that many retail investors taking a position on interest rate movements. And of course, there have been news reports that say that most of the current trading is being done by PSUs, private banks, and corporate clients.

That said, there is a huge segment of retail investors who are interested in speculation, and a futures contract with relatively low margin requirements is as good a tool as any for speculative purposes.

Like any derivative, this Interest Rate Future (IRF) also has an underlying which is the 91 Day GOI T – Bill, so to understand this product better, let’s first understand the underlying of this product.

The Underlying or the 91 Day T Bill itself

91 Day T – Bills are issued by the Government of India to finance their short term funding requirements. They mature in 91 days, which is 13 weeks or about 3 months, and these are not interest bearing securities.

This means that they don’t pay interest, but are instead issued at a discount, and then mature at par value, so that’s why investors buy them even though they don’t get any interest.

RBI issues these T- Bills in auctions where market dealers can bid for these securities, and that’s how the price is determined. RBI announces these auctions, and the next one is going to happen on August 3rd 2011. The results of these auctions are announced the same day as well. The last auction was done on July 27th 2011, and both these auctions were for 91 Day T Bills worth Rs. 7,000 crores or Rs. 70 billion.

Now, let’s take a look at the T – Bill Future itself.

NSE T – Bill Future

There are 4 series of T – Bill Futures currently being traded on the NSE. Three of them are monthly series, and the fourth one is a quarterly series.

Right now the following series are trading:

1. 91DTB300811 – The August Series
2. 91DTB280911 – The September Series
3. 91DTB251011 – The October Series
4. 91DTB281211 – The December Series (Quarterly Series)

Every contract will expire on the last Wednesday of the month, but I see not all these series mentioned here are dated on the last Wednesday. For October, this series expires a day earlier because 26th is Diwali, and the same thing happens for August as well, because 31st is Ramzan Id.

From the NSE website I see that the near dated Future which is the August series has the maximum volumes right now.

Each contract will be worth 2,000 units, and the SEBI circular about NSE T Bills explains the pricing as follows:

Daily Contract Settlement value
2000 * (100 – 0.25 * yw)

(Here yw is weighted average futures yield of last half an hour). In the absence of last half an hour trading, theoretical futures yield would be considered for computation of Daily Contract Settlement Value.

2,000 because that’s the number of units, 100 because that’s the face value, 0.25 because you are taking the annual yield and the maturity of this instrument is a quarter.

So based on that – a move of one percentage point will translate into a change of Rs. 500

Suppose yield moved from 5% to 6%.

2000 * (100 – 0.25 x 5) = 197,500

2000 * (100 – 0.25 x 6) = 197,000

But, yield doesn’t move that much. Here is a chart of the daily settlement price movements of the 91DTB 270711

So, as far as this is concerned – you need to keep in mind that movement of a basis point results in change of Rs. 5 because the change in yield movements is small.

Bond yields and prices are inversely proportional which means if the interest rates increase then the price decreases and vice – versa. This means if you are betting for an interest rate increase then you should go and short the future, and vice – versa.

This is also cash settled, which means that you will either pay up or get paid at the expiry of the contract. It doesn’t have Securities Transaction Tax (STT) either.

This is an interesting product, and has already done much better in volumes than the other IRFs introduced in India. I’ll be keeping an eye on it and learning more about this as time goes because so far my knowledge about this is very theoretical – just based on the SEBI circular, and the NSE note it. There are many gaps in my knowledge that I’d like to plug, and understand them better not only because of the T – Bill trading itself, but also because the bond market is developing very rapidly in India, and I think the bond market landscape five or ten years from now will look completely different from what it is now.

 

A friend recently told me this story, and I thought it was worth sharing here. My friend was at a jewelery shop in Delhi, and a lady came there to sell her gold bangles. After weighing the gold, finalizing the gold rate, negotiating the deductions – the jeweler said that they will cut through the bangle before buying it.

Apparently, this is common practice and jewelers do this while buying gold ornaments that weren’t sold by them.

When they did cut the bangle in half – the lady was stunned to see that a copper wire ran through it, and it wasn’t pure gold like she thought it was all these years!

I was amazed to hear this story because I’ve never heard anything like this before, and I don’t think my family has ever done any test on their gold, so who knows how much copper they will find! I just hope this is an exception and doesn’t happen all that often, especially when you buy from reputed jewelers.

Some time ago a reader had left a comment about a jeweler telling him that his gold has lost its purity in the locker, and though my knowledge about gold jewelery is very limited, this sounds like a case where the jeweler was misleading the reader.

Niraj Kothari – a regular commenter on gold related matters here, answered that comment and also provided some information on how you can get your gold purity tested. I think that’s very useful information for people wondering about that kind of thing, and I’m pasting his comment below (with minor editing) as regular readers may not have come across that comment.

Dear Mr.Nole,

Firstly I would like to clarify some myths which exists in the market for gold jewellery

1. GOLD no matter whatever purity you buy will never get impure / corroded/ degraded / decrease or increase in weight even 0.o5o grams, if you keep it in a safe place even for 100 years, it is this property of gold that has made it valuable.

So, the jeweler who advised you that your purity of gold changed while you kept in the locker for a while is incorrect.
The purity of gold when you buy it from a jeweller will remain same and will never change with time, if someone says that the gold is of less purity than you had bought it, then it implies that the jeweller from where you bought the gold has sold you gold less than the assured purity.

Now , concerning your point of testing your jewellery through a spectrometer, as you rightly mentioned spectrometer / karotometer ( commonly used ) are very costly and the pricing of karotometer ranges between 6 lakhs to 12 lakhs!.

So how a common man should get his jewellery tested?

Government of India has recognised BIS hallmarking centres across India. These centres are usually located in main wholesale / retail jewellery market areas of a city, like in Chennai it should be located near T Nagar.

You can walk into these hallmarking centres with your jewellery and ask them to test the jewellery for the purity which jeweller has assured you.

During the testing the hallmarking centres are required to cut upto 0.100 – 0.200 grams behind every product and subject it to different gold testing methods like

1. Fire assay test.
2. Spectrometer test
3. Nitric Acid and Touchstone scratch test

They then take an average of all these different methods of testing and give you a certificate of purity for the jewellery product which you have given, and they also give you the 0.100 – 0.300 grams of gold back which they had taken from your ornament in the form of pure gold.

These reports are completely unbiased and authentic from a government recognised hallmarking centre. The charges are Rs.20 / per product or piece. The process requires between 3 – 5 hours.

Note: Kindly confirm the process with BIS hallmarking centre of your city before handing over your products for testing.

Link to BIS

I wasn’t aware of what Niraj has mentioned at all, and have no experience with this, so it was a good thing for me to learn, and I’ll be interested to hear if anyone has used this method, or if you’ve ever faced any other issues with your gold jewelery?