November 2012 – Page 2

Does the 40% discount on Hindustan Copper shares mean anything?

The government starts off its disinvestment program for this financial year with the divestment of up to 9.59% stake in Hindustan Copper tomorrow.

They have set a floor price of Rs. 155 which means that bid for shares can only come at that price or higher, and the entire process will close tomorrow.

The announcement says that it will take place on a separate window of BSE and NSE, and this doesn’t seem to follow the usual IPO or FPO process. I’m not quite sure how retail investors can bid for these shares, and if anyone has information on that then please do leave a comment or send me an email.

The Hindustan Copper stake sale is very interesting in one respect which is the fact that the floor price set by the government is Rs. 155, and the stock closed at Rs. 266.30 today.

If your eyes lit up thinking about the great arbitrage opportunity here, hold your horses.

Remember how the government is willing to divest up to 9.59% of its stake in Hindustan Copper? That’s because they have already divested 0.4% of the stake in Hindustan Copper, and that’s all the stock that trades in the stock exchange.

So, the the float is so low that the current market price doesn’t indicate much, and by extension, the huge discount of floor price to the market price doesn’t mean much either.

Also note that this is the floor price and not the price at which the shares will be ultimately sold. That level will be decided by how many bids come at what levels.

In my opinion, the thing to remember is to forget about the discount of offer price to current market price.

Treat this is as an IPO and think of valuation in terms of P/E multiples or free cash flow or whatever else you normally use. A quick look at the financials show that the EPS in the last financial year was Rs. 3.50, so that’s a trailing P/E multiple of about 44 on the floor price.

This will likely not present an arbitrage opportunity because the shares offered in the current sale are so much more than what’s already traded in the market, and therefore your decision to buy should be based on whether you’re willing to hold the shares for at least the slightly longer term.

Edit: Changed the discount number mentioned in the title from 70% to 40%.

Infographic: Greatest Investors of All Time

Rplan UK published a great infographic featuring some of the greatest investors of our times, and some interesting bits of information about them.

I learned many new things about them which I didn’t know earlier, and it was fun to revisit stuff that I already knew. Perhaps the best bit is about George Soros breaking the Bank of England, and here’s a good Telegraph story for anyone who wants to read more.

Two other things that I particularly liked in this was the emphasis on time not timing by some of these greats, and the idea about certainty belonging to maths, not markets, that’s something I had not heard earlier.

Enjoy this great infographic, and thanks to Rplan for allowing me to publish it!

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Income Tax on Gifts from NRIs and Relatives in India

This article is written by Aashish Ramchand, a Chartered Accountant by profession. Aashish is the co-founder of makemyreturns.com. He also has completed his CFA Level I (American) and is very passionate about writing articles on taxes and tax advisory. He can be reached atÂ connect@makemyreturns.com

Generally, gifts are not regarded as Income chargeable to tax. However by virtue of Section 56(2) any sum of money exceeding Rs. 50000 received without consideration by an individual or an HUF from any person is chargeable to tax as income under other sources subject to exclusions as below:

Receipts on occasion of marriage of the individual
Receipts under a will or inheritance
Receipts received from a relative.

Since 1/10/2009, Section 56(2) has been amended and the scope of gifts and will include even immovable properties or any other property besides sums of money under its ambit.

Gifts that are not taxable at all are those that are received from relatives. Relatives are defined by the following relationships of the individual:

Parents
Parents siblings and their spouse
Siblings
Spouse of siblings
Daughter and son
Spouse of daughter and son
Spouse
Spouse’s parents
Spouse’s siblings and their respective spouse.

Even NRIs are covered as long as they fall in the category of relatives. Therefore an individual Indian resident can receive a tax free gift from an NRI as long as he/she is that individuals relative. Any amount can be received as a gift from a relative. Also the purpose for which the gift is received from a relative is inconsequential as it is completely tax free. Thus a gift received can be used for any purpose ranging from purchasing shares to buying property to even simply keeping it with the bank.

Note on gifting on immovable properties

There is a valuation aspect involved in gifting of immovable properties:-

If the property is gifted without any consideration then if the stamp duty value exceeds Rs. 50000/-, stamp duty value will be taken
If the property is gifted for a consideration, then the actual value of the property will be taken

In case of other properties:

If gifted without consideration and fair market value exceeds 50000, then the fair market value will be taken as the final value
If gifted for a consideration and the FMV less consideration is greater than 50000, then the FMV less consideration amount will be taken as the value of the gift.

As mentioned earlier NRIs can also give gifts to resident Indians. Therefore, It is important to understand the meaning of an NRI as per the IT act.

An individual will be treated as a non resident in India in any previous year if he fulfils any of the following two conditions:

he/she is NOT in India in that year for period or periods amounting in all to 182 days or more, or
Having within the four years preceding that year NOT been in India for a period or periods amounting in all to 365 days or more, and has NOT been in India for 60 days or more in that year.

What do I need to buy tax free bonds?

A friend recently emailed asking for suggestions on investments for her baby girl, and I suggested that tax free bonds are going to be issued later this year, and that’s a good option for you.

She asked what she needed to invest in them, if she needed a Demat account, and I thought it would be a good idea to write about three things that I think everyone should consider (not necessarily need) if they want to invest in tax free bonds.

You need a Demat account to buy tax free bonds

As far as I can remember all tax free bonds needed Demat accounts last year, and although I haven’t checked all older posts, the ones I saw mention that a Demat account is needed.

Now, as far as who you should open that with – I think there is very little difference apart from cost and even with cost it doesn’t vary a lot.

Tax free bonds already listed in the market

The next thing to consider is that you can buy tax free bonds already listed in the market so the new bonds should be compared with what’s on offer already. The tax free bonds that are issued this year will very likely have a lower interest rate than the ones issued last year but because the price of the existing bonds has risen up in the past few days it may still be just better to buy the new bonds.

We have to wait and watch what happens but that’s one comparison that is useful, and when the terms of the bonds are out, I will have that on here.

Tax free bonds don’t reinvest your interest

There was a very lively debate last year among readers on the returns calculation from a SBI fixed deposit that compounds your interest 4 times a year, and then you can reinvest this money for a longer term, something you can’t do with a tax free bond as it pays you the interest every year without the reinvestment option.

I did a very detailed post with calculations that showed comparisons between the two, but I think Hemant did a much better job explaining how this affects returns and you should read point 2 from the post before investing in these bonds.

The takeaway is that if you don’t reinvest the interest from the bonds, and just spend it away then you aren’t going to make too much.

Conclusion

Finally, though not really the topic of this post, if you’re planning investments for your baby or retirement or buying a car or just about anything, just one product will not give you the best results. You have to mix and match and buy a few things to get the most out of your money.

What is the difference between operating income and net income?

There aren’t many accounting posts here partly because accounts is not my strong suit and partly because financial accounting is not really all that important as far as personal finance goes.

However this question popped up a few days ago and it is easy enough to answer so I’m doing this post.

First, the original comment for context.

Krishna V R Muppavarapu November 16, 2012 at 6:56 pm [edit]: What does it mean when a company has positive operating income but a negative net income? To my understanding the these two numbers differ only by the taxes and interest to be paid. Does that mean the company has lots of debt? Is it a good idea at all for one to seek employment with such a company, given that the person has a median financial profile (in terms of savings and debt)?

Reply

Krishna partly answers his own question in the comment because Net Income really is Operating Income minus interest, taxes, and exceptional items.

Operating income is sales minus operating expenses and is also referred to as EBIT (Earnings Before Interest and Taxes). Sales is easy enough to understand where you don’t need further explanation on it and Operating expenses are the expenses needed to run the business like raw materials and employee salaries. Depreciation is a non cash expense that’s also deducted from sales to arrive at Operating Income.

I took a screenshot of Suzlon’s financial results (click to enlarge) to show Operating Income and Net Income because I had a feeling that they are a company that is likely to have a positive operating income and a negative net income, something that proved to be right for the financial year ended March 2012, and I have highlighted the two amounts that show a positive operating income and a negative operating income.

For the second part of the question, that’s a bit harder to answer but personally I can’t see myself saying no to a job just because the company has made a loss.

If a company makes a loss this year, that doesn’t mean it will continue to make losses forever and while there is a greater chance of layoffs in such a company than a company without any losses, other things being equal, I wouldn’t say no to a job just because of this. Even if you see Suzlon’s example, it employs a lot of people and has done that for a number of years, what the future holds no one knows but just the fact that people have been gainfully employed in loss making companies in the past shows that this alone is no reason to say no to job in my mind.

Thoughts?

Effects of black money on Indian economy

A few days ago Mr. Ramamurthy posted an interesting comment which didn’t actually talk about black money, but I believe that’s what he meant and indeed that’s what a lot of people mean when they talk about corruption in this context.

Here’s his comment for context:

RamamurthyÂ November 12, 2012 at 8:25 amÂ [edit]

Lot of talk is going on with corruption in India.Corruption is of 2 kinds.Major and Minor.Major is the corrupt money earned by the politicians etc running into several crores which normally is kept in foreign banks.The minor is in smaller sums small time officials receive money for favours rendered.
What happens to the money received and what are the consequent effects on the Indian economy?.I feel the Major corruption money which gets transferred to foreign countries and which do NOT come back to india is a loss to Indian economy.What remains in India is not a loss.It just means a mere transfer of Indian rupees from one pocket to another.Am I right?
Please dont assume I am advocating corruption. It is very bad as the consequences need not be always economical.

Although there is no set definition of black money, I think it’s fair to say that when you talk about black money, you’re usually referring to either money that’s earned doing something illegal like smuggling or stealing or you’re talking about money on which you haven’t paid taxes.

We will not talk about the first type of black money in this post because that’s a criminal activity and at least for this post, I think it will be simpler to just think about the money on which taxes haven’t been paid.

Before I go any further, I’ll refer to the budget post that I wrote earlier this year, and specifically to the chart that showed how the government raises money to run the country.

What this shows is that the bulk of government revenues come from taxes, and that’s where black money eats into government revenues.

When someone evades taxes then government revenues decline and this in turn adds to the already massive deficit that the Indian government has.

To finance this deficit, the government has to borrow more money which is one cause of inflation and high prices, so you can say that black money causes strains on the government finances which in turn affects the common in the form of high prices. So, to that extent I feel that even the black money that is not transferred out of India is not merely a transfer and does affect the economy negatively.

However, I do feel that money that is transferred out of India affects the economy even more negatively than the money that’s still within India as long as the money that’s in India gets spent.

If the black money is just lying stashed away in trunks and mattresses then that’s no good, but if people spend it then that stimulates the economy.

If the money gets spent then that works to stimulate the economy and though not as good as trade done in white money is still better than the money not getting spent at all.

Khan Academy, Sir Alex Ferguson and a Starless Planet

The most fascinating thing I read this week was this Forbes piece on the Khan Academy, I have seen many of his videos myself and I’m just blown away by how effective his tutorials are and how he simplifies difficult concepts and makes them easy to digest. This is a great article and if you have time for only one article then this should be the one you read.

Next, an interesting piece about how our brain can do maths unconsciously, more than the idea itself I’m always fascinated by the way they carry out such experiments.

Ajay Shah writes about the IRR of UID scheme.Â

A very interestingÂ HBS case study on Sir Alex Ferguson.

ET on the 2G auction failure.

An interesting piece about a starless planet that floats alone in space.

Finally, have you done the puzzle where you have to get the goat and the wolf across the river in your boat?

Enjoy your weekend!

Introduction to mutual funds in India

Ankita Dhokia posted the following comment in the Suggest a Topic page back in August:

Ankita Dhokia August 28, 2012 at 8:17 pm [edit]: Hi ,
I wish to invest in mutual funds. I am an amateur and am completely lost in the numerous schemes offered by all companies. I wish to know the co relation between interest rates and stocks, debentures and money market instruments. Kindly guide on the same.
Thanking you ,
Ankita

Reply

What is a mutual fund?

The first thing to understand is that mutual funds are investment vehicles, and that simply means that investors pool their money together and then the mutual fund invests that money on their behalf. The easiest way to understand this is to think that as an individual investor you would’ve gone to the stock market and bought a share, but now as a mutual fund investor you buy a mutual fund unit, and then the mutual fund pools together your money with money from other investors and then goes and buys shares on your behalf.

What do mutual funds invest in?

There are four main type of mutual funds based on what they invest in.

1. Equity Mutual Funds: These are mutual funds that invest in shares of other companies.

2. Debt Mutual Funds: Debt mutual funds are mutual funds that invest in debt instruments so they may buy debentures of a company or government and other such things. Here is an article that lists out the different types of debt funds.

3. Commodity Mutual Funds: These are mutual funds that own commodities like gold, and in reality, India only has gold based mutual funds.

4. Hybrid Mutual Funds: Hybrid mutual funds invest in a mix of the above three classes at the same time. So for example, they may invest 65% of their money in shares and 35% in debt.

The answer to which mutual fund you want to invest in depends on what you actually want to buy and your appetite for risk.

If you want to invest in shares and understand that investing in shares can sometimes mean that you even lose your capital then equity funds are for you.

If you want to be safe and protect your capital then you should only invest in debt mutual funds.

If you were interested in getting returns from gold then you should invest in a gold mutual fund. A hybrid fund is for someone who needs a balance.

Take a look at this page with the explanation of the different types of debt mutual funds, and this page if you want to know the difference between a debt and an equity product.

Deepak Shenoy has a great video on the different type of equity mutual funds.

How can I buy a mutual fund?

There are several ways to buy a mutual fund, you can go to the website of the mutual fund directly and buy it from there. You can buy them from an agent offline, you can buy them from a brokerage portal like ICICIDirect.com, and then there are free platforms like FundsIndia.com that you can use to buy mutual funds.

Conclusion

I understand that even this basic information can be a little overwhelming for the beginner so I think if you know nothing, then start by learning three things about them – what they are, what do they invest in and how can you invest in them?

The what is simply that they are investment vehicles that pool together money from different investors and then invest it on their behalf.

They invest in either shares, bonds, commodities or a combination of these.

And you can invest in them by using online portals or just contact an agent offline; there are many ways to buy them based on what you’re most comfortable with.

Please leave a comment if you have any questions or comments.

Can one person open two PPF accounts?

Srinivas posted the following question a few days ago:

SRINIVAS September 17, 2012 at 10:48 pm [edit]

Can an exclusive article be written on PPF?. Actually, there is lot of confusion on this, despite the popularity of the product . The question is ,whether one individual can open two accounts -one in his name and the other on the name of minor child- and contribute Rs.100000/- to each of the accounts? everybody talks about availability of tax exemption upto Rs.100000/-, but nobody explicitly conforms that contribution can be made to multiple accounts exceeding Rs100000 and claim tax exemption upto Rs1.0 lakhs only.

I think there are two questions here, and I’ll try to break this up and answer each one individually.

1. Can one person open more than one PPF account?

No, you can’t, you can only have one PPF account for yourself except if you want to open one as a guardian of your child.

2. If I can’t open multiple accounts then can I open one for my minor children as their guardian?

You can open another account for your minor children as their guardian but that doesn’t mean that the tax deduction doubles, that still remains applicable as an individual.

As far as I know, it doesn’t double the amount that you can put in these two accounts, so you can’t put Rs. 2 lakhs in the two PPF accounts, for the purpose of calculating the limit, they are treated as one account only. If someone knows this to be different then please leave a comment.

The husband and wife both can’t open an account on the name of the same child, and grandparents can’t open an account for their grandchildren.

Other Questions

Other than these two questions, I see that PPF has a thread on Jago Investor discussion forum and there they have dealt with some questions like how much this money will amount to after 15 years and that’s a good link for further reading.

Can NRIs invest in the Indian stock market?

NRIs (Non Resident Indians) are allowed to invest in the Indian stock market and while I’ve felt the paperwork and the methods are a little cumbersome to do so, there are many NRIs who regularly invest in the Indian stock market and I’m sure like most other things, once you overcome the initial setup hassles and teething troubles, this process isn’t all that bad.

In my mind, there are three main ways for NRIs to invest in the Indian stock market.

1. Invest in India based ETFs

The US and UK have ETFs that allow you to invest in the Indian stock market without having needing to do any additional paperwork or documentation with an Indian bank or broker.

These ETFs trade in their respective countries in their respective currencies and you can trade in them like you would trade in any other stock.

There is one big thing to consider when you buy India based ETFs.

They will be impacted by the exchange rate movements, which means that along with the underlying asset, which is usually the Nifty, this ETF will also be impacted if the Rupee goes up or down against the host currency.

Also, this ETF is just not for NRIs, and anyone living in the country can buy these ETFs. Here is a list of India based ETFs in the US that I did some time ago.

2. Invest Directly in Indian Stocks

NRIs can also invest directly in Indian stocks, but they need to set up some accounts before they can do this.

First, you either need a NRE or a NRO bank account, then you need an approval under the PIS (Portfolio Investment Scheme) which allows you to invest in the Indian stock market, and then you also need a Demat account to transact in India. Usually, banks can help you get this approval and the same bank can help you open a NRE / NRO account, get a PIS approval and open a Demat and a trading account.

When you have all this done, you can invest in Indian stocks but not all stocks are eligible for NRI investment. RBI publishes a list that shows you which stocks are or aren’t eligible for NRI investing.

3. Invest through Indian mutual funds

NRIs can also invest in Indian mutual funds and you need a bank account in India like the NRE or NRO account to invest in mutual funds. As far as I understand, you don’t need to have PIS approval or a Demat account in order to invest in mutual funds. If anyone knows differently then please leave a comment and let me know.

Conclusion

These are the three ways for a NRI to invest in India, and when you actually go down to the execution of these ways you will find that it is difficult to do all the paperwork or even get answers to your questions if you are going for the second or third route, which is why you see a lot of Indians sending money home to their parents or spouses and then letting them invest this on their behalf. These things have their own complications and it’s just better to face the trouble to have everything setup correctly at the beginning rather than face trouble later on down the road.