Investing
Fundamentals
LIQUIDITY
MAKE SHORT TERM
INVESTMENTS TO
MAINTAIN LIQUIDITY AND
EARN SOME RETURNS
AVOID UNUSUALLY HIGH
RETURN INVESTMENTS-IT
MAY BE RISKY
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Return from investing in stockDividends
Price
appreciation also called capital
appreciation or capital gain
Growth Stocks Vs Income Stocks
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Income stocks- generally older,
established firms that have less chance
for substantial growth and less variable
earnings
Swaraj Auto, Oracle Fin., Infosys etc
The income companies believe in declaration of high dividends.
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Growth stocks- generally younger
firms that have more growth
opportunities and more variable
earnings
ICICI, HCL, Eicher, Indiabulls etc.
The growth companies give low
dividends
Bonds
Return
from investing in bonds is in
the form of coupon payments and
price appreciation
Mutual Funds
Return
from investing in mutual funds comes from
coupon or dividend payments generated by the
portfolio of the fund
Real estate
Buying
Return
a home or purchasing rental property or land
from investing in real estate
comes in the form of rent payments and selling the
property for a higher price than paid for it
INVESTMENT RETURN AND RISK
Measuring the return on your investment
Total return = Cash payment received + price change over
the period
Purchase price of the asset
Example: If you pay $1,000 to make an
investment and receive $1,100 when you sell the
investment in one year, you earn a return of:
R=
$1,100 - $1,000 = .10 or 10%
$1,000
DIFFERING TAX RATES ON
RETURNS
Income received as interest payment is classified
as ordinary income
The income from sale of investments is called
capital gain
long term capital gain (LTCG)-Capital gains
resulting from sale of investments
held more than one year in case of- shares and
equity MFs.
held for more than three years in case ofproperty, land, gold, shares sold off market etc.
Short term capital gain (STCG)- if held for
shorter durations as in the above cases.
Differing tax rates on returns
Share
dividends are not taxable in India.
STCG
from investments in stocks (if levied STT) are
taxed at 15%
LTCG
from sale of stocks (if levied STT) are not
taxable.
CAPITAL ASSETS
STCG
from sale of capital assets are taxed as ordinary
income.
LTCG
from sale of capital assets are taxed at 10%
without indexation (Sale cost), or 20% with
indexation (Sale Indexed cost), whichever is lower.
(LTCG = sale price indexed cost of acquisition)
Indexed Cost of Acquisition or inflated cost = Actual
Purchase Price * (Cost Inflation index during the year
of sale / Cost Inflation Index during the year of
purchase)
Let us try to understand this with a simple example.
An asset was purchased in FY 1996-97 for Rs. 2.50 lacs. This asset was
sold in FY 2014-15 for Rs. 8.50 lacs. Cost Inflation Index in 1996-97
was 305 and in 2014-15 it is 1024
So, indexed cost of acquisition: Rs. 2,50,000 * (1024/305) = Rs. 8,39,344
Long Term Capital Gains would be calculated as :
With Indexation: Capital Gain= Selling Price of an asset Indexed
Cost i.e. Rs. 850000 Rs. 839344 = Rs. 10656. Therefore tax payable
will be 20% of Rs. 10656 which comes to Rs. 2131.
Without indexation: The Capital Gains = Selling Price of an asset
Cost of acquisition i.e. Rs. 850000 Rs. 250000 = Capital Gains is Rs.
600,000. Therefore tax payable @ 10% of Rs. 600000 would have come
to Rs. 60,000.
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So you save Rs. 57,869 in taxes by using the benefit of
indexation.
INVESTMENT RETURN AND RISK
(CONTD)
Risk from investing
Returns
are uncertain
Future
values of investments are dependent on
demand by investors
Before
you select an investment, you should assess
the risk
Measuring an investments risk
All stocks are subject to two forms of risk
Systematic risk
is the risk that all publicly traded equities
share due to market-wide movements.
Wall Street proverb a rising tide raises all boats
Non-systematic risk
is based on the earnings strength of
the underlying company of your stock, and not the overall
market.
Non-systematic risk
systematic
risk
is generally more manageable than
for
the
individual
investor.
The traditional way of offsetting non-systematic risk
diversification across different sectors and asset classes
is
Measures of Risk
1. Range of returns: returns of a specific
investment over a given period
(range = highest return lowest return)
2. Standard deviation: standard deviation of stocks
monthly returns. It measures the degree of volatility
in the stocks return over time
A risky stock will normally have a relatively wide
range of returns and a high standard deviation of
returns
There are other subjective measures of risk
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3. Beta
Beta measures nondiversifiable risk i.e. Systematic risk.
Beta calculation is performed using a statistical technique called
Regression analysis.
The whole market is assigned a beta of 1.
Stocks that have a beta greater than 1 have greater price
volatility than the overall market and are considered to have
greater risk.
Stocks with a beta of 1 move up and down with the market.
Stocks with a beta less than 1 have less price volatility than the
market as a whole and are considered to have less risk.
Risk relates to return. Investors normally expect that stocks with
a higher beta should command a risk premium, that is provide a
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higher return than the market.
More risk should mean more reward!
Beta for one year period
November 2012 October 2013
Company
Beta
Beta
Company
Values
LARSEN & TOU
1.3
MAHINDRA & M
0.92
HOUSING DEVELOPMENT FINANCE CORP.LTD. 1.3
TATA MOTORS
1.56
CIPLA LTD.
0.59
HIND UNI LT
0.33
I T C LTD
0.52
BHARAT HEAVY ELECTRICALS LTD.
1.42
STERLITE IN
1.66
STATE BANK OF
INDIALTD.
1.13
WIPRO
0.75
SUN PHARMACE
0.52
DR.REDDY'S LABORATORIES
LTD.
0.56
GAIL INDIA
0.52
HDFC BANK LTD.
1.2
ICICI BANK L
1.54
HERO MOTOCORP
LTD.
0.67
JINDAL
STEEL
1.46
0.87
INFOSYS LTD.BHARTI ARTL
0.58
MARUTISUZUK
0.7
Sesa Sterlite Limited
1.32
TCS LTD.
0.88
OIL AND NATURAL
LTD.
1.24
NTPCGAS
LTDCORPORATION 0.77
BAJAJ AUTO
0.65
RELIANCE INDUSTRIES
LTD.
1.11
COAL INDIA
0.64
TATA POWER CO.LTD.
1.01
HINDALCO INDUSTRIES
SENSEX LTD.
1.32
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Using Beta to Estimate Returns
Capital Asset Pricing ModelRs = Rf + Bs(Rm-Rf)
Where:
Rs = the required return on investment
Rf = risk-free rate of return
Rm = the average return on all stocks
Bs = the stocks beta
It is easy to see that Rs increases with
increase in its beta.
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Assume a security with a beta of 1.2 is being
considered at a time when the risk-free rate is
4 percent and the market return is expected
to be 12 percent.
Rs = 4% + (1.2 * (12% - 4%))
= 4% + (1.2 * 8%)
= 4% + 9.6% = 13.6%
The investor should therefore require 13.6%
return on this investment as compensation
for systematic risk assumed , given the
stocks beta of 1.2.
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TRADEOFF BETWEEN RETURN AND
RISK
Return-risk tradeoff among stocks
Small
firms tend to have more growth potential, but
higher risk
IPOs may offer high returns, but also have high risk,
especially for individual investors
Return-risk tradeoff among bonds
Large,
well-known firms have low return, low risk
High risk bonds offer higher payments
LEARNING FROM THE
INVESTMENT MISTAKES OF
OTHERS
Making decisions based on unrealistic goals
Borrowing to invest
Taking risks to recover losses from
previous investments
Focus on Ethics: Falling prey to online
investment fraud
Avoid
making decisions without facts
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