Archive for February, 2007

Absent in Budget 2007

1 Comment » Written on February 28th, 2007 by
Categories: Budget2007
One of the biggest positives in Budget 2007 was the lack of negative news that was expected, and did not happen.

No "EET" regime
I had earlier reported that the finance ministry is actively considering taxing ELSS schemes and other investment exemptions at the time of exit, meaning when you sell such investments. This was the EET regime (Exempt on investment, Exempt on accrual, Taxed on exit) Fortunately for investors, the EET regime is not in this time. So if you invest in tax savings schemes, you will not be taxed on exit, as no change has been made to this policy.

No increase in service tax
The FM was expected to increase service tax to 15%, to augment revenues. Fortunately this has not been done; but I think the rationale for avoiding this was the fact that service tax is applicable to a number of people and increasing this tax would have increased inflation further.

No change in STT and capital gains taxes
Securities Transaction tax (STT) is interesting - a small levy on your capital market transactions that allows you to claim lower capital gains taxes. The FM has not tampered with this setup, meaning you will continue to pay lower taxes for investment gains in shares or mutual funds. (It was expected that the short term capital gains taxes would increase, and STT would be raised)

No service tax for some sectors
Some sectors that were expected to be added to the service tax regime are not there - for instance media artists (like TV actors) were supposed to be added as service providers and taxed accordingly. That service tax would have negatively impacted media companies like Adlabs, Zee TV, TV 18, TV Today, Balaji Telefilms etc., but there is no such change.

Some expected positives were also absent from the budget, which would have been very nice.

No reduction in taxes
Apart from some minor tinkering, the tax rates stay largely the same. The lack of an EET regime has probably meant that personal tax rates could not be reduced. But the FM didn't reduce the corporate tax rate either, as was expected, or even remove the 10% surcharge introduced last year. (Other than for companies less than 1 crore - which won't affect you much unless you own a small company)

No opening up of banking sector
The banking industry was supposed to be opened up for foreign acquisitions - something a number of analysts, news channels and others had reported. This hasn't happened, meaning that banks can't be acquired by deep pocketed foreign banks, and therefore the sector does not have a positive impact.

No serious cut in petrol duties
A way to counter inflation would have been to pare petrol prices through reduction of duties. The finance minister has reduced duty from 8 to 6% but that's a very very small measure, and if you consider the total taxes on petrol and diesel they add up to over 30%. Some more could have been done, and inflation would have been arrested faster. Even now, the onus of passing the duty cuton to the customer is left with the oil companies, which aren't going to want to do this.

Posted in Budget2007

Budget 2007

No Comments » Written on February 28th, 2007 by
Categories: Budget2007
The budget is out today and I will be doing a complete analysis on it. I will be posting a number of entries that will provide my views on the budget.

Overall, Budget 2007 is positive for most of the industry. Yes, you read that right. The Sensex has fallen 550 points, and this guy is saying it is positive, you're thinking - but the fall was not because of the budget (Other market indices were down 3-6% and that precipitated the fall)

This time the budget was expected to have a number of negative items which are absent from the actual proposal. So this in itself is a positive! Also some positives that were expected are absent. (read more)

Let me talk about each budget item separately. (More links to follow)

What is absent in Budget 2007
Corporate India Impact
Personal Impact (on you and me)
Budget Impact: Tech

Posted in Budget2007

I am a father now

11 comments Written on February 18th, 2007 by
Categories: Uncategorized
Hi folks - just a quick post to let y'all know I'm a dad now (check out my personal blog and photos) and am extremely excited and happy. Perhaps over the next few weeks I will not be able to respond quickly to any comments. Cheers!

Posted in Uncategorized

Earning Per Share (EPS) and Price to Earnings (P/E) ratios

18 comments Written on February 12th, 2007 by
Categories: Stocks
To invest in stocks you need to understand a few terminologies about valuation. How do you figure out if the stock price of a company is overvalued or undervalued? There are many ways to do this but the most often quoted ratio is the P/E ratio, or the Price to Earnings Ratio.

But before you have that, you should understand EPS - or Earnings Per Share. Every company releases quarterly results in which it announces its profits, total equity capital and basic and diluted Earning Per Share. This means Net Profit divided by total number of shares. The idea here is - if a company has 10,000 shares in total, and the company makes 500,000 in profit (in a quarter), the EPS for that quarter is Rs. 50. If you "annualise" that EPS - meaning prorate it over a year, the EPS would be Rs. 200.

But of course the company may go through quarterly earnings changes, so you don't just multiple quarterly earnings by four. What you do is to take the LAST FOUR QUARTERS EPS, and add them up to get the "trailing four quarter EPS". This is the Trailing EPS.

Aside: How you get these figures is to go to http://www.nseindia.com and look for the last four quarter results. For instance this is the BHEL page, which has links to the last eight to twelve quarters of results. You can add them up manually, or visit sites such as moneycontrol.com or myiris.com to get a pre-added set.

Now, the past is the past. It is not the future, right? So some analysts will check the company and release estimates of how much the EPS will be for the next four quarters. This is called the "forward EPS".

P/E Ratio: How does the EPS help you? It does not. It's not reflective of anything in itself. You must take the stock price and divide it by the EPS, to get the P/E ratio. The P/E ratio, for BHEL for example is about 26 for the trailing four quarter EPS. If you consider that it's last quarter earnings will be the same over the next four quarters, the forward EPS is 108, and the forward P/E is about 22. (at todays price of 2350)

The P/E ratio (also called the "Earnings Multiple") needs to be compared in the same sector that a company is in. P/E of a sector is usually at similar levels - for instance, tech companies have P/E of around 30-35, PSU banks 5-10, Private banks 22-25 and so on. BHEL might sound high at 26 - but other heavy engineering companies like Praj Industries have an even higher P/E.

Other factors can influence P/E - visibility of earnings (longer the better), order book, brand name etc. What people generally say is that the P/E should reflect the percentage growth in earnings of a company. That means if BHEL gets a P/E of 26, it should grow at 26% (net profits) - now the most recent quarter has shown much more than that - 45%+ so the company is still undervalued by that measure. Forward growth looks robust, with an order book of more than 30,000 cr. and going forward, I would expect that even if the P/E is lowered (because of a correction), BHEL's earnings growth itself would cover it and the stock price will sustain itself.

There's one more thing called "diluted EPS". When a company issues stock options, or raises capital using convertible debentures, the number of shares issued will increase when the stock options are exercised or when the debentures are converted. Eventually this means an increase in the number of shares, that is sure to happen, it just hasn't happened yet. So the company needs to release the "diluted EPS" meaning the total known number of shares that must be used for the EPS calculation. Always use diluted EPS when making any P/E comparisons.

Note here that forward P/E calculations can be based on unknown numbers - every analyst will have his or her own set of numbers. Always take an average of multiple numbers when you analyse estimates.

Posted in Stocks

Benchmark Gold ETF New Fund Offer

17 comments Written on February 9th, 2007 by
Categories: Gold, MutualFunds
Benchmark fund is launching a Gold Exchange Traded Fund (ETF) from Feb 15 to Feb 23, 2007. Read the Offer Document and a set of Frequently Asked Questions - a very informative set provided by the fund house.

If you don't know what ETFs are, click here.

What's a Gold ETF?
You might have heard of Investments in Gold. Buying Gold has traditionally (in India) seen as a "safe" investment, and is known to appreciate regardless of inflation. In fact gold is rated so highly that it is the last possession that a family will sell - in local parlance, if a family is selling gold, it is thought to be in dire straits.

Gold can be bought from your local jeweller, and is given a value depending on the purity of the gold. In fact, banks also offer "pure" certified gold bars and coins for long term storage. Being traded daily on national and international markets, Gold has a transparent value that you can see on most business sites or exchanges.

Physical gold
If you buy gold and keep it in your house, you have a problem. Gold is expensive for its weight. A kilogram of gold - that's as heavy as one litre of milk - costs Rs. 9.5 lakhs today. So if you bought 10 grams, for about Rs.9,500, you will have to now deal with an object around the weight of a five rupee coin but costs a heck of a lot more.

To avoid theft you have to get yourself a locker or a metal safe which costs more money.

Another problem is purity. A jeweller may tell you a bar is 22 carat or 24 carat, but it may not be so. You can take the same gold to 10 jewellers and they will give you different opinions on its purity. And it's worse with jewellery. Jewellery usually moulded because pure gold by nature is too soft. In fact Jewellery is not as valuable as gold bars or coins for that reason.

You may also choose to buy from a bank, which will give you a certificate of purity. Unfortunately while banks will sell you gold, they won't buy it back. And that purity certificate, when given to someone who will buy the gold (like a jeweller), is as good as toilet paper.

Of course, there are also "making charges". Jewellery costs the most for making - and from what I know, the jewellery industry makes its biggest margins here. Even gold bars and coins have making charges.

And finally there is arbitrage. The jewellers or banks charge you a rate that is usually a premium on the market gold rate (or a discount when selling).

The Benchmark Gold ETF serves to solve these problems. Imagine this as saying: I will give Benchmark mutual fund some money, they will buy gold, they will store it safely, they will not have any making charges and the price will be very transparent and at market rates. The mutual fund then issues me units for my money.

Further, as an ETF, you can buy units and keep them in your demat account. That means you can buy or sell online.

Benchmark Gold ETF new fund offer
The ETF starts off with a new fund offer (NFO) - you can invest in the NFO with as less as Rs. 10,000. The ETF will issue units that are equivalent to 1 gram of gold. (for a price of Rs. 950 per gram, each unit will be Rs. 950) The fund management charges are pegged to a maximum of 1% per annum, a very low value.

But should you invest in the NFO? The short answer is no, don't buy the NFO, but buy this fund after it lists on the exchange. Because of two factors.

One, there is an entry load for the NFO - 1.5% for under 50 lakhs. After listing, there is no load.

And two, the NFO expenses can be as high as 6%, and this is an open ended scheme so the funds allocated will be 6% lower (or the expense ratio). This cannot be amortised, so they will hit the NFO investors as an additional load.

That means if you invest in the NFO, you'll get units for about 7.5% less than you pay - for every Rs. 10,000 you put in, you will get units worth only Rs. 92,500. The fund probably recognises that this makes little sense, that's why the NFO period is only nine days - so I expect that issue expenses will not be very high.

I would have recommended this NFO, if it were not for the loads - but I whole heartedly recommend purchase after the fund is listed on the exchange.

Investing in Gold is an alternative to equities, and carries different risks. But investing in gold has had problems that I've listed earlier - now, it's a lot easier and transparent. A friend on an online group mentioned that this is a way he looks to hedge against gold prices rising, so that at a later date, he can purchase physical gold to make jewellery for his family. You may have different reasons to buy or own gold, but if it's for price appreciation you might want to buy this ETF instead.

Note: You must have a demat account to purchase or sell this fund, NFO or otherwise.

Posted in Gold, MutualFunds

Exchange Traded Funds (ETFs)

7 comments Written on February 8th, 2007 by
Categories: ETF, MutualFunds

You are perhaps familiar with mutual funds and the fact that you can purchase and sell units of the mutual fund through any distributor. When you do so, you buy directly from the fund and sell to the fund when you redeem units. You can't buy your units from another person (like me for instance) or sell to me.

This creates a number of issues - firstly that everytime a purchase is made, commissions are paid out, and funds will sometimes charge exit loads to discourage early redemptions, so money needs to be paid on a sale as well. Unfortunately this doesn't make too much sense - if you want to sell and I want to buy, why should we be charged any load? It's just a transfer of ownership! But regular mutual funds don't allow such a transfer.

Also fund NAVs are only released at the end of a day, and you have to enter your purchase or sale order earlier - so you're buying or selling "blind". And finally, there are some funds which are not redeemable when you need them - many closed ended funds don't allow redemptions every day, just a few days a quarter.

Enter the exchange traded fund (ETF)
To solve the problems listed above, mutual funds may choose to list the units of their mutual funds on a stock exchange. So you and I can buy or sell through a stock broker (online or offline) and get units into our demat accounts. ETFs are widespread and follow different philosophies - the most common of them are index funds (which track a particular index) and Benchmark is a fund house that only has ETFs.

How do ETFs work?
What the mutual fund does is that it appoints market participants or market makers to transact on the exchange. Retail individuals like you and me can buy through our brokers - and we can bid or ask for units at market prices. These prices are usually close to the NAV of the fund - if the market price is lower than the NAV, a market participant will buy from the exchange and sell to the fund directly, making the arbitrage difference as profit.

Can you buy directly from the fund?
The fund may dictate that only market participants may buy or sell directly (most closed ended funds are like this) or that you can deal with the fund only above a certain number of units, called the creation unit. The limit is usually quite high - 500,000 units or so, which is out of the reach of small retail investors, but in the realm of commercial market participants.

This means that if you want to deal with the fund directly you have to deal in multiples of the creation unit size.

Also, market participants don't give money to the fund - they buy a "creation unit" from the market and give it to the fund. A Benchmark NiftyBeES ETF participant will thus give a basket of Nifty Stocks (in the numbers specified by Benchmark) in a demat transfer to the Nifty BeES account, and Benchmark will give them that many Nifty Bees ETF Units in exchange.

What about loads and charges?
As you buy directly on an exchange, funds don't charge you loads. You may of course pay brokerage to your broker, and further fees such as service tax, transaction tax etc., but these usually add up to less than 1% (compared with a typical equity fund load of 2.25% - note, no longer applies since 2009). But you must remember that there could be a difference in the NAV and the market price - the exchange price is dictated by supply and demand, which can make it a significant discount (or premium) to the NAV. In fact some ETFs trade at deep discounts to the NAV, because they must be held for a long period by a buyer before the fund will redeem (even for market participants). So the discount works against you when you're selling.

Management fees are directly charged to the fund. These can be really small, because the fund manager expertise usage is low - Nifty BeEs charges as low as 0.5%. Gold ETFs, though, might charge more due to the handling charges of gold itself. Gold ETFs trade at a discount to the underlying Gold value due to these fees.

On the other hand Nifty BeES might trade at a premium to the corresponding Nifty Value because of dividends. (details below)

Which fund do I buy?
You can buy individual stocks on an exchange. But if you wanted to buy an Index, such as the Nifty or the Sensex, you have to buy ALL the stocks of the index, in the corresponding weightage. So you may need to buy 1.6 shares of Reliance, 1.2 or ONGC etc - but obviously this does not work too well for you, since you can't buy fractional shares, and buying at a higher multiple can involve lakhs of rupees! Plus, you have to keep shifting stocks around because the weightages change daily.

A cheaper way is to buy Index futures - these are derivatives that will allow you to purchase or sell the Nifty or the Sensex, but on a future date. Unfortunately, such derivatives are only available for the short term - a maximum of three months. Additionally, index futures have a huge margin - Rs. 40,000 or above - per contract.

ETFs are very good for index purchases. Firstly, they are much cheaper than buying stocks in the index or buying futures. The Nifty BeES by Benchmark fund, for instance, costs about 1/10th the value of the nifty (per unit), which is around Rs. 420 today. The fund management is passive - almost entirely computerised - which means fund management charges are very low (less than 1%). Add that to the fact that your entry load is nil and brokerage charges are very little, you can trade an exchange traded index fund and reap benefits of overall market growth.

There are ETFs for the Nifty, the Sensex, Nifty's bank index and a few other indices.

Remember though, that not all ETFs are available on all exchanges. The Nifty BeES for instance is traded only on the NSE, and the Sensex based ETFs are traded entirely on the BSE.

Dividends
Funds declare dividends as usual, and this adds to your return. Because the NAV is close to the index value, funds have to buy and sell and this can generate substantial profits, which may be distributed as dividend. In Index based ETFs, this is truly a case where dividends may reduce NAV but very soon the NAV goes back to a value close to the Index peg.

For instance, Nifty BeES declared a Rs. 8 dividend recently - that should have created a difference of Rs. 8 between the index value (Nifty divided by 10) and the fund NAV. But obviously market arbitrageurs would use the difference for profit, so the price on the exchange remained the same. That means you got Rs. 8 per unit and the price remained stable, which is a Rs. 8 profit in your pocket.

What are the current ETFs for Indices?
Nifty BeES (NSE Nifty), Prudential SPiCE (Sensex) are a few - you can find a number of them at the Benchmark site.


More reading
Benchmark ETF FAQs
Rediff article on ETFs

Posted in ETF, MutualFunds

Is the Nifty Overvalued?

6 comments Written on February 7th, 2007 by
Categories: Commentary
The Nifty trades near its all time high, at 4214 today. Is this too high? We have come up more than 60% from the June 14, 06 low of 2632. Everyone seems to be skeptical and is waiting on the sidelines, but is this market really overheated?

On May 10, 2006 the markets were at their last highs - on May 11, the markets crashed and fell nearly 30% from there. So what was the Nifty doing at that time? On May 10, the Nifty closed at 3754, at a P/E of 21.28, which translates to an EPS of Rs. 176. Today, the Nifty's at 4214 with a P/E of 20.18 - that means an EPS of 209.

That means, since the last peak of the Nifty, the markets have moved up 12.25%. And earnings have moved up 18.37%! Is it really irrational? If this continues for three more quarters, the effective P/E at todays rate is 17.5 - which is quite reasonable for an annualised earnings growth of 24% in the top companies.

Interestingly, this is after moving out low P/E companies like Tata Tea and SCI and replacing them with High P/E companies like Suzlon and Reliance Communications. Usually, such a move would have resulted in a spike in the Nifty P/E, but earnings growth has left it steady - that means the real earnings growth has been even more stronger than the 18% noted.

I expect the budget to boost earnings, but pare down speculative growth. That will probably not affect the Nifty very much, and almost definitely will push earnings growth to stay at current levels. That leaves room for growth from here - the market is at a high, but it's definitely not overvalued.

(Read the Nifty details)

Posted in Commentary

Mindtree IPO Analysis

41 comments Written on February 6th, 2007 by
Categories: IPO
Mindtree Consulting is offering shares in an IPO between 9th and 14th Feb 2007. The offer is for around 56 lakh shares, of which about 6.6 lakh shares are reserved for employees and customers.

Price : Rs. 365 to Rs. 425 per share
Issue size: 204 cr. to 238 cr.
Pre Issue Shares: 3.17 cr. shares
Post issue public equity: 15% (total: 3.73 cr. shares)
FY 07 EPS : (Pre issue) Rs. 27.55 annualised.
P/E: 13.25 (lower band) and 15.43 (upper band)

The company
Mindtree provides software services - R&D and IT services. While the company provides standard IT services such as software development, consulting, data warehousing etc. it also has a research arm that produces proprietary technology in the wireless space.

The company was started in 1999 by Ashok Soota, previously CEO of Wipro Technologies. Another famous MindTree "mind" is Subroto Bagchi, their COO. Capital was initally provided by Walden Investments and by Amalgamated Investments, a V.G.Siddhartha company. (Siddhartha owns Coffee Day, and has seed funded a large number of tech ventures like Kshema Technologies)

Further funding has been obtained from Global Technology Ventures (another Siddhartha company), Capital International and Franklin investments, and a customer, AIG, has also chipped in. In the last two years, the company acquired three different companies for a total of 33 cr.

What are the funds for?
Mindtree intends to build a big development center in Chennai, for which they'll spend about 12 cr. This will be in an SEZ, which ensures that they don't pay income tax for the near future.

18.7 crores will be used to immediately pre-pay a loan from HSBC.

That adds up to about 30 crores. The rest of the issue is for "general corporate purposes" and issue related expenses. Let's say the issue expenses are about 12cr (6%) - so nearly 188 cr. at the higher band is now unallocated!

Mindtree has acquired an IC design company for cash on Jan 10, 2007. No further details are available, but I assume that IPO proceeds will be used for the acquisition and perhaps for further expansion.

Valuation
I am happy that this company has provided financial data upto December 31, 2006. Mindtree grew at about 46% annually over the last four years (revenue wise) and profit has grown from from 17 cr. in FY05 to a forward looking 87 cr in FY07. (annualised growth of 121% ).

Revenue and Profits for 9M FY07 are 407 cr and 65 cr respectively, which is a pre-issue EPS of Rs. 20.66.

Annualised EPS for FYO7 is Rs. 27.55. The corresponding upper band P/E ratio is 15.43.

(Note: this does not account for about 24 lakh shares as outstanding ESOPs, but they won't affect the valuation by much - about 8%)

Most competing companies have a much higher P/E - most of the top companies like Infosys, Wipro and TCS command over 30 P/E and most second rung companies (like Tech mahindra, Visualsoft, Patni) get 25+. The only comparable company is NIIT Technologies which gets a P/E of 16, still higher.

I feel the company is extremely cheap at this IPO price.

Other interesting points
Mindtree has always wanted to contribute to society and has provided 6500 shares to the Spastics society, so that they will reap benefits as the company grows. This, and their other social responsibility initiatives are highlighted on the company web page and shows their commitment to social growth.

Low top management compensation: Ashok Soota has a CTC of only 60 lakhs, and Subroto Bagchi of Rs. 30 lakhs. This is much lower than what other companies pay their middle management! This is good for shareholders of course, but I wouldn't mind a 300% increase in top management compensation, based on performance.

The company has about 40 cr. in cash investments which is about Rs. 10 per share (post issue).

Problems
In general, I feel that there are some issues with the tech story going forward. The dollar looks to be under some pressure with India's market rating improving, and if more dollars come in (as investment) the rupee will gain and the dollar will lose. A slide in the dollar will affect exporters - and therefore the margins of most tech companies.

Compensation overheating: With salaries growing at over 20% in real terms, there is immense pressure on margins. Additionally, there is high attrition - nearly 20% - which affects profitability in terms of hiring and retraining costs. The market itself is overheated, and there is a severe lack of high quality middle management. Mindtree, though, has been rated among the best companies to work with (in India), and that cultural advantage will benefit it very much in these mercenary times.

Lack of H1-B visas: With so many tech companies in the fray, the limited number of H1-B visas to the U.S. (which are work permits) is slated to be used up in a very short period, some say by April 15. Lack of work permits means lower onsite presence, which reduces the growth potential by a little bit - onsite presence is required even for projects which are mostly done in India, because contracts are usually fashioned with a mix of onsite and offsite personnel.

Debt: Even though some debt will be retired through the issue, there is still some debt left over from HSBC and OBC. This is all less than 10%, but excess cash from the IPO should have been used to remove such debt - to leave the door open for further leveraged acquisitions later.

Overall recommendation
At the valuation given, this is a blind buy. "Aankh band kar ke le lo" types.

But I think this IPO will be severely oversubscribed so there is simply be no point in holding up your money in it - I would recommend buying after it lists (around March 9 or so). Yes, you will end up paying substantially more than the IPO price. But the Firstsource IPO was oversubscribed 50 times, and I expect as much for this IPO. Frankly, I don't think you will get many shares for your money. So why lock the money?

Buy at any price upto Rs. 800. Remember that they have announced an acquisition but more details are forthcoming - and that acquisition in a new space (IC Design) will surely prop up the share price later, when they provide the details.

Posted in IPO

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