Understanding Dividends, Bonus, Stock Splits & Buybacks

1. Dividends
During a bull market capital gains take precedence over dividends. This is because a dividend is always on face value and not on market value. Consequently, even if a company whose share price is say ruling at Rs. 400 declares a healthy dividend of say 60% (face value Rs. 10), the dividend while being at Rs. 6 per share, the dividend yield would be an abysmal 1.5%. However, it doesn't mean that dividends are of no significance to shareholders. Apart from the utility during a bear phase, dividends are looked upon by the market at large as an important signaling mechanism determining the health of the corporate. Dividends are paid out of reserves and by paying dividend the company is distributing a part of its reserves amongst shareholders. However, there is another school of thought that considers dividend payouts as a waste of money. Fast growing companies are perceived to be much better off ploughing their profits back. Case in point : Most of the US tech giants are extremely stingy dividend payers. Equity dividends in India are tax-free in the hands of share holders. However, u/s 115O, the company distributing the dividend has to pay a dividend distribution tax of 12.8125% to the exchequer. In effect, it is the share holders who bears the tax since they receive that much lesser amount as dividend. Also, the dividend amount gets subjected to tax twice, once at the company's end since it is the post tax profits which may be distributed as dividend and the second time as dividend distribution tax. Hence sometimes reserves may even be distributed as bonus shares.

2. Bonus shares
Bonus shares are nothing but shares issued free of cost to the shareholders of a company, by capitalizing a part of the company's reserves. Following a bonus issue, though the number of total shares increase, the proportional ownership of shareholders does not change.
Also, post the bonus the cum bonus share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the share holder. However, more often than not, as explained earlier, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.
As far as tax is concerned, since no money is paid to acquire bonus shares, these have to be valued at nil cost while making calculations for capital gains. An incidental benefit is that since the price more or less falls in proportion to the bonus, there may arise an opportunity to book loss on the original shares.

3. Stock splits
Stock splits are a relatively new phenomenon in the Indian context. It is important that investors understand the reasons that companies may split their shares and how a stock split is different from a bonus issue. A stock split is when the number of shares in a stock is increased and the value per share is decreased. This in no way affects the intrinsic value of your investment and has no effect on your net wealth. A typical example is a 2-for-1 stock split. Say a company announces a 2-for-1 stock split in one month. That means one month from that date, the company's shares will start trading at half the price from the previous day. Consequently you will own twice the number of shares that you originally owned and the company in turn will have twice the number of shares outstanding. The question that arises is if there is no difference to the wealth of the investor, then why does a company announce a stock split. Well, the primary reason is to infuse additional liquidity into the shares by making them more affordable. Here it has to be reiterated that the shares only appear to be cheaper, it makes no difference whether you buy one share for Rs.3,000 or two for Rs.1,500 each. As far as the tax implications for stock splits are concerned, well, there aren't any. A stock split, like a bonus issue, is tax neutral. However, when the shares are sold, the capital gains tax implications are different that what is applicable for bonus issues. Here, the original cost of the shares also has to be reduced.

4. Share buybacks
Even share buybacks are a comparatively new phenomenon. Reliance and Siemens are a couple of examples of companies which have bought back their shares. A buyback is essentially a financial tool in the hands of the corporate that affords flexibility in the capital structure. A buyback in this case allows the company to sustain a higher debt-equity ratio. It is also a tool to defend against possible takeovers. Generally companies buyback when they perceive their own shares to be undervalued or when they have surplus cash for which there is no ready capital investment need. Stock buybacks also prevent dilution of earnings. In other words, a buyback program enhances the earnings per share, or conversely, it can prevent an EPS dilution that may be caused by exercises of stock option grants etc.

Stock Idea - Indian Hotels

Research done by - HDFC Sec

Q4FY07 & FY07 Results Review; Marginally below expectation:
IHCL reported a turnover of Rs 15,445 million for the year ended March 31, 2007, and a PAT of Rs 3223.9 million, which were 40% and 75% higher yoy. The healthy topline growth was led by 28% rise in ARRs (Rs 9,234) and 3% rise in occupancy (73%).

For the quarter ended March 07, the turnover of Rs 5051.6 million and PAT of Rs 1345.2 million were higher by 45% and 71% yoy, respectively. The top line growth was aided by 25% rise in ARRs and 4% rise in occupancy.

OPM for the quarter improved 638 bps to 42%, while for the full year, it jumped a whooping 745 bps to 36.5%. Other income during the quarter and the year ended March 31, 2007, included the benefits of higher dividends received, profit booked on sale of shares and foreign currency gain.

The consolidated top line rose by 36.7% to Rs. 25115 million, against our estimate of Rs. 24300 million, a gap of 3.2%. The bottom line stood at Rs 3699 million, a growth of 48.7% against our estimate of Rs 3849 million.

Outlook and Valuation
Envisaging a tight demand-supply mismatch in the luxury category (incremental demand of over 55,000 rooms in the next 5 years, against the planned expansion of 18,000 rooms), we believe, ARRs would continue to be on the uphill, at least for a year or two. Also, within IHCL, over 1000 rooms would be added in the next 2 years. With standalone IHCL expected to do better (assuming a proxy to the industry), a turnaround in the performance of subsidiaries and higher share of profits through JVs and associates, would remain key to future earnings growth. IHC’s extensive geographic reach, strategy of spreading itself into all segments, from star deluxe to budget hotels and increasing tie-ups for management contracts would not only give it a competitive advantage, but de-risk its revenue stream too.

We value the target price at Rs 195, offering 36% upside from current levels. The stock is available at a PER of 16.0x FY08E & 11.1x FY09E EPS of Rs 9 and Rs13. We re-iterate “Outperformer”.

Stock Idea - ABG Shipyard

Research Done by - Prabhudas Lilladher

Result Snapshot
ABG Shipyard grew revenues by 8.2% YoY and 13.4% QoQ to Rs 1,746 million and profits by 6.7% and 12.5% to Rs 330 million after booking an income from subsidy of Rs 185 million. OPM improved from 12.3% last year to 17.9% during the quarter. Sequentially there has been a dip of 90 bps due to one time payment of octroi. For the full year revenues and profits have grown by 33.4% and Rs 38.9% to Rs 6,235 million and Rs 1,163 million respectively. OPM improved from 14.2% last year to 18.4% in FY07.

Result Highlights
Recent acquisition to help consolidate presence at Magdala

The company recently signed a MOU with Vipul shipyard. The total capex including the acquisition cost and modernization is about Rs 1 billion. It is located next to ABG’s existing yard at Surat thereby making the acquisition is strategic in nature. This will help ABG consolidate its position there and also help ward of any future competitors who could have set up a yard there. This shipyard will augments ABG’s capacity by 25%. It offers about 5-8 berths depending on the size of the vessel. ABG has also had to take over Vipul’s current order book, which is roughly worth about Rs 400 million. Once these orders will be executed ABG can execute its own orders there.

Other expansions on schedule
Apart from this, the expansion at Dahej is also progressing as per schedule. This yard will commence operations by April 1, 2008. In addition another rig yard is also being set up. The estimated capex on both expansions is close to Rs 10 billion all of which will be funded by way of internal accruals and borrowings. The company has already tied up the debt. No equity dilutions are expected. The company is currently already in negotiation with Essar for an order to construct a rig. The first rig is likely to be delivered in the next 24-30 months. The company is in talks for converting its unit at Dahej in to an EOU or a SEZ. No clarity is available yet.

Well-diversified order book
The current unexecuted order book stands at Rs 30.8 billion of which 75% is in favour of exports. About 40-45% of these orders are from the oil and gas sector. Within this category, it has received orders to construct DP – 2 and DP – 3 that are more sophisticated in nature. The company also boasts of being one of the only shipyards to build coastguard vessels. Currently it also has orders in hand to construct specialized vessels such as icebreakers. It continues to witness robust order inflow and is in negotiation for new orders. The last delivery on the current order book is slated for November 2011. Of the Rs 40 billion order book, about Rs 10 billion is for the new yard coming up at Dahej, where the company can build up to 90,000 DWT vessels.

Valuation
As on March 07, the company has total borrowings to the tune of Rs 2.6 billion, which is expected to rise to Rs 7 billion by March 08, and Rs 12 billion by March 09 due to expansions at Dahej I and Dahej II. Debt to equity ratio will rise from the current 0.5x to 1.5x over the same period. At the CMP, the stock is trading at rich valuations of 14.7x FY08E and 12.5x FY09E EPS estimates of Rs 27.3 and Rs 32.0 respectively. On an EV/EBITDA basis it is quoting at 14.8x FY08E and 11.8x FY09E. Thus while order book visibility continues to remains high (5.0x order book to sales based on last 12 months trailing revenues), we feel that the stock may loose momentum in the near term. Receipt of money on account of subsidy could act as a trigger for the stock. From a medium to long-term perspective we maintain Outperformer on the stock.

10 tax saving funds that can make your money grow

There are very few of us out there who don't want to make money. Most of us, in fact, are very interested in seeing our wealth grow, particularly if it happens without too much effort on our part. If you fall in this rather large category, then mutual funds are an investment option you must consider. If you are worried about tax implications, you could invest in ELSS or tax saving mutual funds.
According to a premier mutual fund research company, investing in certain ELSS funds would have seen the value of your money grow by more than 50 per cent in the last one year.
To put it simply, if you had invested Rs 10,000 on June 7, 2006, it would have multiplied to more than Rs 15,000 by June 8, 2007.

This table shows the top 10 tax saving mutual funds:

5 ways to diversify your portfolio

Diversification should be regarded as one of the basic tenets of financial planning. Having the desired degree of diversification makes the portfolio a resilient one. A downturn in a given investment can be offset by the presence of another. The following five ways would help you to minimise your losses

1. Diversify across asset classes - Firstly, the portfolio must be diversified across various asset classes. Depending on the investor’s risk profile and needs, assets like equities, fixed income instruments, gold and real estate among others should find place in the portfolio. This will grant stability to the portfolio, by making it resistant to the vagaries of the market. For example, when equity markets are at their volatile best , the portion invested in fixed income instruments like fixed deposits (FDs) and fixed maturity plans (FMPs) can prove to be handy.

2. Diversify across investment avenues - Within each asset class, there is a need to be diversified across various investment avenues. For example, the equity portfolio can comprise of direct equity investments, investments in mutual fund schemes and unit linked insurance plans (ULIPs). Similarly the fixed income portfolio can be constructed from FDs, FMPs and small savings schemes. An insurance portfolio could hold a combination of term plans, endowment plans and ULIPs.

3. Diversify across time horizons - Investors should hold multiple investment portfolios each catering to a distinct need and running over a commensurate time horizon. For example, typically an investor could have short-term goals , medium-term goals and long-term goals . Each of these objectives should be backed by a distinct portfolio and the investments therein should be aligned with the time frames. Equities can account for a higher portion of the long-term portfolio given that they are best equipped to deliver over longer time frames. Conversely, fixed income instruments could dominate the short-term portfolios.

4. Diversify across providers/suppliers - Ensure that your investments are spread across various providers/suppliers. For example, the mutual fund portfolio should have schemes from various asset management companies (AMCs). Each AMC can offer a unique investment style and process, thereby aiding the portfolio on the diversification front. Similarly, FD offerings from multiple banks can be considered for investment. Investors should make use of the plethora of providers to their advantage, by selecting the “best-in-class” financial service providers/asset managers and in the process de-risk their portfolios.

5. Diversify across countries - Investors now have the option to invest globally. Domestic mutual funds have been granted permission to invest in foreign stocks. Similarly, resident Indians are also permitted to invest in assets and securities abroad, subject to the regulations issued by the Reserve Bank of India (RBI). By adding foreign assets to their India-centric investment portfolios, investors can expose the same to a different set of market forces, thereby imparting it a unique diversification edge.

Six good habits for tax payers

The thought of doing something for the first time could make you either excited or nervous, depending on the task at hand and your natural temperament. First time tax assessees, for example, are more likely to be nervous than excited. Are you one of those individuals who, from this year onwards, will be compelled to shed the regal 'tax-free' tag?

If yes, the following might make for useful reading.

Different persons prepare differently for first-time encounters. Some get into the planning mode and seek counsel from friends and advisors. A lucky few find that their ignorance is the source of their bliss. For a tax assessee, it is vital to draw a distinction between tax planning and tax avoidance. Tax planning is your passport to tax nirvana; tax avoidance could easily make your life miserable. Tax planning is the cornerstone of a healthy tax life. Prepare for your tax life by inculcating the following good tax habits.

1. Get a Permanent Account Number
PAN is a 10 digit alpha-numeric unique code that lends you an identity and is a must for various financial transactions like buying a new house, opening a bank account, opening a demat/ stock broking account. PAN, in the days to come, will be used as a tracking mechanism for any tax deducted against this number. The effort to convert physical TDS certificates into electronic form is on as well. Once this is done done, your tax payments will become transparent and will be easy to track. The importance of PAN cannot be overemphasised. For example, you might not get credit for tax deducted by your employer from your salary if you do not have a PAN.
Obtain your PAN either online by visiting https://tin.tin.nsdl.com/pan/index.html or get a tax counsellor to help you to make a physical application.

2. Appoint a tax counsellor
Enlist the help of a good, ethical tax practitioner. She/ he would enable you to organise and structure your thought process so that you can manage your taxes efficiently. It is a myth that low-level and middle-level salary earners have no use for tax planners; getting a grip on your finances and related tax aspects early on in life will help you to eventually achieve a more holistic approach to managing your finances. In order to derive maximum benefit from your personal tax guide, maintain a smooth communication channel. Have complete trust in her/ his counsel.

3. Talk to your payroll department
For salaried individuals, it is definitely a good idea to have a reasonable amount of interaction with your office payroll team. They are the best people to educate you with regard to the amount of tax you are liable to pay. They will provide you with forms that seek infomation about your planned tax saving investments and the tax deductions you are planning to claim.
Complete these documents with the assistance of your tax/ financial counsellor and submit them within the time frame provided by your payroll team. This will help avoid deduction of excessive tax from your salary.

4. Disciplined record maintenance
If you are self employed, you need to religiously maintain relevant information/ records/ documents as stipulated by your tax practitioner.

5. Be regular in completing your tax investments
Very often, individuals end up with a tax nightmare at the end of the year because of their failure to invest in tax saving instruments evenly through the year. This acts as a double-edged sword. On the one hand, your credibility with your payroll team could take a knock; they might disregard your investment plan for the next year and resort to tax deduction from your salary.
Also, your skewed investment strategy may strain on your liquidity at the end of the year; you may have to invest all your savings to save on tax and you may also end up higher taxes by way of TDS on salary.

6. Be regular in filing your income tax returns
As the financial year comes to an end, collect all your relevant documents and hand them over to your tax counsellor. Ensure that the returns have been filed and obtain acknowledgement for your records.

These simple steps will ensure you lead a stress-free tax life. Aim, prepare and you will certainly succeed in becoming an honest, yet efficient, tax assessee.

Simplifying mutual funds for you

What is it that makes mutual funds such an attractive investment option?
Here is a look at the basic factors that are necessary in a sound mutual fund, and some dos and don'ts you must keep in mind before signing up.

Understand your expectations and the risk involved
Before deciding to invest in a mutual fund, you need to have a clear idea about what your expectations from your investment are (how much you expect your money to grow) and whether you are comfortable with the level of risk involved

Think first, choose later
Understand what you need the money for, and let that decide the future course of your investments.
Here are some steps that might help you pick the right funds:
~ Carefully assess the portfolio to check for the sectors it is focusing upon. Choose a fund where your level of comfort with their preferred sector is higher. In an ideal scenario, choose a fund that does not have a heavy focus on any particular sector; this cuts down the risk the fund is taking.
~ Understand whether your fund subscribes more to the 'value philosophy' or the 'growth philosophy'. This will give you an impression of the nature of risks the fund will be taking in the future.
It is probably a safer investment to choose a mutual fund that does not buy and sell stocks too often if you are looking for a long-term investment and stability. This is also known as the 'value philosophy'. If you are comfortable affording a higher risk and choose to ride the markets, then you might opt for a fund that makes the most out of current booming sectors. This is the 'growth philosophy'.

A bird in hand...
Most investors are restricted by the degree of risk they can take with their investments. Give good thought to your investment process and also to the time horizon of the intended investment . Don't change mutual funds just to make a quick buck. If you stick with a particular mutual fund scheme for more than two years, the chances of earning a decent profit on it increases. However, if you often sell units of one scheme to buy units of some other scheme, you may end up paying more in terms of fees than earning any profits. Instead, stick to a few funds that you think will give you good returns. Mathematically too, the chances of making money are far higher with investing small amounts regularly than with speculation. Remember, there is no way of perfectly timing the market .Unless there is a compelling reason, exiting a fund might not be the prudent choice.

Avoid putting all eggs in one basket
As a rule, always diversify the risks associated with your investments no matter what your ability to take risks may be. For instance, assume you have invested Rs 100,000 in a mutual fund scheme. And it would not make any difference to you even if the value of your investments come down to Rs 50,000. If this is your risk-taking capacity then you will be better off by investing Rs 50,000 in two different schemes, say one in an equity scheme and the other in a debt scheme. This will help you manage your risks better.

A few pointers to cutting down on risk are:
~ Average out the risk in each category; invest in different asset classes like equity, gold, real estate, commodities etc.
Equity investors would cut down on risks by investing a portion of their funds in debt. Diversifying even within a class like either debt or equity might be prudent.
~ Split your investments across fund managers. Every fund manager has his own areas of strength when it comes to investing. There is no 'ultimate fund manager'.
~ More often than not, the quirks in the market decide who ends up maximising the returns. This will cut down on your profit margins a bit, but will also heavily bring down the risk.

Success is nine parts observing, one part investing
There are merits to studying and following the markets regularly.

If you do not plan to invest for the next two months, it does not mean you should ignore the ups and downs in the markets for that period. You can never be sure when to enter or exit the market, but you can better your chances by being systematic.

The basic philosophy of rupee cost averaging would suggest that if you invest regularly through the highs and lows of the market, you would stand a better chance of generating higher returns than the market for the whole duration.

Systematic investment plans, SIPs, offered by all funds helps you invest regularly. Simply issuing post-dated cheques to the fund takes care of most of your worries. In the case of a majority of funds these days the amount is directly debited electronically from your account.

Which is the right fund for me?
Debt funds have lower returns. It is of higher importance to find funds that charge a low fee, as the fee charged eventually goes from the pocket of the investor.
Funds can be utilised in saving tax. Investors of equity should use the dividend payout option. This is since all dividends are currently tax-exempt in India, and this will help in reducing tax-liabilities.
Debt investors should avoid the payout option, as they will be taxed dividend distribution.
If the market enters a bearish period, equity investors can minimise losses by switching to debt funds. And it is never a problem to switch back to equity once the equity markets start rising.

When to throw in the towel?
On meeting with the initial expectations of the fund, you should immediately book profits, that is, sell your units and take home the profits made. At times, it may not be advisable to continue with the current fund.

Some of these pointers may help in deciding when to quit:
~ In case the fund is not performing relatively in the long run. If a fund has not performed as well as most of its peers in the past, then quitting might be an option worth exercising. When comparing funds, however, ensure that comparisons are drawn between parallels and across the same category. For example, do not compare debt funds with equity funds.

~ Changes in the Asset Management Company , open-ended funds changing to close-ended funds and any change in the premises from the offer document might be reason to quit.

~ Significant rise in the fund's expense ratio leading to lower returns.

~ In case a fund does not comply with its objectives. For example, if some diversified equity funds had large exposures to ICE (Information technology, Communications, and Entertainment) sector scrips, then it adds to the volatility and also defies its objective.

Futures and options for you

Derivatives are among the most complex financial instruments and also one of the most controversial. Their critics claim that they make markets less transparent and more prone to instability and speculation. Their supporters say that derivatives improve risk management and increase liquidity. Both sides would agree that derivatives are extremely important and have a big impact on other financial markets and the economy. So even if the average investor doesn't invest directly in derivatives it's important that he or she knows what they are.

What is a derivative instrument?
A derivative, as the name suggests, is a financial instrument whose value is derived from underlying asset . The underlying can be a stock, a commodity, and a market index among other things. The two main types of derivatives are options and futures.

Options
An option gives you the right to buy or sell the underlying asset but not any obligation.
A call option gives you right to buy the underlying asset while a put option gives you the right to sell. An option contract specifies the strike price, that is, the price at which you can buy or sell the underlying and the expiry date after which the option is no longer valid. The expiry is the last day on which a contract expires or ends. In Inidan markets, expiry is the last Thursday of every month.

A mutual fund with a difference
Options are also classified into American, which can be exercised at any time prior to the expiry date and European which can only be exercised at the expiry date. In India options on individual stocks are American-style while options on indices like the Nifty are European.
So in the newspaper if you read, say, a Ranbaxy option contract: CA-330-Mar, it means that this is an American-style call option which gives you the right to buy Ranbaxy shares at Rs 330 and which expires in March (the last Thursday).
Similarly a PE-4300-April Nifty contract is a European-style put option, which gives you the right to sell at Rs 4,300 and expires in April.

Futures
A futures contract is a standardised, tradable contract, which requires the delivery of the underlying asset at a specified price and specified future date. Unlike options, buying a futures contract gives you the obligation to buy the underlying and thus involves greater risk. Another difference is that commodities like gold, cotton, crude oil etc are especially prominent in futures markets.
Futures transactions can be settled in three ways: squaring off, delivery and cash settlement.

How to trade in futures
Squaring off means taking a position opposite your initial one. For example, you square off the purchase of a gold futures contract by selling the identical contract. Delivery means physically delivering the underlying asset on the agreed date. If you sell a gold futures contract of say 1 kilogram then you will have to give real gold to the buyer on the mutually agreed date. Cash settlement involves paying the difference between the futures price and the spot price of the underlying asset.
For example, if you sell a gold futures contract worth one kilogram for say Rs 1.2 lakh and the price of the contract on expiry day is Rs 1.3 lakh then you will have to pay the buyer the difference of Rs 10,000.

Speculation and hedging
So what are derivatives actually used for?
At the simplest level both options and futures can be used to speculate on price movements. For example you can obtain a profit if you purchase Nifty futures at 3700 and the Nifty goes up to 4000. In this case your profit is 300.
Similarly let us say you purchase a call option with a strike price of 3000. The option itself will have a cost of, say, 100 rupees. If the price goes above 3000 the option is said to be "in the money" which means that you can exercise the option, buy the underlying share for 3000 and make a profit. However that won't cover the cost of the option.
For that the share price will have to rise above 3100 after which you can make profit net of the cost of the option. In practice you will usually be able to book a profit by squaring off your position without having to exercise the option.

Should ordinary investors invest in derivatives?
Derivatives trading require extra preparation and caution. At their simplest, options and futures are calculated bets on the movements of the underlying asset. If you guess right you could earn a multiple of your initial investment in days but if you guess wrong your investment can be wiped out equally quickly. So if you do invest in derivatives make sure you are especially diligent in researching both the derivative and the underlying asset. You should understand precisely how changes in the price of the underlying would affect the value of your investment and also study the underlying market whether it's stocks or commodities.