Before Picking up stocks..

Bonus shares – A positive sign.

WHAT ARE THEY?

Bonus shares are issued in a certain proportion to the existing holders. A 2 for 1 bonus would mean you get two additional shares — free of cost — for the one share you hold in the company.If you hold 100 shares of a company and a 2:1 bonus offer is declared, you get 200 shares free. That means your total holding of shares in that company will now be 300 instead of 100 at no cost to you.

WHO BEARS THE COST IF IT’S FREE FOR ME?

You are right. There is no free lunch.Bonus shares are issued by cashing in on the free reserves (accumulated profits) of the company.A company builds up its reserves by retaining part of its profit over the years (the part that is not paid out as dividend). After a while, these free reserves increase, and the company wanting to issue bonus shares converts part of the reserves into capital.So you do not pay; and the company’s profits are not impacted.

WHAT ARE THE EFFECTS OF A BONUS ISSUE?

Bonus shares do not directly affect a company’s performance. Bonus issue has following major effects.

1. Share capital gets increased according to the bonus issue ratio.
2. Liquidity in the stock increases.
3. Effective Earnings per share, Book Value and other per share values stand reduced.
4. Markets take the action usually as a favorable act.
5. Accumulated profits get reduced.
6. A bonus issue is taken as a sign of the good health of the company.

WILL THE SHARE PRICE CHANGE AFTER BONUS ISSUE?

A bonus issue adds to the total number of shares in the market.Say a company had 10 million shares. Now, with a bonus issue of 2:1, there will be 20 million shares issues. So now, there will be 30 million shares.This is referred to as a dilution in equity.Now the earnings of the company will have to be divided by that many more shares.(Earnings Per Share = Net Profit/ Number of Shares)Since the profits remain the same but the number of shares has increased, the EPS will decline.Theoretically,When EPS declines, the stock price should also decrease proportionately. But, in reality, it may not happen.

That’s because:

i. The stock is now more liquid. Now that there are so many more shares, it is easier to buy and sell.

ii. A bonus issue is a signal that the company is in a position to service its larger equity. What it means is that the management would not have given these shares if it was not confident of being able to increase its profits and distribute dividends on all these shares in the future.

THE RECORD DATE.

When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus.

After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.

HOW BONUS SHARES CREATES ENORMOUS WEALTH

Bonus shares, in the long run would create enormous wealth for the investor. For example, a Rs 10,000 invested in Wipro in 1980 would have grown into several Crores as shown below:-

In 1980 You buy 100 shares @ Rs 100 per share in your name . In 1981 company declared 1:1 bonus = you have 200 shares

In 1985 company declared 1:1 bonus = you have 400 shares. In 1986 company split the share to Rs. 10 = you have 4,000 shares

In 1987 company declared 1:1 bonus = you have 8,000 shares. In 1989 company declared 1:1 bonus = you have 16,000 shares

In 1992 company declared 1:1 bonus = you have 32,000 shares In 1995 company declared 1:1 bonus = you have 64,000 shares

In 1997 company declared 2:1 bonus = you have 1,92,000 shares. In 1999 company split the share to Rs. 2 = you have 9,60,000 shares

In 2004 company declared 2:1 bonus = you have 28,80,000 shares. In 2005 company declared 1:1 bonus = you have 57,60,000 shares

In 2010 company declared 2:3 bonus=you have 96,00,000 shares.

Share price of Wipro is Rs 428.00 in July 2010

The value of 57,60,000 shares in 2010 – 406.60 Crores.

CONCLUSION

Declaring Bonus shares is a sign that companies are increasing their profitability. If you look back, many companies have announced issues of bonus shares to their shareholders by capitalizing their free reserves . Shareholders have benefited tremendously, even after accounting the inevitable reduction in share prices post-bonus, since the floating stock of shares increases. So keep an eye on bonus history when you decide to buy a stock-It may be a good indicator that the company is healthy.

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Using price and volume to find market trends.

Hi there,

In this post i’m going to talk about two vital pieces of information that you have to keep a close watch. They are ‘price’ and ‘volume’. Both these figures are important and it gives a quick idea about the direction of the stock price.

WHAT DOES IT TELL?

  • Volume – tells you whether there are buyers or sellers for this stock in the market.
  • Price – tells you which direction.

RELATION BETWEEN PRICE AND VOLUME.

If the number of shares traded is high and the prices are also moving higher- that’s a positive signal. You are probably looking at a large group of people investing heavily in that stock. On the other hand, If the number of shares traded is high and the prices are coming down – that’s something to be careful about. You are probably looking at investors backing out from that stock.

Several combinations of price and volumes are possible. Let’s look at the most common scenarios:

  • A price advance with steady increasing volume

This indicates continuing upward momentum. As the price is climbing, more and more buyers are getting attracted until the stock gets into a stage of euphoria that usually indicates the end of the price advance.

  • A slowing pace of buying with decreasing volume

Slow pace in buying also means that there are not many sellers for the stock, which is a good sign. It also indicates that the price is almost at it’s peek and a further up move is unlikely immediately. Since the sellers are in short, the stock might move higher after a pause.

  • A relatively big volume increase during the price advance with lower volume on the pullback.

This indicates a continuing uptrend. The lower volume during the pullback indicates that there are not enough sellers in the market to drive the stock down.

  • Big buying volume without the price going higher

This indicates distribution, which means resistance. A big seller is likely in the market. There is no way to tell yet if the buyers will win this battle and are able to drive the price higher, or if they will give up and the stock eventually reverses.

  • A slow and steady movement upward with consistent volume

This indicates continuing upward momentum. There might be a buyer in the market who is steadily buying shares while trying to not attract too much attention.

CONCLUSION

Tracking on price and volume for a few days will give you an idea about general direction of the market and with some expertise, you can spot the warning signs that a change in direction/trend is coming.

That’s about price and volumes

Bye for now ..

..have a nice day !!

3 Comments

Can you measure management effectiveness?

Hi there,

The success or failure of an organization depends on how effective the management is. The management team of a company is responsible for propelling the future growth in the right direction. It also responsible for administering and controlling the business activities and accounting for the results. An ineffective management at the top results in failure of the company. Such is the importance of management.

So, one has to measure the effectiveness of the management before purchasing a stock. It’s all about finding answer to one single question- Are they doing the right thing?

How do you go about finding answer to that question? To be more specific, how would you assess whether the management utilizing the available resources in the best possible way? How well is the company being run relative to others in its sector and the market as a whole? The answer lies in finding three important ratios -

  • .Return on assets
  • Return on investment ( ROCE)
  • Return on equity ( ROE)

ROE and ROCE was discussed in the earlier posts, so I don’t want to repeat the whole thing here. What remains to be explained is return on assets.

RETURN ON ASSETS

Return on assets is calculated by taking the net income and dividing it by the total assets.

  • ROA = Net Income / Total assets

ROA is a very effective tool . For example – If the total assets of Company as per the balance sheet is Rs 10 million and if it has earned a net income of Rs 20 million , the ROA would be 2 (20 / 10) . It means, for every Rs 1 in assets, the company has made a profit of Rs 2. So , higher the ratio, the better it is.

This ratio should be only used to compare companies in the same industry. The reason for this is that companies in some industries are more asset-insensitive i.e. they need expensive plant and equipment to generate income compared to others. Their ROA will naturally be lower than the ROA of companies which are low asset intensive – like IT service industry.

A single period ROA of a company will not tell you the whole story. You have to check the ROA for the past years and check if it’s showing an increasing trend. An increasing trend of ROA indicates that the profitability of the company is improving.

By measuring the management’s effectiveness,  you will be able to make reasonable comparison between the company and its peers from the same industry or sector.

Before I close, here’s some more thoughts about using ROE, ROCE and ROA.

  • In order to make a clear view of the company’s management effectiveness use all the three ratios mentioned.
  • With ROE you get an idea about how the management is using the money given by the shareholders.
  • ROCE would reveal how the management is utilizing the total capital employed, which includes loans and other debt funds.
  • ROA is a totally different take. It measures the number of times earnings generated using the assets of the company.
  • The basic balance sheet equation is  assets = liabilities + Equity.  So, if there were no liabilities in a company’s balance sheet , the ROA and ROE would be same. In other words, If the ROA and ROE of a company are different, the reason is the presence of liabilities or loan funds in the balance sheet.
  • If a company has loan funds, ROE would be more than the ROA.  How?  A company buys more assets by taking loans, but since equity = assets – liabilities, a company decreases its equity by increasing debt. So, when debt increases, equity shrinks, and since equity is the ROE’s denominator, ROE,  gets a boost. Hance the presence of debt in a company’s balance sheet boosts the ROE in relation to ROA.

That’s about measuring management effectiveness.

Bye for now!!

Have a nice day!!

1 Comment