Financial health of a company: some tips

We started off by eliminating all those companies that had recorded less than 15% growth in net sales and PAT in any of the past three years.

Further, we filtered companies on the basis of debt-to-equity ratio and return on capital employed (RoCE). While a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, a low leverage ratio increases a company’s potential to raise funds.

Hence, we selected companies which had a debtto-equity ratio of less than 1.5. In order to carry sustainable operations, it is necessary for a company to operate at an RoCE which is well above its cost of capital. Only those companies with an RoCE of more than 15% could make it to the next stage.

The final criterion was to do away with all companies whose three-year average net cash flows from operating activities was less than 50% of their reported cash profit.

Behavioral Economics Podcasts

To view some relevant podcasts for Consumer Behavior, visit:

http://www.marketingprofs.com/events/4/podcasts/?adref=emA24468

Ensure that you have enough bandwidth to see a smooth video.

Cheers,
Sachin

SIP + Insurance but Not ULIP

A number of mutual fund companies have tied up with insurance companies to offer long-term investment plans that offer you an insurance cover for the residual part of your entire investment plan. If you die part of the way through the plan, then your survivors will get not just the principal and returns of the amount that you have invested, but also the amount that you had not yet invested, but intended to.

Because this product is so unusual, it's probably not quite clear how this works, so let me explain through a detailed example. Let's say that a forty-year old person decides to invest Rs 20,000 a month till he is fifty-five years old. This amounts to investing Rs 2.4 lakh a year, or Rs 36 lakh over the entire fifteen year period. He decides to invest this money in a Systematic Investment Plan of an equity fund. Based on past experience, he expects to earn an average of perhaps 15 per cent a year on the investments he makes.

He starts investing and for five years, everything is fine. His has invested Rs 20,000 a month for five years, which comes to a total of Rs 12 lakh. His investments have yielded an average of about 15 per cent a year and are now worth a total of Rs 17 lakh. At this point, an unfortunate mishap occurs and he passes away. Normally, that would be the end of the investment plan. Of the Rs 36 lakh he originally intended to invest, he could invest only Rs 12 lakh before he died.

However, if this person had invested in the insured investment products that I'm talking about, then this would not be the end of the story. The 24 lakh that he couldn't invest because he died will be paid to his family by the insurance company. So his family gets the Rs 41 lakh which is Rs 17 lakh (the current value of the 12 lakh that he was able to invest), plus the 24 lakh that he intended to invest but couldn't because he died. His family could then invest the money and thus make sure that the financial plan is not disrupted. This isn't like a normal insurance where the amount you are insured for stays constant. Instead, the amount insured keeps decreasing. At any point, this amount is equal to what remains out of the original investment plan that the investor signed up for.

The obvious question is who pays for the insurance. After all, if the insurance company is covering the risk of the investor's death, then the investor must be paying the premium somehow. The answer is that this premium is paid in the form of an extra one per cent load that is deducted out of the money that is invested. Normally, fund companies charge a load of 2.25 per cent out of the investment you make. In the case of this product, this load is one per cent more. For Rs 20,000 a month, that comes to an extra Rs 200, which would strike most of us as a fair price to pay for the peace of mind that this product offers.

What is interesting is that there is no lock-in and there's no obligation. If you want to pull out of the scheme at any point then you can just stop investing and withdraw your money. Such product, with minor variations, are offered by a number of fund companies including Kotak, DSPML and Reliance.

The obvious downside is that this product ties one to a particular fund company for a long period of time. I think that's where one should spread the risk a bit by splitting one's investment across funds from different companies.

Few things to know before you decide your SIP + Insure

1. Is there a minimum amount that has to be invested in the SIP?

2. Must the SIP be of a certain tenure?

3. Are all equity schemes of AMC, eligible or is it offered only on certain schemes?

4. Will the insured amount be given to the nominee or be used to continue with the SIP so that the investment plan continues?

5. Will all the insurance expenses be borne by the AMC?

6. Is there any age limit to avail of this scheme?

How Big is Large -- Know your Home

The Milky Way's Astronomical Numbers

100,000 - Diameter of the Milky Way, in light-years. It's also around 1,000 light-years thick, and that's just the main stellar disk. One light-year is a little less than 6 trillion miles (10 trillion km), so we're talking about a very big disk. In fact, if our solar system was just the size of a coin in your pocket, the Milky Way would still be the size of the United States. 26,000 - Distance from our solar system to the Milky Way's center, in light-years. Astronomers think our solar system completes an orbit around the galaxy's center once every 225 to 250 million years. That means it was just one "galactic year" ago when the dinosaurs began to appear on Earth. 2.6 million - Low-end estimate of the number of suns it would take to equal the mass of the supermassive black hole that lurks at our galaxy's center. The sun is roughly 333,000 times more massive than Earth. So, it would take at least 858 billion Earths to equal that black hole's mass. Of course, no one can see the black hole. But astronomers theorize that such massive monsters lurk at the hearts of most galaxies. 200-400 billion - Number of stars in the Milky Way. That number is staggering enough. But consider this. Most astronomers say there are at least 100 billion other galaxies out beyond ours. Big as it is, our little corner of the universe really is just that. The Milky Way is but a drop in the bucket.
--Steve Sampson

Warren Buffett's 6 smart tips on investing

Not all businesses are created equal

Buffett is often heard saying that of the thousands of businesses around, there are only a handful of businesses that pass through his screen test. He calls these businesses 'franchises' and believes they should have the following attributes

Buffett says, "An economic franchise arises from a product or service that:
(1) Is needed or desired,
(2) Is thought by its customers to have no close substitute, and
(3) Is not subject to price regulation."

If the company under evaluation has enjoyed a long track record of greater than average returns on capital as well as profit margins then there is a good chance that the company qualifies for the definition of a 'franchise.'

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Price is what you pay, value is what you get

Identifying a strong Indian 'franchise' is one thing and valuing and investing in it is another. Even the best 'franchises' bought at expensive valuations will not do the trick. So how does one value a 'franchise'? Mr. Buffett has this to say on valuations.

He says: "The value of any stock, bond or business today is determined by the cash inflows and outflows - discounted at an appropriate interest rate - that can be expected to occur during the remaining life of the asset. Note that the formula is the same for stocks as for bonds."

The technique Buffett has mentioned about is also popularly known as the discounted cash flow, or the DCF.

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Ignorance is bliss

While DCF can be performed on all companies, the result the technique spews out may not be reliable in a lot of cases. So, what is the solution? Simple, ignore such companies! Don't trust us? Let us see what Buffett has to say on the problem.

He says, "What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes."

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Tackling the 'forecaster' in you

You've identified a strong Indian 'franchise' and you've performed DCF on it. Your DCF based valuation gives you a valuation that is 10 per cent higher than the current market price. Sensing opportunity, you are ready to take the plunge aren't you?

Yes, if you believe you are the perfect 'forecaster' of a firm's cash flows. However, Buffett thinks that he is not and, hence, he relies on a concept called as 'Margin of Safety' (MOS). What is this MOS? Let us hear in his own words.

He says: "We insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success."

When you buy, please ensure that your DCF-based value per share is at least 50 per cent higher than the current share price so that even if your assumptions turn out to be little aggressive or something unexpected happens to the company, the loss of your initial invested amount is minimized.

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The all-important 'SELL' decision

That solid 'franchise' that you bought two years ago and the one that had a strong margin of safety has given you attractive returns and now you wish to dump it. Dump you should if you've found another equally attractive opportunity in another equally strong 'franchise.'

But that is seldom the case. Furthermore, selling involves transaction costs. For these very reasons, Buffett is against the concept of selling strong 'franchises' unless their performance looks weaker from a long-term perspective. This is what he has to say on the issue.

"If the work is done right while investing in a stock, the time to sell it is never." Furthermore, he adds, "Our holding period is forever."

In Buffett, we have someone who has walked the talk and has remained invested in business for years together. Indeed, the urge to sell is very high, but you would do your investment returns a world of good, if you continue to stick with good, solid 'franchises' for years together.

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The golden rules

Having taken you through the entire process of investing, which probably comes closest to the way Buffett does it, we would like to sign off with two of his rules that we believe can transform you into a much better investor.

They are:

Rule #1: Do not lose money; and

Rule #2: Always remember the rule #1.

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Stop Loss Trigger Details

With the introduction of compulsory Rolling Settlement from July 2, 2001 the trading period (T) has been reduced to one day. Obligations are netted and determined on the basis of trades done on the trading day (T). The obligations have to be settled on the second working day after the trading day in a T+2 rolling settlement scheme. Thus, there is a settlement everyday and all orders are good for day in the cash segment of the market.

With the Good For Day Tool, you can tell us for how long you want us to keep trying to fulfill your order during a trading day. If your order doesn't get executed before the close of trading today, the order automatically lapses. The order option is typically useful when you are placing a limit order to buy or sell, because you believe the price of a particular stock will fall or rise within a trading session. And needless to say, the "We will try" is merely an expression. In reality, everything is done seamlessly by the system, untouched by human hand.

Stop Loss Trigger Tool
The Stop Loss Trigger Tool is actually a bit of a misnomer.This tool is most useful in protecting your profits on an open position. The Stop Loss order is a conditional order to either Buy or Sell.The condition being that the order is activated only when that stock trades at a specific price defined by you. As is the case in any order, you will have to specify the quantity and the limit price (or market price) at which you want the order to be executed.And in addition you will have to specify a Trigger Price.

Only if the Exchange records a trade at the price defined as Trigger price by you, will your order will be activated.

In case you choose to use a Limit price (as opposed to market price) for your Stop Loss order, you must remember the following guideline :

- For a Buy order, the limit price must be greater than or equal to the trigger price.
- For a Sell order, the limit price must be less than or equal to the trigger price.

If, for a stop loss order to buy, the trigger price is 93.00, the limit price is 95.00 and the market (last trade) price is 90.00, then this order will be released into the system once when the market price reaches or exceeds 93.00. This order will be added to the order queue at the exchange with the time of triggering as the time stamp, as a limit order to buy at Rs95.00. Till such time that the order is triggered it will stay in a separate queue at the exchange which is not visible to other market participants.Remember even the stop loss tool is valid only for a trading day.

If your stop loss order is not triggered during the trading day, it shall lapse automatically at the end of the trading session.

When do you use a Stop loss order?

The Stop Loss order is a great way for a trader to manage his exposure in the market. Lets us say that a trader wants to buy ABC company at Rs100 because he expects the price to rise to Rs120 in a short time. But he does not want to take an unnecessary risk and hence he wants to exit the trade (sell his shares) in ABC company if the price drops below Rs95. So he first buys 100 shares at Rs100. Then to protect himself against an unexpected movement and limit his losses he would punch in a stop loss sell order for 100 shares of ABC Co. with a trigger price of Rs95. He could choose to sell with a limit price of his choice or at market price.

So if the shares of ABC drop to trade at Rs95 his order is immediately triggered and pushed into the queue for execution. This system finds similar application in the case of short positions.

EBITDA ratio explained

EV/EBITDA ratio is the Enterprice Multiple: A ratio used to determine the value of a company. The enterprise multiple looks at a firm as a potential acquirer would, because it takes debt into account - an item which other multiples like the P/E ratio do not include. A low ratio indicates that a company might be undervalued. The enterprise multiple is used for several reasons:1) It's useful for transnational comparisons because it ignores the distorting effects of individual countries' taxation policies.2) It's used to find attractive takeover candidates. Enterprise value is a better metric than market cap for takeovers. It takes into account the debt which the acquirer will have to assume. Therefore, a company with a low enterprise multiple can be viewed as a good takeover candidate.Keep in mind that enterprise multiples can vary depending on the industry.

Therefore, it's important to compare the multiple to other companies or to the industry in general. Expect higher enterprise multiples in high growth industries (like biotech) and lower multiples in industries with slow growth (like railways). P/E is the Price to Earnings Ratio, also known as the price multiplier: It is a valuation ratio of a company's current share price compared to its per-share earnings. Its formula is:Market Value Per Share/Earnings Per Share (EPS)It basically tells you how much an investor is willing to pay for a dollar of earnings. For example, if a companyés shares are traded at $25 and its last 4 quarters earnings per share was $2, then the P/E ratio is = $12.In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.