Archive for August, 2010

Exchange Traded Funds – Explained

Riding the indices- Exchange Traded Funds, bigger than super and mutuals?

Exchange Traded Funds (ETFs) are becoming a real threat to the big super and mutual funds. They’re easy to manage yourself, useful for SMSF operators, and their returns are pretty good, given the state of the global markets and the soggy, slow moving cash and bond rates. The most important thing about the ETFs is that they provide direct access to the highly mobile indices that the funds use themselves.

ETFs and indices- Portfolio structures

Another thing investors need to consider when setting up working portfolios which indices to target. Getting the structure right, and creating exposure to indices used to be very hard work indeed, even for professional fund managers. With ETFs, it’s very easy. The ETFs are designed to work on specific indices.

One of the reasons ETFs are so investor- friendly is that they take the arduous decision making out of the stock selections. Buying in to an ETF means buying in to the pick of that index. Indices are much easier to target than trying to buy a range of stocks, all with different returns on investment and those adorable deferred dividends, etc which drive most investors up the wall at some point.

Getting started with ETFs.

That means you can set up your portfolio to cover a range of indices. If you’re new to the ETF market, it’s a good idea to keep things simple. The ETF market includes some quite complex products. You need to learn this market step by step, so your judgment and investment instincts are kept well informed at all times. A typical starter ETF portfolio will include things like blue chips, always useful for getting returns from this often pricey, as well as jumpy, index.

Note: The blue chips are also a good way of seeing how ETF performance, market performance and stock performance interact. These are valuable lessons in themselves, and you’ll also be able to put dollar figures on your choices and your investment options.

Unlike mutuals and super, there’s also direct access to real time market values for ETFs. The simple fact of being able to sell ETFs in the market is a working valuation of your holdings when you need one. That’s particularly useful when you need verifiable asset values in a hurry.

Riding the indices

Using indices as investment vehicles compared to individual stocks is effectively providing yourself with multiple income streams, rather than the snail- like effect of investing in a stock and hoping it goes up, not down. The critical risk factor of putting all your eggs in one shaky corporate basket during earthquake season on the markets is also avoided.

If you’re doing DIY superannuation, your natural need is for something a bit more trustworthy than a CEO’s glowing review of his own performance as the basis for investment. ETFs are a type of natural insurance against the very debatable merits of reliance on “market sentiment”, “pundits” and the rest of the equity sales pitch culture. Indices aren’t sentimental. They can be analyzed, but not particularly influenced by rhetoric and other non- cashable commodities.

The ETF ride on the indices is a lot less bumpy than the ride on the markets themselves.

India Expansion of Ports Critical for Continued Economic Growth

Bloomberg recently reported on the Indian government’s aims to triple its port capacity in the next ten years. While India’s economy is strong–being the third largest in all of Asia–the country has reached a critical point where it must expand its infrastructure to keep up with its economic output.

In a recent interview, Indian Secretary of Shipping K. Mohandas noted that “urgent action” must be taken with port expansion. Current projections estimate that by the year 2020, Indian ports will process more than 2.5 billion tons of cargo per year. This past year, Indian ports handled about 845 million tons, while India’s full port capacity is estimated to be around 996 million tons.

In a detailed plan that is set to be released next month, the Indian government will reportedly sell port stakes and open new harbors in an effort to push annual capacity to 3.2 billion tons. There are also plans in the works to increase building of other modes of transportation, like highways, railways, and airports.

One way in which the government hopes to push port expansion is by corporatizing the currently state-controlled Jawaharlal Nehru Port. In addition, the state will award concessions for two new terminals for the Mumbai-based port at the end of the fiscal year, one of which will be able to process more shipments than the current three existing terminals taken together.

A Business Standard article reports on the investment possibilities inherent in container traffic. The article zeroes in on Gujarat Pipavav Port Ltd (GPPL), which is the biggest terminal and port operator in the world, and one of the first private sector port developers operating in the region. The report goes on to suggest that while prospects for investment in Indian ports, especially in the northern areas, which comprise 64% of the country’s container traffic, remain promising, the IPO’s expensive prices are cause for concern.

In any case, the bottom line dictates that the push to privatize previously state-controlled port logistics will undoubtedly open up more global and domestic investment opportunities in India in the future.

About the Author –

This guest post is contributed by Lauren Bailey, who writes on the topics of online colleges. She welcomes your comments at her email Id: blauren99 @gmail.com.

Purchasing Power Parities (PPP) explained

In our endeavour to enrich the knowledge of our readers we regularly come up with articles giving simple explanantion of economic and financial terms. Next in this series is the Purchasing Power Parity (PPP). Please write to us if you have further queries or you would like us to post explanation of any such term.

What is Purchasing Power Parities (PPP)?

Purchasing power parities (PPPs) are currency exchange rates obtained by comparing the prices of identical goods and services in different countries. These price comparisons are made by dividing the price of a specific good or service in one country by the price of the same item in another country.

For example, if a 300 milliliter can of Pepsi costs Rp16.42 in country A and $3.24 in country B, a price relative can be calculated as 3.24/16.42, or 0.197. This is the “Pepsi PPP” for countries A and B. Also called “price relatives”, PPPs are calculated for several hundred items covering all the final expenditure components of GDP. These PPPs for individual goods and services are then combined to obtain PPPs for higher levels of aggregation such as “Bread and Cereals”, “Food and Beverages”, “Household Individual Consumption” and, eventually, GDP as a whole.

How are PPPs used?

PPPs are used in two ways:

  • First, they are used to convert GDP and its expenditure components to a common currency so that GDP comparisons can be made in real terms. “Real terms” means that differences in price levels between countries have been eliminated so that it is the underlying volumes of goods and services in each country that are compared.
  • Second, PPPs are used to measure differences in price levels among countries. Market exchange rates are currency convertors that include differences in price levels among countries; PPPs are currency convertors that exclude these differences. The ratios of PPPs to exchange rates, therefore, measure the differences in price levels among countries. These ratios are called price level indexes.

Where does India stand in terms of PPP?

As per data compiled by International Monetary Fund (IMF), India ranks fourth in terms of PPP behind only USA, China and Japan. Following is a list of top 15 countries in terms of PPP as compiled by IMF for the year 2009.

Top 15 countries as per PPP (2009)

(Source: IMF)

Adapted from Asian Development Bank (ADB) publications.

Integration of Indian stock exchanges: Some startling revelations

The huge daily turnovers of the two national exchanges hide some shocking facts, as the finance ministry’s startling revelations in Parliament reveal.

Narrow, shallow, illiquid and concentrated in the hands of a few individuals located in a few centres — that describes the state of the Indian Capital Market, nearly 20 years after India embarked on financial liberalisation and ostensibly unleashed a boom in stock investing and spreading the equity cult. In fact, the boom is eyewash and this information is provided by none other than the minister of state for finance, Namo Narain Meena, in response to a question in Parliament (Unstarred question 1669) on 10 August 2010 by Rajya Sabha MP Sardar Sukhdev Singh Dhindsa.Mr Dhindsa asked for the number of client identities and PAN identities who actively traded in the National Stock Exchange (NSE) and contribute to 50%, 60%, 70% and 80% and 90% of total trading turnover on an average, on a daily basis in the cash equity market and in the equity futures & options segment. He asked for these numbers to be provided for the three-month period from April 2010 to June 2010. The numbers are absolutely startling.

  • According to Mr Meena, only 30.90 lakh investors traded on the NSE’s cash market in the April-June quarter. Of these 52% were retail, High Networth Individuals (HNIs) and corporate customers. Institutional investors and proprietary traders accounted for 48% of all trading (24% each).

 

  • Slice the data further and these figures should be extremely worrisome for policymakers.First, 90% of trading in the April-June 2010 period came from just 192,200 investors, says the Minister.

 

  • Break it down further and the Minister says 80% of turnover came from just 41,654 investors. In other words, 1,50,546 investors (78%) accounted for just 10% of trading turnover.

 

  • Cut it further and it gets worse. Just 8,727 investors accounted for 70% of turnover among which 413 were proprietary traders, mainly brokerage houses.

 

  • The Minister goes on to say that 60% of trading came from a mere 1,563 traders and half the trading turnover (50%) came from a shockingly low 451 of which 156 were proprietary traders! Mind you, this is data for a three-month period and not one single day.

 

  • The National Stock Exchange (NSE) records an average daily turnover of over Rs12,000 crore in the cash segment (up from over Rs4,500 crore in 2005-06) and over Rs83,000 crore in the futures and options (derivatives) segment while the Bombay Stock Exchange (BSE) records a daily turnover of over Rs3,000 crore in the cash segment.

 

  • While these numbers are much higher than what they were a decade ago, but they are misleading.The derivatives segment of NSE is seven times larger than the cash segment and the main source of NSE’s profits and therefore massive salaries of its top management.

 

  • So, shouldn’t it have more participants and a less skewed participation? Instead, the numbers here are downright scary and indicate that this market is just a casino frequented by a small closed club.

 

  • According to Mr Meena, only 5.75 lakh clients traded in derivatives in the three-month period. Of these, 90% of trading came from just 18,035 (including 520 proprietary traders). This means that 5.57 lakh clients (97%) accounted for only 10% of total trading while only 3% of clients accounted for 90% of the trading!

 

  • Split it further and the number drops dramatically. Only 2,188 investors accounted for 80% of derivatives turnover in the three-month period.

 

  • Just 537 investors account for 70% of trading, 223 investors accounted for 60% of trading, of which over half were proprietary brokerage firms. And a massive 50% of trading NSE’s derivatives trading turnover, the main pillar of the Indian stock market system, comes from just 106 investors of which 58 are proprietary traders!

 

  • How skewed can a stock market be, which is supposed to include a wide swathe of population?Further, the Minister says that the top 25 brokerage firms on the NSE accounted for 42% and 43% of the cash equity and equity stock futures and options turnover in the April-June 2010 period.

 

  • Can you imagine the phenomenal influence on stock prices that these 25 firms (out of 1,055 in the derivatives segment) have on stock prices? Hopefully, some Member of Parliament will ask the finance ministry for the names of these firms.

 

  • Since the NSE has been fighting against disclosures under the Right to Information Act and the data is not in its annual report, the only way that the India public can get information about the big national hoax of an expanding capital market is through questions asked in Parliament.

It will also be interesting to ask if the Securities and Exchange Board of India (SEBI) has any special monitoring mechanism for the 106 investors who account for half the derivatives market turnover.But to really put the information in perspective, you have to look at the massive trading numbers that hide these pathetic participation figures. In the April-June 2010 period, the NSE’s trading turnover in the derivatives segment was Rs58,31,715 crore and in the cash segment it was Rs8,47,300 crore. In comparison, the BSE’s derivatives turnover was a pathetic Rs7 crore while its cash turnover was Rs2,73,101 crore.In effect, the NSE, with a 96% market share (cash and derivatives put together) is a virtual monopoly. Yet, misleadingly, we tend to talk about the NSE and BSE almost as though they are equally large exchanges.

This is probably because the BSE enjoyed a virtual monopoly for all but the past 15 years of its 130-odd years of existence. Our perception about investor participation is also grossly misleading. According to the D Swarup Committee report, India has 80 lakh investors (who invest in debt and equity markets, either directly or through mutual funds and market-linked insurance plans). This official figure also represents a sharp decline from the two crore (20 million) investor population, claimed in investor surveys commissioned by SEBI in the 1990.

Author:Rahul Sonthalia, Research Head, Kredent

IFRS for exploration of mineral resources and Oil & Gas industry

What does it mean by Exploration for and evaluation of mineral resources, Oil and Gas?

It is basically search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources after the entity has obtained legal rights to explore in a specific area, as well as the determination of the technical feasibility and commercial viability of extracting the mineral resource.

 

 

 

Relevant IFRS applicable for Exploration and evaluation of Mineral resources, Oil and Gas Industry

  • IFRS 6: Exploration for and Evaluation of Mineral Resources
  • IAS 16 – Component accounting for assets
  • IAS 36 – Impairments
  • IAS 37 – Asset retirement obligations
  • IAS 38 – Intangible assets
  • IFRS 1 – opening balance sheet

What are the Exploration for and Evaluation Cost?

  • Lease acquisition rights
  • Technical studies and services
  • Seismic costs
  • Geologic and geophysical costs
  • Exploratory drilling and testing
  • Tangible and intangible costs

Transition issues (IFRS1)

Requires retrospective restatement of beginning balances which is subject to very high cost and limited benefits to users

Cash Generating Unit

IFRS 6 defines Cash Generating Unit (CGU) as smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets

Impairment of assets is done at the CGU level.  Application of CGU requires judgment. It will involve how management monitor operations, product line, regional areas, decision regarding continuing or disposing operations.

We have already discussed Component accounting in our previous articles.

IFRS 6

Objective - To specify the financial reporting for the exploration for and evaluation of mineral resources

Scope: It applies only to expenditure incurred before exploration and evaluation of mineral resources. It does not apply to companies who are engaged in exploration and evaluation of mineral resources.

Measurement: Exploration for and evaluation assets shall be measured at cost

 It allows Full Cost Method for exploration and evaluation after this the companies are required to follow Successful effort method.

Successful Effort method (SE) v/s Full Cost Method (FC)

Oil and gas sector is only industry where companies are allowed to chose between two extreme different accounting methods.

Exploratory dry holes cost are capitalized in FC method where as in SE it is expensed.

Geologic and geophysical costs are capitalized in FC method where as in SE it is expensed.

Steps to proceed with IFRS 6

  • The entity must determine accounting policies specifying which exploration and evaluation expenditures are recognized as assets, and how such assets are to be measured.
  • On recognition, exploration and evaluation assets are measured at cost. Subsequently they are measured using either the cost model or the revaluation model. 
  • Exploration and evaluation assets are classified as tangible or intangible assets according to their nature.

 

An exploration and evaluation asset is assessed for impairment when circumstances suggest the carrying amount exceeds the recoverable amount.

Author: Shalini Tibe, IFRS Consultant

July Inflation just under double digits @9.97%

The WPI for the month of July’10 stood at 9.97% compared to the previous month’s figure of 10.55%. It registered a growth of -0.54% in July’09 on a y-o-y basis . The inflation figures this month is the lowest in the past six months. They just managed to miss the double-digit by few marks. The figures were almost in line with the expectation

The benchmark indices were almost flat after the data release while there was also no major movement in INR. The RBI in its monetary policy review in mid-September now, is not expected to increase the interest-rate as it had said earlier that it would wait for the inflation figures to consider any further hike in the interest-rates

  • The sub-group of primary articles rose by 14.94% y-o-y against 7.64% in July’09.It registered a growth of 1.85% m-o-m mainly because of high growth in the food articles, which increased by 0.90% m-o-m. Food articles increased more than last month due to rise in prices of mutton, fish milk, eggs, cereals and pulses
  • In the same sub-group, the non-food articles increased by 0.80% m-o-m due to higher prices of fodder, oil-seeds, raw jute, rubber and silk and increase in the price of copra, etc. The index for minerals rose to 19.25% m-o-m which was due to higher prices of flluorite, magnesite, iron ore and steatite
  • The second sub-group of fuel, power, lights and lubricants increased to 14.29% y-o-y from -10.37% in July’09 which was pretty high. It registered a growth of 3.21% m-o-m due to higher prices of LPG, high speed diesel oil, aviation turbine fuel and petrol
  • The third sub-group of manufactured products jumped to 6.15% y-o-y from 0.10% in July’09. It registered a degrowth of -0.14% m-o-m mainly because of increase in the prices of edible oils, manmade textiles plastic products and machinery and machine tools
  • Food products declined by 0.61% m-o-m due to lower prices of bran, butter, khansari, coffee powder and gur. Sugar prices declined by 2.55% while there was an increase of 1.27% in edible oils due to higher prices of oil-seeds. Cotton textiles and man-made textiles surged by 0.38% and 0.48% due to increase in the prices of raw cotton, jute, raw silk and fibres. Rubber and plastic products increased by 0.06% while machinery and machine tools increased by 0.22%

 

Author:Rahul Sonthalia, Research Head, Kredent

Industrial Production rises 7.1% in June’2010

 

The IIP expanded at 7.1%, the slowest pace in 13 months compared to the previous month’s growth of 11.35% (revised). The production index registered a growth of 8.3% on a y-o-y basis

  • The IIP was almost in line with the expectations. The market was neutral to the data release and the benchmark equity indices closed flat while the bond yields across various maturities softened

 

  • Only 13 out of 17 manufacturing sub-groups could manage a positive growth in June compared to the growth in 15 sectors last month. The index has also been revised downwards for the last month signalling a slowdown in the IIP growth

 

  • The slowdown in the production has been mainly due to moderation in capital goods production which has shown a huge correction. The data also suggest that the divergence between the capital and consumer goods might narrow down as the demand for consumer durables is picking up.

 

  • As already pointed in the report before the manufacturing production has slowed down and would moderate further because the capacity limit has already been reached and the global demand is also slowing down amid the economic uncertainty

 

  • The mining sector did not show much of drastic change and cooled down to 9.5% from 10.1% in May’10 on a mom basis while the electricity sector gave a drastic performance falling from 6.4% to 3.5% in Jun’10. Both the mining and the electricity sector are approaching towards a downward trend after peaking in Apr’10

 

  • The manufacturing sector slowed down to 7.3% in Jun’10 from 12% in the last month. After giving its best performance in Apr’10, recording a growth of 13.4% the sector has slowed down and has again came back to single-digit growth after almost about 11 months signalling a downward trend

 

  • In the use-based category the basic goods, capital goods and the intermediate goods sector registered a growth of 3.4%, 9.7% and 8.7% y-o-y respectively compared to 8.2%, 34.2% and 10.1% y-o-y respectively in the last month. All the three sectors have moderated but, it is the capital goods sector which shown one of the weakest performance

 

  • The consumer goods sector has shown a muted performance on an overall basis registering a growth of 8.3% compared to its previous month’s growth of 7.4%. Again it is the consumer durables good in this segment which like usual has given a good show increasing by 27.4% due to increased demand of durables among the masses. The non-durable section has only managed to grow by 1.3% compared to a growth of 1.4% in the last month

 

Authro:Rahul Sonthalia, Research Head, Kredent

Valuation of Business: Financial Analysis

“Valuation of Business” (valuation of companies) is a series of articles launched by MoneyBol to apprise our readers about different aspects of valuation of business.

The first article in Business Valuation series was Analysis of Environment and Industry

Now in the second article we are presenting different aspects of Financial Analysis of the company to arrive at the intrinsic value of the company.

Financial analysis

Financial statements of a company provide immense information about the financial standing of a company. They must never be taken at their face value; rather a careful scrutiny is required to unearth the hidden facts.

Financial analysis aims at reclassification and summarization of information through the establishment of ratios and trends.

Horizontal Analysis-

Also known as comparative analysis, this is conducted by setting consecutive balance sheet, income statement or statement of cash flow side-by-side and reviewing changes in individual categories on a year-to-year or multiyear basis. The most important item revealed by comparative financial statement analysis is trend.
A comparison of statements over several years reveals direction, speed and extent of a trend(s).

The horizontal financial statements analysis is done by restating the amount of each item or group of items as a percentage the figures of a predetermined base year.

Vertical Analysis-

In this analysis, each entry for each of the three major categories of accounts (assets, liabilities and equities) in a balance sheet is represented as a proportion of the total account. The main advantage of this form of analysis is that the balance sheets of businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes in one business.

Ratio Analysis-

Ratio Analysis enables the valuer to spot trends in a business and to compare its performance and condition with the average performance of similar businesses in the same industry.

To do this a firm’s ratios are compared with the average of similar businesses. The ratios are also compared with the firm’s own ratios for several successive years, watching especially for any unfavorable trends that may be starting.

Ratio analysis may provide the all-important early warning indications that can allow one to solve business problems before they assume a larger magnitude.

Normalization of financial statements

Normalization is required to present a true and fair picture of the firm’s economic financial position. The financial statements must be made to comply with GAAP. The following adjustments need to be made:

Comparability Adjustments- Only occasionally do any two different closely held companies use the same set of accounting practices to keep their books and prepare their financial statements. The analyst must adjust for them by eliminating such differences.

Non-Operating Adjustments- More often than not, the financial statements of a firm present a picture that is very different from economic reality. Any assets or liabilities which are not related to the production of earnings must be eliminated from the balance sheet.

Non-Recurring Adjustments- The subject company’s financial statements may be affected by events that are not expected to recur, such as the purchase or sale of fixed assets, a lawsuit, or an unusually large revenue or expense. These non-recurring items are adjusted so that the financial statements will better reflect the management’s expectations of future performance.

Fair Value Adjustments- In most cases, closely held businesses have actual values that are different from what is recorded in their financial statements. Balance sheet adjustments are made to present the current market value position of an enterprise, with both assets and liabilities shown at their respective current market values. Discretionary adjustments also need to be made with respect to compensation paid to all employees including owner, benefits and perquisites given, rent paid, etc. to industry standards.

Keep visiting our website for further articles which would take up company specific ananlysis for valuation.

Author name: Preeti Patawari, MBA- Intl Business (IMT)