One of my friend is fond of shares and options trading , from a capital of Rs.50,000 , he grew it to Rs 2,00,000 , whereas I am almost at the same place from where I had started because I do some thing called “Risk Management” … Every time I take a trade or invest in anything . This is how I go about it .
– Either I don’t take the trade
– Or I take the trade, but work on risk management, I hedge it using PUTS or invest less in that.
Because of these two things I either miss big profits or make very small profits. managing risk involves cost and that’s the cost you have to pay for trying to be “safe”.
Last week we both purchased some thing which gave him 50% return, but gave me just 7-8% return over my investment. The reason was that I also hedged my position and tried to be “smart”, which my friend didn’t Acknowledge.
There are many incidents like this, because of which I always lag behind him when it comes to performance, and I am always ahead of him in being safe which never helped until now.
Jan 7 2008 :
10:30 AM :
Markets were a bit up and things looked good , He bought Satyam’s Calls with almost all of his capital, He has good intuition of which options may work and which may not, but I tried to convince him that buying a PUT on a lower strike price will save him in case he is wrong.
But to my expectation, he was “sure” that it would work, He put SL at 175 just to show me because of the fact that he knew it wont be touched at least today.
11:30-12:00 PM :
Satyam Fiasco news came in and within no time Share was down 30-40%, No surprise that even SL was not entertained … because prices never stopped .. everyone was just in a rush … With in some time Share plunged to 60-70, My friends calls were worthless and It doesn’t look that it will now move up from this point.
In short He is dead … He is out of this game now … He has 20,000 cash and all 1,70,000 or 1,80,000 he had put in calls are not even worth 4,000 – 5,000.
Price of Satyam 120 PA Jan 29
11:00 AM : Rs.1
2:30 PM : Rs.90
Return : 9,000% in 3 hrs.
What is the point I’m trying to make?
Everybody likes to make big profits and we should but not at the cost of risk of blowing up all our capital. Its not just related to Share markets or options. It also applies to Debt market, Mutual funds.
Do everything you can do to minimize or avoid the risk. Its very true that returns comes with risk. I am not saying “not to take risks”, i am talking about “managing risk”.
“Managing Risk” is the biggest measure you should take if you are in this field.
In some of the next posts we will try to see what are the different kind of “risk management” techniques and its importance.
95% of the salaried people are rushing to invest in tax saving (India). 5% of smart people have already done it (like me). The biggest rush I know must be still for LIC policies and PPF because very fewer people in India invest in Mutual funds still.
Both of these mutual funds are long term consistent performers and come from very respected and best AMC’s in India. Both of these have always been one of the best in the category.
But time changes, situation changes :), We can analyze some numbers and see what are the future prospects for these two mutual funds in comparison to each other. We will see on what basis we can conclude that. Please read the following conversation with my friend. It should give you some idea about how to choose mutual funds and why one could be possible is better than others.
Robert: Hey Manish, need some suggestion from you.
Manish: Hi Robert, what’s up … how is life these days?
Manish: How is a job going on?
Robert: Nothing yaar, I am just busy with my tax savings, have to submit the documents ASAP, so need to invest now, I am thinking of investing in an ELSS, Any suggestions?
Manish: Hmm… See, There are two good funds I think you can invest in, SBI Magnum tax gain and Sundaram BNP Paribas Taxsaver. These are the 5 star rated funds from valueresearchonline.com. You can consider those. But if you only want to invest in one ELSS, I would say go with Sundaram.
Robert: Hmm. Can you give me how you did this analysis and why are you saying that Sundaram looks better than SBI at this moment? I thought if a mutual fund has been long term consistent performer and our time horizon is more than 3-5 years, We can invest in any good funds.
Manish: That is true, I am not saying that SBI is bad and Sundaram is the best, we are trying to see why Sundaram is a better choice for now. We will see the numbers and some charts, and we can look that Sundaram is doing much better than SBI for quite some time.
That gives us a good estimation of which one is good for investing now. So, this requires some long-duration talk, I will have to tell you the details, are you ready?
Robert: ok
Manish: So, Let me first tell you that Since Inception returns for SBI has been 16.67% and for Sundaram its 19.35%, Which is highly respectful .. Let us also look at the following chart of NAV of both mutual funds for last 3 years.
Green: Sundaram
Red: SBI
Blue: Sensex
Manish: You can see that in the last 3 years, Sundaram has outperformed SBI Magnum and also was less volatile than SBI, when it comes to being consistent with Sensex. Also, we must see the last year charts of these two in isolation.
Manish: You can see that Sundaram has taken over SBI around Jun 2008 and has performed better than SBI. You must keep in mind that NAV and index values have been rebased to 100, for comparison purposes only.
Robert: Hmm.. that is fine, I understood that we have some charts which try to prove the point, But there must be other numbers also which favors Sundaram over SBI.
Manish: Yes, let me tell you some things which you can use for comparison purposes.
1. Sharpe Ratio:
Generally, people judge mutual funds performance by the returns only, whereas the better parameter is Return with respect to the risk taken. The Sharpe Ratio of a fund measures whether the returns that a fund delivered were commensurate with the kind of volatility it exhibited.
This ratio looks at both, returns and risk, and delivers a single measure that is proportional to the risk-adjusted returns.
So, the Sharpe ratio is noting but risk-adjusted returns, So the higher Sharpe Ratio is better. Currently, in the Mutual fund’s industry, Sundaram Tax saver and Canera Rebecco mutual funds have the highest Sharpe ratio of 15. SBI has 0.0.
2. Alpha Ratio:
This is a very important ratio in mutual funds. Alpha is a measure of an investment’s performance on a risk-adjusted basis. It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index.
The excess return of the investment relative to the return of the benchmark index is its alpha.
Simply stated, alpha is often considered to represent the value that a portfolio manager adds or subtracts from a fund portfolio’s return. A positive alpha of 1 means the fund has outperformed its benchmark index by 1%.
Correspondingly, a similar negative alpha would indicate an under-performance of 1%. For investors, the more positive an alpha is, the better it is.
Alpha for Sundaram: 3.35
Alpha for SBI Magnum: -1.18 !! (Bad)
3. R-Squared:
R-Squared is a statistical measure that represents the percentage of a fund portfolio’s or security’s movements that can be explained by movements in a benchmark index.
Higher the R-squared Value, closer the mutual fund to the index, what it means is that it will behave like Index funds up to that percentage, which means what if a mutual fund has r-square value of 100, its nothing but an index fund, then why to buy the mutual fund and pay high managing fees, A mutual fund should have a balance in R-square it should not be more than 90 and less than 80.
A mutual fund with less than 80 R-square shows that they have more tendency to be volatile and be close to the index benchmark. forbes.com says: Mutual fund investors should avoid actively managed funds with high R-squared ratios, which are generally criticized by analysts as being “closet” index funds.
In these cases, why pay the higher fees for so-called “professional management” when you can get the same or better results from an index fund.
Robert: Great !! those ratios are really important parameters while judging the mutual funds. Btw, I understood these things. Any thing regarding holdings?
Manish: Definitely, Ratios are important, but we should also look at simple things like its holdings in different types of companies. See below –
Sundaram Portfolio
[su_table responsive=”yes”]
Market Capitalization
% of Portfolio
Giant
56.17
Large
17.10
Mid
24.88
Small
1.85
Tiny
—
[/su_table]
SBI Magnum
[su_table responsive=”yes”]
Market Capitalization
% of Portfolio
Giant
46.07
Large
21.48
Mid
25.52
Small
6.91
Tiny
0.01
[/su_table]
If you compare the investments by Sundaram, it has a high concentration in Giant companies and has avoided investments in Small and Tiny Companies, which helps in avoiding Risk (also returns can be affected, but more important is managing risk).
Also in the future when Markets improve and start rising, front line stocks (big companies) will be the first to move up.
Robert: Any other small things to consider?
Manish: Other things you should see are
Expense Ratio (lower the better) : Sundaram : 2,.24 , SBI : 2.5
Market Turnover
PE Ratio: Lesser is better
PB Ratio: Lesser is better, SBI is better in this Market Capitalization There are many other,
Robert: That is fine, but I can see that SBI is ranked 1st when you consider 5 yrs return and Sundaram is 2nd, I saw it on Value research online site.
Manish: True, But did you see its 3 yr Rank also? Its 5th !! and did you see 1 yr rank: its 12th for SBI Where as Sundaram is 2nd in 5 yrs, 1st in 3 yrs and 2nd in 1 yrs return category, which gives an indication that Sundaram is taking over as one of the best funds available over SBI slowly.
Robert: Hmm.. that makes sense, Great !! I would really consider these points, this helped a lot. Manish: My Pleasure !! But please understand that there is no guarantee that Sundaram will outperform SBI next year or from now on. There is just a high possibility for it, because of our analysis.
Question: Guys (and gals) … Do you know who is Robert and Manish 🙂 Ans: Both are Me … :), I just created this talk to present the article and learning in a different way and to make it practical and enjoyable .. I hope you all liked it.
Note: Please note that the views and analysis are personal, there may be some error, if someone finds any please, let me know. I will correct it. But I am sure there is no mistake or error in data.
During the last 5-6 months GILT funds have given returns like Equity funds … Something around 20-40% in last 5-6 months … And they are almost safe on downside … Lets see more on this Read : 5 mistakes of my first trade
What are GILT Funds ?
A mutual fund that invests in several different types of medium and long-term government securities in addition to top quality corporate debt.
To have a look at different GILT Funds see : http://www.moneycontrol.com/india/mutualfunds/gainerloser/17/15/snapshot/dlong/ab Risks factors
Gilt funds have different kind of risks associated with it .. Once of them is interest rate risk … There returns are inversely proportional to the interest rates and the reason for the exploding returns given by most of these GILT funds or other Debt funds are the result of “interest risk drop in last 6 months because of the measures taken by RBI” .
However, there are some negatives too to these funds. Bond yields carry a higher credit risk than G-Secs and in bad times ratings can go for a toss. Some retail investors don’t understand ratings and are also not aware of which corporate debt these investments are made in to. Read about “Why you need Contingency Funds”
In the link http://www.moneycontrol.com/india/mutualfunds/gainerloser/18/03/snapshot/op1/ab/option/dlong/sort/yr1 , If you see the 6 months returns and 1 year returns , they are 41.2% and 41.8% , Think about what was the return during the 6 months period before 6 months (Dec 07 – May 08) .. The last 6 months have been exceptional for our Economy because of drastic decrease in interest rates in short period of time . This happens rarely .
To get a good idea of actual performance of these funds , you should see long term returns like 5 yrs returns or Since Inception returns .
Now if you see http://www.moneycontrol.com/india/mutualfunds/gainerloser/18/09/snapshot/op1/an/option/dlong/sort/yr1for annualized returns , No fund has crossed 12% returns CAGR , and most of the top funds are in range of 7-8% Except the out performers with 10.3 and 12.4% .
http://www.valueresearchonline.com/funds/newsnapshot.asp?schemecode=1921 Shows the snap shot of a fund from the list .. you can clearly see that the risk Grade is HIGH for this fund , because of the risk associated with interest rates . (try to click on Portfolio part and see risk return chart) .
What you should do now ? Should you invest in Them ?
Don’t get fooled by the past returns for these Funds , because now there is no charm left in these funds now . They were excellent funds before 6 months and those who anticipated the interest rates drop made most of it . So next time where you anticipate there is going to be fall in interest rates , then you can consider these funds for your DEBT part of portfolio … These are still good funds if you don’t believe in Equity investment in these troubled times, but from my side “Equity Investments are best as of now ” considering your time frame is 4+ years .
Summary
GILT funds are mainly DEBT products , the normal long term returns expected should not be more than 8-10% on average … But still short term opportunities exists when drop in interest rates are expected … To read more articles : Go to the blog directory (Click Here)
This is a time when long term investing should be done. If you have spare cash for long term, Equity is for you. But how do you do it? How do you choose them? What are the important things you should look at while buying shares for long term?
There are some key things we will have a look at today, these are the key ratios discussed in book Profitable Investment in Shares, by S.S Grewal and Navjot Grewal.
But, before reading them understand that they are ratios which good indication of share prospects and are not guarantee about share price rise in long term, Share markets always run on Emotions and perspective which can change anytime…
Also periodic review is necessary, just buying today and looking after 10 years is not the idea… Buying is always the first step, Periodic review is the next.
8 Ratios to look before buying a share
1. Ploughback and reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts — dividends and ploughback.
Dividend is that portion of a company’s profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company’s reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders’ funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book value per share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company’s books of accounts.
The company’s books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders’ funds.
If you divide shareholders’ funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders’ funds / Total number of equity shares issued
The figure for shareholders’ funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn’t reflect the current market value of the company’s assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company’s shares. It can, at best, give you a rough idea of what a company’s shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs.10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs.6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share.
This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback.
This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend and 20 per cent (Rs 4 per share), the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company’s shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company’s share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company’s EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market’s opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilizing the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company’s future prospects.
If it is low compared to the future prospects of a company, then the company’s shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 doesn’t summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth.
On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company’s future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends — capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money — it doesn’t really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment — he doesn’t really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends.
Watch this video to know more detailed information about dividend and yield :
In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company’s shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs.2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE), and
7. Return on Net Worth (RONW)
While analyzing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders’ funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders’ funds) are valuable financial ratios for evaluating a company’s efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company’s business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company’s operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company’s efficiency, financial viability and its ability to earn returns on shareholders’ funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company’s share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company’s future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
People who want to trust someone more experienced and more knowledgeable should read SudarshanSukhani recommendation at https://tt-wealth.blogspot.com/2008/10/portfolio-for-safety.html
SudarshanSukhani is a well know and respected Technical Analyst of India and often talks on CNBC .
This page contains all the “Term of the Day” posted on this blog earliar .
1. Short Selling
Short Selling : Short Selling refers selling of shares without owning them . If you short sell a stock , you first sell them at higher price and later you buy them (cover them) back at lower price .Lot of times you feel that markets will go down , at that time you short sell a stock . People who deal in Derivatives can either Sell the Futures or Buy PUT options . Short Selling can offer tremendous returns in short frame , because bear markets are markets fall with much speed and momentum compared to rising market . Read more
2. Derivatives
Derivatives : Derivatives are contracts whose value depend on value of some other thing. Examples are Futures and Options . Value of Stock is independent , But value of Futures or Options depend on the movement of Stock . Derivatives are dangerous Instrument and not recommended for Starters . In India People are attracted towards Derivatives because of its Return potential , but they underestimate its Risk potential and its ability to paralyse investor or trader financially , Better to learn first and then enter in Derivatives. Read more
3. P/E Ratio
P/E Ratio : P/E ratio is a reflection of the market’s opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios. This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company’s EPSremaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment. Its one of the most imortant Ratios you can look at .
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
4. ETF
ETF : ETFs are a basket of securities which tracks an underlying and are traded on a recognised stock exchange. Examples are Nifty Beas (this tracks Nifty) and Gold ETF’s (this tracks Gold prices) . Read More
Soon there will be Silver ETF’s in India .
5. FMP
FMP : FMP’s are close ended mutual funds , similar to FD’s but much more tax efficient and with marginally superior returns , but they have there own risks . The returns offered by FMP’s is indicative and not guaranteed. They come from 1 month maturity to 1 yrs maturity . In year 2008 , FMP have done very badly because of defaults . Read here for more
6. Technical Analysis
Technical Analysis : A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. It is generally used by people who want to take advantage of short term price movement. Technical Analysis can make you a better than average Investor
7 . Demat Account
Demat Account : Demat account is an account where shares are stored electronically . Just like Bank account deposits money , Demat account deposits your shares . Now a days , you cant hold shares in physical form , every share has to be in physical form . A person can only hold a single Demat account (trading account is different) .
8. Trading Account
Trading Account: Trading Account is an account through which you can buy and sell things on stock market . Dont confuse it with Demat account , Demat account is just a place of storage . Trading account is a platform which provides you a service of buying and selling things . You can have multiple trading accounts , which will all be connected with your single demat account .
9. Futures
Futures: Futures are the contract which gives you a right to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price . For Example, If you buy Reliance Futures for June series, you will get a right to buy specific number of Reliance shares at a fixed price on last Thursday of June . The future date is called the delivery date or final settlement date . Read more
10. NAV
NAV: NAV is a price of a mutual fund unit . You can see it just like a share price of company . Mutual funds invest the money in market and its tracked by NAV , if investments goes up , NAV goes up and vice versa . Generally NAV value starts with Rs 10 .
There is a myth among investors that low NAV mutual funds are better than high NAV mutual funds, which is totally wrong .
In this article I’m going to talk about importance of partial profit booking. The scope of this article is only risky investments where we have risk of loss. It’s not related to Debt products where we are sure of returns.
Partial profit booking is relevant if you invest in Shares, mutual funds or derivative products.
What is the main goal of investments in Equity?
When we ask this question, most of the people would get it correct, Answer is Capital appreciation or fast growth of money. But most of the investors concentrate so hard on maximizing profits that they underestimate risks and that’s the main reason for most of the losses they make.
The biggest goal while doing Equity investments has to be “Capital Preservation” and only then you must think about any profits. So the main concentration must be on “Capital Preservation”. If you don’t concentrate on capital preservation, it can erode because of continuous losses and then you will have to try for profits just to get back to level you started.
Suppose by taking a lot of risk you can either earn 60% or lose 60%. If you get profits, it’s great. But if you lose 60%, then you will have to earn 150%, just to get back to your starting Capital. Whereas if you take a less risky route where you just earn 10% or 15%, your money will grow slowly and steadily, it will soon increase due to compounding effect.
We are investors, we are not god, we can’t predict markets move accurately. We can only avoid bad moves and take decisions which can help us minimize our risk and losses. We will soon see how Partial booking of profits can is so important while doing investments.
What is partial booking of Profits?
When we invest our money and if we get some profit and then we are not sure what can happen next, we book a part of it to minimize our risk. The main idea here is that if we gain some profits, we should book some part of it to make sure that we already got that profit in hand and not just in mind.
For Example
Ajay invested 1,00,000 in shares, which grew by 20% in 6 months. Now he is not sure what can happen, Markets are uncertain and now there might be 40% profit or 40% loss (just for example). He has 3 options here
1. If he does not book partial profits
His investments grew to 1,20,000 and now he can get profit or loss of 40%. Let us see the range of his return.
In case of 40% profit, he will get 1,20,000 * (1 +.4) = 1,92,000
In case of 40% loss, he will get 1,20,000 * (1 – .4) = 72,000
Total investment: 1,00,000
Returns: In range of -28% to +92%
2. If he books partial profits
Here we assume that he books his 50% profits. His investments grew to 1,20,000 and books profit of 10,000, he get backs 60,000 back and rest 60,000 is still invested. Let us now see the range
In case of 40% profit, he will get 60,000 * (1 +.4) = 96,000
In case of 40% loss, he will get 60,000 * (1 – .4) = 36,000
As he has got back 60,000 back earlier, the actual range will be
Just before the NSG waiver meeting, Robert invested 35,000 in options, he was very sure that markets would rise. Just after news came about NSG waiver, markets were suddenly up and He was in 12k profit overnight. This was a positive news for market and he wanted to remain invested.
He was very sure that market would rise further for next few days and his money would grow to 60-70k. People who are familiar to option trading will know that 30k can become 60k or 90k in a single day.
Robert was so confident that he did not book partial profits. Next day there was Lehman Brothers Collapse and it was a great shock to world. From next day stock markets fell and his investments fell by 90% in 2-3 days. His money grew from 35,000 to 47,000 and then fell to 8,000 in 3 days. Now he was in 27,000 loss.
What if he would have booked partial profits?
If he would have booked 50% profits. It means he invested 35k which grew to 47k and he takes out 50% of his investments, He should have taken out 23k and left 24k invested. In that case even if markets feel by 80%, His 24k would become 5k. Remember here, that he has already booked half of his profits and his exposure has reduced by 50%, which will help him in minimizing losses.
Total investments = 35,000
Final value = 23k (booked earlier) + 5k = 28,000
Loss : 7,000
Summary
Markets are uncertain and volatile. If we get profits anytime, make sure that they are partly booked, By doing that, you make sure that you have actually got some profit materialized and reduced your exposure to investments after it has gone up. If your investments start falling again, you will suffer some loss, but that loss can be compensated by the profits you have already booked.
By partially booking profits you reduce your risk for huge losses, at the same time you also cut your chances of making large profits, which is fine. Concentrate on cutting and avoiding losses and risk and not making profits. Profits will automatically come once you know how to manage your risk.
When it comes to invest in equities or mutual funds lots of people becomes concern about their investments. This article is surely for you if you invest in Equities (Direct shares or Equity Mutual funds). In this article I’m going to tell you how to hedge your portfolio using Derivatives.
Risk Management of Portfolio using Derivatives
Many people might have seen their investments go down to anywhere between 20-50%, if they invested in Indian Stock markets around Dec 2007 or Jan 2008, and they might be wondering if it will go more down in value .
Just like we know take life Insurance to cover the risk of Life, Home insurance or car insurance to cover the risk if anything goes wrong, Can we also take Portfolio insurance?
What does insuring the portfolio means?
What does insurance means? It means securing something from some event which can cause loss or damage. We ensure our Lives, our homes, our Car. What happens when nothing happens to our lives, Home or Car.? We pay a small price for it and that is a kind of fees, which we pay for the security.
In the same way, we can also insure our portfolio, we can make sure that our loss is limited, the loss is always limited. If you are one of those who invested in Equity mutual funds or Shares during 2007 or Jan 2008, and you are sitting on a loss of 30-60%, you will understand this very well.
Anyone who invested Rs.1,00,000 in stocks or mutual funds has loss of anything from 30,000 to 60,000 (depending on his investments). Just wonder if they could insure their portfolio and make sure that there loss cannot go beyond a certain limit. That would be wonderful. We are going to discuss this today.
I assume that you now understand what are Options and how do they work , what are call and put options and what is expiry date, in case you have not read about it, please read it at above links (try first link to get basic info).
If you have invested in Mutual Funds
Ajay has invested Rs.2,00,000 In Equity mutual funds in Aug 2008, Nifty is around 4,200. He has invested his money for 4 months and would like to withdraw his investments in Jan 2009. He is a smart investor and knows that markets can crash and there is no limit to how much down it can go, so he decides to minimize his risk.
For this he has bought Nifty 4200 PA DEC-2008 trading at 200, for which he spent Rs.10,000 (Rs.200 * 50 lot size).
Now let’s see 3 different cases and what happens to his portfolio
1. Markets boom and goes up to 5,000 : Nifty has gone up by 20%
I am assuming that his investments followed and his Rs.2,00,000 has grown to Rs.2,50,000
Value of his Nifty PUTS : 0
Profit from investments : 50,000
Loss in Puts : 10,000
Total Profit : 50,000 – 10,000 = Rs.40,000
2. Markets Crash by 25% and nifty goes down to 3,100.
His investments follow and now its value is around 1,40,000, but his PUTS will be valued at 1,100 (4200-3100). So its value at the end would be 1,100 * 50 = 55,000.
Loss in investments : 60,000
Profit in PUTS = 45,000 (55,000 – 10,000 investment)
Loss = Rs.15,000
Here you can see that Out of his loss of 60,000, 45,000 is covered from PUTS.
3. Nothing happens and markets are still at 4,200.
His investments will be almost same, and his PUTS will expire with value 0.
Profit from investments : 0
Loss from Options : 10,000
Total loss : Rs.10,000
In all the 3 cases, we should note that in all the cases his Losses are minimized.
Let us also take an example of Shares.
Ajay bought 300 shares of Reliance @2,000 on 1st Jun 2008. He wants to sell these shares around Dec 2008.
He senses that markets are uncertain, so he buys 4 lots of RELIANCE 2,000 PUTS DEC 2008 @100. One lot of Reliance options has 75 shares, that’s the reason he buys 4 lots, so that he has total 300 shares control.
What does it mean? It means that on Dec 2008, he has the right to see 300 shares of reliance @2,000 and for this right he has paid Rs.100 for each share.
The maximum loss for him is now Rs.100 per share.
Let us see the 3 cases.
1. Shares price has gone up to 2,500.
Profit in shares = 500 * 300 = 1,50,000
Loss in Puts = 100 * 300 = 30,000
Total profit : 1,20,000
2. Shares price remain same at 2,000
Profit in shares : 0
Loss in Puts : 100 * 300 = Rs.30,000
Total Loss = 30,000
3. Shares price go down to 1,500
Loss in shares = 500 * 300 = 1,50,000
Profit in Puts = 500 * 300 = 1,50,000 – (30,000 investments)
Total Loss = 30,000
Again, we can see that in any case his loss is capped by 30,000 (5% of his investments of 6,00,000)
So options can be used to hedge or security. Watch this Youtube video to understand.
Summary
So the main idea of options is to use them to minimize the losses. If there is loss in investments, the puts will end up in profit and we will have very less loss or maybe we can get some profits only. The same way, if people do short selling they can use calls to minimize their losses.
So if you have invested in Shares or mutual funds and want to minimize your losses, use options or Futures as Hedging tools.
People say its always a wise thing to Diversify your investments. Its gives you better security and better returns. It minimizes your risk and if one part of your portfolio is doing bad, it will not affect others and you will benefit from other side.
That is true, But then there are some things to note here.
Diversification – By investors point of view
Ask any investor who Started investing in Equities around 2002 and then sold his holdings at the end of 2007. If he sold it just by luck its great, but if he managed to take this decision based on his study on markets and hard work. Then its worth appreciating.
Diversification is very good, but only when you don’t have much time to track whats happening in things which you have invested in. Its a trade off between return and the time you can contribute tracking your investments.
What if you can watch your investments closely and take decisions based on any move in markets or investing world. In that case Diversification is not that important.
Warren Buffet’s views on diversification:
One of the greatest investors of all time Warren Buffet also says that Too much diversification is needs only when investors doesn’t know what he is doing. If you are cautious and well aware of things which affect your investments, then too much diversification is not required. Because you will take actions fast as an when required.
People who can not give time for there investments on daily or even weekly basis need better diversification. Read https://finance-and-investing.blogspot.com/2008/04/what-is-diversified-portfolio-and-how.html
to read more on diversification of portfolio.
Warren Buffet says that he likes to put his eggs in a single basket and watches it closely.
Lets take a Case study.
Ajay and Manish want to invest 1,00,000 each for 1 yr. During this period returns from different things were
Equities : 25% (for a year, but there were ups and downs in Equities market for whole year)
Gold : 20% Debt : 9%
Real Estate : -10%
These were returns after an year, so before making investment both of them did not knew that what will be returns.
Ajay do not have time to track his investments, but Manish has, so Ajay diversifies his investment like this/
On the other hand Manish do not diversify, because he has much time to track things closely, He does some study and understands that Real estate has short term bear market as there is lot of supply and interest rates are also going up which will affect demand and hence prices. He Invests most of his money in Equities and some money in Debt and Gold.
His portfolio looks like :
Equities : 80,000
Gold : 15,000
Debt : 5,000
His portfolio after 1 yr:
Equities : 1,15,000 (He sold his equities when he sensed that markets may fall in near term and then again bought at low levels, because of his good timings he earned more than 40% return)
Gold : 18,000
Debt : 5,450
His total = 1,38,450
Return = 38.45%
Conclusion:
Though this is hypothetical example, it shows that Because Manish kept a close eye on this investment, he does not need very highly diversified portfolio. He can have more concentration on something which he can closely track.
But risk can also be minimized by keeping a close eye on your investments, So the investor can choose more risky products and hence also increase there chances or earning higher returns.
Today I am going to talk about something which is one of the extremely important tool for risk management and also something which is encouraged if you want stable returns from your investments. We are going to talk about the investments in Equity and Debt.
How Re-balancing the portfolio will help in –
Risk Management
Stability
Maximize returns
Understand the pros and cons of Equity and Debt
EQUITY
Pros : High returns, Low risk in Long term, High Liquidity
Cons : Risky, not suitable for short term investment
DEBT
Pros : Stable and assured returns, Good investment for short term goals
Cons : Low returns
Equity + Debt :
When we combine Equity and Debt, returns are better than Debt but less than Equity, but at the same time risk is also minimized compared to Equity and Debt, and when we apply technique of Portfolio Rebalancing, both risk and returns are well managed.
What is Portfolio Rebalancing?
The first step to understand is that each person must divide his investments into Equity and Debt in some ratio, it can be 40:60, 50:50, 60: 40, 75:25 or any ratio, The ratio depends on a persons risk taking capability and return expectation.
For an example let take the ratio to 60:40, portfolio rebalancing is nothing but rebalancing your portfolio in same ratio, in case they got changed after some months or years, as you wish. Preferably the good time is every 6 months or 1 yr, but not 15 days or 1 month.
Why Do we do it?
You have to understand that each person should concentrate on both returns and risk.
Case 1 : Equity:Debt goes up.
Action : Decrease the Equity part and shift it to Debt so that Equity:Debt is same as earlier.
Reason : As our Equity has gone up, we could loose a lot of it if some thing bad happens, we shift the excess part to Debt so that it is safe and grows at least.
Case 2: Equity:Debt Goes Down.
Action : Decrease the Debt part and shift it to Equity, so that Equity:Debt is same as earlier.
Reason : As out Equity part has decreased, we make sure that it is increased so that we don’t loose out on any opportunity.
Limitations Lets also talk about the limitations of this strategy, once your equity exposure has gone up, if you rebalance and bring down your Equity Exposure, you will loose out on the profits if Equity provides great returns after that, or if your Equity exposure as gone down and you bring up your exposure from Equity and if Equity does bad, then you will loose more.
Understanding the Game of Equity and Debt
But, we already said in the start that our primary concern is managing risk and profit is secondary. Let us understand that markets are unexpected and they can go in any direction, so better be safe than sorry. Many people are confused that if there equity has done very well then shall they book profits and get out with money and wait for markets to come down so that they can reinvest.
Portfolio rebalancing is the same thing but a little different name and methodology, so once you get good profit in something which was risky you transfer some part to non-risk Debt.
When we say Equity we mean shares or mutual funds which are related to Stock markets, which tend to go up and down, if it goes up, there are high chances that it will come down and when it comes down, its highly probable that it will move up again.
Lets us now see the most interesting part : Examples
Ajay has Rs 1,00,000 to invest and he want to invest it for 5 yrs and the 5 yrs returns are 30%, -35%, 40%, 60% and -30% .
Lets look at his money and its growth in 3 different mode
– Only Equity
– Only Debt
– Equity + Debt in some ratio (without Portfolio Rebalancing)
(click on this image to see in large resolution)
We can see here that Debt performed better than Equity, because of the uncertain movement in returns, also the Equity+Debt performed better than Equity but not Debt.
Let us now see the performance of Equity + Debt (with portfolio rebalance)
So now, every time our Equity and Debt ratio changes, we will rebalance it.
Ratio = 30:70
Investment = 1,00,000
Equity = 30,000
Debt = 70,000
At the end of 1st year (Equity return = 30% , and debt = 9%) :
Equity = 30,000 * (1.3) = 39,000
Debt = 70,000 * (1.09) = 76,300
Total Capital = 39,000 + 76,300 = 1,15,300
Now we will rebalance the portfolio
Equity = 30% of 115300 = 34590
Debt = 70% of 115300 = 80710
Now This is our new Equity and Debt investment
At the end of 2nd year (Equity return = -35% , and debt = 9%) :
Equity = 34590 * (1-.35) = 22484
Debt = 80710 * (1.09) = 87974
Total Capital = 22484 + 87974 = 110457
Now we will rebalance the portfolio
Equity = 30% of 110457 = 33137
Debt = 70% of 110457 = 77320
In this way we keep rebalancing the portfolio and lets see its performance for 5 yrs
(click on this image to see in large resolution)
Here, you can see that The column (E+D with PR) is the our main column which shows the performance with portfolio rebalancing. Here we have example for two ratio’s 30:70 and 70:30, we can clearly see that at the end of every year the final corpus for rebalanced portfolio was always greater than the non-balanced portfolio for both the ratio.
For ratio 30:70
Year 1 : 115300 vs 115300
Year 2 : 110457 vs 108517
Year 3 : 130671 vs 126142
Year 4 : 162424 vs 155595
Year 5 : 158039 vs 147452
For the 70:30 ratio also we can see that rebalanced portfolio outperformed the non-balanced portfolio.
Also you can see that for most of the years re-balanced portfolio outperformed “Only Equity” and “Only Debt” except 1st year and 4th year.
1st yr is very easy to understand why it happened and for 4th year, the returns were positive again after 3rd year and we made more profit in “Only Equity” portfolio because of high concentration on Equity side, but you can see that in 5th year, when there was a negative return of -35%, then the “Only Equity” fell heavily, but the rebalanced Portfolio fell very little because we have rebalanced it already and dropped our Equity Exposure to be safe.
Conclusion
So at last the question is what is the ultimate conclusion of all this talk.
Each person has his own Equity and Debt diversification, if the person is high risk taker his Equity component will be high else it will be less, every time your Equity and Debt component changes you have to see that it matches your risk profile, if it does not you bring it back to your level.
By bringing Equity exposure from high levels to your level, you are managing the risk you can take and by increasing the Equity exposure to your level back (in case it went down), you are making sure that you don’t miss out the chance.
Other reason is that Debt always increases, Every time your money goes up in Equity from your comfort level, you take that money which is earned by risk and shifting it to a safe place which will rise for sure though with less speed. Equity is linked with Stock Market and they tend to go up and down always and you don’t know when will it happen. So better manage that risk by Portfolio Rebalancing.
Please comment of this article to let me know how you feel about this article, Feel free to comment on anything which you feel is wrong .
Also, the example taken for this article was self made and does not represent any real life situation, but for sure its possible and similar scenarios have happened in our Stock Markets
