Archive for 2005

Where to invest now?

4 comments Written on December 16th, 2005 by
Categories: Commentary
The Sensex has gone above 9,100 - and the NIFTY is touching 2,800. What to do now? Is it too high?

Well, a number of people are saying it's overvalued and it should fall around 10% at least and all that jazz. I think that's a load of bull. It may fall, but the underlying value in the market is still untapped.

Want to know what I mean? How can I be so insolent that I refute the analysis of Top Fund Managers?

Let me be frank. I'm not a fund manager. I'm a regular guy that's investing for value. To me, it's straightforward, if a company is doing well, and going to do even BETTER, it's a good buy. An intelligent investor knows what to buy. But a smart investor knows when to buy. The "when" part of things is all about timing - this is something fund managers are good at. But they aren't necessarily intelligent - they will sacrifice a good stock today because of the "herd mentality". The concept is: just because everyone else is dumping a certain stock or sector, they will continue to do so.

Take a look at some top line stocks, and tell me if they are overvalued:

Reliance Industries (RIL)

This is the biggest of the lot. The second highest market cap, and the largest private company. It's being valued at Rs. 850 per share. Everyone's thinking - too high!

They made a net profit of Rs. 52 per share last year. They made Rs. 34 in the first half of this year, and are most likely going to make another Rs. 34 in the last half. That's 68 Rs. per share for 2005-06, which means they are being given a valuation of P/E = 12.5. (Price to Earnings Ratio, or P/E is the market price divided by the earnings per share) This is less than the growth rate of 30% that they will achieve!

Markets usually value a company by a P/E of the value as it's growth rate. And RIL is India's largest private company! So let's say that being a developing nation, Reliance is only given HALF it's growth rate - 15. A P/E of 15 means the share must be valued ABOVE Rs. 1000 per share. From 850 today, that's nearly 20% potential!

This does not include the fact that they hold a BIG investment in Reliance Infocomm, Reliance Energy and IPCL. The recent demerger news means that each shareholder of RIL will get a share of the demerged entities - the holding companies for these sub-investments. That means, APART from Reliance itself, a person that buys the share today and upto the demerger date (not yet announced) will get the demerged entities shares. That's another benefit that could push returns to even higher levels.

I've been advocating RIL since the "big fight" days when the brothers got into their tussle. I bought at the 500 levels, and even the 480 levels late 2004. In one year, I've made more than 50% on this one stock itself!

State Bank of India (SBI)

Who hasn't seen the ads? SBI is India's largest banks, but makes only 5,500 crores in profits. That's nothing compared to it's real size, and it's making real efforts to change things. What's the financial figures? SBI has earning Rs. 102 per share in the past year (2004-05) and in the first half of 2005-06, has earned Rs. 55 per share. (Consolidated). My guess is that in 2005-06 it will earn around Rs. 115 per share totally. (with the recent growth in visibility)

This means SBI has a P/E of 8. SBI is HUGE, and yet, gets a valuation of only 8 P/E, which HDFC Bank and ICICI Bank have P/E of over 20! This is obviously incongruent and is a remnant of the past. Going ahead I think SBI should get a valuation of at least 12 - which is a price of around 1380. That's a good 50% jump from today! When? Perhaps a year from now - and in my opinion 50% a year is a good deal.

I haven't yet bought SBI, because I'm short of cash. But come January I will buy it!

There are more such companies - Tata Steel, Sintex, Tata Metaliks etc. If you know any, write a comment!

Posted in Commentary

ULIPs : A good investment?

85 comments Written on November 23rd, 2005 by
Categories: Insurance, ULIP
(Some of you have asked for the "basics" of investing - I'm writing an article about this, and hope to have it ready soon)

Meanwhile, I was recently evaluating Unit Linked Insurance Plans (ULIPs) - the idea here is that you put in your money and it "grows" with time. So you also have life cover (i.e. your family gets money if you die) and money also grows at the same time. You get "units" like in mutual funds, and the value of these units grows because the company invests it for you. You also get a tax benefit under section 80C.

That's a very simple way to look at things. But is it actually better than using other options? What is the real "cost" of such a plan?

I was pointed to http://www.iciciprulife.com/ipru/docs/lifelink2.pdf for a comparison. This is a "single premium" plan (you don't have to pay every year), with a Rs. 50,000 minimum premium.

Now you need to know - is this plan the best way to go?

Let's take an example of someone (say Ajay, 30 yrs old) who wants to invest Rs. 50,000. This will include investment amount plus premium for an insurance policy, sum assured of Rs. 250,000. Let's say Ajay has no problem locking his money in for three years, but wants to exit after three years.

In a ULIP, Ajay would pay (taking the Pru ICICI LifeLink 2 as an example):

- Entry load of 5% = Rs. 2,500 - Admin charges of Rs. 20 p.m. = Rs. 240 per year. - Mortality charges of Rs. 360 per year . - Fund related charges of 1.5% (maximiser plan) = Rs. 750.

This means the amount that is paid out as charges is: Rs. 3,850. Money actually invested using ULIP is Rs. 46,150/-

Now if Ajay decided to use ELSS for investment and a term plan for insurance.

Term plan cost (@Rs. 300 per lakh for 2.5 lakhs) = Rs. 750. (most plans have a minimum, but this is just for illustration)

Money left for investment = Rs. 49,250. If Ajay puts this in an ELSS he gets charged:

- 2.5% entry load = Rs. 1,232. - Fund management (it's a hidden cost in MFs) @1.5% = Rs. 740

So money invested using ELSS is Rs. 47,278/-

That means, if you use the ULIP route, around 2.5% LESS of your money is invested.

There's another disadvantage. Let's say Ajay dies in the third year - How much does his family get?

In ULIP case, the limit is the HIGHER of invested units or the sum assured, in this case: Rs. 2,50,000.

In ELSS+TermPlan case, ELSS is recovered in full, around Rs. 50,000 (Assuming terribly low growth in three years of the invested amount) Term plan pays out full sum assured of Rs. 2,50,000. What this means is the family gets Rs. 3,00,000.

Looking at this, I feel ULIP is not a good option when compared to taking a term plan for insurance and ELSS for investment. (That's putting it lightly. Frankly, it's a lousy investment)

(note: tax savings on both schemes are the same)

Further Note: I personally cannot invest Rs. 50,000 as a single time premium - I would rather choose something that takes 20 to 30 K per year, and grows. For THAT, the ICICIplan is : LifeTime Pension II

But, guess what, in the first year I lose 22% of my money to allocation fees in that plan!!!!

I would much rather choose TermPlan + ELSS. Or TermPlan plus a FIXED deposit.

ELSS has it's disadvantages too, but those are far overridden by the costs of ULIP. I would actually suggest a regular Equity Fund plus a term plan.

Update (29.1.2006): Manish Chauhan has written an article on this as well, and says with an example that ULIPs aren't going to return anywhere close to the Term Plan + Mutual Fund option.

Update 2 (3.4.2006):This Rediff article has more on ULIPs vs. Mutual Funds. An interesting read.

Posted in Insurance, ULIP

Thanks for the comments!

3 comments Written on November 15th, 2005 by
Categories: Uncategorized
Yasmeen posted a comment and I thought I'd reply in a separate post:

Great Job Deepak. Neat BLog. I like the content and the style!

Thanks, Yasmeen!

I have been investing mainly in equity and I find the tax implications quite ok. I haven't tried any mutual funds and do some (very little) insurance only for some tax saving and some risk coverage.

Insurance: I'd suggest you get a risk cover, just in case. I have taken a "pure risk" term policy - which is only Rs. 300 per lakh! For 20 lakhs I pay 6,000 per year, and this also gives me a tax saving. Effectively, I pay only around Rs. 4,200 per year, to ensure that my family is taken care of if I die.

As I build up my liabilities I will further add to such pure risk term insurance - to cover my liability (like a housing loan, if I take it) and have some money left over for family.

How I look at my equity investments - Theres only so much that is tax exempt so I'd rather play my money on equity, pay tax and be done - anything i miss in thinking this way? - esp since I also wont tear my hair over it if it all crashes.

I agree completely. You might invest in Equity Linked Savings Schemes (ELSS) of mutual funds but as I'd mentioned in an earlier post, it has too many disadvantages. You could also invest in unit linked insurance schemes, but I think they have the same disadvantages as ELSS.

Tax wise: if you hold your shares for a year, you have no tax liability. This only applies for market transactions where you have paid Security Transaction Tax (STT) - this should be there in your contract note.

What I have to ask:
a) What benefits do mutual funds offer over equity investing - other than being somewhat low risk? Is their any tax saving or anything else?

Tax Saving - ELSS schemes are tax exempt upto investments of Rs. 1,00,000 - this is all inclusive of all 80 C investments.

Mutual Funds have another alleged advantage - they are professionals and can get better returns than most of us. While this is true in many cases, I've seen enough people make a lot more by value investing - investing in stocks that have much more long term value.

For instance, an investment in Hero Honda in 1997 has given a return of over 1000%, apart from some astoundingly huge dividends. No Mutual Fund that I know of has come anywhere near this.

Also remember that Mutual Funds are simply other people's money (for the fund). This means that people can withdraw funds when they like - in a market downturn, lots of people suddenly withdraw, and in the redemption pressure, MFs sell good stocks to generate cash. This will involve loss of revenue.

Having said that, you will only beat a Mutual Fund if you have lots of time for research and employ a sound investment strategy. If you don't have the patience or the time, Mutual Funds are a better bet.

b. Also I am keen on looking at getting a house (for my parents)and some land (mostly for our non-profit work) - And since you manage your existing real estate assets - some information on profitability, current prices and such like would be what I would like - I wonder if this is a good market at all to buy???- if you have some answers and predictions...

Current Prices in Bangalore are high. But in every market there are some good deals - you have to look hard. Sometimes you get a deal that is just great!

In terms of profitability, you have to depend on capital appreciation - betting that the property value will go up - for your gains. Cash flow is usually miserably bad since in most properties you can't even expect rent enough to pay for your EMI for the first five to ten years! I will explain using a very interesting Excel sheet I have developed for this model (I call it the Robert Kiyosaki Model)

Price wise: Real estate is a cyclical - it will go up and down. In the past it has gone down much lesser than up, so the prices now are much higher than 20 years ago. Also you will see that some areas will develop well, so you can pay a premium for such areas - since they will command a better price for better infrastructure in the long term.

I'm not particularly interested in real estate for investment. I think it's too much of a hassle :)

( I not only will take it with a pinch of salt I will also take only what I want and leave the rest.)

Once again very good work - I am sure this will induce people to address their investments and perhaps also some seasoned investors will comment.

Thanks Yasmeen, and keep posting. I don't have any accreditation or long term experience - I'm just another investor, and I would love to hear from more seasoned folks.

Posted in Uncategorized

ELSS: Not that attractive?

5 comments Written on November 11th, 2005 by
Categories: MutualFunds
Budget 2005 announced that you could save tax by investing Rs. 1,00,000 - one lakh - in any specified scheme, and the invested amount would be tax exempt for that year. Section 80C, they called it, and it contained a number of investment avenues - Insurance policy premium, NSCs, PPF, Equity Linked Savings Schemes (ELSS) etc.

ELSS is an offering by mutual funds that invests 80% or more of it's money on Equity - i.e. Regular Shares, Convertible Preference Shares or Debentures/Bonds. Obviously most go through the stock markets. The money you invest is locked for three years (at least). Idea being, you must invest for the long term.

Assuming you invested 1,00,000 in ELSS, you save 30.6% (at the highest slab) - this equates to Rs. 30,600 saved. Additionally, you get price appreciation after three years, which adds to the yield - especially if you were planning to invest anyway.

What's wrong then? Well, the IT department has issued a notification - no. 226 on 3.11.2005 - that changes a few things.

There's a very good article by Sandeep Shanbhag at moneycontrol.com that tells you in more descriptive terms about the issues involved, but I'll try to explain further.

ELSS is perhaps not a tax saving scheme it's a tax deferring scheme. The government may not tax you this year, but may introduce a later notification to tax you on maturity or on withdrawal. This is the concept of EET (Exempt-Exempt-Exempt)

The EET concept is simply that

  • Investments are Exempt from tax (in the year of investment)
  • Accumulated gains are Exempt from tax (in the year of the gain itself)
  • Withdrawals or maturity benefits are Taxed (in the year of withdrawal/maturity)
(Note: The government hasn't yet introduced EET, but it is likely to happen soon.)

Simply put, in ELSS, you don't pay tax THIS year, you pay tax after three years or whenever you withdraw.

Now, few important concepts in the notification:
1) From 2005-06, plans must be closed ended - i.e. they have a fixed period of existence. A new plan must be introduced every year, which closes 10 years after introduction. So, each year you have a new "plan" or "series" of the mutual fund. This is not like regular Equity Mutual Fund units.

2) An ELSS plan must be open for a minimum of one month per year (three months from 2006-07 onwards). What does that mean? You can put in money now - November - and the MF can allot your units in February 2006. (The one month can be ANYTIME before March 31 of the financial year)

You are then locked in for three years from the date of allotment. This may be splitting hairs, but those extra three or four months of lock in could be a pain!

3) NAV is no longer transparent. Unlike Equity Mutual Fund units, ELSS schemes do not need to announce the NAV daily. No, not even weekly! A "series" - a particular year's units - need not announce the NAV until one year elapses (after date of allotment). After that it only needs to announce the NAV twice a year. After three years, you get your NAV only once a month.

So, you can't even know how your ELSS is performing, until a year elapses! How do you decide whether an ELSS scheme is worth investing in, next year? After all, we're not one time investors - we need to regularly invest.

4) As Shanbhag says, an early repurchase may not be in your favour. Since NAVs aren't daily, the difference between the day you invest and the NAV date may work against you. MFs can say they wont give you upto 50% of such gain. Remember, in a boom, fund NAVs can go up 1% to 1.5% every day, so even 15 days is a HUGE loss. And you can be sure that if there's any loss, you'll be made the loser.

---
Let's now see, what is the ELSS Analysis?

Benefits
Disadvantages
1. Tax saving (in the year of investment) 1. Tax is paid on investment PLUS gains on year of withdrawal.
2. Amount locked in for three years
3. NAV is not transparent
4. You can get ripped off during repurchase.

Why bother with ELSS then? Invest in a regular mutual fund instead.

Posted in MutualFunds

Capital Gains Tax: A primer

7 comments Written on November 3rd, 2005 by
Categories: CapitalGains, IncomeTax
If you make a profit buying and selling Capital Assets (Property, Stock, Mutual Fund units etc.), you need to pay Capital Gains Tax. Here's a primer:
  1. Capital gains tax applies to you if you have both bought and sold property, shares etc (capital assets)
  2. The concept is that the "profit" you make from the purchase and subsequent sale of these assets is taxable - obviously, since it's income to you.
  3. The government doesn't like to tax you at the SAME rate as for your salary income - which is 30.6% at the high slab. The idea is that the government WANTS you to build capital assets, so capital gains tax is LOWER than tax on salary.
  4. There are two types of Capital gains: Long Term - when you've held the asset of 36 months or longer (12 months for shares/MFs). Short Term: Any period less than the long term period.

Okay that's the basics. The complicated stuff is this. Each type of asset can have different tax implications on "profit". Let's take the stuff that I know about:

Real Estate Capital gain is the difference between the purchase price and sale price. But usually real estate gets sold after a LONG time, sometimes more than 20 years after the purchase! I know cases where the purchase price was 1 Lakh and sale price was 55 Lakhs!

So the "purchase price" would be meaningless without accounting for inflation. The Government allows you to "adjust" your purchase price for inflation, and pay Capital Gains tax (20%) on the difference. There are government index tables for capital gains ratios - for each year starting, I think, with 1980. (Cost Inflation Index is available at the "Further Reading" link below)

For real estate: You can "ditch" paying tax by two ways:

  1. Invest in another capital asset (real estate only) within 6 months of the sale. If you purchase another property for less than the sale value of your earlier property, tax is paid on the retained gain.
  2. Invest in infrastructure bonds (or other section 54 tax saving products): You will be locked in for three years (can't touch the money) but you won't pay tax on the gain.
(Gold follows the same concept as Real Estate)

Shares/Mutual Funds etc.
This is a little complicated. There are many laws here, but here's the basic thing: The long term capital gains on such assets is 10%, which applies if you have sold your shares or units at least ONE year after their purchase.

(The government also allows you this: You can pay either pay 20% on inflation indexed profit or 10% tax on the total capital gain WITHOUT adjusting for inflation - this is your choice and you can use whichever is lower. This is only for shares/mutual funds)

IF you have bought AFTER October 2004 then you paid something called "Security Transaction tax" (STT) on your purchase. This will be reflected in the contract note. If you have paid STT, then long term capital gains tax is ZERO - you keep ALL your money!

If you sold in LESS than one year, then Short Term Capital Gains Tax will apply. With STT in place, Tax is 10% on profits. (Earlier it used to be added to your net income - like salary income etc.)

You can't avoid paying tax on share/MF sale profits by infrastructure bond investments (I think, correct me if I'm wrong)

That's all the assets I know about.

One more Funda: LOSSES: You may lose money when selling your asset. (i.e. sell for LESS than you buy for) Such losses can be adjusted for gains in the same asset type only (i.e. Long Term losses against long term gains only, real estate against real estate only etc.) Exception: Short Term Losses can be set off against Long Term Gains.

You can carry forward the losses too (adjust a loss this year against a profit next year etc.) for upto 8 years.

You cannot adjust losses against Salary Income. (sorry folks)

Further Reading:
Income Tax Department's Website on Capital Gains

Posted in CapitalGains, IncomeTax

Investments. Period.

1 Comment » Written on November 3rd, 2005 by
Categories: Uncategorized
Welcome to my new blog. I've started this blog for information on:
  • Investments
  • Tax issues
  • Stock market stuff
This is going to be very India specific so don't expect ticker symbols and all that jazz. What we're going to do is to analyze investment ideas for long term gains. Note: Long Term Gains. I'm not really looking at insider theories, MACD or other technical trivia, or anything that I can't logically understand. I'm leaving comments on, and I'll be creating site links from time to time. Send me information or ask me stuff. I'm not a very rich guy. Just planning to get there. So take all advise with a pinch of salt!

Posted in Uncategorized