Saturday, July 29, 2006

Fooled by Infomedia India!

In the first week of July, I saw a notification on the BSE which said something like this:
  • Infomedia India Ltd has informed BSE that the Hon'ble High Court of Judicature at Bombay has approved the Scheme of Arrangement between the Company and the equity shareholders of the Company u/s 391 read with sections 100 to 103 of the Companies Act 1956 filed by the Company for purchase and consequent cancellation of its equity shares on June 16, 2006.
The notification meant that the Scheme of Arrangement would go through. The salient features of the SoA were that the company would buy-back its shares representing 14% of its paid-up capital. The buy-back will happen at a price of Rs.245 per share and will be across-the-board. However, there was one thing about the buy-back that struck me - shareowners holding less than 50 shares will have the option to tender their entire holding at Rs.245 per share, irrespective of the 14% ceiling announced by the company. CMP at the time when I came to know about this was Rs.172 per share. This meant that I could buy say 49 shares of Infomedia India and tender the same to the company at Rs.245 for a "risk-free" profit of 42.4%.

The company announced the record date for the event on 26-July-06. Everything seemed fine till then as many of my close friends and I bought 49 shares each in our accounts. We were quite happy to get this "free lunch". But that was not to be.....

The company revised its announcement on 27-July-06 and came up with a shocking modification to the SoA. As per the new SoA -
  • The Shareholders holding 50 (fifty) Equity Shares or less per ledger folio in physical form and / or per Client ID in dematerialized form on June 16, 2006, shall have an option of tendering their entire Equity Shares for purchase by the Company and the Company shall purchase the Equity Shares tendered for a consideration of Rs 245/- per Equity Share.
This meant that all of my friends & I who bought 49 shares of Infomedia India during the second week of July cannot tender their entire holdings for Rs.245 or a 42.4 per cent "risk-free" profit. :-(

In the end we all exited the counter at cost (just about recovering brokerages paid, thankfully!) I think this was a case of sheer bad luck.....since the "risk-free" continues to rest with those pple who bought the shares prior to 16-June-2006. Plain simple bad luck, I think.

Friday, July 28, 2006

Interesting measures of risk & return on the Nifty

Kaushik Gala of Galatime has put a nice article on reading the movements of the Nifty on any given day. Here are some of the inferences:

  • On any given day, the change in Nifty will range from -1.6% to +1.6%, with a 68% probability. Thus, a 1% move is either direction is random, in the grand scheme of things.
  • The average intraday range is ~2% with std-dev of 1.5%; thus, what might seem like a very volatile day may not really be so.
  • If we separate UP & DOWN days, we realize that even a 2% move is not beyond normal expectations.

Read the full article here. It will be interesting to know whether these stats have any predictive value? Or more importantly, can one use such data points to predict returns?

Tuesday, July 25, 2006

Are we following the US? RBI hikes interest rates by 25 basis points

The Reserve Bank of India today announced a hike in interest rates by 25 basis points. The repo rate was hiked to 7 per cent whereas the reverse repo rate has been hiked to 6 per cent. This is the fourth such hike in the last one year. Reason: rise in the rate of inflation, which currently is a notch below 5 per cent.

I am not an expert in monetary economics but I would like to understand a few things:

Lets begin with the basic question: Why does the RBI feel the need to hike interest rates? Probably because it feels that inflation is acquiring dangerous proportions and would therefore like to anchor inflation expectations. But, a WPI at 4.9 per cent is certainly not dangerous. In fact, it is less than the last two years average (5.9 per cent), less than last five years avg (5.2 per cent), less than even the last 10 years avg (5.2 per cent), there's is less than even the 34 yr avg (7.98 per cent). So what is it that the RBI is worried about?

Another problem is that the current rise in the rate of inflation is primarily driven by supply constraints and not excessive demand. That brings me to another question: When faced with supply shocks should the central government hike interest rates or take the "reduce import duties" path(?). Inflation today is driven by food articles and petroleum products. While nothing can be done about the latter, import duties on the former can certainly be reduced. Thankfully, the government has taken some measures on that front, eg. sugar, wheat..etc. Shouldn't it be doing the same wherever it can? be continued.

A sea of green; rare sight in today's markets.

Will India and other Asian markets do the same today? Looks like they will......

Sunday, July 23, 2006

What increases shareholder value - dividends or buybacks?

Lets take the first case: Dividends

Dividends are profits earned by a company and shared with its shareholders. So if a company earns let say Rs.100 crore in the current year and has retained profits of earlier years amounting to another Rs.500 crore, it technically has Rs.600 crore which belongs to the shareowners and can therefore be shared with them by way of dividend payouts. Economists, financial consultants and ofcourse companies across-the-globe have long argued that dividends are a way of rewarding shareholders or put simply sharing some of the profits that the company has earned.

However, do dividends really add to your wealth? I think not.

Share prices on the bourses quickly adjust (read: decline/fall) by the same quantum almost immediately. That means, if I owned a share worth Rs.100 & which paid a dividend of Rs.10 per share, the stock will immediately fall by Rs.10 on the bourses on the ex-date. So where is the reward/gain....?

Next is buybacks: Companies announce buybacks when they have ample cash (more than what is required to run & expand the business) in their books and instead of paying direct cash to the shareholder they offer to buy shares from the market at a price which is higher than the prevailing market price (that is obvious actually). Microsoft recently announced one.

So how does a buyback benefit a shareholder?

The answer is: It does not to the shareholder who sells out to the company, but benefits the one who does not. The reason is quite simple, shares bought back under a 'buy-back' scheme are cancelled thereby reducing the total shares outstanding. Reduction in shares results in an increase in the earning per share, which pulls down the price-to-earning ratio. If the company is well-run then a lower p/e ratio will attract new investors, driving up the share price.

However, buy-backs increase shareholders wealth only when done in the form of a 'tender-offer'. In recent times there have been cases where companies have announced buy-backs but not in the form of tender offers but by offering to buy shares from the secondary market at a price they feel right. Put simply, the management has no obligation to buy its share back under this form of buy-back and guess what more often than not it actually ends up buying no share, eg. Reliance Industries (in 2002-03), SRF Polymers and SRF Ltd (more recently).....etc.

Bottomline: Dividends do not add shareholder value, not anymore. Tender-offers do, but plain buy-backs do not.

Sunday, July 16, 2006

Ratio analysis trivia: Return on capital employed?

Return on capital employed as defined by Wikipedia goes something like this:

Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is realizing from its capital employed (Total assets - current liabilities). The ratio can also be seen as representing the efficiency with which capital is being utilized to generate revenue. It is commonly used as a measure for comparing the performance between companies and for assessing whether a company generates enough returns to pay for its cost of capital.

The formulae used is: (Profit before interest & taxes) / Avg. Capital Employed

There is another way of computing this ratio:

(Profit after tax + Interest) / Avg. Capital Employed

The argument here is that since the capital employed can be broken up into two components: owners capital and borrowed funds, one should look at the returns to individual components, ie. return on owners fund and the return on the borrowed funds. From a company's perspective the same thing would be to find return on owners fund and cost of borrowed funds (interest). The return to shareowners is the profit after tax and the cost of borrowed funds is the interest. Simply put, PAT + Interest is the return that a company generates to from the capital employed.

The difference between the two ratios is that the first one takes pre-tax return on capital employed whereas the second computes the post-tax return over capital employed.

The question: which of these is the right way of computing the return on capital employed?