Finance & Investing

Here are eight financial and three non-financial parameters that you should look into when you invest in a company.

Return on Capital employed: This refers to the amount earned by the company on the total funds employed in business. The capital means both equity capital and loan capital. Equity capital would, of course, include reserves as well. Return would mean profit after tax plus interest on long-term funds, adjusted for tax. This measures the productivity of money and is the closest measure of finding out the underlying economics of the business. Higher the ROCE, better for the investor. At minimum, ROCE should be equal to the Weighted Average Cost of Capital (WACC) of the company. The WACC is the rate of return that equity shareholders and debt holders put together want to earn.

Return on equity: The return on equity measures the total return earned on the shareholders fund invested. It is the ratio of profit after tax to shareholders funds. Over the long term, the value of a company would move in lock step with the return on equity. Higher the ROE, better for the investors. Generally, ROE is higher than ROCE since the cost of debt is generally lower than ROCE, thus resulting in equity holders enjoying a higher share in the total returns pie.

Historical sales growth: This indicates how the company has been able to grow its business over the long term. Compared with the industry growth rate, this would give an indication of whether the company is increasing its market share or not. Also, it would help in finding out whether the business is in the growth or maturity phase and in understanding the seasonality of the business and, interpreting growth of the recent past, accordingly.

Free cash flows to shareholder: Business is not about booking accounting profit; hence cash surplus is more important than accounting surplus. Free cash flow is found out by deducting the upcoming maintenance capital expenditure from the cash from operations.

A business might be earning lots of profits, but if a large portion of it are to be spent in maintaining the fixed assets, then the "real returns" to shareholders will be less. Thus, higher the free cash flows, better for the investor.

Stock Options?
The stock market is a reflection of psychology as well as earnings, dividends and asset value. The BSE Sensex is currently at 15,000 level, implying a price-to-earnings (P/E) ratio of about 18 (with EPS of say Rs 850) and an earnings yield of nearly 6%. So, is this the time to buy, hold or sell stocks?

This is definitely a difficult question to answer as no one can accurately predict the future direction of stock markets. Historically, a P/E ratio of 15 for the stock market is considered fair, implying a BSE Sensex of 12,750.

Although, the economy is currently expected to grow at 8% and the corporate sector is showing strong developments and profits, although it is showing some weakening trends now. Hence, an investor should start gradually investing at/ from BSE Sensex 12,750 to 15,000 level from a long-term perspective.

As for the promising sectors to invest in, retail, diversified financials, real estate, healthcare services, capital goods and telecom can offer good returns over the long-term. In India, over the last 10 years, growth stocks have outperformed value stocks which have generated returns of 15% and 13%, respectively.

Although this is far below the earlier estimates of Rs 4,00,000 crore, the telecom giant's initial public offering (IPO) would still by far be the largest in Indian corporate history with its size pegged between Rs 15,000 crore to Rs 20,000 crore for a dilution of minimum 10 per cent equity shares.

The IPO is most likely to be an offer for sale by the government, which currently owns 100 per cent in the company.

The valuation is based on the assumption that each share will be priced between Rs 300 and Rs 400 at the time of listing as disclosed by telecommunication minister A Raja.

However, Kuldeep Goyal, chairman, BSNL, said the IPO would fetch close to Rs 40,000 crore as the company, that received spectrum for a pan-India roll out of third generation (3G) services on Thursday, may be valued at Rs 4,00,000 crore.

Antiquities would be one such avenue.

Over the past year or so, one has come across the occasional write-up on a spurt in antique collection. The newfound interest among the art fraternity has already begun taking shape with the recent entry of a whole new breed of collectors. The March sale of Indian and Southeast Asian Art in New York said as much. Collectors bid aggressively with the hammer going down at 5 to 10 times the estimated value for several masterpieces.

But, while it is common knowledge that antiquities are undervalued and there is marked disparity in valuations in comparison with contemporary art, not much has been reported on the crucial economic drivers that will fuel the boom, or about the various media, their importance and valuation.

The antiquities market consists of small collectibles (like vessels, lamps, prints and puppets, etc), wooden carvings and textiles, stone sculptures, bronze works and miniature paintings in a more or less ascending order. Most of the pieces acquired range from the 10th to 19th century.

Miniatures constitute the top end, requiring expert knowledge and understanding. Stones and bronzes range from various dynasties. Wood carvings, textiles and pichwais usually range from the 17th to 20th century.

Although not a thumb rule, most antiquities sell in India for barely 1/3rd the international price. Small exceptions to this rule are the Tanjore and Mysore paintings, which sell at a higher price in India than overseas. It is this price differential, coupled with a boom overseas, that is set to drive prices in India. Now, for the three basic economic reasons for the impending boom:

They enjoy free returns for two days, fund their accounts on Monday morning, stay invested for a few more days and then switch to a new scheme to play the game all over again. For mutual funds, it's like offering the net asset value (NAV) of the scheme to the investor without receiving any money. It's akin to a bank paying interest on a non-existent deposit. Fund houses know the game, but are unwilling to spoil their relationship with big investors.

Here is a typical sequence of events:

Friday, 2.30pm: A corporate gives a cheque to invest in a liquid-plus MF scheme. At this point, there's no money in the company's bank account. Saturday: The investor gets Friday's closing NAV.

Sunday: Investor gets Saturday's NAV, which includes the accrued interest. The scheme invests in fixed income securities, which carry a fixed interest coupon. This is also why NAV of such schemes inch up over the weekend.

Monday: The investor funds the bank account so that when the MF presents the cheque, it is honoured.

The MF cannot deposit the cheque before Monday since high-value cheques are not cleared on Saturdays. Tuesday & Wednesday: The company stays invested in the liquid-plus scheme. Thursday, 2.30pm: The investor directs the MF to switch the investment from liquid-plus to a liquid scheme.

A liquid scheme invests only in securities with less than one-year maturity while a liquid-plus has papers of more than one-year as well. Friday: The company gives a redemption order for the liquid scheme units. Almost simultaneously, it gives another cheque for making a fresh investment in a liquid-plus scheme.

Again, there's no money in the company's account. Saturday, Sunday: Enjoys free NAV. Monday: The money from the redemption order gets credited to the company's bank account. The money also helps in honouring the cheque that was given on Friday for investing in the liquid-plus scheme.

So, in the 11-day cycle, the investor enjoys free NAV for four days. The gains may vanish if there is a sudden decision, like an interest rate hike. Otherwise, the corporate investor can rotate the money week after week. What makes all this possible is the different cut-off timing rules.

For instance, in a liquid fund, the investor can get the same day's NAV only if the money is available for utilisation on the same day. But not so for liquid-plus schemes. Here, the investor can give the cheque by 3pm and get the same day's NAV even if the MF cannot readily use the money.

This is a game where other investors may end up subsidising the smarter players while the fund house may end up investing in more high-risk securities to generate that extra return. According to a senior official with a large fund house, since most mutual funds are under pressure from their managements to grow their assets under management (AUM), they have no choice.

"Besides, the rules allow it. As long as an investor in a liquid-plus scheme gives the cheque before 3pm, the fund has to give the same day's NAV. If the investor insists, it becomes difficult for the fund to say no," said the CEO of another asset management company.

Two years ago, Sebi had changed the cut-off timings for acceptance of investment by MFs. The guidelines had helped plug quite a few loopholes. However, even under a stricter regime, clever investors have found a way to get around the rules. "If a corporate finds it will have a treasury surplus on Monday, it can benefit by placing a liquid-plus order on Friday afternoon. This is becoming an accepted practice and some of the big corporates are doing it," said a bond market dealer.

A spate of NFOs -- those of Morgan Stanley, HSBC and Mirae that hit the market after the market meltdown in January -- together managed to mop up only about Rs 250 crore. Funds are now offering protection on the downside for investors.

Birla Sun Life's equity-linked fixed maturity plan (FMP) is positioned as giving returns between an equity fund and an FMP. The fund will invest in debt securities with coupon linked to the Nifty and will offer the enhanced upside of the equity market as well as protection if the equity market goes down.

The other fund -- JP Morgan's Alpha Fund -- will follow a long-short strategy. The fund manager will buy stock or its derivatives if it is likely to go up and balance it with another stock or a derivatives contract likely to go down, depending on the view the fund house has on those stocks. The fund house is touting the fund as an "all-seasons fund". Krishnamurthy Vijayan, chief executive officer, JP Morgan Asset Management Company, says last year if people were offered anything apart from equity, they would not have taken it. But this year, with the markets being in the dumps, investors are willing to look at newer ideas.

Recently, Bahrain's TAIB Bank acquired a 26 per cent stake in Anant Raj Industries. Lightspeed Ventures and Sequoia Capital invested $18 million (Rs 76.3 crore) in Tutorvista.com, followed by JP Morgan, which has picked up a 33 per cent stake in Alok Infrastructure's Special Purpose Vehicle.

"Real estate, as a sector, has corrected a lot and probably we could see some more correction but there is no dearth of demand. Price has now become attractive for some of the good companies in the sector. One will see lots of deals going forward," said the country head of an international PE fund. The Bombay Stock Exchange's Realty Index has crashed more than 60 per cent this year from its peak of 13,848 as on January 8, 2008.

Promoters too, as the PE funds say, are coming to terms with the reality. The lag effect is showing and the PE funds have realised that they cannot make aggressive projections way ahead of fundamentals.

When the markets were in doldrums a few months ago, some of the deals were called off. Indivision Partners scrapped a deal with Dish TV. Similarly, Citi Venture Capital and AIG called off the Rs 1500 crore deal with Akruti City citing market conditions and delay in getting government approvals.

Some of the larger funds such as Citigroup Venture Capital, Sequoia, Baring Partners and Actis, which raised money last year, are now deploying the corpus as the markets have stabilised a bit now. With the US and European markets taking a beating, PE funds have once again increased their expectations with India and China.

C G Srividya, partner, Grant Thornton, said, "We expect much more stability in the second half of 2008. Key focus will be on sectors such as pharma and healthcare, telecom, real estate and energy and power."

That is bad news for stock market investors, given the lag effect of rising interest rates on growth and corporate earnings. Stocks from rate-sensitive sectors such as real estate, banks, automobiles and capital goods, which had posted a tentative recovery in the run-up to the policy, may now face a setback.

For realty companies, the concern is that if rates continue to rise, property buyers will have to deal with rising borrowing costs along with still unaffordable prices. To prop up offtake, developers may have to adopt aggressive pricing, sacrificing profit margins in the process. Developers may also find their fund crunch magnified by the market's increasingly cautious stance on lending to this sector.

For banks, the earnings outlook may depend on the extent to which they are able to pass on recent increases in costs. Increases in lending rates to corporate borrowers may soon follow. But effecting the same for retail borrowers may be tricky; with recent bank results already showing evidence of slower growth and rising delinquencies in the retail segment. Further rate increases may only peg up the credit risk for the bank.

Companies in capital-intensive sectors such as capital goods and infrastructure, already dealing with escalating interest costs for ongoing projects, may face a further squeeze. Needless to say, frontline companies in each of these sectors, with good credit ratings and access to funds, are better placed to weather these challenges than mid and small-sized companies.

But if rising interest rates present a threat to stocks, they do open up a fresh set of options for debt investors. Many banks have recently opened "special deposit" windows for 1-2 years that offer annual interest rates of 10-10.5 per cent. Mutual funds have rolled out fixed maturity plans that "indicate" yields of 10.5-11 per cent a year, a good 2 percentage points higher than six months ago. Liquid mutual funds, in which investors can park temporary surpluses, are now offering healthy (annualised) returns of between 8-9 per cent.

The PE fund, the first from Milestone's stable, will focus on sectors such as education and infrastructure. "Right now, I am bullish on these two sectors as there is lot of scope for companies to expand and reach a mass base," said Ved Prakash Arya, managing director, Milestone Capital Advisors.

Its fourth real estate fund -- Milestone Domestic Fund Part-II -- has raised Rs 430 crore and will close shortly. The fund house is proposing to raise Rs 500 crore from this fund. Despite the rough market weather, the fund house's track record and investment strategy have helped in getting investor commitments, Arya said.

Realty funds have been finding it difficult to raise funds from high networth individuals (HNIs) and institutions owing to a credit crisis in the US, the impact of which has been felt in India as well.

Rising interest rates and curbs on external commercial borrowings have added to the woes of real estate companies as well as funds. A correction in the real estate sector has further soured the mood of investors like PE funds towards this sector. The company currently manages four real estate funds worth Rs 2400 crore.

Red Fort Capital which manages three active funds under its aegis including an offshore and a domestic fund for Indian real estate market, as well as a hedge fund for listed Indian entities - is already in talks with some of its existing investors for floating the new fund, which would invest in infrastructure projects in the country. It may also rope in new investors to the proposed fund.

Growing infrastructure
"The new fund is likely to be over $600 million and will focus on projects such as ports and power, amongst others. In fact, some of our existing investors approached us for a fund in the infrastructure, a sector whose risk profile is very different than the real estate segment. Globally, the returns for infrastructure projects are in teens whereas in India it averages at about 20 per cent," Mr Subhash Bedi, Director and Partner, Red Fort Capital Advisors, told Business Line.

He said that in future, the investments in infrastructure projects could also find synergies with the projects that Red Fort has funded in the real estate sector. "For instance, there could be synergies between port projects and development of warehouses," he pointed out.

On Tuesday, the local joint-venture business of French insurer AXA SA launched its first two mutual funds in the Indian market. Bharti AXA Investment Managers Private Ltd., a joint venture between AXA and Indian telecoms-to-agribusiness conglomerate Bharti Enterprises, received regulatory approval to run mutual funds in April.

On Monday, fund manager Pioneer Global Asset Management SpA established a funds joint venture with Bank of Baroda, an Indian bank, after receiving a go-ahead from regulators. Dario Frigerio, chief executive of Pioneer, described the Indian mutual-funds industry as "one of the most exciting opportunities we see around the world."

Also on Tuesday, Deutsche Bank AG promoted the chief investment officer at its $2.6 billion Indian asset-management business to chief executive. Suresh Soni takes over following the departure of Vijay Mantri, who left to join the recently established joint venture between the U.S. financial services group Prudential Financial and Indian real-estate firm DLF Group as chief executive.

Short-term funds, where many investors were looking to park their funds during this volatile period in the stock markets, have given negative returns in the last one month period.

"I can understand that the returns have fallen because of the rise in the interest rates, but what is hard to believe is the loss in capital," says Kartik Jhaveri, director, Transcend India.

And it is not just Templeton, there are a host of other short-term funds that are giving negative returns. DWS Short Maturity tops the list with -0.66 per cent, followed by IDFC SSI Short-Term at - 0.61 per cent and Lotus India Short-Term Retail at -0.57 per cent.

Negative news is pouring into the market from all the ends and as a result investors' sentiments in market are quite negative at the moment. These are some of the major negative news prevailing in the markets:

Crude oil prices: Crude oil prices are going up without any control and have touched 145 dollar per bbl this week. Analysts are worried about the rate at which crude oil prices are going up in the international markets. Crude oil price has gone up 30 percent in last 1 quarter itself. There are many theories behind this sharp rise.

Some analysts believe that the demand from emerging economies has increased sharply in last few years where as the crude oil production is near its peak. Others believe that the speculation and trading activities is driving the crude oil prices in the international markets as people are switching their funds from other investments to crude oil.

Rising crude oil prices is one of the main sentiments dampener in Indian stock markets. India imports more than 75 percent of its crude oil needs. Since this sharp rise can not be passed quickly to the consumers it is resulting in surge of oil pool deficit for our country.

Heavy FII selling: Foreign fund inflows were one of the major factors driving Indian markets in last 2-3 years have turned negative since the start of this year. Foreign institutional investors (FIIs) are selling big time in Indian markets this year. They have sold over 6 billion dollars stocks in Indian markets this year so far.

But this has not deterred leading equity funds from investing in the sector as they are looking at a period of 4-5 years for getting returns on their investments.

A study on private equity investment in public equity (PIPE) of infrastructure companies in India undertaken by SMC Investment Solutions & Services found that the recent slump in the equity market wiped off Rs 2,428 crore of private equity capital.

Though the domestic infrastructure sector is regarded as the engine of the country's economic growth, experts say higher valuations at the time of investing and readjustment of the Indian financial markets to global economic environment has impacted the calculations of private equity players.