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.

However, trade in foreign entities, including buying lottery tickets, proscribed magazines, etc., or any items prohibited under Schedule II of Foreign Exchange Management (Current Account Transactions) Rules, 2000 is not allowed. Resident individuals cannot, directly or indirectly, send remittances to countries designated by the Financial Action Task Force (FATF) as non-co-operating countries and territories. 

LRS and international transactions

Before international trade and transactions, you need to convert the Indian rupee into US currency for foreign investment or consumer purposes. The Liberalised Remittance Scheme describes how these transactions work. As an Indian resident, you must purchase dollars using the Indian rupees (INR) from an authorised dealer (the bank) in India. 

The dollars can then be remitted or spent abroad for buying property or diversified assets like equity dividends. Here, the allusion of the dollar as a currency is easier as remittance can be in any openly adjustable foreign currency, including dollars.

Types of LRS transactions

LRS current account transactions

If you are engaging in international travel, the foreign exchange facility determines if LRS is allowed for you. In addition to remittance, you also have the forex facility at your disposal for specific purposes. These are referred to in Paragraph 1 of Schedule III of FEM (CAT) Amendment Rules 2015, which consist of the rules for the period of the surrender of foreign exchange. The individual must maintain the usage of forex within the limit of $2,50,000 only. 

During Security in Ban

When security is under the ban, the only transaction that traders can do is reducing their position. They can reduce the place by selling the original position. To put it simply, you cannot open a new position until the security ban is lifted in F&O Segment. However, traders may opt for intraday positions as it is not related to open interest.

Why is a ban on securities imposed?

The vital reason why exchanges impose a ban on security in the F&O segment is to reduce the volatility in particular shares on both sides. The ban saves retail investors from significant losses. It also gives time to investors for rethinking their positions. Traders are not permitted to open any new positions in securities during a ban period. But they can exit already opened positions.

Penalty for breaching the ban

If a trader breaches the F&O ban, i.e., raises or opens a new position in security during the ban period, they are levied a fine of 1% of the rising position’s value. The lowest penalty limit is set at Rs 5,000, and the upper limit is Rs 1,00,000.

Ban resumption and normal F&O trading 

After the ban, regular trading in securities only resumes when total open interest on all exchanges comes below 80% or less of the MWPL. In simple terms, when the open interest drops to 80% or less, stocks come out of the ban, and regular trading resumes.

Suppose a company’s market wide position limit is 80 crore shares and open interest is 78 crore shares. By calculating the percentage, i.e., 

• • {Open Interest / MWPL} x 100

{78 / 80} x 100 = 97.5, 

The open interest comes out to be 97.5%. As the percentage is above 95%, the ban will remain on the company’s securities. It will only come out of the prohibition if the rate slips below 80%.

So, if the open interest reaches, say, 60 crore shares, which will mean 

60/80 x 100 = 75%. 

Thus, the share will be under 80% and will come out of the ban.

In the end, it is essential to remember that securities in the F&O segment that enter a ban period are the ones that are highly speculative and risky. Such shares are not a promising investment choice, especially for retail investors just beginning their investment journey. Still, even if you have entered such a risky transaction, you can trade the stock in the cash segment, where no such limits apply.

Net Interest Margin for accessing a banking stock

The Net Interest Margin (NIM) is the differentiated value between total expenses and the net interest income. It is usually defined as a percentage of average fixed-income assets. The net interest margin measures the profitability of a bank’s investments. It considers the interest a bank makes on its securities and loans, subtracts the interest payable on debt and deposits, and divides it across the value of those securities and loans. For investors looking to invest in banking stocks, a higher net interest rate is desirable.

Non-performing Assets

Non-performing assets (NPAs) determine the risk of loans repayment by debtors to a bank. If no interest or instalment of the principal amount is paid for 90 days, the loan becomes a non-performing asset. NPAs are divided into gross and net non-performing assets. Gross NPA covers the principal and interest on total debt, and net NPA is calculated primarily by deducting bank provisions from all bad loans under Gross NPA. 

Credit problems and non-performing assets have threatened Indian state-owned banks in recent years. The State Bank of India, India’s largest public sector bank, recorded 11% of its debt as outstanding loans as NPA in 2018. Investors should consider a bank with low or no NPAs before investing in its stock.

Cost of Liabilities and banking stock relation

Banks carry out different types of activities. But they majorly make money from loaning money to debtors. Simultaneous to banks’ lending activities, the interest payments on the deposits form a significant part of their operating expenses. Thus, deposits are a bank’s liabilities as there is an interest cost they must pay on these deposits.

The banks also need funds to function correctly. For that, it must borrow other than the received deposits. These borrowings usually come from the Reserve Bank of India, other institutions, banks, bonds, etc. Any borrowings carry an interest component that needs to be paid at regular intervals without fail. This interest component that a bank needs to pay is a part of the Cost of Liabilities.

Quantitative Easing (QE) effect and interest rates

Quantitative easing lowers interest rates. This reduces the returns (ROI) for investors on safe investments, such as certificates of deposit (CDs), money market loans, corporate bonds, etc. Therefore, investors are forced to invest with reasonable risk to generate significant returns. As an alternative, many of these investors consider building their stock market investment portfolios which heavily alter stock prices and increase volatility.

Falling interest rates also influence the decisions of listed companies. Lower interest rates mean lower borrowing costs. This encourages companies to grow their business and borrow more often.

Taper Tantrum

Tapering is the decrease of the rate at which a central bank purchases new assets. It is a gradual reduction in the flow of significant acquisitions of goods and securities by a central bank. Once the tapering is complete, a central bank may reduce the balance sheet size. The goal is to remove financial rewards and incentives slowly.

Tapering is not a new phenomenon. However, the first time it occurred in a way that had a significant global impact was during the 2013 Taper Tantrum. The “tantrum” resulted from the overestimated fears of stock market participants after the US government announced aid cuts.

Example

Suppose XYZ company has 50,000 outstanding shares with the following as shareholders:

Total: 32,000 shares {these are restricted or closely held shares that are not available for trade in the open market}

In this case, the floating stock of XYZ will be => 50,000 – (5,000+10,000+15,000+2,000) = 18,000 shares.

The above number is significant for investors as it reflects the total available shares traded openly by the public. Shares traded by investors do not affect the floating stock because this does not reflect any change in the restricted and closely-held shares.

The formula for Calculating Floating Stock

The outstanding shares of a company do not always signify the floating stock amount. The subsequent formula can be used to obtain the floating stock value:

Floating Stock = Outstanding Shares – {Restricted Shares + Institution-owned Shares + ESOPs}

Here,

Limited shares are non-transferable until the lock-up days after the initial public offering (IPO) is over. The shares are non-transferable.

ESOP is an employee stock holding policy in a corporation through which the workers get an ownership interest.

Significance of floating stock 

The number of floating stocks determines the liquidity and volatility of the share. Small-cap companies, i.e., companies with a low number of shares available, have low floating stocks. Sellers or buyers for these stocks are not easy to find because fewer stocks are available to trade. Therefore, small float stocks tend to have more variations than larger ones.

A company’s free-floating stock changes over time. If a company sells more shares to raise more capital, the free float will increase. Conversely, if the company buys back the remaining shares, the free float percentage rate will fall.

How do NSDL and CDSL work?

When you start trading in stocks and shares, they are debited or credited respectively from a depository and shown in your Demat account. Once the transaction has been validated, depositories shall provide the public company with information about the shareholders. For example, investors can receive delivery instructions from the depositories, among other actions. On the other hand, companies that trade on the stock exchange often contact depositories regarding information of shareholders for actions such as notifying them about their right to profits, shares, etc.

Transforming stock market investment

The depositories have transformed trading in Indian stock markets by making it possible to hold and trade stocks, securities etc., electronically. By using technology, they have paved the way for secure, reliable and convenient transactions in the stock market.

Basics of an IOC Order

Investors can place either a limit or a market order using the IOC option based on specific requirements. The IOC limit order is placed at a specific price, while the IOC market order has no specified purchase price, and the shares are traded at the best selling (or buying) price.

An IOC order specifies that it must be executed as soon as it is published in the market. This ensures that you sell or purchase a stock almost immediately. If this is not done, the order is cancelled, post which it does not have the pending status. The order is cancelled immediately, and no action from the investor is needed.

An IOC is a ‘period’ order, which means that the investor chooses how long the order will stay in the market. IOC is a ‘zero duration’ order as the time between placing the order and execution is only a few seconds.

An IOC order may be set as a market or limit order. A limit order delineates that you can sell or purchase security only when it reaches a specific price. The transaction is done at the current price point when you initiate a market order.

Example

This age-old method of saving wealth can also be applied to the share market using the Coffee Can investment strategy. It is primarily a long-term investment strategy with a maturity period of at least ten years. At the end of the decade, you can realise substantial profits from a diverse portfolio of stocks.

Coffee Can Portfolio in the Indian context 

Coffee Can Portfolio in the Indian context includes companies that have generated a Return on Capital (ROCE) of more than 15% per annum with the Coffee Can Investing approach. This makes the process a low-risk way to generate incredible wealth.

How to build a Coffee Can Portfolio?

The pandemic has pushed us to learn the fundamentals of market investment to generate a passive income. It is not a simple subject since real money is a concern. There are horrifying accounts where people have lost all their life savings rapidly.

There are some advantages to long-term investing. It is very profitable and fetches compounding dividends. When a company releases a dividend, you get more interest over your holdings.

Coffee Can Portfolio is mainly concerned with stock quality. The following parameters must be analysed while selecting stocks for your Coffee Can investment strategy. 

• • Invest in fundamentally strong companies.
  • Market capitalisation should be above Rs. 5000 crores. 
  • The company should have a good brand value and a competitive advantage. 
  • Diversify your stocks and invest in different industries.
  • Structure your portfolio
  • Invest in no more than the stocks of 10-15 companies. These companies should be market leaders having an outstanding growth record of at least ten years.
  • The revenue growth should be at least 10% year on year, not CAGR or SAGR.
  • ROCE of at least 15% for ten years
  • Use a Coffee Can Portfolio screener

Let us take an example of a milk company. If a milk company increases its product prices, will people stop having milk? Clearly, that will never be the situation. Similarly, the Coffee Can strategy is not heavily dependent on quantity and growth – it works on quality investing. You can find the Coffee Can Portfolio India 2021 on the internet.

Bandwagon effect in investment and finance

The bandwagon effect has a swaying impact on the financial and investment markets. Stock markets are heavily dependent on the rise and fall of information-economising, psychological, and social factors. The prices of assets tend to rise as more people jump on the bandwagon of what others are doing. This results in a positive response to increasing costs and growing demand for assets, and vice versa.

During the Dotcom Bubble of the late 1990s, entrepreneurs incorporated many companies with no practical business plans and minimal end products or services. They were just names with “.com” or “.net” as the suffix in several cases. Yet, despite their lack of foresight and plan, these companies attracted millions of dollars in investment, mainly because of the bandwagon effect. No wonder only a handful of dot-com era companies, including Amazon and eBay, are thriving today.

Effect in financial markets

• • Price bubble

Price bubbles are common in financial markets, especially as higher-ranking security prices continue to rise. The price is likely to exceed baseline in such a case, causing the security to be highly overvalued. The reason behind it is that many investors line up to buy the security, which raises prices and attracts more investors.

• • Liquidity holes

In case of unforeseen events or news, a business’s activities can be suspended until the situation is clarified to market participants. This cuts down the number of sellers and buyers in the market and reduces the liquidity drastically. This phenomenon adds more confusion and uncertainty amongst investors and is extremely hard to recover from.