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Friday, May 30, 2008

Retirement Planning: How to retire healthy, wealthy & wise

It sounds a little odd. Thirty-year-old person is yet to get a receding hairline, but is already talking of retiring. Just five years ago, he did his post graduation from a reputed B-school in India, and is already a vice-president in a large entertainment company.

He has had a successful career till date, earning a seven-digit salary. Now, he is planning to throttle his career life even more for he doesn’t see himself working after the age of 50. For that’s the time he is planning to pursue his life-time passion of wildlife photography.

This person is not the only one who aspires to retire early. But could that be a reality for this person and many other people? While the idea of a retired life could be a permanent good bye to all the work-related stress, the fear is of outliving your savings. Financial planners, therefore, advices a proper retirement plan to target a kitty that could earn enough income to sustain one’s lifestyle.

Take the case of this person who is planning to retire at the age of 50. And the life expectancy say is 70 years. Which means he needs income for 20 more years after retiring. Our analysis shows that anywhere from Rs 1-4 crore is needed to be build as a retirement kitty to earn an income of Rs 5-10 lakhs post-retirement for individuals aged between 25 and 40. And these income levels have been adjusted for inflation. And to earn that kitty, monthly investments of Rs 6,000 upwards is needed.

So, for a 25-year-old, who has 25 years more to invest and build a kitty of Rs 1.9 crore to sustain income for 20 years, monthly investments required would be Rs 6,613 for 25 years. This is to target a kitty of an annual income of Rs 5 lakhs. For this person, to earn Rs 10 lakhs annually, he would need to invest Rs 21,526 on a monthly basis for 20 years. The expected investment return on portfolio has been assumed to be different (in the range of 8-15% pa) due to a varied investment horizon. As a thumb rule, as the age increases, expected investment return has been reduced.

Early beginner advantage

When you turn 25, you have least financial responsibilities. The chances are that you are staying with your parents. That saves you from paying rent. Also, it is likely that either or both your parents are still working. So they are not dependent on your income. That leaves you with huge surplus income to invest.

Once you near the age of 30, you may think of buying a house. That brings the EMI component to your monthly outgo. Then, as your responsibility increases — like a family, car, children’s education and their upbringing, there is limited scope for you to save, say financial planners.

An investor shows a higher risk appetite when he is young and kicking. The fact that an investor doesn’t have too much of financial responsibilities on his/her shoulder, influences him to look at riskier investments. The fear of losing the capital is often muted by the possible higher gains he/she may make in future. But this risk-prone behavior subsides with increasing age and responsibilities.

Facts and figures you must know

The decision to retire early has to be viewed from two sides. One is the willingness to retire and another is the ability to retire. When you start saving early, you see large chunks of money, hence, savings — which make you believe that you can afford to retire early. But when you pass through the age band of 24 to 45 years, you can’t foresee many contingencies.

If you have contingencies coming your way, it necessitates building some buffers into your financial plan to retire at 45. Today, life expectancy has gone up because of medical advancements. Medical costs too have gone up. Inflation is on the rise. So if you plan to retire at 45, you have to build a huge corpus to retire rich.

Now, this corpus depends on what you want to do after the retirement. It should be Rs 2-4 crore or upwards to have a basic living, especially if you decide to stay in a metro city. How inflation impacts your finances

To put it simply, say you want to earn an annual income of Rs 5,00,000 after 25 years. In that case, you should actually be earning an income of Rs 17,00,000 after 25 years. This is after adjusted for inflation of 5% annual inflation. One of the main reason why a youngster should target a larger kitty than otherwise.

Live more for future than present

If you plan an early retirement, then you are left with no option but to live for the future than live in the present. You need to make significant trade-offs in existing lifestyle to ensure a good retired plan. At the current life expectancy level, if you plan to retire at 45, your working life may work out to 20 years and life after retirement is likely to span over 30 years.

Another aspect you cannot ignore is that most important milestones in your life, including children’s education and their marriage will hit you when you are at mid 50. That implies you have to save even more as the Rs 2 crore to Rs 4-crore corpus is just enough to meet your monthly expenses. But the most important component of your investment portfolio is the healthcare-cover. This is especially relevant for today’s generation who want to retire early on account of mounting healthcare costs.

Life expectancy has also gone up significantly, which means that you may frequent the hospitals/medical centers in case of any health complaints. You can save on this cost with a comprehensive health cover.

In this story, one should note that the monthly investment requirement is just an indicative figure and, in fact, it comes down to the extent one has already invested. The idea is to target a kitty post retirement and work diligently towards getting it.

Tuesday, May 27, 2008

Stock Market - Sensex hasn’t got its valuation it deserves

Take A Leaf Out Of Historical Happenings, There Are Returns To Be Made

THE long-term trend is pointing towards under valuation of the Indian equity market. The market, as measured by Price-to-earning ratio (PE) of the Sensex has just about pierced the long-term trend line. At the current valuation, it is quoting at a one-year forward of 16, little less than the earnings growth rate that Sensex companies have managed since 1991. If the theory of market returns chasing earnings growth is to be believed, this is just about time for accumulation for those looking at the longer haul. Since 1991, while the Sensex has grown at CAGR of 15.5%, its earnings grew at a rapid 16.6% per annum.

In the past two years, the market went up partially on the back of ‘PE expansion’. It meant PE of the Sensex was getting priced higher than usual, since the market expected faster growth in earnings. But with the current correction, while valuations have been ‘cleansed’ of such expectations, there are probably returns to be made if investors were to take a leaf out of historical happenings.

After all, Indian economy has been growing at a brisk pace ever since liberalization. And during that period, the rate of earnings growth of the Sensex has grown higher than the nominal GDP growth rate (current prices) of the economy. While Sensex earnings averaged 15.5%, it was 13% for the economy. While the January IIP growth figures (5.4%) weren’t encouraging, even matching the long term averages could mean getting 16% returns from the Sensex.

Arguably, there have been four equity market cycles that India has witnessed ever since economic liberalization. It witnessed a peak in 1992, followed by one in 1996, 2000 and then the 20,000 plus levels that it witnessed recently. And if one were to analyze the Sensex earnings and its returns since the past peak of April 2000, it seems the Sensex has not got its valuation it deserves. Since April 2000, the Sensex has multiplied 2.7 times while its earnings multiplied 3.6 times. While the market obviously gazes into the immediate future to give current valuations, it is a million dollar question whether it is missing the big picture.

Friday, May 23, 2008

Mutual Funds - Invest & Hold for Long Term

“When the going gets tough, the tough get going”

That really sums up what it takes for a retail investor to survive in these volatile times – nerves of steel and lots of courage.

If you have poured in a substantial amount of your savings in equity shares or equity mutual funds, and are crumbling under the pressure of the falling markets, all’s not lost.

It’s unanimous: Stay put for the long term

Equities are for the long term. Anyone who has been investing for the long-term should not be affected by the market fluctuations. By long-term I mean 7-9 years.

People should continue holding their investments. The current fall has been too sharp and it will take some time for the market to recover. The pain will be longer this time but the market will recover.

Remember that a loss is not a loss till you sell. So don’t panic simply looking at the notional loss. Hold on to your investments and watch them turn to profits in the long run.

Why long term pays

A little bit of number crunching supports the long-term argument. Had you invested in the BSE Sensex for any one-year period between 1979 and 2005, in 10 out of those 26 years, you would have lost money (see table). But had you stayed invested for more than 10 years, your chances of loss would be almost zero. And that too, you would have made an average return of 17-18% per annum.

Over 1979 to 2005 1 year 3-year 5-year 7-year 10-year 15-year 20-year Probability of loss 10/26 5/24 3/22 3/20 1/17 0/12 0/7
Avg. Return 27% 18% 17% 17% 18% 19% 17%

And for those who thought equity was a place to make the quick buck, its time to revisit this belief. If your goals are any shorter than 5-7 years, then you should have a re-look at your investment avenue. Debt is the better bet for short-term investments when you are looking at steady returns.

First time investors: It’s a good time to begin

If you have been a spectator so far and want to start investing in equities, this is a good time. But that advice comes with its share of caution, Those who haven’t tested the waters as yet should beware of playing the market on a short-term basis, and focus more on long-term investments,

When the market was at 21000, it was more risky to invest but with the crash, the market has certainly become less risky. First timers could invest in index funds. Veterans can experiment with mid cap and large cap stocks.

Some smart moves you can make

If you really want to make your equity investments work for you, follow these simple tips:

i. Your equity investments should give you sound sleep. If it’s giving you sleepless nights then its time for you to have a look at it. Enter the market and remain invested only if you have long-term horizon.

ii. Equity is the only market where people tend to invest when the prices are high, but that is not a healthy policy to follow. With mutual funds, invest in installments, and stick to your plan. With stocks, do your research before you invest. Don’t invest on the basis of tips and recommendations.

iii. Be careful not to invest all the money on day one itself. Ideally, break your investments into smaller parts of say 10 to 15 per cent and complete your deployment over a period of time.

Tuesday, May 20, 2008

Income Tax: I - T Notice? Don’t panic

Under Tax Scrutiny Proceedings, Notice Has To Be Issued Within A Certain Period; It Cannot Be Issued To The Tax Payer After Expiry Of Twelve Months From The End Of The Month In Which Return Of Income Was Filed

THE income tax authorities for various reasons may issue a tax enquiry notice. Sometimes you may also receive a notice despite filing your returns.

Issue of notice where a tax return has not been filed: Salaried employees are required to have their returns filed by July 31, each year for the income earned by them during the previous financial year. To illustrate: For the financial year April 1, 2006 up to March 31, 2007, the tax return was due by July 31, 2007. In case no return of income has been filed but the tax officer feels that a return should have been filed, he or she may issue a notice under Section 142(1) of the Income Tax Act requiring such person to file a return of income within the specified time.

Tax notice where a tax return has been filed: It is possible to get a notice from the tax officer, even if you have duly filed your tax return, in the following situations:

A tax enquiry notice is most commonly issued for audit of income and expense details disclosed in the return of income, commonly referred to as “Tax Scrutiny Proceedings”. Under tax scrutiny proceedings, a notice is issued under Section 143(2) of the act if the tax officer believes that less income has been disclosed or excessive claims have been made of losses, exemptions, deductions, allowance or relief in the return.

The tax payer is normally requested to answer certain questions, file documents as evidence and provide additional information. However, such a notice has to be issued within a certain period; it cannot be issued to the tax payer after the expiry of twelve months from the end of the month in which the return of income was filed.

There is also a provision under the act, which empowers a tax officer to initiate audit proceedings by issuing a notice under section 148 for the past six assessment years for which scrutiny proceedings may or may not have been conducted, subject to satisfaction of certain conditions. These proceedings are commonly referred to as “Reassessment Proceedings” and are initiated where the tax officer has reasons to believe income which should have been taxed has escaped audit i.e. no taxes have been paid on such income by the tax payer. For instance: As on November 1, 2007, reassessment proceedings can be initiated for assessment year 2001-02 (financial year April 1, 2000 to March 31, 2001), and onwards.

In cases, where a taxpayer has filed his return, and a tax officer requires certain additional information, a notice may be issued under section 142(1) of the Act. A tax notice may also be issued where a return is found to be defective. In such a case, the tax payer is issued a notice under section 139(9) of the act requiring the taxpayer to rectify the defect within 15 days from the date of notice or such extended period which the authorities may permit.

To illustrate: if you have missed filling in all the details in the required columns in your tax return, the return would be treated as defective and you would have to rectify the error. Even a third party can be served a notice to collect information about you. For example, the tax officer can issue notice to a bank asking for the account details of a person who has an account with the said bank. How to respond to a tax notice? In relatively simple issues, you may attempt to handle the situation on your own but in complex cases, please go to your tax advisor. Here are some action points:

Verify the validity of notice as regards whether the same has been issued within the time limit prescribed for issue of such notice and whether appropriate procedures have been followed while issuing the notice. Typically, the act provides for a limitation period for issuance of all kinds of notices.

Go through your past returns, assessments orders, financial statements before responding to the tax officer. Be aware of the deadline for responding to a notice or attending a tax hearing, as any non-compliance may be viewed as non cooperation and may adversely influence the outcome of the enquiry proceedings. Unless the notice or summon requires personal appearance of a person, the details/ information may be furnished via post or through an authorized representative.

Friday, May 16, 2008

Why are the markets down?

It is better to plan for the long term and buy potential stocks at every fall

There have been major corrections in the stock markets all over the world. All major markets have corrected significantly from their peak levels. Major indices in the domestic market - Sensex and Nifty - also saw large corrections over the last couple of months and are currently trading below their 200-day moving averages. The Sensex is at around 16,000 and the Nifty is at around 4,800 levels - more than 20 percent lower than their peak levels. The mid-cap and small-cap stocks are the worst hit in this market correction and this is reflected in the performance of mid-cap and small-cap indices.

There are a series of events/factors that resulted in this global meltdown of stock markets. Here are some of the more significant factors that had a negative impact on the domestic markets.

US sub-prime issue
The meltdown in the markets world over triggered by the US sub-prime news is one. The meltdown worsened thanks to the weak economic data followed by views and predictions of a slowdown in the US economy. The US dollar is depreciating against all major world currencies. This has forced the foreign investors to sell their equity investments in the emerging markets (many foreign funds have borrowed money from markets where interest rates are very low to invest in emerging markets).

Rising inflation and high oil prices
The rising crude oil prices forced the government to raise the prices of fuel in the domestic market. However, the rise in petrol and diesel prices is miniscule in comparison to rising crude oil prices at the global level. Crude is trading around USD 107 per barrel. This rise in domestic fuel prices coupled with higher prices of basic commodities has pushed the inflation rate to above five percent. The rising inflation rate could be another cause of concern for investors as it will require some tough actions from the Reserve Bank of India (RBI) and the government.

Budget Impact
Shares of banking counters led the market fall after the budget announcement this year. The Finance Minister announced a Rs 60,000 crore agriculture loan write-off in this year's budget proposal which impacted the sentiments of investors negatively.

Corporate News
There has been negative news from some large corporate. These announcements from large corporate impacted the market sentiments adversely. The market is full of pessimistic news and views. Its fall over the last couple of months has impacted the sentiments of investors negatively. Foreign institutional investors (FII) are net sellers in the year 2008 and poor buying support from domestic mutual funds has led to a free fall in the markets at many trading sessions.

Market Outlook
Many analysts and expert believe that the domestic economy is not strongly correlated with a US recession and sub-prime issues there. But still, the markets cannot be completely insulated from global factors. Looking at the current situation, the sentiments in the markets look a bit weak. Market rallies are short and most of them end in intra-day or in couple of days. There are sellers at every level in the market. Chances of any quick/fast rally look quite difficult (like what was seen last year). The market should at best remain range bound in the short to medium terms - a few weeks to a couple of months.

It is advisable for short term and risk-averse traders to stay away from the market. Long-term investors (with an investment horizon of one to three years) can look for value buying in the market, especially in index/large-cap stocks that are available at quite lower rates from their peak levels. Long-term investors should accumulate identified stocks in small quantities at every market correction and slowly try to build their equity portfolio.

Market sentiments on low ebb

News of slowdown in growth rate affects market sentiments negatively

The stock markets were in a state of panic last week. The markets were threatening to hit new lows here. The sentiments across global markets were extremely weak and bearish. The mood was gloomy with investors were questioning whether it made sense to hold on to stocks even for the long term. A recession in the US and probable decline in the domestic GDP growth were the main contributors to the gloomy scenario.

The US Fed and index of industrial production (IIP) numbers occupied centre stage during the week. The Fed, in a move to increase liquidity in the markets, had announced a new Term Securities Lending Facility. Under this facility, it will lend up to $ 200 billion of treasury securities to primary dealers for a 28-day term. The Federal Reserve said it would lend treasuries in exchange for mortgage backed securities and other debt that all but collapsed in the sub-prime mortgage crisis. Basically it was exchanging high quality government instruments for near junk securities. So all the instruments whose value has been eroded are taken away by the Fed and would be replaced by highly regarded US treasuries.

This was an innovative way to bring relief to the credit markets as cutting interest rates would only fuel inflation further. This amount was to replace losses suffered by financial institutions. Global financial institutions have written down almost $200 billion due to the credit crisis. Further, big US investment banks are expected to report more losses when they issue first quarter results. The stock markets rallied in reaction to this news but the optimism did not last long. The Fed's action obviously is welcome but investors did not see it as a long-term solution.

Apart from global worries, the domestic stock markets had to confront another set of bad news with the release of the economic data. The numbers indicate a decline in all important production estimates. The industrial growth was at 5.3 percent this January as compared to 11.6 percent last year. Manufacturing industries grew at 5.9 percent as compared to 12.35 percent last year. Manufacturing industries accounts for 80 percent of IIP. This shows that the domestic economy is indeed slowing down.

So far, the theory was, as the domestic GDP growth was high, the stock markets would recover quickly. But, with the slowing down of growth, the very platform on which the story is built - high GDP growth - becomes shaky. Hence, the market has not only the global problems to worry about, but also a slowing economy and lower earnings here. Now, there are new worries about leading banks' exposure to sub-prime. And many large corporate are expected to show losses in their derivatives exposures.

All the negative news has affected sentiments very badly. The market mood has moved since January 2008 from optimism to pessimism, and then to despair. It will be a long time before investors, hurt by these falling markets, gather courage to start investing in stock markets again.

Tuesday, May 13, 2008

Financial Planning: Track expenses to build wealth

Most people merely earn and spend. But if you want your money to stretch far, learn to make a budget

Mid year is the time when people take stock of broken resolutions. Not just those they made on New Year’s Eve but also the promise they made to their financial planner about preparing a household budget.

As the finance minister takes the stage in Parliament to present the Union Budget, the financial consultant casts a sidelong glance at his client, prompting an apology and a fresh promise. The exercise is repeated the following year.

The economic situation in India has come a long way from the time when the man of the house would hand his wife a fixed sum of money every month which she would spend, and save, in a diligent manner. Unlike before, both partners are earning and spending, not just by cash but cheque and credit card as well. So there are multiple points of inflow and outflow of money in a family. This makes it difficult to keep track of expenses.

Where did all the money go?

Planners advise their clients to take the first step by simply writing down their daily expenses in a small notebook. But a combination of factors has led people to abandon the concept of a household budget.

The family income is augmented now that both partners are working and salaries have increased. Young couples who do not have children are seldom motivated to keep track of their expenses. They own a house and car and have nothing to save for. Moreover, after a long working day all they want to do is spend time with each other rather than list the day’s expenses.

But the right way to keep money is to know where it is going. Those who keep track get valuable insight about their wasteful expenditure patterns. A couple whose goal to buy a house was thwarted because they did not have the courage to go in for a home loan. It was only when they began to tabulate their daily expenses that they realized they were spending almost Rs 15,000 on eating out and entertaining each month. Once they saw the pattern, they were motivated to lessen their indulgence and the EMI on a loan became an attainable goal.

On track with saving and spending

Most people merely earn and spend. Some do note down their expenses. But few are aware of the thumb rules of h o u s e h o l d budgeting.

Writing a budget, for instance, involves putting aside a contingency fund that covers three months’ household expenses. Not more than 40% of your income should go toward paying off loans, and only 25% towards home loans. Ideally, 10% is to be invested, although Indians score better in this respect by often investing up to 25%.

The process of inculcating a budgeting habit is slow. In the first quarter, experts advise clients to make a note of one-time purchases, like clothes, for instance. Weekend purchases are added in the second quarter, and then expenses that are incurred 12-15 times a year are added to the list. In the second year, categories like groceries, school fees and bills are assigned. Mashruwala begins the actual task of budgeting only in the third year when the process of noting down expenses has been streamlined.

Writing a budget is not about curtailing expenses or saving more. It is about being aware of your spending pattern. Each of us has a rough idea of the amount we spend on groceries, electricity and telephone bills, cable TV, shopping and entertainment, and yet there are broad patterns that escape our attention.

A young couple who began to write their accounts found they were spending Rs 18,000 annually on telephone bills. They changed their cell phone handsets every year, spending about Rs 12,000 in the bargain. Internet surfing cost an extra Rs 7,000. As a result, the total annual expenditure on communication was about Rs 30,000, and hardly any of it was related to work. They used a credit card on their weekend outings, spending about Rs 2,000-3,000 each time on malls, movies and dinner. The amount shocked them.

Positive cash flow, but no profit

Yet, the purpose of writing a budget is not to curtail expenditure. Go ahead and spend all you want, but be aware. Once you budget, individuals will discover that they may be making lots of money but are merely spending it instead of generating wealth in the long term. Companies will find their cash flow is positive but the profits are not coming in.

Like the finance minister in his Union Budget must manage the inflow of money in terms of direct and indirect taxes, interest and borrowing and channelizes it towards various heads of outflow like defense, agriculture and education, the household budget must strike a balance between income and expenditure because imbalance could result in deficit or loss.

For this reason, experts advise parents to inculcate the habit of budgeting in little children when they give them money for pocket expenses. A child who merely learns to spend will instead learn to manage money.

Keeping tab can throw up some pleasant surprises at times. A media professional from Delhi who moved to Mumbai kept note of her regular expenses for a few months without curbing her lifestyle in any manner. To my surprise, I found that I could not only live comfortably, but also indulge myself occasionally,” she says. “I can now enjoy guilt-free spending because I know I have budgeted for it.


Begin by making a note of one-time purchases, like clothes or a new cell phone handset. Do so for three months Add weekend expenses in the second quarter, which includes trips to the movies and eating out.

At the end of the first year add the expenses that are incurred 12-15 times a year like telephone bills or cable TV charges.

In the second year, enter categories like groceries, school fees and bills into your notebook and list expenses under each head diligently

Once you are accustomed to making notes of all purchases, begin to see whether you need to cut down on wasteful expenditure. You may be pleasantly surprised to find you are managing well within your means and can enjoy the occasional guilt-free indulgence

Friday, May 9, 2008

Tax Returns: Myths and facts of filing your Tax Returns

THE fiscal year has ended and many choose to make tax-filling.
Despite this being a regular, annual ritual, several tax payers have some misconceptions, some of which are listed below:

Misconception No. 1
Filing tax returns is a complex and cumbersome process. I need a Chartered Accountant to help me file my tax returns.

Contrary to popular belief, preparing and filing tax returns is actually quite simple. If you have a digital signature you can accomplish the entire process sitting at home on your computer thanks to the e-filing facility on Alternatively, you can submit the returns online, print a one-page receipt, sign it and drop it off at the income tax office within fifteen days of submitting the returns. No documents are required to be submitted with the receipt. However, if you want help, there are several third party service providers who offer tax preparation and filing services for a fee as low as Rs 200.

Misconception No. 2
The interest I pay on a home loan is deductible from my income from house property up to a maximum of Rs 1, 50, 000 per year.

This is true if you have taken a home loan for a single house and it is self-occupied. However, if you take a home loan on a second house, the entire interest paid on the loan can be claimed as a deduction from your income on house property. If you expect that the property would appreciate in value over time, you could take advantage of the above rule. Thus a smart investment strategy would be to take a home loan on a second house, rent out the house and claim interest paid on the loan as a deduction from rental income, thus reducing your borrowing costs significantly.

Misconception No. 3
I receive tax exemption on the actual rent I pay for my rented home.

This is not entirely accurate. Section 13 A of the Income Tax Act states that the maximum amount that is exempt from tax is the lower of the following amounts:

(i) the House Rent Allowance given by the employer,
(ii) 50% of your basic salary if you live in a metro, (iii) or, actual rent paid minus 10% of your basic salary.

If actual rent paid is lower than 10% of your basic salary, you receive no exemption. Also, you cannot claim any exemption under this section if you live in your own house or if you are not paying any rent.

Misconception No. 4
Section 80C benefits are available only on making an investment or saving or paying a premium on insurance.

You can claim a deduction for the school or university tuition fees you pay for your children (maximum of two) provided they are enrolled in a full-time course at any institute in India. In addition you can claim a deduction for the repayment of principal on any home loan that you may have taken. Both these deductions have to, of course, be within the overall annual Section 80C cap of Rs1 lakh.

Misconception No. 5
If I avail of tax-free medical reimbursement from my employer up to Rs15, 000, I cannot claim deduction on health insurance premium paid.

Tax-free medical reimbursement by your employer up to an amount of Rs 15,000 per year for your family’s medical expenditure is separate from the Rs 15,000 deduction available under Section 80D for the premium paid on health insurance.

Both these exemptions are covered under different sections of the Income Tax Act. The former covers cost of your daily medical needs and outpatient treatment (OPD), while the latter protects you from expenditure for hospitalization.

Tuesday, May 6, 2008

Equity: The Facts & Figures of Bonus Issues

THE Reliance Power bonus issue is finally out and ex-bonus date is also out, its 28 May. The company declared a 3:5 ratio giving three extra shares for every five shares held by a shareholder. These shares were issued to only non-promoter shareholders. The record date for the issue is still to be declared by the stock exchange.

What is a bonus issue?

Any company, which has excess reserves that it may have build by retaining part of its profit over the years, may decide to convert some amount into its share capital by issuing bonus shares. This doesn’t change the market value of the company. It is one of the ways, in which reserves of the company get capitalized. In case of Reliance Power, the company is converting its share premium reserves into bonus.

What is bonus ratio?

New shares are issued in the proportion of their holdings. If the bonus ratio is 1:2, for every two shares held by the shareholder, he will get one extra share. This means, if someone was holding 100 shares of a company, he will get 50 free shares making total holding of shares in that company to 150 instead of 100.

Rajesh Exports was another company to issue bonus. The ratio declared by the company was 2:1, which means every shareholder got two extra shares for each share held.

Why a bonus issue?

It is one of the ways for companies to capitalize their excess reserves and reward its shareholders. Rajesh Exports has reserves in excess of Rs 500 crore and so the company decided to pass on the benefit to the shareholders in the form of bonus issue, Also, a bonus issue is seen as a sign of a company’s good health.

How do shareholders benefit?

The shareholders get the bonus shares for free, thus bringing down the cost of owning the shares and the company’s profit too remain intact. It’s a win-win situation for both the issuing company and shareholders. While the company doesn’t need to generate free cash and issues the bonus shares from its accumulated reserves, the shareholders get free shares

How does the company benefit?

Corporate actions like dividend payouts and bonus issues are ways of rewarding shareholders. While dividends are paid from profit after tax (PAT), bonus shares are issued from excess reserves the company may have. This means in case of the latter, the company is able to reward the shareholders without touching its profits. Also, from the company’s point of view, it is more of an accounting entry that moves money from one accounting head to another. Except for the sentiment among shareholders, there is no change in the company’s valuations after the bonus issue.

Record date & ex-bonus

Record date is the date set by the company for determining the holders entitled to receive bonus shares. For Rajesh Exports, it was February 5, which means that anyone who had shares of the company till this date were entitled for free bonus shares. For Reliance Power, the date is yet to be declared. After record date, shares of the company become ex-bonus.

What about Reliance Power?

Anil Ambani holds 45% stake in Reliance Power and another 45% is held by Reliance Energy. Mr Ambani said he will be transferring his own 2.6% stake in Reliance Power to REL so that REL’s holding in Reliance Power remains intact. The cost of acquisition for retail shareholders came to Rs 269; here’s the math: Suppose you were allotted 17 shares, making the total amount you invested to 430*17 or Rs 7,310. After the 3:5 bonus issue, most likely you will get 10 ‘free’ bonus shares, which means you now have 27 shares still keeping the invested amount at Rs 7,310. Now divide 7,310 by the new total number of shares you own (27) and you will get the answer.

Friday, May 2, 2008

Zurich Axioms

The First Major Axiom:
Worry is not a sickness but a sign of health.
If you are not worried, you are not risking enough.

The Second Major Axiom:
Always take your profit too soon

The Third Major Axiom:
When the ship starts to sink, don't pray.Jump.

The Fourth Major Axiom:
Human behavior cannot be predicted.
Distrust anyone who claims to know the future, however dimly.

The Fifth Major Axiom:
Chaos is not dangerous until it begins to look orderly.

The Sixth Major Axiom:
Avoid putting down roots.
They impede motion.

The Seventh Major Axiom:
A hunch can be trusted if it can be explained.

The Eighth Major Axiom:
It is unlikely that God's plan for the universe includes making you rich.

The Ninth Major Axiom:
Optimism means expecting the best, but confidence means knowing how you will handle the worst.
Never make a move if you are merely optimistic.

The Tenth Major Axiom:
Disregard the majority opinion.
It is probably wrong

The Eleventh Major Axiom:
If it doesn't pay off the first time, forget it.

The Twelfth Major Axiom:
Long-range plans engender the dangerous belief that the future is under control.

It is important never to take your own long-range plans, or other people's, seriously.

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