The PEG Ratio

The PEG Ratio is the PE Ratio of the stock divided by the growth in future EPS of the stock.
When used in conjunction with the PE and the P/BV ratios, it gives a clearer picture of the
under or over valuation of the stock. Typically a stock with a PEG of 1 means that it is fairly
valued in the eyes of the market provided the market is trading at a PEG of less than 1 and
so are the peer group stocks. It is important here to note that the PEG ratio cannot and
should not be used in isolation.

Lets take the example of the transmission and distribution sector. Given the government's
thrust on the power sector most of the stocks in this sector have a PEG of less than 1. While
the market growth rate warrants that in the large cap universe as well as the mid cap
universe the market is overvalued and fairly valued respectively, what this means is that
the sector which comprises of companies like Kalpataru Power Transmission, Jyoti
Structures and KEC International will be a relative outperformer in the times to come. What
this also implies is that these companies with high growth potential and PEGs of less than 1
are currently undervalued.

Similarly a PEG ratio of greater than 1 means that the company (assuming that the sector
that the company belongs to has a PEG of less than 1) is overvalued. Here we can take the
example of Larsen and Toubro. The company's valuations including the PEG are way beyond
the EPS growth that it can deliver. But hold it. This does not mean that the stock has to be
written off and dumped. Growth stocks also have PEGs greater than 1. Maybe the market
does not have an alternative stock to replace Larsen in any portfolio.

This brings us to the point of sector dynamics. In this sector a large order book size and
accretion to the order book every quarter is more important than anything else. So given
Larsen's huge order book, the market has no hesitation assigning premium valuations to the
stock. And this includes a PEG ratio of more than 1. Hence Larsen is a growth stock. By the
same token a stock with a PEG ratio of less than 1 is perceived as undervalued. These
stocks whose earnings growth potential may be very high in the future are waiting to be
discovered by the market. Again we assume that the PEG is less than that of the peers and
the market. One stock here that comes to my mind is J Kumar Infraprojects. The stock at
the CMP Of Rs 114 is trading at a PE of 4.24x FY11 and a PEG of 0.15 FY11. The company
belongs to the infrastructure space and the order book is Rs 1220 crores. In FY09 the
company clocked sales of 405 crores, which means that the stock is waiting to be
discovered by the market (given its track record of timely execution of projects).
P/E Ratios, what are they and what do they mean?

Introducing the P/E ratio

The P/E, or price-to-earnings ratio, is one of the most important metrics for an investor as it
describes the true price of a stock. The ratio measures the relationship between market
price and current profits (earnings) and can be calculated as follows;

P/E ratio = Market Price / EPS

, where EPS = Earnings per share

For example if a stock trades at 20Rs and current Earnings Per Share (EPS) is 2Rs, the
stock has a P/E ratio of 20/2 = 10. This could also be calculated by

Dividing market capitalization by total profits.

The P/E ratio expresses the cost of purchasing the right to one unit of profit. For example, a
P/E ratio of 10 means that based on the current levels of profitability an investor must pay
10 units in order to acquire the rights to 1 unit of profit. A higher P/E ratio means investors
pay more per unit of profit than a lower P/E ratio.

Why do stocks have different P/E ratios?

Ownership of a stock implies the (somewhat theoretical) right to a share of future profits.
Differences in P/E ratios generally represent a risk premium being applied to the earnings of
one company versus another, due to uncertainty around the future.

For example, if company A and company B have the same EPS but company A is expected
to double its profits next year, while company B is expected to have static profits, then
company A will trade at a higher price. Because both stocks have the same EPS, but
company A trades at a higher price, company A has a higher P/E ratio.

Typically a stock which is expected to grow profits in the future, will trade at a higher P/E
ratio than one which is expected to have static profits. Similarly a company with secure (low
risk) future earnings will have a higher P/E ratio than a company with unsecure (high risk)
future earnings. In this sense the P/E ratio expresses market's confidence in a stock's future
earnings.
What is a high P/E and what is a low P/E?

As an extreme generality, for a market as a whole, P/E ratios below 8 is considered to be on

the low side, P/E ratios between 8 and 20 are often to be considered to be fairly valued
while P/E ratios above 20 indicate the stock is highly valued (or over valued).

However these are broad generalizations and can be dangerous to rely on. Investors should
not just look at P/E ratios for stocks in isolation, as different sectors tend to have different
P/E ratios. For example a P/E ratio which would be considered low for a small and immature
communications company may not be considered low for a large oil refining business.

A quick and simple way of using P/E ratios is to compare a stock's P/E with the P/E ratios of
its competitors, the average P/E ratio for their sector and the market average. This gives a
good indication of how the market views the stock in relation to others.

Using P/E ratios to make investment decisions

Although P/E ratios are extremely important, two pieces of information should be
remembered;

Firstly, the right to future profits implied by owning a stock does not in itself generate
income for the investor. The actual return earned on a stock depends on the future sale
price and the dividend yield, which is determined not only by earnings but also the
company's dividend policy.

Secondly, in most circumstances the current market price has already taken account
(factored in) expected future earnings. This means that in order for the price of a stock to
rise (over a prolonged period of time) the current earnings expectations must be exceeded
by the firms actual performance or future expectations should be higher than current
expectations, for some other reason.

The key point to remember is that a high P/E ratio may imply earnings are expected to rise
in the future, but if they do rise this does not automatically mean the price will also rise.
This is because the increase was expected and already factored into the price.

Because of this, investors often shy away from stocks with extremely high P/E ratios (25+)
because in order to make a decent return, the company must improve upon the already
extremely high expectations. In fact value investors, such as Warren Buffet specifically look
for stocks which are under priced and often invest in stocks with low P/E ratios (although
this is by no means the only criteria). The important thing to remember is that the P/E ratio
of a stock is the true measure of price and even an extremely good company may be a bad
investment if the price is too high.

[email protected]
Does P/E Matter?

P/E multiple is the most used and the most abused multiple in the investment world. It is
generally believed that company with high growth rates will have high multiples and vice
versa and if one finds a stock with high growth but low P/E than it's a good buy. But what
we fail to appreciate is the important role that returns on capital (ROIC) play in channelling
growth into a high or low multiple. It's common sense: growth requires investment, and if
the investment doesn't yield an adequate return over the cost of capital, it won't create
shareholder value. That means no boost to share price and no increase in the P/E multiple.

To illustrate, most Retail companies, like Pantaloon, are witnessing high growth. To give
high P/E multiples to retail companies just because of their high growth is misleading, as it
doesn't take into account returns on capital (ROIC). Retail companies fight it out primarily
on price, which translates into lower margins and relatively low returns on capital. Such
high P/Es, based on the high growth rate of the company, will not be sustainable.

To demonstrate the relationship between Growth, ROIC & P/E, Michael Mauboussin, CIO of
Legg Mason Capital Management, developed a grid describing growth and return for a
theoretical company.

The grid clearly proves that P/E is determined by both ROIC & growth. The table is
shown below: -

ROIC and P/E Multiples: Theory

         
Earnings   ROIC    
Growth 4% 8% 16% 24%
4% 6.1× 12.5× 15.7× 16.7×
6% 1.3x 12.5x 18.1x 20x
8% NM 12.5x 21.3x 24.2x
10% NM 12.5x 25.5x 29.9x

NM = not meaningful.

Note: Assumes all equity financed; 8 percent WACC; 20-year forecast period.
Thus we see that it is both growth and ROIC that determines whether company will create
or destroy value. We as investors should look for the rare company that can combine high
growth with high returns on capital.

We should remember that we should not avoid stocks just because it has a high multiple
relative to peers or buy a stock with high growth but low P/E multiple. We should try and
understand the complex chemistry of growth, return on invested capital, and P/E multiples
while making investment decision.

To summarize, we see that P/E and company's investment success or failure will
be determined by:

· Growth rate of the company

· The magnitude of capital required to sustain the growth

· The spread between the return on capital and the cost of capital and how long a company
can deploy capital at positive spreads

PE is so simple to calculate: Price per share divided by the EPS (earnings per
share). And you are bashing it?

Simple to calculate, yes; but it has several deficiencies, especially in the Indian context.
Most Indian companies' P&L (profit and loss) accounts feature significant `other income',
which is usually not related to business operations and varies a lot from year to year.

Also, by definition, growth drivers and risk factors of `other income' are quite different from
income from business operations. A key item is income from investments, which is driven
mainly by interest rate scenario, investments sale activity during the year, and also non-
market rate related investments made by the company (in related entities).
Enterprise value (EV) demystified

A lot of attention is paid these days to market capitalization of a company in order to

discriminate between the large caps and the mid and small cap companies. It is almost as
though the enterprise value of a company has gone into oblivion. The concept of enterprise
value is a more wholesome concept than market capitalization. The enterprise value (EV) is
an indicator of how the market attributes value to the company as a whole. The problem
with market capitalization is that it leaves a few important factors out of its ambit. For
example a company's debt and its cash reserves. Enterprise value takes both into account
in determining the company's valuation. Here is the formula to calculate EV:

EV=Market capitalization + Debt – (Cash and investments).

But why are debt and cash considered in EV? Debt because, if you are planning to buy the
whole company you have to also clear its liabilities. The cash, because when you buy the
company, you get the cash for free. Which is why the debt is added and the cash is
subtracted from the market capitalization.

Think of two companies that have equal market caps. One has no debt on its balance sheet
and the other is laden with debt. The debt-laden company will be making interest payments
on the debt over the years. Preference share capital and convertibles also have to be
treated as Debt for this purpose. Clearly even though the two company's have the same
market capitalization it is more desirable to buy the company with Zero Debt. This is why
stock market pundits these days advocate zero debt companies.

Now imagine two companies with equal market capitalization and zero debt. Let's say both
have a market cap of 500 crores. One has no cash and the other has 50 crore cash. If you
bought the first company with zero cash for 1000 crore your investment is worth just that.
While if you buy the second company it costed you just 950 crores!!. Since you instantly get
Rs 50 crore cash.

Knowing a company's enterprise value is just not enough. You can learn more about a
company by comparing EV to EBITA (Earnings before interest and tax and Amortisation).
EV/EBITA can demonstrate how EV works better than Market cap for evaluating companies
with different cash and Debt levels i.e capital structure. It is important to use EBITDA in the
ratio because EV assumes that upon the acquisition of a company, its acquirer immediately
pays debt and consumes cash.

Lets say there are 2 comparable stocks A and B. At Rs.50 per share A has a market cap of
500 crores and a P/E ratio of 5.But it had Debt of 50 crores on its Balance sheet. So A's EV
is 550 crores and an EBITDA of 150 crore (assumed). So EV/EBITDA=3.67.

B enjoyed a share price of Rs 45 and a market cap of 300 crore. And a P/E ratio of 10. But
because A had less debt (50 crores) its EV was 550 crores and its EV/EBITDA was 3.67.
Compared to B's 2. (Assume B's Debt was 100 crore and EBITDA 200 crore).
By P/E A looked half the price of B. But on EV/EBITDA basis B is a better pick. In sum we
can say that EV gives us the capability to compare 2 companies with different capital
structures.

[email protected]

EV/EBITDA is a smarter ratio to be used as part of comparable multiples analysis.

Smarter, because it is purely driven by business operations of the company unlike PE
multiple, which additionally gets impacted by non-business factors of discretionary or non-
recurring nature. Non-business factors are usually less predictable from retail investors'
point of view.

If we decide to switch to the alternative, that is, the EV/EBITDA multiple, how do
we go about the exercise?

It should first be noted that the EV/EBITDA multiple, being a brilliant metric, is more tedious
to compute than the PE multiple. EBITDA, the denominator, overcomes all the deficiencies
that PE suffers from. But, one needs to make some adjustments...

Such as?

Add back to `net profit after tax' the charge for depreciation, interest and tax, and also
remove the non-operating/non-recurring items of income/expense.

The removal of latter items may not be easily possible as requisite information is not very
transparent in annual accounts as per Indian company law format.

Making adjustments to the price, i.e. market cap is a little more tedious in fact. One needs
to reduce market value of non-operating assets (e.g. surplus properties, investments, loans
to group companies) from market cap. Loan funds borrowed by the company need to be
added to the market cap to arrive at EV, the enterprise value.
Company Valuation

Valuation means the intrinsic worth of the company. There are various methods through
which one can measure the intrinsic worth of a company. They are mentioned below:

Net Asset Value (NAV)

NAV or Book value is one of the most commonly used methods of valuation. As the name
suggests, it is the net value of all the assets of the company. If you divide it by the number
of outstanding shares, you get the NAV per share.

Say, a company’s share capital is Rs. 100 crores (10 crores shares of Rs. 10 each) and its
reserves and surplus is another Rs. 100 crores. Net worth of the company would be Rs. 200
crores (equity and reserves) and NAV would be Rs. 20 per share (Rs. 200 crores divided by
10 crores outstanding shares).

NAV can also be calculated by adding all the assets and subtracting all the outside liabilities
from them. This will again boil down to net worth only. One can use any of the two methods
to find out NAV.One can compare the NAV with the going market price while taking
investment decisions.

Discounted Cash Flows Method (DCF)

DCF is the most widely used technique to value a company. It takes into consideration the
cash flows arising to the company and also the time value of money. That’s why, it is so
popular. What actually happens in this is, the cash flows are calculated for a particular
period of time (the time period is fixed taking into consideration various factors). These
cash flows are discounted to the present at the cost of capital of the company. These
discounted cash flows are then divided by the total number of outstanding shares to get the
intrinsic worth per share.

POSITIVE OPERATING CASH FLOW

The net cash that a business generates through its operations, as reflected in the company’s
cash flow statement, is also a critical feature. It is important for a company to have a
positive cash flow from its operations. A company can report net profit in its profit & loss
account without generating a positive cash flow from the socalled ‘profitable’ growth.
Another parameter to be considered is free cash flow, i.e. the cash left with the company
after capital expenditure (capex). Any company may have negative operating cash flow
(OCF) for one or two years, but a good company with a sustainable business model cannot
have a history of negative OCFs. Similarly, a well-managed company should not have
negative free cash flow for many years in a row.
DEBT-EQUITY RATIO

This is a critical tool to measure a company’s leverage. A low debt-equity ratio is generally
preferred, but is not always necessary. Companies in capital-intensive sectors like
infrastructure, real estate, cement, steel and oil & gas typically have high debt-equity ratios,
while those in sectors like FMCG, IT and pharmaceuticals generally have low debt-equity
ratios.

The phase of a company’s growth is also an important factor to be considered. A company

in a growth phase may, at times, choose to leverage itself more than ideally required,
against a company that has an established business. Higher debt increases the finance
costs, which can be costlier to service in a high interest rate regime. Conversely, raising
money through equity can be difficult during a bear phase.

INTEREST COVERAGE RATIO

The company’s ability to service its debt is another important criterion to judge its health.
The lower the interest coverage ratio, the more difficult it is for the company to service its
debt. Investors should consider the debt-equity and interest coverage ratios simultaneously.
Suppose a company has high debtequity ratio, but it also has high interest coverage, then it
is in a good position to service its debt.

PRICE-TO-BOOK VALUE (P/BV)

This ratio of the stock’s market value to book value helps in knowing its relative under or
over-valuation . A lower P/BV multiple typically indicates that the stock is under-valued , but
this may not always be the case. Again, this ratio varies from industry to industry. A capital-
intensive industry will typically have a lower P/BV multiple. Banks generally use this ratio,
because unlike manufacturing companies, they measure their assets at market value. Since
book value takes into account only tangible assets and liabilities, this ratio may not be
useful for companies holding a significant intellectual property, or an FMCG company with
many brands.

RETURN ON CAPITAL EMPLOYED (RoCE) & RETURN ON NET WORTH (RoNW):

For a company, RoCE and RoNW should be significantly higher than the prevailing interest
rate. If a company’s RoCE is consistently lower than say 15%, that is not a healthy sign and
it indicates an economically inefficient operation. However, any good company may report
lower RoCE or RoNW during an economic downturn or high investment phase. So it’s always
helpful to compare RoCE or RoNW on a historical basis. But it doesn’t make sense to
compare RoCE of two companies in two different sectors. It’s best to compare it with peers
in the same or related industries.
Under Valuation or Over Valuation

“Stock X looks to be overvalued hence book profit"

“Stock Y is undervalued maintain buy"

Above are the statements, which are generally been used by stock market analyst to give
buy or sell signals. Recipe to earn profit is to buy a stock at cheaper valuation and sell a
stock once it gets overvalued. Various ratios like PE, PBV, PEG, PSR, EV/EBITDA and
valuation models like Dividend discount model facilitate investment professionals to best
guess the under/over valuation levels. Construction of a valuation model requires stimuli
generated through proper analysis on Economy, Industry and company (E-I-C), which is
both time consuming and taxing and better left for investment professionals. Hence an
investor resorts to relative valuation wherein he compares two stocks on the basis of
market multiples like Price to Earning ratio (PER) and buy the one, which is quoting at,
lower multiple. Though relative valuation yields fruits but when not done in conjunction with
fundamentals, results can be misleading. Hence in this article I am sharing a simple
strategy that will help you to spot undervalued or overvalued stocks with in a particular
sector so as to maximize profit.

Brief on Valuation

Valuation of any asset, equity or any firm is present value of expected future cash flow,
discounted at riskiness attached to expected future cash flow.

Hence, Valuation= Function (Expected cash flow, growth, risk)

Objective of valuation exercise is to pick a stock that will grow at higher expected cash flow
at lower level of risk

Example: Mr. Sourav Ganguly needs to pick one stock out of the following two

Expected growth in cash flow Risk

Stock A 14% 28%

Stock B 10% 5%

Since Sourav Ganguly is an aggressive investor hence he picked Stock A boasting 14% of
expected growth in cash flow. But valuation theories suggest stock B will be better bet since
it offers 10% growth rate at lower risk of 5% means higher return per unit of risk.

Strategy: Valuation Multiple in sync with fundamental performance

Step 1: Pick up one sector: Each sector is being governed by different underlying forces
and hence valuation constituent like expected cash flow, risk differs from one sector to
another. Sector like retail quotes at higher valuation multiples based on bright earning
visibility leading to higher expected growth rates whereas public sector banks even with
higher expected cash flow growth continued to quote at lower valuation multiple since
banking regulation makes them risky.

Step 2: Construct rectangular grid: Build a rectangle where in breadth get represented by
earning multiple and length gets represented by company's fundamentals. Take the data for
all the required companies belonging to same sector irrespective of market capitalization
and plot it on the grid. Here Price to sales ratio will act as earning multiple and profit margin
reflects company's fundamentals

PSR                    

Here

Quadrant I= Over valuation Zone

Quadrant II= Fair valuation Zone

Quadrant III= Fair Valuation Zone

Quadrant IV= Under valuation Zone

Step 3: Peer comparison: Once rectangular grid is complete then buy stock that fall under
quadrant IV or in outermost boundary of quadrant IV. Similarly, investor should sell the
stock that falls in quadrant I. Quadrant III and IV represent fair valuation zone.

Rationale behind the above strategy

Relative valuation multiples like PSR, PER are the most simple and easy ratios to
comprehend value in given stock. It clearly defines market price as function of earning.

Example: Company X Pharmaceutical Ltd trades at Price to Sales ratio (PSR) =2 suggest
that investor need to pay twice of current earning to buy one stock of company X. Hence, if
in FY 2008 sales per share stands at Rs 10 then market price of stock will be Rs 20(10-2).
Besides above stated benefits still relative valuation is not free from all weaknesses as
mentioned below:

It fails to facilitate fair intra companies comparison: It will continue to justify buying a
undervalued stock in an overvalued sector. Say in IT sector PSR of 10 times (Company A)
looks attractive in comparison to PSR of 20 times (Company B) though sector internals like
earning visibility, profitability might not support higher valuation.

Hence to set right above stated weakness it is imperative to cross verify earning multiples in
light of company's fundamental performance indicators like profit margin

Conventional wisdom suggest that profit margin has a linear relation with PSR

Price/Sales= (Profit margin - Dividend payout -(1+g))

(Cost of equity- g)

Here g= Sustainable growth rate

Above equation suggest that Price to sales ratio is positively correlated to profit margin,
dividend payout and higher expected earning and negatively correlated to cost of equity.

Hence above strategy cross verify earning multiples against profit margin to arrive at
internal strength of earning multiple
Example

To demonstrate above strategy IT sector has been selected with its leading stocks been
plotted on rectangular grid. As per the grid Iflex, Wipro and Satyam appears to be
overvalued as they fall in Quadrant I where in Infosys, Rolta and TCS are fairly valued.

Out of seven IT stocks Helios Matheson stands out in Quadrant IV which suggest buy.

       PSR

 - PSR and Profit margins are for FY 2008

Same strategy can be employed with regression analysis as well indicating a linear
relationship between profit margins and PSR. A regression analysis between profit margin
and earning multiple like PSR for the seven IT stocks results in following regression
equation:

PSR (Regressed multiple)= -.68362+ .180 (Profit margin for IT Stock)

Multiple R= .391

R square= .153

Hence to compute regressed PSR for Wipro profit margin for FY 08 is considered (20.66%)
giving PSR of 3.03 though currently stock is quoting at PSR of 3.57 times making stock
overvalued as indicated by above rectangular grid.

The regression analysis method can be repeated for remaining six stocks to substantiate
finding of rectangular grid as mentioned above.
How to select a company using Fundamental Analysis

In this volatile market, nobody wants to have a bumpy ride and lose money in the risky
instrument like equity. Caution needs to be taken and instead of going for the `tips', doing
your own `homework' certainly helps.

Common investors, if they invest their time in selecting the businesses, which are
fundamentally strong, then they should not fret over the market movements.

Here are some pointers to look at before investing in any business.

1. Income

- Look at the quarterly and yearly progress in the earnings of the company

- Look at its competitors' earnings and do a comparative analysis

- See whether the income is coming from its core businesses and its growing

- Give attention to debt part, see whether it is shrinking or growing

2. Change

- Keep an eye on any change in management, geographical focus or any new launch of
product which could make/destroy the value

- See what is the capital structure of the company, any change, issue of new shares,
buyback

3. General Points

- The stage of the economy, i.e. Expansion, Recession, Peak, Trough

- See whether the company has monopoly or is the market leader in any segment which is
expected to grow exponentially

Following are the additional points which you must look at before selecting the company.
Important parameters in Stock Selection

-The company must have an adequate size (Sales of Rs 150 crore may be taken as
adequate size for Indian companies)

-Current ratio should be 2:1

-The total debt should not be greater than its equity capital

-The company should have paid dividends and earned profits for the last 7-8 years

-There should be a 10% growth in earnings per share (EPS) over the last five years

-The current price should also not be more than 2 times the latest book value.

-The latest year's operating cash flow should be positive and it must exceed the current

year's net income.

-Look for the companies like Infosys which is a zero-debt company. Such companies are
safe investments as the amount of the profit shared by the equity shareholders is bigger
compared to that of leveraged ones.

-Asset Turnover should be growing, as it shows the company's sales are increasing at the
same asset base.

-Return on Assets and Return on Equity, both these ratios should show grow every year as
it shows the efficient use of the assets and capital

-Number of issued shares should be the same or less over the years, if not then dig deeper
to see whether company has issued any bonus shares or split the shares and see whether
your EPS will grow or reduce.

-Ask yourself questions like - How competitive the company is? Is the company equipped to
tap the opportunities, how innovative it is?

-Look at the Order book of the company - How strong it is?

-The company should be investor friendly like Infosys, Reliance. It should pass the benefits
to its shareholders immediately.

E-mail - [email protected]
On how the metric can be put to use.

The EV/EBITDA multiple can be compared to probe real (business) or market imperfection
related reasons for differences in EV/EBITDA multiple across various comparable companies.
A similar PE multiple analysis will not be amenable to this probing.

For example?

Two companies in a sector may have similar PE multiple but very different EV/EBITDA
multiple. A PE multiple analysis may suggest that both are similarly valued by the market
whereas in reality EV/EBITDA multiple analysis will highlight use of very different multiples
for business valuation of the two companies by the market.

EV/EBITDA multiple analysis may upon further probing suggest that market will likely in
future work towards converging both companies' EV/EBITDA multiple to a similar level
(assuming broad operating similarities in the companies), providing basis for buy or sell
investment opportunities.

And, in the converse?

On the converse, similar EV/EBITDA multiples but very different PE multiples may not
suggest converging of both companies' PE multiples. The divergence of PE multiples may be
due to non-operational reasons.

For instance, the company with lower PE multiple may have invested significant sums in
related entities with lower than market returns. And so, the latter will not yield any
significant buy/sell opportunity for an investor.

The bottom line, therefore?

EV/EBITDA ratio's increased usage would benefit capital markets also as retail investors
appraise corporate managements more effectively while making smarter investment
decisions for themselves.

We need to help retail investors by providing this ratio to them periodically.

Valuing super normal growth

In the previous article , we had seen how to put a measure to the growth expectations
embedded in a stock price. In this article we attempt to price a stock, which is expected to
show very steep earnings growth.

We came across very simple formulae, for determining the price of a stock. If g is the
assumed growth for of the dividend over a course of time, the value of the stock is
determined by

D
P0 = ----
r-g

Where Po= expected price

D = Dividend paid out at the end of the year
r = Expected returns
g = Perpetual growth rate of dividends being paid

However, the problems here are twofold. Firstly, the growth rate is not constant and can
vary significantly year to year. For example, Infosys grew by more than 100% in FY01 but
the growth for FY01 is expected to be 30%. Secondly, the value of g is more than r and
therefore, the formulae cannot handle this calculation.

Thus, the best method to arrive at a price is to estimate expected the dividends for every
year for those years in which supernormal growth is expected and then to assume a
perpetual growth rate. This is because a steep or supernormal growth cannot last forever.
Eventually, the growth figure will fall in line with the GDP growth rate of the major economy
in which the business operates. Otherwise eventually the business will become bigger than
the economy.

Thus, the value of a stock is the present value of the expected future dividends. To recall

D1 D2 D3 D4 Dn + Pn
P0= ---- + ------ + ----- + ----- + ........ -----------
(1+r) (1+r)2 (1+r)3 (1+r)4 (1+r)n

Here, future dividends are estimated based on the growth expectations.

D1 D1(1+g2) D2(1+g2) D3(1+g3) Dn/(r-g)

P0= ---- + ----------- + ----------- + ---------- + ... ----------
(1+r) (1+r)2 (1+r)3 (1+r)4 (1+r)n
The dividends after a foreseeable period of time are expected to grow at a constant growth
rate perpetually.

 Estimating the required rate of return (refer ### below)

Thus, the variable that becomes most critical in the calculation is growth. Estimating growth
rates accurately would give an accurate idea about the value of the stock. The growth rates
can be assumed by looking at past data, macro economic numbers, industry growth rates,
relative market share data and other qualitative aspects.

Year EPS DPS Payout EPS DPS

ratio growth growth

FY94 1.2 1.8 143.4% -  

FY95 2.0 2.3 111.9% 64.8% 28.6%

FY96 3.2 2.5 78.6% 58.2% 11.1%

FY97 5.1 2.8 54.0% 60.1% 10.0%

FY98 9.1 3.0 32.9% 79.4% 9.1%

FY99 20.7 3.8 18.1% 126.8% 25.0%

FY00 43.2 4.5 10.4% 108.7% 20.0%

FY01 94.2 10.0 10.6% 118.0% 122.2%

Let us take the example of Infosys here. Infy’s dividends in the past 8 years have grown at
a CAGR of 30.8%. However, this is due to the spike (115% growth) in FY00. The CAGR
growth rate from FY94 to FY00 for dividends works out to be 13.5%. This should give a
good idea about what kind of growth rates to expect from the company under normal
circumstances.

However, considering the fact that Infosys has established a strong brand for itself, the
company is expected to beat industry growth rates and continue to grow swiftly till it
reaches substantial market penetration. Infosys, in FY01, with revenues of around US$ 367
m had a 0.1% market share of the US$ 367 bn services market. IBM that has had revenues
of US$ 14 bn from services in the US (10% market share) is expected to post a growth of
about 7.5% in services revenues for FY01.

For the next three years considering that the US economy revives, Infosys the dividends
can be expected to grow at a rate of around CAGR 30%. However, for the next five years
after that assuming that revenue growth starts to decline the dividend growth could be
expected to taper.

Then we have assumed the growth to be in the range of 15% between (FY08 to FY011).
Growth after this has been taken to be 10% for the next three years. Finally, the company
is expected to grow perpetually at 5% in the future.

Year EPS DPS Payout EPS DPS Present

(Rs) (Rs) ratio growth growth value (Rs)

FY02E 124 15.0 12.1% 31.8%   15

FY03E 175 26.2 15.0% 40.5% 74.5% 23

FY04E 254 44.5 17.5% 45.7% 70.0% 34

FY05E 330 66.1 20.0% 30.0% 48.6% 43

FY06E 413 92.9 22.5% 25.0% 40.6% 53

FY07E 496 123.9 25.0% 20.0% 33.3% 62

FY08E 570 156.8 27.5% 15.0% 26.5% 68

FY09E 656 196.7 30.0% 15.0% 25.5% 74

FY10E 754 245.0 32.5% 15.0% 24.6% 80

FY11E 867 303.4 35.0% 15.0% 23.8% 86

FY12E 954 357.6 37.5% 10.0% 17.9% 88

FY13E 1,049 419.6 40.0% 10.0% 17.3% 90

FY14E 1,154 490.4 42.5% 10.0% 16.9% 92

(Note the expected returns have been assumed to be 15%)

At the end of FY14, the company’s dividends are expected to be Rs 490. Assuming the
dividends continue to grow perpetually at the rate of 3%, value of the stock based on stable
growth in FY14E would be Rs 4, 083. The present value of this works out to be Rs 664. Thus
the total value of the stock comes to around Rs 1,472.
However, the stock currently is trading at a price of Rs 4,533 this works out to be a
premium of about 208%. There are certain reasons for which the company commands
higher valuations, which could be management quality and transparency. Also another
factor contributing to he high price of the stock is sentiment. The markets could be
expecting a recovery in the technology sector and even stronger growth rates from the
company. However, the theoretical calculations could give you an idea about how low the
stock price can move. Post September 11, in the free fall the company touched a low of Rs
2,156.

A significant part of the price is derived from the company’s stable growth rate in the future.
For our calculations we have assumed a very conservative 3%. To justify the current stock
price (Rs 4,533) the perpetual growth rate required (consequent to above mentioned
growth rates) is 12.9%. The question is what says the company will be able to manage such
a fast growth rate? The S&P 500 between 1925 and 1995 has grown at a CAGR of 10%.
This growth rate suggests a price of Rs 2,467.

###
Stocks: Measuring expectations

The most mysterious thing especially with the software stocks has been their price. The
price of a security can be broadly divided into two elements viz. the intrinsic value of the
stock and the speculative element. But from the point of view of making a long-term
investment, and not punting, it is the intrinsic value that ultimately matters. Arriving at the
intrinsic value is, however, of little help as many times the stocks are nowhere near their
correct valuations and in recent times speculative element in stock price has increased
considerably. The idea of this report is to help you evaluate whether market assumptions
that go into pricing of the stock are realistic or not. The attempt is not to put a correct price
to the stock.

The price of a stock is fundamentally based on two components. The future cash flow from
expected dividends and the expected capital gains on the stock.

(P1-P0)
As expected return (r) = D1/P0 + --------
P0
Where,
D1 = Divided expected
P1= Price at end of year one
P0= Current market price

D1 + P1
Rearranging we get, P0 = ---------
1+r

P1 would again depend on the next years expected dividend and the stock price at the end
of year two so on and so forth.
 D1 D2 D3 D4 Dn + Pn
P0= ---- + ------ + ----- + ----- +........ -----------
(1+r) (1+r)2 (1+r)3 (1+r)4 (1+r)n

Thus, the current stock price is nothing but the present value of the dividends and the
future market price at a terminal date. To arrive at a stock price we need to know the future
price, the expected rate of return and the expected dividend.

Estimating the required rate of return

The key variable here is r, the expected return. The value of r, i.e. expected return will vary
according to the risk perception regarding the company in question. More the risk more the
return will be expected.

To determine expected return the risk profile of the individual stock is to be measured. The
benchmark against which risk for an individual stock is measured is the equities market as a
whole represented by indices like DIJA (Dow Jones Industrial Average), BSE Sensex and
NSE Nifty. By plotting the returns of a particular stock against the index, the sensitivity of a
stock to that particular market can be measured. This measure is known as the Beta or
sensitivity of the stock to the market. If the beta is less than one then the stock is less
prone to factors affecting the market as a whole. If the beta is more than one the stock
price is very sensitive to events in the market.

The expected return can be calculated using the capital asset pricing model (CAPM).
According, to the CAPM, the expected risk premium on a stock is the market risk multiplied
by beta or the sensitivity. Thus, we can conclude higher the value of beta higher the
sensitivity and higher the expected risk.

Expected risk premium (Rp) = beta - (Rm - Rf)

Where, Rm = Return on markets

Rf = Risk free rate of return

Once we have estimated the risk premium, all we need to do is add the risk free rate of
return to the risk premium to get the expected return on the stock. As the risky investment
will provide for returns at least equal to risk free investments and additional returns, which
are proportional to the risk profile of the investment.

Thus, expected return r = Rf + Rp

For the risk free returns Government security yields can be used. Thus, for Infosys the
expected rate of return was 21.1%.

Company Risk free Beta Market expected

returns- premium return ( r )
 Infosys 10.3% 1.5 7.0% 21.1%
Satyam 10.3% 1.6 9.0% 24.9%

As per company's FY01 balance sheet.

-Yeild on Government securities dated 2021

Estimating the terminal price

It has been observed that over longer period of time the dividend component of a stock
price is far greater than the present value of the future price. Thus, for simplicity's sake we
will assume that the stock price is a function of the dividends only and neglect the terminal
price.

The stock price therefore is the present value of dividends paid out by the company.
Assuming constant dividends for simplicity the stock price is now the present value of a
perpetuity discounted at r or the expected rate of return.

Thus, D
P0 = ---
r

If g is the assumed growth for of the dividend over a course of time, the value of the stock
price changes to

D
P0 = ----
r-g

Rearranging the previous equation would give us a very interesting interpretation of the
expected rate of return.

Thus,
r=D+g
--
P0

The expected return therefore is a combination of the dividend yield and expected growth.
We often use terms like growth and income stocks. The stocks, which derive a greater
component of their price from dividend yield, are income stocks. While stocks that largely
owe their price to growth expectations are growth stocks.
Infosys is expected to pay Rs 15 in dividends this year. At the current market price of Rs
2,956, this works out to be 0.5%. Thus, remaining 20% return is expected from the growth
in the business. On the other hand HLL is expected to give a dividend of Rs 4.5 in FY02. The
company's cost of equity works out to be 19.7%. Consequently, the implicit growth rate is
17.6%.

To estimate the expected growth rate in a stock price we have to delve a bit deeper.
Assume that the company does not see any growth in the future and pays out all its
earnings as dividends. In such a case DPS (dividend per share) = EPS (earnings per share).

Thus, DPS
r = --------
P0
Rearranging we get

DPS EPS
P0 = ----- = -------
r r

Infosys is expected to earn an EPS of Rs 124 in FY02. Therefore, the price of the stock
assuming no growth and cost of equity as 21.0% would be Rs 589. Of the current market
price Rs 2,956, Rs 589 is on assumption that the company will continue to have a constant
EPS (no growth) of Rs 124 for a considerable period of time in the future.

Thus, Rs 2,368 in the price is due to the present value of the growth. The company pays
dividend of Rs 15 and therefore the money ploughed back into the business is Rs 109. With
a return on equity of 36.4% this investment is expected to generate Rs 40. Assuming that
the investment generates Rs 40 every year

(40)
NPV = -109 + ------ = Rs 80
0.21

Returns on growth oppurtunity

Div for FY02E (Rs) 15
Money ploughed back 109
ROE 36.4%
 Cash in flow from investment of Rs 108 40
NPV of this investment 80

Thus the price due to growth,

NPV
PO = -----
r-g

80
2,368 = -------
0.21- g

Solving for g we get a growth rate of 17.3% embedded into the stock price. Of course this
growth rate is for a considerable period of time. However, any deviation in growth rates
from this estimated (towards the downside) in the near future would adversely impact the
stock price. According to Gartner, markets for IT services are expected to grow at a CAGR
(compounded annual growth rate) of 16%, from a size of US$ 749 bn in FY01 to US$ 1,174
bn in 2004.

In Satyam's case assuming a cost of capital to 24.9%, and an estimated EPS of Rs 52 for
FY02 the price considering no growth comes to around Rs 208. However, the stock is
trading at Rs 146, as on a consolidated basis it is making losses.

Before concluding we would like to make a point, i.e. companies like Infosys have shown a
supernormal growth rates of 100%, which is not sustainable over a long period of time.
Eventually, the growth rates fall in line with the growth in GDP and therefore, a growth rate
for perpetuity is the growth rate of the global GDP. This is a single digit growth figure, which
is below 5%. The decision that has to be made now is will Infosys be able to grow at 17%
for the foreseeable future? And will Dr. Reddy be able to grow at 12% for a considerable
period of time? This will help you determine the price of the stock is realistic or not.
What is an IPO?

Answer:  

IPO or Initial Public Offer is a way for a company to raise money from investors for its future
projects and get listed to Stock Exchange. Or An Initial Public Offer (IPO) is the selling of
securities to the public in the primary stock market.

Company raising money through IPO is also called as company ‘going public'. 

From an investor point of view, IPO gives a chance to buy shares of a company, directly from
the company at the price of their choice (In book build IPO's). Many a times there is a big
difference between the price at which companies decides for its shares and the price on
which investor are willing to buy share and that gives a good listing gain for shares allocated
to the investor in IPO.

From a company prospective, IPO help them to identify their real value which is decided by
millions of investor once their shares are listed in stock exchanges. IPO's also provide funds
for their future growth or for paying their previous borrowings.

Who decides the Price Band?

Answer:  Company with help of lead managers (merchant bankers or syndicate members)
decides the price or price band of an IPO.

SEBI, the regulatory authority in India or Stock Exchanges do not play any role in fixing the
price of a public issue. SEBI just validate the content of the IPO prospectus.

Companies and lead managers does lots of market research and road shows before they
decide the appropriate price for the IPO. Companies carry a high risk of IPO failure if they
ask for higher premium. Many a time investors do not like the company or the issue price
and doesn't apply for it, resulting unsubscribe or undersubscribed issue. In this case
companies' either revises the issue price or suspends the IPO.

Who decides the date of the issue?

Answer:  Once ‘Draft Prospectus' of an IPO is cleared by SEBI and approved by Stock
Exchanges then it's up to company going public to finalize the date and duration of an IPO.
Company consult with the Lead Managers, Registrar of the issue and Stock Exchanges before
decides the date.
What is the role of registrar of an IPO?

Answer:  Registrar of a public issue is a prime body in processing IPO's. They are
independent financial institution registered with SEBI and stock exchanges. They are
appointed by the company going public.

Responsibility of a registrar  for an IPO is mainly involves processing of IPO applications,

allocate shares to applicants based on SEBI guidelines, process refunds through ECS or
cheque and transfer allocated shares to investors Demat accounts.

What is the role of Lead Managers in an IPO?

Answer:  Lead managers are independent financial institution appointed by the company
going public.  Companies appoint more then one lead manager to manage big IPO's. They
are known as Book Running Lead Manager and Co Book Running Lead Managers.

Their main responsibilities are to initiate the IPO processing, help company in road shows,
creating draft offer document and get it approve by SEBI and stock exchanges and helping
company to list shares at stock market.

What is Follow on public offering or FPO?

Answer: Follow on public offering (FPO) is public issue of shares for already listed
company.

What is primary & secondary market?

Answer:  Primary market is the market where shares are offered to investors by the issuer
company to raise their capital.

Secondary market is the market where stocks are traded after they are initially offered to
the investor in primary market (IPO's etc.) and get listed to stock exchange. Secondary
market comprises of equity markets and the debt markets.

Secondary market is a platform to trade listed equities, while Primary market is the way for
companies to enter in to secondary market.
What is the life cycle of an IPO prospectus?

Answer:  Stage 1:  Draft Offer document

"Draft Offer document" is prepared by Issuer Company and the Book Building Lead Manager
of the public issue. This document is submitted to SEBI for review. After reviewing this
document either SEBI ask lead managers to make changes to it or approve it to go ahead
with IPO processing.

Draft document are available on SEBI's website in the section of ‘Reports -> Public Issues:
Draft Offer Documents filed with SEBI" at: http://www.sebi.gov.in/SectIndex.jsp?
sub_sec_id=70

"Draft Offer document" is usually a PDF file having information of an investor who needs to
know about the public issue. It mainly contain information about the company, its business,
management,  risk involve in applying to this issue, company financials and the reason why
company is raising money through IPO.

Stage 2:  Offer Document

Once the ‘Draft Offer document' cleared by SEBI, it becomes "Offer Document".  Offer
Document is the modified version of ‘Draft Offer document' with SEBI suggestions.

"Offer Document" is submitted to the registrar of the issue and stock exchanges where
Issuer Company is willing to list.

Stage 3: Red Herring Prospectus

Once "Offer Document" gets clearance from Stock Exchanges, Issuer Company add Issue
size and price of the issue to the document and make it available to the public. The issue
prospectus is now called "Red Herring Prospectus".

Red Herring Prospectus also can be found on SEBI website at:

http://www.sebi.gov.in/SectIndex.jsp?sub_sec_id=72

 What is the life cycle of an IPO?

Answer:  Below is the detail process flow of a 100% Book Building Initial Public Offer IPO.
This process flow is just for easy understanding for retail IPO investors. The steps provided
below are most general steps involve in the life cycle of an IPO. Real processing steps are
more complicated and may be different. Please visit SEBI website, stock exchange website
or consult an expert for most current information about IPO life cycle in Indian Stock
market.

1. Issuer Company - IPO Process Initialization

1. Appoint lead manager as book runner.
2. Appoint registrar of the issue.
3. Appoint syndicate members.
2. Lead Manager's - Pre Issue Role - Part 1
1. Prepare draft offer prospectus document for IPO.
2. File draft offer prospectus with SEBI.
3. Road shows for the IPO.
3. SEBI – Prospectus Review
1. SEBI review draft offer prospectus.
2. Revert it back to Lead Manager if need clarification or changes (Step 2).
3. SEBI approve the draft offer prospectus, the draft offer prospectus is now
become Offer Prospectus.
4. Lead Manager - Pre Issue Role - Part 2
1. Submit the Offer Prospectus to Stock Exchanges, registrar of the issue and
get it approved.
2. Decide the issue date & issue price band with the help of Issuer Company.
3. Modify Offer Prospectus with date and price band. Document is now called
Red Herring Prospectus.
4. Red Herring Prospectus & IPO Application Forms are printed and posted to
syndicate members; through which they are distributed to investors.
5. Investor – Bidding for the public issue
1. Public Issue Open for investors bidding.
2. Investors fill the application forms and place orders to the syndicate members
(syndicate member list is published on the application form).
3. Syndicate members provide the bidding information to BSE/NSE electronically
and bidding status gets updated on BSE/NSE websites.
4. Syndicate members send all the physically filled forms and cheques to the
registrar of the issue.
5. Investor can revise the bidding by filling a form and submitting it to Syndicate
member.
6. Syndicate members keep updating stock exchange with the latest data.
7. Public Issue Closes for investors bidding.
6. Lead Manager – Price Fixing
1. Based on the bids received, lead managers evaluate the final issue price.
2. Lead managers update the 'Red Herring Prospectus' with the final issue price
and send it to SEBI and Stock Exchanges.
7. Registrar - Processing IPO Applications
1. Registrar receives all application forms & cheques from Syndicate members.
2. They feed applicant data & additional bidding information on computer
systems.
3. Send the cheques for clearance.
4. Find all bogus application.
 5. Finalize the pattern for share allotment based on all valid bid received.
6. Prepare 'Basis of Allotment'.
7. Transfer shares in the demat account of investors.
8. Refund the remaining money though ECS or Cheques.
8. Lead manager – Stock Listing
1. Once all allocated shares are transferred in investors dp accounts, Lead
Manager with the help of Stock Exchange decides Issue Listing Date.
2. Finally share of the issuer company gets listed in Stock Market.

What is the difference between Book Building Issue and Fixed Price Issue?

Answer:  Initial Public Offering can be made through the fixed price method, book building
method or a combination of both.

Difference between shares offered through book building and offer of shares through normal
public issue (Source: BSE):

 Features  Fixed Price process  Book Building process

Price at which securities will be
Price at which the securities are
offered/allotted is not known in advance to
 Pricing offered/allotted is known in
the investor. Only an indicative price range is
advance to the investor.
known.
Demand for the securities offered
Demand for the securities offered can be
 Demand is known only after the closure of
known everyday as the book is built.
the issue.
Payment if made at the time of
 Payment subscription wherein refund is Payment only after allocation
given after allocation.

What is the difference between Floor Price and Cut-Off Price for a Book Building
Issue?

Answer:  Company coming up with Book Building Public Issue decided a price band for the
issue.  The price band usually contains an upper level and a lower level.

Floor Price is the minimum price (lower level) at which bids can be made for an IPO.

Investors can bid for the Book Build IPO at any price in the price band decided by the
company.  In Book Build process retail investors have an addition option to choose "Cut-Off"
price for bidding.
Cut-off price means the investor is ready to pay whatever price is decided by the company
at the end of the book building process. Retail investor has to pay the highest price while
placing the bid at Cut-Off price. If company decides the final price lower then the highest
price asked for IPO, the remaining amount is return to the retail investor.

What is the difference between retail investor, Non-institutional bidders and

Qualified Institutional Bidders (QIB’s)?

Answer:  Investors can apply for shares in an IPO in 4 different categories:

1. Retail Individual Investor (RII)

In retail individual investor category, investors can not apply for more then Rs one
lakh (Rs 1,00,000) in an IPO. Retail Individual investors have an allocation of 35% of
shares of the total issue size in Book Build IPO's.
NRI's who apply with less then Rs 1,00,000 /-  are also considered as RII category.

2. High Networth Individual (HNI)

If retail investor applies more then Rs 1,00,000 /- of shares in an IPO, they are
considered as HNI.

3. Non-institutional bidders

Individual investors, NRI's, companies, trusts etc who bid for more then Rs 1 lakhs
are known as Non-institutional bidders. They need not to register with SEBI like
RII's. Non-institutional bidders have an allocation of 15% of shares of the total issue
size in Book Build IPO's.

4. Qualified Institutional Bidders (QIB's)

Financial Institutions, Banks, FII's and Mutual Funds who are registered with SEBI
are called QIB's. They usually apply in very high quantities.

QIBs are mostly representatives of small investors who invest through mutual funds,
ULIP schemes of insurance companies and pension schemes.

QIB's have an allocation of 50% of shares of the total issue size in Book Build IPO's.

In a book built issue allocation to Retail Individual Investors (RIIs), Non Institutional
Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of 35:15: 50
respectively.
QIB's are prohibited by SEBI guidelines to withdraw their bids after the close of the IPOs.
Retail and non-institutional bidders are permitted to withdraw their bids until the day of
allotment. 

As a retail investor I want to apply more then Rs 1 lakhs in an IPO. Can I invest in
Non-institutional bidder’s category? If yes then what are advantages or
disadvantages of this?

Answer:  Yes, a retail individual investor can bid for more then Rs 1 Lakhs in an IPO by
applying in 'Non Institutional Investors' category. There is no upper limit for bidding amount
in 'Non Institutional Investors' category.

Advantage: You can apply for more then Rs 1 Lakhs and may get much better allocation
then a retail bidder.

Disadvantage: Non-institutional bidders have an allocation of 15% of shares of the total

issue size in Book Build IPO's, while retail Individual investors has 35% (remaining 50% is
for QIB's).  As Non-institutional category has much smaller in size, issue usually
oversubscribed much higher (then in retail category) and less shares allocation.

Is it mandatory to have PAN number to apply in an IPO?

Answer:  Yes, Since July 2006, SEBI made PAN number mandatory for IPO applicants.
Forms submitted without PAN number or wrong PAN numbers are considered as faulty
application and they are not considered for IPO allotment.

It's highly recommended that you double check your PAN number information before
submitting the IPO application form. If you are filling the IPO application through online
stock broker, make sure he has correct information.

How many days is the issue open?

Answer:   As per Clause 8.8.1, Subscription list for public issues shall be kept open for at
least 3 working days and not more than 10 working days. In case of Book built issues, the
minimum and maximum period for which bidding will be open is 3 - 7 working days
extendable by 3 days in case of a revision in the price band. The public issue made by an
infrastructure company, satisfying the requirements in Clause 2.4.1 (iii) of Chapter II may
be kept open for a maximum period of 21 working days. As per clause 8.8.2., Rights issues
shall be kept open for at least 30 days and not more than 60 days.
What information should I keep after I submit the IPO application form?

Answer:   This is a very important question for all IPO investors. If you are applying for an
IPO, make sure you retain following information for future correspondence with the
company or registrar of the issue.

1. Application form photo copy

2. Cheque photo copy
3. Application number in case of online IPO submission

What is 'Market Lot Size' and 'Minimum Order Quantity' for an IPO?

Answer:  IPO 'Market Lot' and 'Minimum Order Quantity' are two important factors investor
should know while bidding for an IPO.

Minimum Order Quantity, as name says, is the minimum number of shares investor can
apply while bidding in an IPO. If investor wants to bid for more shares, they can apply in
multiples of IPO market lot (lot Size or IPO bid lot) of shares.

Usually (Market Lot - Lower side of the issue price) values around Rs 5500/- to Rs 6000/-.

Example:
IPO: Power Grid Corporation of India Limited IPO
Public Issue Price: Rs. 44/- to Rs. 52/- Per Equity Share
Market Lot: 125 Shares
Minimum Order Quantity: 125 Shares

Investor can apply in this IPO as below:

At Rs 44/- - 125 Shares - 1 Lot = Rs 5500/-

At Rs 44/- - 125 Shares - 2 Lot = Rs 11000/-
At Rs 44/- - 125 Shares - 18 Lot = Rs 99000/-

At Rs 52/- - 125 Shares - 2 Lot = Rs 13000/-

At Rs 52/- - 125 Shares - 1 Lot = Rs 6500/-
At Rs 52/- - 125 Shares - 15 Lot = Rs 97500/-

Does applying in an IPO guarantee me to get certain amount of shares?

Answer:  No, applying for shares in an IPO or actually bidding for shares in an IPO doesn't
give any guarantee to get the shares.
As it's a bidding process, allotment depend on number of bids received in different
categories, the price at which investor applied for shares etc.

Once IPO closes, registrar of the issue collect all the bidding information and prepares a
‘Basis of Allotment'. This document provides information about the bids received by verity of
investors at different prices and the pattern of allotment.

Investing in IPO’s is much less riskier then directly investing in stock market. Is
that true?

Answer:  Not really. But IPO's are excellent way to enter in to some stocks. Not all the
IPO's give good returns.

Few risks involve in applying in IPO's are:

1. Stock list at lower then issue price.

2. Issue oversubscribed heavily and investor doesn't get allotment.
3. Any mishandling in processing refund could delay in getting the money back for
shares not allocated.

Can I apply in an IPO through multiple applications on same name?

Answer:  No, one person cannot apply multiple times through multiple applications for an
IPO. It's a rule and if you apply in an IPO though multiple applications with same name or
same demat account or same PAN Number, all of your application will be rejected.

If you would like to place order for multiple application, it works if you apply one each of
your family member's name. But again all eligible family members should have a demat
account and a PAN number.

How many days is the issue open?

Answer: Book Building IPO remains open for 3 to 7 days and may extend for another 3
days in case of revision in price if issue remain unsubscribe in initially decided days. Number
of days issue remain open is decided by the issuer company and its issue lead manager.
Right issues remain open for minimum 30 day and no longer then 60 days.

What is Basis of Allocation or Basis of Allotment?

Answer: Basis of Allotment or Basis of Allocation is a document publishes by registrar of an

IPO to stock exchanges and IPO investors. This document provides information about final
price fixed for an IPO, issue subscription (bidding) information or demand of an IPO and
share allocation ratio.

The IPO allotment information is categorized by number of shares applied by an applicant.

For each such category detail bidding information is provided in this document including
number of valid application received, total number of share applied, ratio of the allotment
and number of shares allocated to the applicants.

Ratio of the allotment is a critical field for IPO's oversubscribed multiple times. This field
tells how many applicants will receive single lot of shares among a certain number of
applicants. For example, ratio 1:8 means only one out of eight applicant received one lot of
shares; ratio value 'FIRM' means all the applicants are eligible to receive certain amount of
share.

Click here to check Basis of Allotment of recently closed IPO.

Can I revise or cancel my IPO application?

Answer:  Book Building IPO: Yes an investor can revise bided quantity and price of an
already applied Book Building IPO anytime if the issue is still open for subscription. Investor
has to fill a revision form and give it to the syndicate member.

Where do I get an IPO application form?

Answer:  Investor can get the IPO Application Forms from:

1. Nearest stock broker office or

2. From the syndicate member office of an IPO. Syndicate members are usually
banks or other financial institutions (i.e. SBI). List of syndicate members of an IPO
are published in IPO Prospectus.

IPO application forms are available for free. Filled application can be submitted to any stock
broker office or syndicate member office.
Can a minor apply in IPO?

Answer:  Some companies allow minors to bid for their IPO and other doesn't. So it
depends on IPO to IPO.

This information is usually provided under section "Who can apply?" of the IPO
Prospectus.

For example:

Religare Enterprises Limited IPO prospectus says:

Indian national's resident in India who are majors, or in the names of their minor children
as natural/legal guardians in single or joint names (not more than three) can bid for this
IPO.

Power Grid Corporation of India Limited IPO prospectus says:

Bidders are advised to note that Bids are liable to be rejected on, inter alia, the following
technical grounds - Bids by persons not competent to contract under the Indian Contract
Act, 1872, including minors and persons of unsound mind etc.

Investor has to disclose age of the applicant in IPO Application Form.

Tips to choose right IPO for investment.

Answer:  

Checklist for banking on the right IPO. Published by Ruma Dubey from Premium
Investments.

1. The issue size has to be big, the bigger the issue, the higher is the capability of the
promoters.

2. Money begets more money, so if they have raised more money, be sure, they will be able
to earn more.

3. A higher promoters stake is a must, instills a sense of responsibility.

4. A background check on the promoters capabilities

5. Size of projects in the pipeline, will indicate the scalability of the company
6. Last but not the least, in big companies, look for long term wealth creation and not
speculative gains.

Click here to check the complte article.

Can a person apply in the non-institutional bidder category of an IPO?

Answer:  Yes an individual investor can apply in Non Institutional Investors category of an
IPO.

"Individual investors, NRI's, companies, trusts etc who bid for more then Rs 1 lakhs are
known as Non-institutional bidders. They need not to register with SEBI like RII's. Non-
institutional bidders have an allocation of 15% of shares of the total issue size in Book Build
IPO's."

There are few advantages and disadvantages for retail investor to apply under non-
institutional category of the IPO.

Advantage is that there is no upper cap on application amount. An individual investor can
bid for any amount in this category where there is limit of Rs 100'000 in Retail category.

Disadvantage is that only 15% of total shares are part of Non Institutional Investors
category. The Retail Individual Investors (RIIs) category has 35% of total shares available
for investors. This means that Non Institutional category oversubscribed heavily and
chances of getting allotment are much lesser.

What is the minimum & maximum investment one could do in HNI category?

Answer: Any bid made by the Retail Investor in excess of Rs 1,00,000 is considered in the
HNI category (Non Institutional Investors category of IPO).

Thus minimum investment amount for HNIs in an IPO is Rs 1,00,000 and the maximum
investment amount is the max amount in the Non Institutional Investors of the IPO.

Can I place a buy order during after hour session before the listing date of an IPO?

Answer:  No, you can not place the buy/sell order for shares which are not yet listed in
stock exchange. Shares can only be traded after they get listed on stock exchange.
Remember that this is not the case in grey market or over the counter trades. Share holders
can trader shares on personal basis before they get listed in stock exchanges. As stock
exchanges are not involved in these deals, they are not responsible for any failure in the
deal.

How one can apply in IPO’s online?

Answer:  To apply in IPO's online an investor has to open an account with financial
institution that provides this facility.

Most of the banks and stock brokers allow its account holders to apply in IPOs online.  Few
popular banks and brokers are ICICI, HDFC, Religare, Motilal Oswal Securities etc. You can
find more detail about these brokers at:

 http://www.chittorgarh.com/newportal/online-stock-brokers-list.asp

There is almost none paperwork involves in applying IPO's online.

Please note that applying in IPO online doesn't give you guarantee to receive the refund
amount through ECS or direct deposit in your account. Refunds are processed by the
registrar of the public issues and its up to them to choose the way they want to refund your
money back which may include refund through cheques.

What is right issue or RI?

Answer:  A public company that wants to raise capital can opt for a Public Issue or a
Rights Issue. Oftentimes they opt for latter, followed by former. In a rights issue, existing
shareholders have the right to buy a specified number of new shares of the firm at a
specified price within a specified time. Usually this price is below market price. The idea is to
reward existing shareholders with an investment opportunity, which is perceived to be
attractive.

Long-term investors can purchase additional shares in right issue at lower than current
market price and hold the stocks.

From short-term investment prospective, one can sell the rights entitlement.

Alternatively, the rights may be allowed to lapse.

If a company is not in growth phase, rights issue tends to lower earnings per share and
dividend yield. In such a scenario, offering rights (or public issue, for that matter) may not
be a prudent course of action.
Declaration date This is the date on which the board of directors announces to
shareholders, and the market as a whole, that the company will pay a dividend, the quntum
of dividend per share and the date on which it will be paid. Declared dividend is an
obligation for a company.

Record Date is the date set by the company to determine, from the records, who are the
holders of shares/bonds of the company. Holders of securities on that date, are entitled to
dividend/interest. An investor must be listed as a holder of record to ensure the right of a
dividend payout.

Ex Date is the date when existing shareholders are entitled to get dividends/ Rights Issue
shares. If you buy a dividend paying stock one day before the ex-dividend you will still get
the dividend, but if you buy on the ex-dividend date, you won't get the dividend. On its ex-
dividend date, the price of a stock usually falls by an amount approximately equal to the
value of the upcoming dividend. Conversely, if the price stays same on that date, the share
price is said to have risen by an amount equal to declared dividend.

Date of payment (payable date) is the date on which the company mails out dividends to
holders of record.

The Investor: Current Shares 100@100rs=10000, right issue declare as 1:1 offer price is Rs
50, 100@50=5000 so Total Purchase price 200@150=15000Rs At the day of Ex Date the
share price will be rs75. So First day Investor will not get any profit.

The Company: Company has 100,000,000 Shares @ 100rs= Capitalization of the stock is
10,000,000,000 Rs. After Right issue Company Has capitalization of the stock (100,000,000
Shares @ 100 rs) + (100,000,000 Shares @ 50 rs ) = 15,000,000,000 If the company were
to do nothing with the raised money, its Earnings per share (EPS) would be reduced by half.
However, if the equity raised by the company is reinvested (e.g. to acquire another
company), the EPS may be impacted depending upon the outcome of the reinvestment.

Why does the retail Individual Investor RII bidding status is not getting updated
every hour?

Answer:  IPO subscription detail or bidding status for book building IPO is provided by the
stock exchanges when IPO is open for bidding. NSE and BSE websites usually publish this
information.

Only part of bidding status gets updated every hour and remaining information is made
available at the end of the day.

Usually Total Bids Received, Total Bids Received at Cut-off Price and total number of times
issue is subscribed information is updated every hour.

The detail bidding status including category wise bidding detail (i.e detail for Qualified
Institutional Buyers (QIBs) - Foreign Institutional Investors (FIIs), Domestic Financial
Institutions (Banks/ Financial Institutions(FIs)/ Insurance Companies), Mutual Funds, Non
Institutional Investors - Corporates, Individuals (Other than RIIs), Retail Individual
Investors (RIIs) etc.) is updated once in a day.

How much tax I have to pay on returns (capital gains) for a particular IPO?

Answer:  If any Capital Asset (stock, property, precious metal etc) is sold or transferred,
the profits arising out of such sale are taxable as capital gains in the year in which the
transfer takes place. 

Capital Assets are of two types i.e., long term and short term.

Shares, debentures and mutual funds are considered as Long-term capital assets when they
are held for more than 12 months before they are sold or transferred. If they are sold or
transferred before 12 months they are considered as short-term capital.

Different rates of tax apply for gains on transfer of the long term and short-term capital
assets. Gains on short-term capital asset are taxed as regular income.

If an investor sells IPO allocated shares with in 12 month of IPO Allotment, he comes under
short-term capital gains. All such gains are taxed along with the investor's regular income
i.e tax on his salary etc.

For long term capital gains and more detail about taxation in India visit:

http://incometaxindia.gov.in/general/computation.asp

Hello friends,

I am 25 yrs old and planning to invest Rs 15,000 every month in the below structured way:

1. start a PPF with monthly installment of Rs 3000.

2. Invest Rs 10000 in 4 SIP's covering

a. large caps.
 b. Small and Mid caps.

c. Gold etfs.

d. Index ETF

Could u please suggest me some good SIP schemes where i can park my money?

3. Buy e-gold with the remaining Rs 2000.

I need suggestions whether this structure is good enough or any modifications need to be
done. Im open to complete change of plan as well. Please advise me on the same. i have a
investment horizon of minimum 3 yrs.

Thank you.

Regards.