They've got it wrong again! You shouldn't.

Feb 2, 2010

In this issue:
» Food prices may go up again
» Big bonuses are back. This time in India
» Here comes yet another crisis for the US economy
» How to reform the TBTF?
» ...and more!!

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00:00
 
'Investors rake in big bucks with bonus shares' screams the headline of a leading business daily today. The news anchor of a popular business channel seemed to be in bliss as he interviewed another CEO announcing bonus shares for his company. While logically these made no sense to us, we were amused to see how easily the financial media can lure unsuspecting and ignorant retail investors into believing that an ordinary corporate activity can actually make them wealthier!

As against what the newspapers and business channels would like you to believe, bonus shares have never and will never increase the value of a stock. It only increases the stock's liquidity. The adjustment of the stock price to the bonus issue gives it the perception of becoming 'cheaper'. What investors fail to realize is that they are buying into diluted equity and thus are entitled to a lower EPS. More importantly, it does not change the fundamentals of the company. The net worth and margins are indifferent to the stock's liquidity. Also, more number of shares does not mean more dividend as there is a proportionate fall in dividend per share as well.

Promoters of small and midcap companies that have been acclaimed by the media for offering "free" shares to the minority shareholders have all the more reason to smile. For they are able to push up the share price without any fundamental reason. Really, they would be better off creating some serious long term value for their shareholders rather than resorting to bonus issues. We do not think that bonus issue is a bad thing in itself. But you as an investor need to make sure that you buy into a business because it can ensure healthy returns. Not because it can divide the shares you already own!

00:55
 Chart of the day

Capital raised by way of IPO or follow on issue. No issues in FY09, 9mFY10
Data source: RBI

There are 27 of them, but only few have scaled up to the size and profitability necessary to attract investor attention. Nonetheless, as today's chart shows, Indian PSU banks have in recent years enhanced their appetite for equity capital. Infact over the past few years, they have outdone their private sector peers in terms of capital raised per issue. With the UPA government's disinvestment drive, several PSU banks have lined up their offerings in 2010 as well. While their competitiveness to the private sector in seeking better growth avenue is appreciated, we hope the PSU banks can match their private sector peers in terms of return on capital as well.

01:55
 
After the recent correction in food prices, one would be forgiven to believe that the worst is over. However, the weak monsoons have demonstrated that the food production is on an edge between demand and supply. We have seen a small disruption on the supply side push up prices of food commodities two folds. The Prime Minister's office has expressed concerns that with the rising prosperity in India, the demand for food items is bound to go up. This will again throw the demand-supply equation out of gear. On a long term basis, to ensure that India remains food sufficient, we have to take steps to increase farm productivity. And unless that happens, affordable food prices are but a temporary phenomenon.

02:29
 
It is said that what is plenty in one boom becomes extremely scarce in the bust that follows it. Hence, it comes as no surprise that debt financing is going to be difficult to come by over the next few years. US corporate and consumers have lived through nearly two decades of credit excesses. And it should take at least half that time for things to normalize once again. But some companies that had taken on too much debt and that too, without any disregard to value creation, are likely to have a horrid time.

Global ratings agency Moody's has already sounded the warning bell. It predicts that more than US$ 800 bn worth of debt is likely to come up for refinancing over the next few years. And if the economy as well as bank lending remains weak, default rates on this debt would increase precipitously. Clearly, just when the US tries to kill one cockroach of bad lending, there emerges another.

03:14
 
Layoffs, job losses and salary cuts quickly seem to be a thing of the past. Since India is expected to grow at a strong pace from here on, salaries across India Inc. are also likely to follow suit. Corporate honchos are looking to capitalise on this optimism and reward key people in their organizations. Hiring exciting talent is also on their agenda. As reported in a leading business daily, there are indications that the salary hikes on an average may be in the 9-18% range. Further, there are increasing hopes of bonuses too. Sectors which could see employees getting rewarded are telecom, FMCG, retail, automobiles and consumer durables. What a turnaround it has been! Just last year, people across organizations were concerned about losing their jobs let alone their salaries being cut. Bonuses then were not even contemplated. Now with the improved economic scenario, big bonuses are looking to make a comeback. And this time, India is making headlines.

03:46
 
The New York Times carries an article written by the former US Federal Reserve chief Paul Volker. Titled 'How to reform our financial system', the article suggests the need to find more effective fail-safe arrangements to avoid financial crises in the future. Volker has also talked about reforms that will bar big commercial banks from engaging in risky investments and trading.

He writes - "...in no sense would these capital market institutions be deemed 'too big to fail'. What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital - and as ordinary businesses in a capitalist economy, to fail."

The essence of Volcker's article is that regulators need to face up to the needed structural changes, and place them into law. "To do less will simply mean ultimate failure - failure to accept responsibility for learning from the lessons of the past and anticipating the needs of the future," he warns. These are indeed some wise thoughts in unwise times!

04:08
 
The common man everywhere - whether the US or here in India - feels its pinch. We are talking about the fact that some forms of income and different levels of income are taxed differently. As a result, the tax burden is not distributed equitably. If you are a salaried person, you would know what we mean. Warren Buffett has spoken about it for years. How the tax burden is more on his secretary than on him. US president Barack Obama seems to be listening. As per Bloomberg, Obama is seeking a US$ 1.9 trillion tax rise on the richest sections of his society. Incomes more than US$ 200,000 will be taxed more. So will be oil and gas companies, life-insurance products, investment managers and U.S.-based companies that operate overseas. While the specifics are complicated, as all tax laws are, there is an interesting message here. Distribution of wealth is critically important even in the Mecca of capitalism. Or does a financial crisis make socialists out of everyone?

04:40
 
Despite the World Bank raising India's GDP growth estimate for FY11 to 7.5%, profit booking in key heavyweights kept the Indian stock market in a solemn mood throughout the session today. The BSE-Sensex was down nearly 93 points at the time of writing. Weakness in stocks from the energy and realty sectors dragged the benchmark indices lower. Infact, the Indian markets were amongst the biggest losers in Asia today along with the Korean markets. Europe has also opened on a negative note.

04:55
 Today's investing mantra
"Spend at least as much time researching a stock as you would choosing a refrigerator." - Peter Lynch

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14 Responses to "They've got it wrong again! You shouldn't."

Ashok

Feb 2, 2010


I agree only partly with you on the bonus thingy!

a bonus creates that warm feeling of getting something for free.

It also increases liquidity and availability to more shareholders.

It also reflects the ability of the company management to service the equity, even though the equity remains same and a book entry only.

If bonus issue was that easy, why every company doesn't issue bonus?

Most of all, a bonus share improves the sentiment abt a company and its hares in the eyes of teh shareholders and others who would like to buy these shares.

Like 

Lalit C.Shah

Feb 2, 2010

Dear Sir,

Your article is very realistic.
You will notice that the small investors are the one who loose the most when small cap companies declare Bonus.They truely divide the stock value which we already hold.

Regarding the tax structure which Mr Obama would like to follow for the higher income group I think he needs to only follow the Indian Income tax regulations.

Medium income people get fair exemption and rich do pay higher tax.

This creates fair playing ground.

I wish our Finance Minister in the forth coming budget increases the exemption limits for lower income citizens and levies higher tax for higher income and very high income group of citizens.

This could reduce the disparity between the rich and those not rich.

Lalit C.Shah

Like 

Sunil Pai

Feb 2, 2010

I would like to comment on your note on issue of bonus shares. You are absolutely right as it does not create value for the shareholders. But that is for short term, due to improved liquidity and affordability of the share to the masses, it would not be inappropriate to comment that on a long run, it does help in improving capital appreciation. You may want to look at the past instances of bonus issue and their performance say 3-4 quarters down the line.

Like 

ELANGOVAN P

Feb 2, 2010

You have clearly explained about the issue of bonus shares which I hope small investors will understand. One is not clear why such leading newspaper makes the headlines that Bonus shares made investors rich, when it is merely a book entry.

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