Terminologies

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What is Equity?

‘Equity’/Share

Total equity capital of a company is divided into equal units of small denominations, each called a share.

For example, in a company the total equity capital of Rs 2,00,00,000 is divided into 20,00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then is said to have 20,00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and have voting rights.

  • Warrants

    Certificate issued along with a bond or preferred stock

    Entitles holder to buy specific no. of securities at a specific price

  • Convertible Debentures

    Can be converted in stock at specified date in future

    At the discretion of either the issuer/lender

    Issuer can borrow at lower cost if the lender has convertibility option

Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a ratio to those already held, at a price. For e.g. a 2:3 rights issue at Rs. 125, would entitle a shareholder to receive 2 shares for every 3 shares held at a price of Rs. 125 per share.

Bonus Shares: Shares issued by the companies to their shareholders free of cost based on the number of shares the shareholder owns

Cumulative Preference Shares: A type of preference shares on which dividend accumulates if remained unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares.

Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company.

  • IPO (Initial Public Offer)

    The first issue by a company to public investors

  • Public Issue

    Any issue by a company to public investors

  • Bonus

    Issue of securities to existing investors in a specific ratio without any consideration being received by the issuer

  • Rights

    Issue of securities to existing investors in a specific ratio for a consideration received by the issuer

  • GDR / ADR (Global Depository Receipt/ American Depository Receipt)

    Issue of securities that are listed in an international stock exchange; each security representing a specified number of securities listed in the local stock exchange

  • Buyback

    Acquisition of securities by the issuer from existing investors, through a public offer or purchases in the secondary market

Basics terms of Equity

The nominal or stated amount (in Rs.) assigned to a security by the issuer. For shares, it is the original cost of the stock shown on the certificate; for bonds, it is the amount paid to the holder at maturity. Also known as par value or simply par. For an equity share, the face value is usually a very small amount (Rs. 5, Rs. 10) and does not have much bearing on the price of the share, which may quote higher in the market, at Rs. 100 or Rs. 1000 or any other price. For a debt security, face value is the amount repaid to the investor when the bond matures (usually, Government securities and corporate bonds have a face value of Rs. 100). The price at which the security trades depends on the fluctuations in the interest rates in the economy.

Dividend

It is a percentage of the face value of a share that a company returns to its shareholders from its annual profits. Compared to most other forms of investments, investing in equity shares offers the highest rate of return, if invested over a longer duration.

Market Capitalization

Number of equity shares outstanding x market value per equity share. Represents the market value of the entire company

Enterprise Value

Enterprise value is a figure that, in theory, represents the entire cost of a company if someone were to acquire it. Enterprise value is a more accurate estimate of takeover cost than market capitalization because it takes a number of important factors such as preference shares, debt and cash that are excluded from the latter matrix.

Enterprise value = Mkt cap + preference shares + outstanding debt - cash and cash equivalent Market capitalization =Number of outstanding shares * CMP

Intrinsic Value

It is discounted value of cash that can be taken out of a business during its remaining life. It is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at same set of facts will come up with different intrinsic value figures

Beta

A measure of the volatility of a stock relative to the overall market. A beta of less than one indicates lower volatility than the market; a beta of more than one indicates higher volatility than the market. Generally Consumer and utility stocks have low beta compared to cyclicals and industrials

Book Value

It shows the historic cost of the assets as reduced by the depreciation. It is significant for evaluating Banking company stocks. Stocks of companies holding large blocks of land and other hidden assets are evaluated on this basis. It does not make sense to look at book value for companies in high growth businesses. BV = Shareholders funds / No. Of Equity shares

Cost of Capital

This is the cost of borrowing funds from the market. The ROE and the ROCE should be more then the cost of capital or else it would make little sense for the company to borrow funds. For stocks in the emerging markets the cost of capital should be 300 to 400 basis points above the risk free rate of return. COC = Risk free rate of return + Equity risk premium.

Debt Equity Ratio

Long-term debt divided by shareholders' equity, showing relationship between long-term funds provided by creditors with respect to the Shareholders funds. A high Debt Equity ratio indicates high risk while a lower ratio may indicates lower risk. Short-term debt is not included as long as cash is greater than short-term debt. As equity increases relative to debt, the company becomes a more attractive investment. Finally, bond debt is preferred to bank debt because bank debt is due on demand. Companies that repay bank debt experience PE expansion compared to companies that take on debt. DER = Long term loans / Shareholders Funds

Dividend yield

This is the current yield on a stock. Dividend paying companies have in built bottoms. When the stock prices fall too much their dividend yield becomes attractive enough for existing investors to hold on as well as for new investors to get in. This is a basic criterion for a value investor Stocks that pay dividends are obviously favored over stocks that don’t. Dividend paying stocks are likely to fall less in an economic downturn as stock prices fall with no fall in dividends, the dividend yield rises attracting new investors.
Finally, if you do buy a stock for dividend, you should make sure that the company has a history of paying the dividend in both good times and bad. DY = Dividend per share / Market Price

Discounted cash flow statement

Discounted Value of free cash flow that a business generates during a particular period of time. Companies embarking on a major Capital expenditure program will experience reduced free cash flow and lower valuations. A rise in interest rates increases the cost of capital and also reduces valuations Most of the analyst fraternity uses this concept. The risk free rate is used as the discount rate. This evaluation tool is helpful only for evaluating stable businesses rather than high growth businesses

Earnings per share (EPS):

This is the net income divided by the number of shares outstanding however; both the numerator and denominator can change depending on how you define "earnings" and "shares outstanding. The E.PS as an absolute figure means nothing and is significant only when viewed in relation to the price of the stock. EPS = Net Profits / No. Of Equity Shares

Enterprise Value

EV = Market Capitalization + Debt.
Enterprise value for cash rich companies is market cap as reduced by cash. During bear markets smart Investors are able to spot a number of companies that are available at zero or negative enterprise value. In2002 Trent was available at Rs 60 when it had Rs 100 as cash on its balance sheet. The stock has been a multibagger since

EVA

EV = Market Capitalization + Debt.
Economic Value added is the excess of ROCE over the cost of capital . Companies with higher EVA's are able to generate higher PE's and are generally wealth creators compared to companies that have a low or negative EVA.
EVA = (ROCE – Cost of capital) Capital employed

Free Cash flows

The amount of cash left in a company after all expenditure both revenue and capital has been accounted for. This is also known as net addition to cash. Free cash flow per share = Cash earnings - capital spending. Companies that generate substantial free cash flows make for very good investments.

Growth in Stock Price vs. Growth in earnings

A dangerous signal is generated when the stock price of a company increases faster than its earnings. Invariably this leads to a higher PE multiple and makes the stocks liable for decline. Generally it is better to invest into businesses their earnings growing at an equal pace to their stock prices..

Market Capitalization

The market cap is the amount of money that the acquirer would need to buy back all the outstanding shares. In case of absurd valuations the market cap reaches stupid levels. During the 2000 tech boom Himachal Futuristic sold at a market cap of Rs 20,000 crores. Multibaggers (stocks that go up a number of times) generally have a very small market cap to start with. Companies with a market cap of more than US $ 1 billion are classified as large caps, between US $ 250 million to 1 $billion as mid caps and less than 250 million as small caps.
Market price x No. Of Equity shares

Market Cap to Sales

It is the number of times the sales exceeds the market cap. For companies in growth businesses the market cap to sales could be about 3 times whereas for companies in low growth businesses it should be equal to
1. The sales number is the most difficult to fudge and therefore the market cap to sales is a more reliable indicator in corporate analysis. In the 2000 technology bubble Infosys traded at a market cap to sales of more than 100! Market Cap / Sales

PEG

This is known as the Price earnings to growth ratio. It should be less then equal to 1 Growth in Earnings vs. the P/E Ratio. The ratio will be lower for slow growers and higher for fast growers.
PEG = PE / Sustainable Growth

Price Earnings (PE)

This is one of the most widely used tools in sizing up stocks. Simply put, it is how much investors are willing to pay for a rupee of the company's earnings. It is also termed as referred to as a "multiple." When you calculate a P/E based on the past year's earnings, the P/E is called "trailing." Another way to determine a P/E is to substitute future earnings projections. This is the "forward" P/E (also referred to as the "anticipated" P/E). Another way of looking at the PE is as the number of years it will take to earn back the initial investment.
PE = Market price / EPS

Price to Book Value

This is used mainly for Banking (where the book value is adjusted for Non performing assets) and old economy stocks. It is defined as the number of times the market price equals the book value of the stocks.
PBV = Market Price / Book Value

Return on Equity (RoE)

Return on Equity (RoE) is an indicator of how efficiently the shareholders funds (Equity) are being used.
Companies having a higher RoE tend to be wealth creators and companies having a RoE of less than 15%tend to be wealth destroyers. Normally higher the RoE higher the PE. Companies that are engaged into commodity businesses have lower RoE's compared to the ones that are engaged into high growth businesses. As with the PE Companies that are in the initial stages of growth and are available at small market caps or the ones, which are yet to see the earnings hit a peak, can be bought in spite of having a low RoE. Commodity companies exhibiting very high RoE's are a sign of danger since that would encourage new entrants to rush in and push prices down.
RoE = EPS / Book Value

Return on Market Cap

The percentage that profits that can be earned if an investor buys all the shares from the market. It is theoretically equal to the inverse of the PE (1/PE)

Types of Orders

There are various types of orders, which can be placed on the exchanges:

Limit Order: The order refers to a buy or sell order with a limit price. Suppose, you check the quote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price.

Market Order: The order refers to a buy or sell order with a limit price. Suppose, you check the quote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price.

Stop Loss Order: A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the Share is reached or crosses a threshold price called as the trigger price. The trigger price will be as on the price mark that you want it to be.

Concept of Margin Trading

  • Normally to buy and sell shares, you need to have the money to pay for your purchase and shares in your demat account to deliver for your sale
  • However as you do not have the full amount to make good for your purchases or shares to deliver for your sale you have to cover (square) your purchase/sale transaction by a sale/purchase transaction before the close of the settlement cycle
  • In case the price during the course of the settlement cycle moves in your favor (risen in case of purchase done earlier and fallen in case of a sale done earlier) you will make a profit and you receive the payment from the exchange
  • In case the price movement is adverse, you will make a loss and you will have to make the payment to the exchange
  • Margins are thus collected to safeguard against any adverse price movement. Margins are quoted as a percentage of the value of the transaction
 

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