Goodwill in the financial statements

Because goodwill is an elusive asset, it is recorded on the balance sheet as a noncurrent asset. A noncurrent asset is a long-term asset like fixed assets such as property, plant, and equipment.  The goodwill entered in the books may not realise any cash profit in the future. Thus, a company’s valuation should be calculated using the book value method based on its total assets. 

For example, if the company’s total assets are shown to be $1 billion on its balance sheet, and the goodwill value is $200 million, the net asset value is $800 million, and the net asset value per share is adjusted accordingly.

A vital conclusion that you can draw from this is that if it increases year on year, that does not mean that the company’s reputation in the market has improved. It only means that the company is involved in numerous take-overs and mergers. 

In addition, a decline in goodwill does not necessarily mean that the company’s reputation has deteriorated from year to year. It just means that the corporation is gradually writing off the goodwill from its balance sheet.

Looking beyond the annual report 

As we have established, goodwill is an intangible asset of a company that plays a phenomenal role in enhancing its earnings. It is a factor that gives a company an edge over the competition. It could be brand value, usability, product buying habits or customer loyalty. Goodwill reflects elements that you cannot measure. Hence, these are not a component of the company’s yearly report.

What is a bulk deal?

Bulk deals involve the transaction of shares of at least 0.5 percent or more of the total listed shares of a company. There are no separate trading windows and the trading happens during normal trading hours. Unlike block deals it is visible to the retail investors and the trading is reflected on the volume charts in trading platforms. The broker participating in the bulk deal trade has to provide the details of the transaction to the stock exchanges whenever they take place. Investors can find out the number of shares traded in bulk deals, provided that he/she already knows a company’s total outstanding shares. It can be calculated like this 

No. of shares traded in bulk deal = Total number of shares * 0.5 %

Bulk deal vs Block deal

Traders sell a stock short when they believe the stock’s price is set to fall. However, if the stock’s price goes up, the trader may reduce or eliminate his exposure to a short position. This is called short covering.

Let us understand the working process of the short-covering practice in the stock market.

Price increment in short positioning

Prices are expected to fall during short positioning. Traders register a profit if a stock’s price falls. But if the price rises, they can encounter severe losses. Therefore, they may rush to exit the short position by buying back the stock. But as the demand goes up, the stock’s price rises too. This results in a short-covering rally.

Short covering is how short position traders in the market settle their trade; the buy transaction closes out their initial sell order. Short covering is a unique situation where people start buying to settle their positions. 

Since many people buy, this increases the stock price in the short term. However, this price increase does not last long; it increases only due to demand-supply mismatch in the short time.

Example of short covering

For example, a trader shorts 1,000 shares of Asian Paints at Rs. 330 per share, assuming the share price will drop. Instead, the price rises to Rs. 350 per share. To cover their short position, the trader purchases 1,000 shares of Asian Paints at Rs. 350 per unit. In this situation, s/he makes a loss of Rs. 20,000 i.e. (350 – 330) x 1,000 shares. 

However, if the price of Asian Paints had dropped to Rs. 300, they would have covered the short at that price and made a profit of Rs. 30,000 i.e. (330 – 300) X 1,000 shares.

Thus, short-covering helps traders protect themselves against potential losses if the market moves against them.

What is REIT (Real Estate Investment Trust)? 

This real investment plan is similar to how mutual funds work. In mutual funds, investors do not invest directly in securities but their funds are invested in stocks whose dividends or profits are distributed. In a similar fashion to investing in REIT, the funds are invested by that trust to build and finance various real estate projects such as hotels, malls, offices, IT parks, residential properties, and other commercial spaces. It cannot invest in vacant or agricultural land provided there is a project involved. REIT is a company that makes investments in income-producing real estate. So far only three REITs on the Indian exchange are listed – Embassy office parks, Mindspace office parks, Brookfield India Real Estate.

This real estate investment is ideal for investors who do not have deep pockets to invest in direct real estate. The beauty in this investment lies in an investor being able to invest with a minimum of Rs 2 lakh. 

There are three types of REIT:

Equity REIT: In this, the trust uses an investor’s funds in building or purchasing commercial spaces like malls, hotels, SEZs or offices, etc. The trust here generates income through rent or sell properties that are further distributed to the investors as dividends or returns.

Mortgage REIT: In mortgage REIT, the trust collects the funds from the investors to lend loans to a different investor or a different builder at a certain interest. The trust here earns dividends for its investors through interest applied to the loan lent. 

Hybrid REIT: They are a combination of the above two where the trust can either lent loans to other investors or can invest in building and purchasing properties. 

REIT vs direct real estate – the ideal investment 

How to identify multibagger stocks?

The stock market can never assure returns while we invest in a stock, but certain signs can help an investor identify multibagger stocks. 

• • Look at the P/E ratio and EPS (earnings per share) 

The rule is simple, an investor can milk profits only if the company makes profits. We should look at the earnings of a company to find an upward trajectory. Typically, the company of a multibagger stock will have a high revenue growth model, profitability model, and capital allocation model.

Investors can calculate EPS (earnings per share) of trailing 12 months to check against each share how much a company has earned. In the case of a multibagger stock, the EPS should be on a climbing mode. Another metric to find if the company is making profits is through the P/E ratio. The probability of a stock becoming multibagger is high if its P/E ratio is high as compared to its stock price.

 Apart from these two metrics, one should also look at the debt to ensure that it is not more than the EPS value. 

• • Check EBITDA and revenue

To determine multibagger stocks, investors must look into the quarterly performance of the company’s revenue, EBITDA, and net profit. Parameters – revenue and EBITDA – reflect the company’s operating profitability and cash flow. If the EBITDA numbers are high, it reflects the company’s operating expenses to be low against the profits earned eventually meaning the cash flow to be high. Such signs make the stocks multibagger.

Moreover, the stocks of the companies should be able to produce sustained margin over time that does not vary with every quarter or year. 

• • Strong management 

A strong management team is key to a business’s growth. Aspects like governance practices, board independence, diversion of funds to other businesses or for personal interest, pledging of shares, discipline with obligations, capital expenditure and financial matters, etc. should be researched by the investor. Good management practices have an impact on a company’s operations eventually driving its profits.

• • Source of earnings 

With revenue numbers, one must check the sources from where the company is making money. See, if the operations of the company are easily scalable? The primary revenue should be able to grow at the macro level to become a stock giving explosive returns. 

Benefits of investing in multibagger stocks 

Multibagger stocks yield tremendous returns that increase investor’s wealth. Also, purchasing multibagger stocks is not risky since such companies can withstand failures and can perform well. 

Are risks involved in multibagger stocks?

Investing in multibagger shares can throw investors into the problem as trading at high prices might be a possibility of creating an asset bubble. An asset bubble is formed when the prices of stocks or securities surges at a rapid pace without any strong fundamentals such as EPS, P/E ratio, etc. to justify the rise. When investors pin their high hopes on the stocks to perform but if the company’s products fail to perform in the market, this is where the bubble bursts resulting in massive losses. 

Thus, investors need to carefully analyse the financial statements of a company and the prevailing market situation in stock markets before investing in multibagger stocks. 

The purpose of overnight funds  

The reason behind the growing popularity of overnight funds is that investors are able to use their funds in a better and profitable manner with low risk. Here are the purposes of investing in overnight stocks. 

• It is a short investment

   The overnight mutual funds mature in just one day. This short period of investment allows investors to make better use of the extra cash they have at their hand.

• Low-risk

  As the prices remain unaffected to varying interest rates with maturity being for a day, it limits the funds’ exposure to risk and keeps it to a minimum.

• High-liquidity

  Overnight funds are regarded as the most liquid investment securities. It strives to give better returns than a savings bank account.

Who should invest in overnight funds?

• Investors looking for greater liquidity and expecting returns more than a savings bank account. 

• Risk-averse investors who want to park their money overnight.

• Also, ideal for institutional investors such as banks, insurers, and corporates seeking overnight returns by investing their surplus funds.

• Investors who require quick money during financial emergencies. 

 How are these funds taxed?

Investors receive dividends and capital gains from overnight funds. Receiving dividends does not attract taxes but capital gains do. Capital gains are the difference between the purchase price and the selling price of the fund. The tax rate on capital gains depends on the time an investor holds the units of an overnight fund. Capital gains tax is of two types- short and long term. 

• Short-term capital gains tax:

  If the investor holds the funds for a period of up to 3 years and taxes are charged as per the income tax slab rate applicable to the investor.

• Long-term capital gains tax:

  When an investor holds the funds for more than 3 years, he/she gets the benefit of indexation. Indexation means the purchase price is adjusted with the inflation that causes tax amount to reduce. Investors in the long term are taxed at 20% after indexation. 

Pros and cons of investing in overnight funds 

Overview of arbitrage funds

• • Inter-exchange trades 

Suppose the shares in ABC company cost Rs. Rs 1,000 per share on the Bombay Stock Exchange (BSE). The same company’s shares cost Rs 1,010 per share on the National Stock Exchange (NSE). If the fund manager of an arbitrage fund identifies this opportunity, s/he can buy shares from the BSE and simultaneously sell them on the NSE. From there, they can earn an Rs. 10 profit at low transaction cost and no virtual risk.

• • Transactions between the cash and futures markets

Assume that ABC’s shares are traded for Rs. 1,000 per share in the money (cash) market and Rs 1,015 in the futures market. In such a case, the arbitrage fund manager may buy shares in the money market and enter future contracts to sell the shares for Rs. 1015. They can sell the shares on the futures market at the end of the month and earn Rs. 15 at low transaction costs and no risk.

Benefits 

• • Low risk

Arbitrage funds generally pose a low risk to investors. There is no long-term investment risk as shares are bought and sold in one go. Volatile markets have the most potential for profits as well as losses. It depends on how you act on your trade and your risk appetite regarding investment in arbitrage funds. These funds are a good choice for prudent investors who want to take advantage of a volatile market but not take too much risk.

• • Tax treatment as equity funds

While investing primarily in stock equities, arbitrage funds are a mixture of funds as they leverage the benefits of both debt and equity investments. Therefore, they are treated as equity funds for taxation as long equity showcases an average of at least 65% of the investment portfolio. Holding an arbitrage fund for more than a year brings it under the tax bracket of capital gains, significantly lower than the ordinary income tax rate.