Wednesday, October 28, 2009

Did your company just Split Shares?

Thought to do a separate post on share splits after getting a lot of comments/questions on this. see comments at here is a humble try to explain what a share split is.

What is a share split

When a company splits its shares, it agrees to issue additional shares to the existing share holders, but it doesn't intend to issue new shares like in a Follow-on Public Offer. The shares would come from the existing shares only and hence the face-value of the existing shares would be reduced. For example, if a stock has a face value of Rs 10, a two-for-one stock split will mean that there will be twice the number of shares as before with a face value of Rs 5 each for the new share. So if an investor owns 100 shares, he will have 200 shares after the split. In case of a five-for-one split, there will be five times the number of shares and the investor will own 500 shares for every 100 shares.

Fair enough, but how is this different from a bonus share

As discussed in the other post, in case of a bonus share, the current market price of the share decreases and the face value remains constant, where as in case of share split, both change. 

These 2 are inherently different in terms of accounting. A bonus reduces a company's reserves, converts it into equity capital and then issues additional shares from it. In absolute rupee terms, the equity capital (number of share multiplied by the face value) rises after a bonus. After a 1:1 bonus, the equity capital will double.
In a split, the absolute rupee capital is maintained at the same level and the reserves remain as before.

Merits of such an action
  • To make the share price affordable for more people to buy them in open market.
  • Increase in liquidity. It is now more readily available in the market to be traded.
What does it change

Practically nothing! A share split or a bonus changes nothing on the fundamentals of the company. It is much like cutting a 12 inches pizza into 8 pieces instead of 4. But investors love stock splits and bonuses. Empirical studies in the US do suggest that stock splits improve prices in most cases as investor sentiment improves. Bonus issues in India have also provided returns to investors.

Analysts do feel that both bonus and stock split indicate the management's conviction to sustain a higher profit growth to service the higher number of shares.

Saturday, October 24, 2009

Recession Over???

The last one and a half year has been like hell for every one. The economy of the entire world slowed down drastically forcing organizations to cut jobs and sending the economy in a downward spiral.

Some of the most common questions these days are: Is recession coming to and end? Is economy showing an improvement? Has the employment rate recovered? Recession is generally described as "a period of economic decline". Lets find out some signs which show that recession is coming to an end.
  • A survey of 44 professional forecasters released by the National Association for Business Economics USA, also known as the NABE, found that 80 percent of the respondents believed the economy was growing again after four straight quarters of declines. 
  • The latest government data on Monday showed the economy growing by 6.1% year-on-year during the first quarter (April-June) of the fiscal the fastest for any quarter since the global financial crisis began almost a year ago making officials expect 6.5% growth this year making India the second-fastest growing major economy after China, which notched almost an 8% growth rate. More importantly, it's an improvement over the 5.8% notched up by India in the previous quarter and 5.3% recorded in the quarter before that. see this video: 

  • FIIs are coming back!
Let's hope these signs result in an end to the recession.


    Thursday, October 22, 2009

    Dividend Explained...

    To carry on what we started with "what is a bonus share?", let's discuss dividends today.

    Definition of Dividend

    That part of the earnings of a corporation that is distributed to its shareholders; usually paid quarterly. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

    What's in it for me (WIIFM)?

    When a company offers a dividend to its stock holders, it is taking money that could be reinvested into the company, and distributing it to shareholders as a benefit of investing in the company. Receiving a dividend is good for investors, because they get a guaranteed return on their investment in the form of the money from the dividend. A stock that returns a dividend is good as an income investment or a long term growth investment. This is because these stocks tend to remain stable, and offer a tangible monetary benefit to investors.

    Dividends are usually settled on a cash basis, as a payment from the company to the shareholder. They can take other forms, such as store credits (common among retail consumers' cooperatives) and shares in the company (either newly-created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

    Dividend generally comprise of 3 factors:
    • Amount - the money that you are getting as dividend from a company. This is generally represented as a percentage of the face value of the share of the company. For example, Hawkins Cooker recently offered a dividend of 200% i.e. Rs 20 per share (face value being Rs 10).
    • Consistency - How often does a company offer dividends. As dividends are not guaranteed. It depends on the company if it wants to declare a dividend or wants to use the profits for some other purposes. A company that offers dividends consistently along with business growth is usually better as it is able to strike a balance between growth and share holder value.
    • Timing - This is when would the dividend come into effect. Usually termed as Record Date, this is when all the shares held by any one would be considered for dividend. The point to note is, the shares should be with you before this date. One day after this date the share is termed as ex-dividend.

    High dividends is not always a sign of good management. A company that needs to reinvest should not pay out all of its accounting profits in dividends. This will cause the productive capacity of the company to diminish and the company to eventually fall into bankruptcy. This actually is a technique of "corporate vultures". They buy a large controlling position in a fine company and purposefully pay far more dividends than they should. This causes the competitive position and productive capacity of the company to falter. This all takes a long time to happen and the company can rest on its laurels for a while. It takes outside analysts a long time to figure all this out. Accounting rules offer lots of scope to obscure what's going on The company is usually able to borrow money to pay dividends for quite a while before the market refuses to offer more credit. Then the inevitable day of reckoning eventually comes, but the "vulture" has already picked the bones clean before the death throes arrive.

    The moral of the story is that it "pays dividends" to analyze the dividend record and dividend policy of a company.

    Saturday, October 17, 2009

    5 investing lessons from the T20 loss

    There can be quite a few similarities between Cricket and Investments. Let us see what we, as investors, can learn from this:

    1. Past perfect, future tense
    In the T20 format, it is far more difficult to predict than in other longer formats. In the equity markets too, the shorter the time duration, the more difficult it is to predict. Just as how no fund manager knew at 21,000 sensex that the market can come down to 9,000, even those who claimed that they could predict, could never have predicted that from 8,700 market will move up 80 per cent in such a short time.

    Lesson: Don't time the market. Invest regularly in a disciplined manner .

    2. Strategy matters
    Mahendra Singh Dhoni in 2007 was playing to win. In the year 2009 he was playing 'not to lose'. This made him very defensive.

    Moreover, the top batsman had a limitation, they could not play the rising ball in England. The bowlers were not effective either.

    Anil Kumble, Sachin Tendulkar were all available in England. The selection was poor.

    Strategic mistakes in investing include
    - too many funds
    - choosing sectoral funds
    - paying income tax on equity funds (by choosing a balance fund with 50% equity)
    - not doing a SIP (systematic investment plan)
    - investing a debt for a long term
    - not taking adequate life insurance, etc.

    These strategic mistakes hurt in the long run.

    Lesson: Stick to the investing basics. Read about that here .

    3. Never reward mistakes
    Most actions are judged on outcomes, not on efforts. When Joginder singh was given the ball to bowl the last over there was no logic, but the result was stunning. So we called Dhoni a strategist. Now selecting Jadeja resulted in a loss. So we call him a failure.

    Fund managers who sat on cash from 21,000 to 10,000 looked smart. That was a mistake we lauded. We called their performance as a ‘1st quartile performance’. However, when they sat on cash at 8,700 index waiting for the index to go to 6,500, they lost out. So the same heroes look like zeros!

    Lesson: If you made a mistake, accept it and don't repeat it. It may have worked once but not always.

    4. Overconfidence kills
    Main causes of India’s failure were overconfidence, too many changes in the team, and playing defensive cricket.

    Most retail investors struggle about which fund to keep and which to remove. The very simple thing to do is choose one fund and monitor progress. Also the need to transact is so high for the retail investor, that it hurts.

    The same hurt you even while investing. Overconfidence (my techniques of last year will work this year), too many transactions, and keeping all your money in debt funds for 20 years.

    Lesson: Be patient while investing.

    5. Sharpen your skills
    Even if you are a good tree cutter you need to take time to sharpen the axe. If you do not take time to think, rest, relax the muscles, how will you recover to play again? We over did our playing. What was the reason that we had a jaded team? Not sure. Many mutual funds tend to relax and rest on their past laurels. Look at their recent performance - it is really jaded!

    Lesson: Keep learning

    [source: moneycontrol]

    Thursday, October 8, 2009

    What is a Bonus Share

    Reliance Industries has declared a Bonus issue of 1:1. WoW!!! But what does it mean? How does it affect me? Should I purchase RIL shares now?

    We will try to get answers to these questions today.

    What is a Bonus?

    Free shares of stock given to current shareholders, based upon the number of shares that a shareholder owns. While this stock action increases the number of shares owned, it does not increase the total value. This is due to the fact that since the total number of shares increases, the ratio of number of shares held to number of shares outstanding remains constant.
    Where did this bonus come from?
    Bonus shares are issued by cashing in on the free reserves of the company. 

    A company builds up its cash reserve by retaining part of its profit over the years (the part that is not used over the years to expand the capacity, pay the dividend etc.). After a while, this reserve increases, and the company wanting to issue bonus shares converts part of the reserve into capital.

    So, the existing investor gets some free shares and the company's profit as well remains in-tact.

    Affect of Bonus issue

    A bonus issue adds to the total number of shares in the market.

    Taking the case of RIL, the company has about 1,642.5 million shares outstanding. Now, with a bonus issue of 1:1, there will be another 1,642.5 million shares added. So now, there will be 3285 million shares.

    This is referred to as a dilution in equity.

    Now the earnings of the company will have to be divided by that many more shares.
    Earnings Per Share = Net Profit/ Number of Shares
    Since the profits remain the same but the number of shares has increased, the EPS will decline.
    Theoretically, the stock price should also decrease proportionately to the number of new shares. But, in reality, it may not happen.
    That's because:
    1. The stock is now more liquid. Now that there are so many more shares, it is easier to buy and sell.
    2. A bonus issue is a signal that the company is in a position to service its larger equity. That means, the management would not have given these shares if it were not confident of being able to increase its profits and distribute dividends on all these shares in the future.

    When does it take effect?

    When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus.
    After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.

    Then how is this different from a share split?

    In case of bonus shares the value of the share decreases proportionate to the number of bonus shares issued. For example, if the company issues bonus shares in ratio of 1:1 and the price of share is 900 , after bonus issue, the corresponding value of the share gets Rs. 450. Genreally company issues this in place of giving dividends. The market captalization doesn't get affected,  becuase if shares double,  the prices is halved.

    In case of a split,  the face value of share decreases. Generally the face value of share is 10 Rs. but face value can be higher as well. So, if face value is Rs 10, then the  company can split the share in ratio of 10:1. Now the person holding 100 shares of rs 10 now will hold 1000 shares of Rs 1 each. now shares can be traded more frequently and this will in turn increase the liquidity of the share.


    Wednesday, October 7, 2009

    RIL announces 1:1 bonus issue

    Mukesh Ambani group firm Reliance Industries (RIL) today said it will issue one bonus share for every share held in the company.

    The board of directors of the company at its meeting held today, recommended issuance of bonus shares in the ratio of one equity share of Rs 10 each for each share held, RIL said in a filing to the Bombay Stock Exchange (BSE).

    The issue of bonus shares is subject to the shareholders' approval, it added.

    The board has also declared a dividend of Rs 13 per fully paid-up equity share of Rs 10 of the company to the shareholders, the company said.

    Shares of RIL today closed down 1.57 per cent at Rs 2,099 on the Bombay Stock Exchange.


    Saturday, October 3, 2009

    Taxing Salaried is back

    It has been quite a long time since I posted here. I know this was wrong on my part to leave the blog orphaned but I was busy with some of the other issues which are generally not in anyone's control.

    Now, I'm back and am determined to not let this happen again. I was thinking of where to start again? So guys, please help me. Suggest a few topics that we can take up here and discuss. Please visit the blog, share your comments or vote on so that I can decide on what to take up.


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