SIP (Systematic Investment Plan)

Very often we find ourselves as saying – "I don’t have time to invest," or "I can't afford to put away a lot at this point." These are all excuses! We bring to you the concept of SIP – that is a Systematic Investment Plan – which allows you to periodically invest small fixed amounts, which grow at a compounded rate into a substantial amount at the end of your long term plan. An SIP is a service offered by mutual funds and provides you, the investor, with an option of committing a small quantity of money regularly towards investing as opposed to a lump sum investment. Simple? Well, we're just getting started!

Why SIP is good

Now that we are about to lay the foundation for regular investing through the means of SIPs, let’s review why this is a good option to start with.

A systematic investment option such as the SIP enables you to build wealth over a long term horizon. Generally, investors look to time the market. This practice is futile and more often than not, investors buy when prices are rising and sell when the prices are depressed. This is in stark contrast to the sound principle of equity investing – Buy when the price is low, sell when it is high. So how does SIP help in this regard? Since the amount invested each month is fixed, what changes is the net asset value (NAV). So, when the prices are down, the NAV dips which means that you get allotted more units of the fund. Similarly, when prices rise, you get allotted more units, plus the returns on your earlier units, acquired at lost cost¸ rise. This does away with the risky business of timing the markets and ensures that you are investing in a disciplined manner.

So you save and invest in an SIP, but do you know why and how an SIP is good for you, especially as a woman investor? First let’s tell you why an SIP works in your favour. Most women save and spend in equal amounts (at least we hope they do!), though there are times when you find your hand reaching more towards your savings pocket to compensate for the shortfall in the spending account. A sure shot way to ensure the funds stay separate is to keep them in two different accounts. And then introduce the concept of SIP to your savings account! A systematic investment plan will enable you to maintain your savings in a disciplined manner and will also help you make money over the long term.

How SIP works

A systematic investment plan is not much different than the savings option of a recurring deposit account with a post office or a bank, except that these small monthly amounts are invested into a mutual fund. The SIP option is available with all types of funds like equity, income or gilt and works in your favour as the NAV (Net Asset Value) is averaged out as opposed to a one time buy. As you will be investing at regular intervals, the NAV may be higher or lower depending on market fluctuations.

	Person A			Person B
Month	NAV*	Amount	Units	Amount	Units
Jan-09	8.512	1,000	117.4812	12,000	1,409.774
Feb-09	9.591	1,000	104.2644
Mar-09	8.451	1,000	118.3292
Apr-09	8.321	1,000	120.1779
May-09	8.269	1,000	120.9336
Jun-09	9.421	1,000	106.1458
Jul-09	9.478	1,000	105.5075
Aug-09	7.598	1,000	131.6136
Sep-09	8.471	1,000	118.0498
Oct-09	7.987	1,000	125.2035
Nov-09	6.958	1,000	143.7195
Dec-09	7.524	1,000	132.908
Total			1,444.334		1,409.774

* These NAVs are assumed

The table above clearly shows how your cost of purchasing the units of any fund comes down and how a sense of discipline is instilled while investing even when there are swings in the NAV due to volatility in the market.

10 Mistakes Investors Make and How to Avoid Them

Warren Buffett (World's Richest Investor): His Secrets Revealed!!!

Mutual Funds

What are Mutual Funds
A mutual fund is a common pool of money into which investors with common investment objectives place their contributions that are to be invested, in accordance with the stated objective of the scheme. The investment manager invests the money collected into assets that are defined by the stated objective of the scheme. For example, an Equity fund would invest in Equity and Equity related instruments and a Debt fund would invest in Bonds, Debentures, Gilts etc.
Mutual Funds in India-Growing from very Modest Beginnings
The Indian Mutual fund industry has started opening up many exciting investment opportunities for Indian investors. We have started witnessing the phenomenon of savings now being entrusted to the funds rather than in banks alone.
Mutual Funds now represent perhaps one of the most appropriate investment opportunities for most investors. As financial markets become more sophisticated and complex, investors need a financial intermediary who can provide the required knowledge and professional expertise on taking informed decisions.
The Indian Mutual fund industry has passed through three phases:
The first phase was between 1964 and 1987 when Unit Trust of India was the only player. By the end of 1988, UTI had total assets worth Rs.6,700 crores.
The second phase was between 1987 and 1993, during which period, 8 funds were established (6 by banks and one each by LIC and GIC). The total number of schemes went up to 167 and Assets Under Management saw the figures improving to over 61,000 crores.
The third phase was marked by the entry of private and foreign sectors in the Mutual fund industry in 1993. The first entrant was Kothari Pioneer Mutual fund, launched in association with a foreign fund. The Securities and Exchange Board of India (SEBI) formulated the Mutual Fund Regulation in 1996, which for the first time established a comprehensive regulatory framework for the mutual fund industry. Since then several mutual funds have been set up by the private and joint sectors. Currently there are 34 Mutual Fund organizations in India.
Today the AUM of the Mutual Fund Industry stands at over Rs.2 lakh crores, a growth of over 1 lakh crores since the last 5 years. Also the percentage of Equity assets in the overall AUM has increased from a shade under 5% to over 30% in the same period.

OPTIONS in DERIVATIVES MARKET

What are options?
Before you begin options trading it is critical to have a clear idea of what you hope to accomplish. Only then will you be able to narrow down on an options trading strategy. Let us first understand the concept of options.
An option is part of a class of securities called derivatives.
The concept of options can be explained with this example. For instance, when you are planning to buy some property you might have placed a nonrefundable deposit to hold it for a short time while you evaluate other options. That is an example of a type of option.
Similarly, you have probably heard about Bollywood buying an option on a novel. In 'optioning the novel,' the director has bought the right to make the novel into a movie before a specified date. In both cases, with the house and the script, somebody put down some money for the right to buy a product at a specific price before a specific date.
Buying a stock option is quite similar. Options are contracts that give the holder the right to buy or sell a fixed amount of a certain stock at a specified price within a specified time. A put option gives the holder the right to sell the security, a call option gives the right to buy the security. However, this type of contract gives the holder the right, but not the obligation to trade stock at a specific price before a specific date. Several individual investors find options useful tools because they can be used either as:
A) A type of leverage or
B) A type of insurance.
Trading in options lets you benefit from a change in the price of the share without having to pay the full price of the share. They provide you with limited control over the shares of a stock with substantially less capital than would be required to buy the shares outright.
When used as insurance, options can partially protect you from the specific security's price fluctuations by granting you the right to buy or sell shares at a fixed price for a limited amount of time.
Options are inherently risky investment vehicles and are suitable only for experienced and knowledgeable investors who are prepared to closely monitor market conditions and are financially prepared to assume potentially substantial losses.
What are the different types of Options? How can Options be used as a strategic measure to make profits/reduce losses?
Options may be classified into the following types:
a) Call Option
b) Put Option
As mentioned before, there are two types of options, calls and puts. A call option gives the holder the right to buy the underlying stock at the strike price anytime before the expiration date. Generally Call options increase in value as the value of the underlying instrument increases.
By contrast, the put option gives the holder the right to sell shares of the underlying stock at the strike price on or before the expiry date. The put option gains in value as the value of the underlying instrument decreases. A put option is one where one can insure a stock against subsequent price fall. If the value of your stocks goes down, you can exercise your put option and sell it at the price level decided upon earlier. If in case the stock price moves higher, all you lose is just the premium amount that was paid.
Note that in newspaper and online quotes you will see calls abbreviated as C and puts abbreviated as P.
The examples stated below will explain the use of Put options clearly:
Case 1:
Mukesh purchases 1 lot of Infosys Technologies MAY 3000 Put and pays a premium of 250 This contract allows Mukesh to sell 100 shares of Infosys at Rs 3000 per share at any time between the current date and the end of May.Inorder to avail this privilege, all Mukesh has to do is pay a premium of Rs 25,000 (Rs 250 a share for 100 shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.
Case 2:
If you are of the opinion that a particular stock say "Ray Technologies" is currently overpriced in the month of February and hence expect that there will be price corrections in the future. However you don't want to take a chance , just in case the prices rise. So here your best option would be to take a Put option on the stock.
Lets assume the quotes for the stock are as under:
Spot Rs 1040
May Put at 1050 Rs 10
May Put at 1070 Rs 30
So you purchase 1000 "Ray Technologies" Put at strike price 1070 and Put price of Rs 30/-. You pay Rs 30,000/- as Put premium.
Your position in two different scenarios have been discussed below:
1. May Spot price of Ray Technologies = 1020
2. May Spot price of Ray Technologies = 1080
In the first situation you have the right to sell 1000 "Ray Technologies" shares at Rs 1,070/- the price of which is Rs 1020/-. By exercising the option you earn Rs (1070-1020) = Rs 50 per Put, which amounts to Rs 50,000/-. Your net income in this case is Rs (50000-30000) = Rs 20,000.
In the second price situation, the price is more in the spot market, so you will not sell at a lower price by exercising the Put. You will have to allow the Put option to expire unexercised. In the process you only lose the premium paid which is Rs 30,000.
What is open interest?
The total number of option contracts and/or futures contracts that are not closed or delivered on a particular day and hence remain to be exercised, expired or fulfilled through delivery is called open interest.
What are Index Futures?
As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock Index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.
What is meant by the terms Option Premium, strike price and spot price?
The price that a person pays for a call option/Put Option is called the Option Premium. It secures the right to buy/sell that particular stock at a specified price called the strike price. In other words the strike price is the specified price at which the holder of a stock option may purchase the stock. If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium. Premium of an option = Option's intrinsic value + Options time value The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract is called the Strike price. Spot Price is the current price at which a particular commodity can be bought or sold at a specified time and place.
What is meant by settlement price?
The last price paid for a contract on any trading day. Settlement prices are used to determine open trade equity, margin calls and invoice prices for deliveries.
How does one determine the price of an option?
A variety of factors determine the price of an option.
The behavior of the underlying stock considerably affects the value of an option. Investors have different opinions about how a particular stock will behave in the future and hence may disagree about the value of any given option.
In addition, the value of an option decreases as its expiration date approaches. Thus, its value is also highly dependent on the amount of time left before the option expires.
Intrinsic & Time Value
An options price is composed of its intrinsic value and time value.
What a particular option contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in the money or out-of-the-money at expiration. Intrinsic value is how far an option is 'in-the-money.' Thus, the phrase is an adjective used to describe an option with an intrinsic value. A call option is in- the-money if the spot price is above the strike price. A put option is in the money if the spot price is below the strike price.
It is calculated by subtracting the options strike price from the spot price. An out-of-the-money option has an intrinsic value of zero.
For example if XYZ is trading at Rs 58 and the June 55 call is trading at Rs 4, to calculate the intrinsic value subtract Rs 55 from 58, leaving you with Rs 3 of intrinsic value. The remaining Rs 1 is known as extrinsic or time value.
Time value is the amount over intrinsic value that a buyer pays for the option. While buying time value, an options purchaser assumes that the option will increase in value before it expires. As the option nears expiration, its time value starts decreasing toward zero.
Theoretical Value
Theoretical value is the objective value of an option. It shows how much time-value is left in an option. The most commonly used formula to calculate the theoretical value of an option is known as the Black-Scholes model.
This model considers the price of the stock, the options strike price, the time remaining before expiration, the volatility of the underlying stock, the stock's dividends and the current interest rate while arriving at the theoretical value of the option.
Although an option may trade for more or less than its theoretical value, the market views the theoretical value as the objective standard of an option's value. This makes the price of all options tilt toward their theoretical value over time.
The Components of Theoretical Value
Volatility
The volatility of the underlying stock is one of the key factors in determining the value of an option. Often, the options price increases as the volatility of the stock increases. The difficulty in predicting the behavior of a volatile stock permits the option seller to command a higher price for the additional risk.
There are two types of volatility, historical and implied. As the term suggests, historical volatility is a measurement of the stocks movement based on its past behavior.
By contrast, implied volatility is calculated using option prices. It is a measurement of the stocks movement as implied by how the market is currently valuing options.
Dividends
As an owner of a call option you can always exercise your right to the stock and receive any dividend it might pay. Interest RateIf you buy an option rather than a stock, you invest less money upfront.
Days Until Expiration
An option, being a wasted asset; wastes a little as each day lapses. Thus its value is calculated in accordance to the amount of days left in its life.
What are swaptions?
A swaption is an option on an interest rate swap. Swaptions are options contracts, which give you the right to enter into a swap agreement at the option expiration, in return for a one-off premium payment.
What is meant by Covered Call, Covered Put, In the Money, Out Of the Money, At the Money?
Ø In-the-money
A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.
Ø Out of the money
A call option is out-of-the-money if the price of the underlying instrument is lower than the exercise/strike price. A put option is out-of-the-money if the price of the underlying instrument is above the exercise/strike price.
Ø At-the-money
At the money is a condition in which the strike price of an option is equal to (or nearly equal to) the market price of the underlying security.
Ø Covered Call
You can take a covered call if you take a long position in an asset combined with a short position in a call option on the same underlying asset.
Ø Covered Put
The selling of a put option while being short for an equivalent amount in the underlying security.

FUTURES in DERIVATIVES MARKET

What are Derivatives?
A derivative is a financial instrument whose value depends on the values of other underlying variables. As the name suggests it derives its value from an underlying asset. For Ex-a derivative, may be created for a share, or any material object. The most common underlying assets include stocks, bonds, commodities etc.
Let us try and understand a Derivatives contract with an example:
Suresh buys a futures contract in the scrip "Satyam Computers". He will make a profit of Rs.500 if the price of Satyam Computers rises by Rs 500. If the price remains unchanged Anil will receive nothing. If the stock price of Satyam Computers falls by Rs 800 he will lose Rs 800.
As we can see, the above contract depends upon the price of the Satyam Computers scrip, which is the underlying security. Similarly, futures trading can be done on the indices also. Nifty futures is a very commonly traded derivatives contract in the stock markets. The underlying security in the case of a Nifty Futures contract would be the Index-Nifty.
What are the different types of Derivatives?
Derivatives are basically classified into the following:
Futures /Forwards
Options
Swaps
What are Futures?
A futures contract is a type of derivative instrument, or financial contract where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price.
The example stated below will simplify the concept:
Case1:
Ravi wants to buy a Laptop, which costs Rs 50,000 but owing to cash shortage at the moment, he decides to buy it at a later period say 2 months from today.However,he feels that after 2 months the prices of Lap tops may increase due to increase in input/Manufacturing costs .To be on the safer side, Ravi enters into a contract with the Laptop Manufacturer stating that 2 months from now he will buy the Laptop for Rs 50,000. In other words he is being cautious and agrees to buy the Laptop at today's price 2 months from now.The forward contract thus entered into will be settled at maturity. The manufacturer will deliver the asset to Ravi at the end of two months and Ravi in turn will pay cash delivery.
Thus a forward contract is the simplest mode of a derivative transaction. It is an agreement to buy or sell a specific quantity of an asset at a certain future time for a specified price. No cash is exchanged when the contract is entered into.
What are Index Futures?
As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.
What is meant by Lot size?
Lot size refers to the quantity in which an investor in the markets can trade in a derivative of a particular scrip.For Ex-Nifty Futures have a lot size of 100 or multiples of 100.Hence if a person were to buy 1 lot of Nifty Futures , the value would be 100*Nifty Index Value at that point of time.
Similarly lots of other scrips such as Infosys, reliance etc can be bought and each may have a different lot size. NSE has fixed the minimum value as two lakhs for an Futures and Options contract. Lot sizes are fixed accordingly which will be the minimum shares on which a trader can hold positions.
What is meant by expiry period in Futures?
Each contract entered into has an expiry period. This refers to the period within which the futures contract must be fulfilled. Futures contracts may have durations of 1 month,2 months or at the most 3 months. Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract.
What are the uses of Derivatives? What are the various derivative strategies that I can use?
Derivatives have a multitude of uses namely:
a) Hedging
b) Speculation &
c) Arbitrage

Chapter 5: Types of Analysis in Stock Market Study

What is Technical Analysis?
Technical Analysis is a method where one studies the market statistics to evaluate the worth of a company. Instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform.
It is a method of evaluating stocks by analyzing stock market related activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts to identify patterns that can suggest future activity. They believe in the momentum that the scrips/markets gather over a period of time and cashing in on the same. Technical analysts believe that the historical performance of stocks and markets are indications of future performance.
This method enables 'short-term' investors to gauge companies who have very good potential to gather increased earnings in the near future.
What is a Fundamental Analysis?
A method of evaluating a stock by attempting to measure its intrinsic value. Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies. A fundamental analyst would most definitely look into the details regarding the balance sheets, profit loss statements, ratios and other data that could be used to predict the future of a company.
In other words, fundamental analysis is about using real data to evaluate a stock's value. The method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth.
What is an Overvalued Stock or an Undervalued Stock?
An overvalued stock can be understood as an inflated hope that a company will do well. Thus, a stock is overvalued if its current price exceeds the intrinsic value of the stock. The market may temporarily price stocks too high or too low and that's how investors determine whether stocks are being overvalued or undervalued. If a stock is overvalued, the current price of the stock exceeds its earnings ratio (PE ratio*) and hence investors expect the price of the stock to drop. A high PE in relation to the past PE ratio of the same stock may indicate an overvalued condition, or a high PE in relation to peer stocks may also indicate an overvalued stock.
Thus the PE ratio is one of the many ways to determine whether a stock is overvalued. *A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.
For example, a P/E ratio of 10 means that the company has Rs1 of annual, per-share earnings for every Rs10 in share price.
A stock is undervalued when, if is selling at a much lower price than what it is actually worth. This can be determined based on fundamentals like earnings and growth prospects. One of the best-known measures for finding an undervalued stock is the price earnings ratio (P/E).
Consider Colgate and Pepsodent, which are in the same industry and have similar fundamentals. If Colgate has a P/E of 15 and Pepsodent's is 20, Colgate could be an undervalued stock.
What does Value Investing mean?
Value investing is an investment style, which favors good stocks at great prices over great stocks at good prices. Hence it is often referred to as "price driven investing". A value investor will buy stocks he believes the market is undervaluing, and avoid stocks that he believes the market is overvaluing. Warren Buffet, one of the world's best-known investment experts believes in Value investing.
Value investors see the potential in the stocks of companies with sound financial statements that they believe the market has undervalued; as they believe the market always overreacts to good and bad news, causing stock price movements that do not correspond with their long-term fundamentals. Value investors profit by taking a position on an undervalued stock (at a deflated price) and then profit by selling the stock when the market corrects its price later.
Value investors don't try to predict which way interest rates are heading or the direction of the market and the economy in the short term, but only look at a stock's current valuation ratios and compare them to their historical range. In other words they pick up the stocks as fledglings and cash in on them when they are valued right in the markets.
For example, say a particular stock's P/E ratio has ranged between a low of 20 and a high of 60 over the past five years, value investors would consider buying the stock if it's current P/E is around 30 or less. Once purchased, they would hold the stock until its P/E rose to the 50-60 ranges before they consider selling it or even higher if they see further potential for growth in the future.
What is Contrarian Philosophy?
Investing with a value philosophy can be considered as one form of contrarian investing. Buying stocks that are out of favor in the marketplace, and avoiding stocks that are the latest market fad is a contrarian investing strategy. Thus it is an investment style that goes against prevailing market trends, where investors buy scrips that are performing poorly now and sell them in future when they perform well. Contrarians believe in taking advantages that arise out of temporary set backs or other such reasons that have caused a stocks price to decline at the moment.
A simple example of Contrarian Philosophy would be buying umbrellas in winter season at a cheap rate and selling them during rainy days.

Chapter 4: Annual Report

What is an annual report and why is it useful to investors?
An annual report provides a company's shareholders with information about its operations. This is an obligation stipulated by law. This is extremely beneficial to investors because it helps make informed decisions.
The report tells you how well the company is doing while also forecasting its future earnings and dividends. The Chairman's letter in the report also profiles the company's future goals.
Inside the Annual Report
Here is what comprises an annual report:
* A letter from the chairman on the high points of business in the past year with predictions for the next year.
* The company philosophy: A section that describes the principles and ethics that govern a company's business.
* An extensive report on each section of operations within the company, describing the company's services or the products.
·Financial information that includes the profit and loss (P&L) statements and a balance sheet. Depending on its income and expenses, the company will either make profits or show losses for a year. The balance sheet describes assets and liabilities and compares them to the previous year. The footnotes will also give you reveal important information, as they discuss current or pending lawsuits or government regulations that may impact the company operations.
* An auditor's letter in the annual report confirms that the information provided in the report is accurate and has been certified by independent accountants.
How do I obtain an Annual Report?
Annual reports are mailed automatically to all shareholders on record. If you wish to obtain the annual report about a company in which you do not own shares, you can call its public relations (or shareholder relations) department. You may also look at the company web site, or search the Internet; as there are several sources on the Internet providing information on public companies.
All publicly listed companies are required to submit the financial reports available in the public domain as per SEBI regulations.
What are quarterly and other financial reports?
Besides the annual report, companies provide several other financial reports such as quarterly reports (issued every three months) and statistical supplements. These however are not as comprehensive as the annual report of the company.
Quarterly reports are very similar to the annual reports except they are issued every three months and are less comprehensive. They may be obtained in the same way as an annual report. What are Company Earnings?
Earnings are a company's net profit. It is the surplus left with the company after it has cleared all its expenses, i.e. Money paid to employees, utility bills, costs of production and other operating expenses The manner in which a company makes its earnings, is defined by the very nature of its business.
For e.g., a cement manufacturer produces cement for sale to its customers.
Two sources of company earnings are:
Ø Income from sales of goods or services
Ø Income from investment.
Investments generate income for businesses by way of either interest on loans, dividends from other businesses, or gains on the sale of investment property.
Thus, company earnings are the sum of income from sales or investment left after the company has met its obligations.
Why are Earnings important to you as an investor?
As an investor who holds shares of the company, you have part ownership of company.When you invest in a company's shares, you become a 'part owner' of the company and you get to share a part of the company's profit as dividend. Thus if the company does well and earns more profit, you in turn to well. If the company reinvests its earnings towards future growth, you are assured of higher dividends in the future.
Meanwhile, if you lend money to the company by investing in its bonds, the company uses part of its earnings to repay interest and principle on the bonds. The more earnings the company has, the more secure you can be that the company will be able to make your interest payments. So, company earnings are important to you because you make money when the business you invest in, makes money.
How do you use earnings information to make an investment decision?
Your investment goals determine how you use information about company earnings. If you are an income investor, interested in earning immediate income from your investments, you probably want to invest in a company that is paying dividends. If you have a long-term investment strategy, dividends may not be as important to you. The "financials" indicate whether a company is oriented for income, growth, or a bit of both. By comparing the financials for different companies in the same industry, you can find characteristics best suited to your investment goals.A convenient way to compare companies is through Earnings per share (EPS). EPS represents the net profit divided by the number of outstanding shares of stock.
When you compare the EPS of different companies, be sure to consider the following:
Ø Companies with higher earnings are stronger than companies with lower earnings.
Ø Companies that reinvest their earnings may pay low or no dividends but may be poised for growth.
Ø Companies with lower earnings, and higher research and development costs, may be on the brink of either a breakthrough or a disaster, making them a risky proposition.
Ø Companies with higher earnings, lower costs and lower shareholder equity, might go in for a merger.
How do I use Fundamentals to make an investment decision?
Fundamental Analysis is a method used to evaluate the worth of a security by studying the financial data of the issuer. But this research can never accurately predict how the company will perform in the stock market. It can however be used as a good comparative framework to know which company will be a better investment choice.
As an investor, you are interested in a corporation's earnings because earnings assure higher dividends and potential for further growth. You can use profitability ratios to compare earnings for prospective investments. These are measures of performance showing how much the firm is earning compared to its sales, assets or equity.
You can quickly see the difference in profitability between two companies by comparing the profitability ratios of each. Let us see how ratio analysis works.
What is Ratio Analysis?
The ratio analysis technique is also called cross-sectional analysis, providing you with important information about a company's financial strength. Cross-sectional analysis compares financial ratios of several companies from the same industry and enables you to deduce success, failure or progress of any business. Thus, a financial ratio measures a company's performance in a specific area and guides your judgment regarding which company is a better investment option. Some of the important ratios that an investor must know are:
1) Price-Earnings Ratio((P-E ratio):
It is a ratio obtained by dividing the price of a share of stock by Earnings per share (EPS) for a 12-month period.
2) EPS (Earnings Per Share):
It is that portion of a company's net income, which corresponds to each share of that company's common stock which is issued and outstanding. EPS gives an indication of the profitability of a company. It is calculated using the formula:
EPS = (Net Income-Dividends on Preferred Stock)/ Average Outstanding Shares
3) Current Ratio:
Companies need a surplus supply of current assets in order to meet their current liabilities. They generally pay their interest payments and other short-term debts with current assets. If a company has only illiquid assets, it may not be able to make payments on their debts. It is a type of Liquidity ratio.
Current Ratio = Current Assets/ Current Liabilities
Leverage Ratios:
Traditionally, leverage is related to the relative proportions of debt and equity, which fund a venture. The higher the proportion of debt, the more leverage.
It is a ratio that measures a company's capital structure, indicating how a company finances their assets. Do they rely strictly on equity? Or, do they use a combination of equity and debt? The answers to these questions are of great importance to investors.
Leverage= Long Term Debt /Total Equity
A firm that finances its assets with a high percentage of debt is risking bankruptcy, higher borrowing costs and decreased financial flexibility; if its performance cannot help fulfill its debt payments. If a company is highly leveraged, it is also possible that lender's may shy away from providing further debt financing fearing the viability of their investment.
The optimal capital structure for a company you invest in, depends on which type of investor you are. A bondholder would prefer a company with very little debt financing because of it lowers the risk of him losing his money.
When a firm becomes over leveraged, bankruptcy can result.
Shareholder's Equity:
Shareholders' equity is calculated as the value of a company's assets less the value of its liabilities. It is the value of a business to its owners, after all of its obligations have been met. This net worth belongs to the owners. Shareholders' equity generally reflects the amount of capital the owners invested, plus any profits that the company generates.
Bankruptcy
Bankruptcy is a legal mechanism that allows creditors to assume control of a firm when it can no longer has the ability to meet its financial obligations. Both stock and bond fear bankruptcy. Generally, the firm's assets are sold in order to pay off creditors to the largest extent possible.
When bankruptcy occurs, stockholders of a corporation can only lose the amount they have invested in the bankrupt company. This is called Limited Liability. If a firm's liabilities exceed the liquidation value of their assets, (the value of assets converted into cash), creditors also stand to lose money on their investments.
Understanding the Balance Sheet
The balance sheet is one of the most important financial statements of a company. The logic behind producing a balance sheet is to ensure that the accounts are always in balance and all the company funds can be accounted for. It is reported to investors at least once a year. You may also receive quarterly, semiannually or monthly balance sheets. The contents of a balance sheet include:
What the company owns (its assets)
What it owes (its liabilities)
The value of the business to its stockholders (the shareholders' equity).
Why should the Balance Sheet be important to you?
As an investor you need to ensure that the company you have invested in, has good potential for future growth and will yield good returns. The balance sheet helps you get answers to questions like:
·Will the firm meet its financial obligations?
· What amount of funds have already been invested in this company?
· Is the company overly indebted?
· What are the different assets that the company has purchased with its financing?
These are just a few of the many relevant questions you can answer by studying the balance sheet. The balance sheet provides a diligent investor with many clues to a firm's future performance.
What are Assets?
Assets are any items of economic value owned by a corporation that can be converted into cash.
Types of Assets:
Current assets are assets that are usually converted to cash within one year. Bondholders and other creditors closely monitor a firm's current assets since interest payments are generally made from current assets. Also incase the company goes bankrupt, assets can be easily liquidated into cash and help prevent loss of your investments. Current assets are important to most companies, as they are a source of funds for day-to-day operations. It is thus evident, that the more current assets a company owns, the better it is performing.
Cash equivalents are not cash but can be converted into cash so easily that they are considered equal to cash.
Cash equivalents are generally highly liquid, short-term and very safe investments.
Accounts Receivable
Accounts receivable is the money customers (individuals or corporations) owe the firm in exchange for goods or services that have been delivered or used but not yet paid for.
As more and more business is being done today with credit instead of cash, this item is a significant component of the balance sheet. Accounts receivable is however recorded as an asset on the balance sheet as it represents a legal obligation for the customer to remit cash.
Inventory
A firms inventory is the stock of materials used to manufacture their products and the products themselves for future sale. A manufacturing company will often have three different types of inventory: raw materials, works-in-process, and finished goods. A retail firm's inventory generally will consist only of products purchased that are still to be stored. Inventory is recorded as an asset on a company's balance sheet.
Long-term Assets:
Long-term assets are grouped into several categories like:
A long-term, tangible asset held for business use and not expected to be converted to cash in the current or upcoming fiscal year, such as manufacturing equipment, real estate, and furniture.
Fixed assets are long-term, tangible assets held for business use and will not be converted into cash in the current or upcoming year.
Eg. Items such as equipment, buildings, production plants and property. On the balance sheet, these are valued at their cost. As the value of the asset declines over the years, depreciation is subtracted from all, except land. Fixed assets are very important to a company because they represent long-term investments that will not be liquidated soon and can facilitate the company’s earnings.
Depreciation gives you an estimate of the decrease in the value of an asset, caused by 'wear and tear' or obsolence. It appears in the balance sheet as a deduction from the original value of the fixed assets; as the value of the fixed asset decreases due to wear and tear.
Intangible assets are non-physical assets such as copyrights, franchises and patents. Being intangible, it becomes difficult to estimate their value. Often there is no ready market for them. Sometimes however, an intangible asset can be the most valuable asset a company possesses.

What are Liabilities?
Liabilities are a company's debt to outside parties. They represent rights of others to expect money or services of the company. A company that has too many liabilities may be in danger of going bankrupt. Eg. Bank loans, debts to suppliers and debts to its employees. On the balance sheet, liabilities are generally broken down into Current Liabilities and Long-Term Liabilities.
Types of Liabilities:
Current liabilities
Current liabilities are debts currently owed for taxes, salaries, interest, accounts payable* and notes payable, that are due within one year.
A company is considered to have good financial strength when current assets exceed current liabilities.
*Accounts Payable
Accounts payable is one of a series of accounting transactions covering payments to suppliers whom the company owes money for goods and services. Therefore, you will often see accounts payable on most balance sheets.
Long-term debt is a long-term loan, for a period greater than one year. These debts are often paid in installments. If this is the case, the portion to be paid off in the current year is considered a current liability.

Stock Market FAQs

Chapter 3:Stock Market FAQS
What are the instruments traded in the stock markets?
There are various types of instruments in the stock market. They include Shares, Mutual Funds, IPO's, Futures and Options.
Why would I choose stocks?
Stocks are one of the most effective tools for building wealth, as stocks are a share of ownership of a company. You thus have great potential to receive monetary benefits when you own stock shares. Owning stocks of fundamentally strong companies simply lets your money work harder for you since they appreciate in value over a period of time while also offering rich dividends on a periodic basis.
How can I track stocks?
Tracking stocks lets you gain from the best stock opportunities available in the market while also letting you know how the stocks in your portfolio are performing. Our website is designed to empower you with all the tools you might require to invest wisely. The portfolio tracker section of the website in which you have an account, lets you regularly monitor your portfolio.
Where do I buy stock?
Stock trading happens on Stock Exchanges, but one cannot individually buy stocks off the exchange. To do so, you need to find a suitable broker who will understand your needs and buy stocks on your behalf. You can think of them as agents who will conduct transactions for you without actually owning any of the securities themselves. In exchange for facilitating or executing a trade, brokers will charge you a commission.
What are some of the orders I can place?
You can place different orders such as Market orders, Limit Orders, Stop Loss Orders, Cover Orders, and Normal Orders etc.
What is a Market Order?
A market order is an order to buy or sell a stock at the current market price. It signals your broker to execute the order at the best price currently available. However, as market prices keep changing, a market order cannot guarantee a specific price.
What is a Limit Order?
To avoid buying or selling a stock at a price higher or lower than you wanted, you need to place a limit order rather than a market order. A limit order is an order to buy or sell a security at a specific price. You could use a limit order when you want to set the price of the stock. In other words, you want to sell/buy particular scrip at a price other than the Current Market Price. However, a limit order guarantees a price but cannot guarantee execution of the trade, because the scrip might not reach the desired price on that particular trading day owing to Market related factors.
What is a Stop Loss Order?
A stop loss order is a Normal order placed with a broker to sell a security when it reaches a certain predetermined price Trigger Price. Sometimes the market movements defy your expectations. Such market reversals often result in loss bearing transactions. The stop loss trigger price is your defense mechanism- an amount at which you will be able to sustain yourself against such unanticipated market movements. Your stop loss instruction is an order to sell when the price of contracts reaches a pre-determined level - the trigger price. Naturally, this price cannot be more than the price of the stock you are trading.
For eg. If you bought a stock at Rs 10, you place a stop loss order with your broker to sell it, if it reaches Rs 8. This helps you prevent further loss, in the eventuality that the price of the stock might dip even further. Thus, it helps limit your loss or protect unrealized profits, whichever the case.
Good-till-canceled (GTC) or Day Order Or Normal Orders
Day orders are orders given to your broker that hold true only during the period of the trading day for which the orders have been given. If the order has not been executed on that day, it will not be passed on to the next trading day. Thus they are orders that are only "good until it is canceled" or "good for the day."
For eg. You place a stop loss order with your broker to sell a stock, if its price reaches to level X. Now, if it does not reach limit X, your broker will not sell the stock. However, the stop loss order given to your broker will not hold true for the next day. For, even if the stock reaches level X on Day 2, he will not execute the trade till you instruct him to do so again.
What are advances and declines?
Advances and declines give you an indication of how the overall market has performed. You get a good overview of the general market direction.
As the name suggest ' advances' will inform you how the market has progressed.'Declines' signal if the market has not performed as per expectations. The Advance-Decline ratio is a technical Analysis tool that indicates market movement. Advance Decline ratio is calculated using the formula:
Number of stocks that advanced/number of stocks that declined.
Generally, it is seen that in Bullish markets the number of stocks that advance is more than the ones that declined and the converse can be said to hold true in a bearish market. The breadth of market indicator is used to gauge the number of stocks advancing and declining for the day.'Remains unchanged' is a term used if the market scenario shows no advancement or decline compared to the earlier day.
Advances and declines are calculated from the previous days closing results. However, a market that is significantly on one side either in terms of advances or declines may have a hard time reversing out of that direction the next day.